Research Korner: Annual Report Samples

Annual Report Commentary : The Case of PetroChina

Corporate Governance The firm adopts internal control system to comply with listing requirements in Hong Kong Stock Exchange (HKSE) and applicable provisions in US particularly on Sarbanes-Oxley Act.  Through time, the company enhances its control system with the vision of creating an integrated model corporate-wide.  An illustration is the improvement in communication between different stakeholders with top-management and different committees in one hand and shareholders on the other.  PetroChina ensures a transparent corporate governance structure to the benefit of different stakeholders.  Shareholders especially those who have minority stakes are protected while managers are confident of continuous employment.   With this, capital inflows will remain stable at minimum and managers will not engage in irrational expansion in order to increase pay or retain their positions.             To assure that directors and supervisors do not engage in anomalous transactions, the firm embraces the Code of Governance Practices including the Model Code for Securities Transactions.  Stakeholders and the capital markets in general are protected from sub-optimal outcomes observed in insider trading.  Top-management who has the personal interest in the growth of the company avoids excessive trading and exposing high risks against the firm.  When insider trading looms, there is a problem that aggressive strategies will be implemented without investment protection.  As it would lead to short-term price gains, long-term investors are at risks.  However, the only assurance that top management follows the Codes is a confirmation.  There should be a background check.             Directors are required not to have family, financial and other substantial relationship with other directors/ executives.  This will reduce decision bias especially in times of vote instead objective and value judgment.  The Board is consists of a Chairman, a Vice Chairman, an Executive Director, six non-executive directors and three independent non-executive directors.  Independent directors are outnumbered which makes them less influential.  As their decisions are highly external and detached from the firm, innovative and original ideas may not be well-established.  Committees in Audit, Remuneration and Investment are also appointed by the Board which is highly controlled by internal directors.  With the opportunity of re-election, the three year expiry date of Board’s tenure can be extended thus the problem is carried-over the long-term.             Remuneration of the Board is not shown in the page “Remuneration of Directors”.