This report aims to analyse and evaluate the business
sustainability and corporate bankruptcy of two companies; Land Securities Group
Plc and Grainger Plc. The methods of analysis include calculations of ratios
such as Debt-to-Equity Ratio and Weighted Average Cost of Capital, as well
applying these figures to theories such as Modigliani and Miller (1958) and
Altman’s Z-Score (1968). Formulae used for these can be found in the
Appendices. The results showed that both companies reduced their leverage
within the last 5 years, with Grainger having a higher Debt-to-Equity ratio and
WACC in 2017. As well as this, Altman’s Z-score Theory (1968) predicted possible
bankruptcy for Land Securities Group Plc within 2 years and a high probability
of imminent bankruptcy for Grainger Plc. This report finds that, of the two
companies, Grainger Plc has a higher risk of financial bankruptcy.
The Debt-to-Equity Ratio is thought by many analysts to be the
most important ratio when analysing the capital structure of a company. Fig 1.0
shows that in 2013 the ratio was at 0.66, meaning the company was financed more
by equity than by debt; this is classed as a conservative capital structure.
Over the last 5 years, Fig 0.1 also shows that the Debt-to-Equity ratio has
further decreased to a point where equity is making up a very large portion of
the capital structure of the company, this puts the company at a very low level
of risk as the company relies less on debt, meaning that profits would need to
fall by more than 30% before their liabilities exceeded their assets.
However, it is important to note that where the capital structure
of the company gives it a very low level of risk, this does not necessarily
mean it is the optimal point for the value of the company. Fig 0.2 shows the Weighted
Average Cost of Capital (WACC), ‘a method of measuring the cost to a company of all the sources
of its capital over time, weighted by the proportion of equity and debt.’ (Lexicon.ft.com, 2018). The
WACC of the company increases nearly every year, making it inversely
proportional to the decrease of the Debt-to-Equity ratio, this supports
Modigliani and Miller’s Theorem (1958) which suggests that Equity is more
expensive to finance than debt and that the optimal capital structure for the
value of a company substitutes all equity for cheap debt. Although Nevins D.
Baxter states that ‘such a conclusion, however, has little intuitive appeal
because of the risks normally associated with servicing and refinancing
outstanding debt’ (Baxter, 1963).
Therefore, it can be determined that through increasing equity and
decreasing debt between 2013 and 2017, thus creating a more conservative
capital structure, Land Securities Group Plc has lowered its level of risk.
Consequently, using Modigliani and Millers Theorem (1958), it can be assumed
that this has negatively affected the value of the company.
Fig 1.1 shows that in 2013 the Debt-to-Equity ratio of Grainger
Plc was 1.71, this signals that Grainger was operating with an aggressive
capital structure compared to that of Land Securities Group Plc. At this time
the company was trading with a very high level of risk, financed mostly through
debt. However the Debt-to-Equity ratio has since decreased every year, sitting
at 0.88 in 2017. The changes in Capital Structure fall down to both an increase
in the equity and a decrease in the debt of the company, it appears that
Grainger Plc has greatly reduced the highly leveraged structure, which in turn
has reduced the risk of the company.
When observing Fig 1.2, it is important to note that the 2017
figure for WACC may not be entirely appropriate to analyse due to the
non-existent cost of debt. Other than 2017, it is evident that Modigliani and
Miller (1958) is again supported in that the WACC has increased as a direct
result of both the lessening of debt and the growth in equity. However,
Grainger Plc is an example of how Modigliani and Miller’s Theory does not always
hold true, as the WACC for Grainger Plc is higher than that of Land Securities
Group Plc despite being higher leveraged. Following on from this the same
assumption can be made that, although the value of the company may overall be
affected, this change in capital structure has reduced the risk surrounding the
once aggressive capital structure of Grainger Plc.
Theoretical Bankruptcy Model
Using Altman’s Z-Score Theory (1968), it is possible to calculate
a statistical level of corporate distress and estimate a probability of
bankruptcy. Fig 2.1 displays the Z-Score of Land Securities Group Plc, which shows
encouraging signs of a decreasing bankruptcy risk; the score itself has
increased every year from 2013 with an exception of 2017. However it is
important to note that this year is a possible anomaly and that 2018’s Z-Score
will be significant, it is therefore imperative that the firm tracks this
The figures show that the company was at a critical point in 2013,
with the Z-Score being 1.9 putting it just above that of the 1.8 that Altman
referenced as a very high risk of bankruptcy. However this was massively
improved to a score of 2.48 in 2014 and continued to improve to 2.85 and a high
of 2.96 in 2015 and 2016, respectively. The main reasons behind the struggle of
Land Securities Group are that their working capital in 2013 was negative and,
despite the increases, has never reached a stable level, this being displayed
by the 2017 figure once again reverting to a negative. The Working Capital is
an important figure as it shows if a company is able to pay off their
short-term debts with the current assets that they own, this is worrying for
Land Securities Group as a negative means they are not able to cover their
short term debts.
Nevertheless, if the Z-Score develops at the 2013-2016 rate, the
company will not be likely to go Bankrupt. A contributing factor for this is
that the market value of the company continues to grow while the liabilities continue
to fall. This is reassuring as it shows that the company has a very large
safety net for their market value to decline before their liabilities exceed
their assets, this in turn helps to negate the lack of short term repayments
and lowers the risk of bankruptcy for the company.
When analysing Fig 2.2, which shows the Z-Score of Grainger Plc,
it’s clear that the numbers show a higher level of Bankruptcy risk than that of
Land Securities Group Plc. When looking at the trend of the last 5 years the
Z-Score stays at a relatively stable level, with the exception of 2016. In 2016
the score was given as 2.12, yet despite the large increase in this number from
the previous year of 1.65, it is still classed as a solid chance of bankruptcy
within 2 years according to Altman’s theory.
As for 2017, the Z-Score figure appears to be very worrying,
showing a high level risk of bankruptcy. The decrease from the previous year is
similar to that of Land Securities Group Plc, but it is a larger drop.
Furthermore, there is a very blatant cause for this steep decrease. The first
Z-Score ratio, which calculates working capital as a percentage of total assets
has suffered a massive decline, this being down to an upsurge in the company’s
This decline of working capital shows a disturbing sign of
liquidity issues within the company, meaning they will soon be unable to pay off
short term debt; coupling this with the final Z-Score figures shows that
Grainger Plc has a very high probability of financial bankruptcy.
When assessing the capital structure and applying
theoretical bankruptcy models of these companies, it is possible to critically
analyse and compare the bankruptcy risks posed to both Land Securities Group
Plc and Grainger Plc.
The Debt-to-Equity ratio, shown in Fig 0.1 and Fig 1.1, is
one of the key ratios for working out the capital structure of companies. It
can be inferred from these ratios that Land LN is financed mostly through equity,
whereas Grainger has a higher proportion of debt. Modigliani and Miller’s
Theorem (1958) would suggest that Grainger Plc has a more efficient capital
structure, as they suggest that the optimal capital structure of a business is
made up of 100% debt. However this is not the case, proven by observing that
the WACC of Grainger Plc, Fig 1.2, is higher than that of Land Securities Group
Plc, Fig 0.2. Modigliani and Miller’s only appears to work from a theoretical
point of view, the risk associated with a firm of such a high leverage would
mean almost certain bankruptcy should profits begin to fall. Therefore,
although Modigliani and Miller’s theory would suggest that Grainger Plc has a
more efficient capital structure for the value of the company, this is not the
case and they are carrying a much higher bankruptcy risk, as a result, than
that of Land Securities Plc.
Altman’s Z-Score Theory (1968) is a very effective method of
predicting financial bankruptcy of public companies, the levels of distress
give an indication of how likely a company is to go bankrupt, over 3.0 means
the company is financially stable, 2.7-2.9 advises that caution should be
exercised, lower than 2.7 down to 1.8 indicates a strong possibility of the
company going bankrupt within two years and lower than 1.8 shows a very high
possibility of bankruptcy in the near future. When coupling these zones with
the success rates of these predictions, 95% one year prior to bankruptcy and
83% two years prior to bankruptcy (Alkhatib & Al Bzour, 2011), it appears
that there are stability uncertainties for both companies.
Land Securities Group Plc had a Z-Score which showed that
the company were eliminating their possible bankruptcy risk from years before;
however in 2017 the Z-Score dipped back into a zone which predicts bankruptcy
within 2 years, albeit the very top of this zone. Nonetheless Grainger Plc
appears to be the company that has the higher bankruptcy risk, 4 out of the
last 5 years have seen Grainger Plc with a Z-Score predicting imminent
bankruptcy. When referencing the incredibly high success rate of Altman’s
predictions for companies bankrupt within one year, it is difficult to envisage
the company continuing to trade for longer than the annum.
By analysing the aggressive capital structure
and incredibly low Z-Score, the conclusive evaluation of this report is that,
although Land Securities Group Plc is not entirely financially stable, Grainger
Plc is the company with the higher bankruptcy risk between the two. This is supported
by Modigliani and Millers Theorem (1958) and Altman’s Z-Score Theory (1968).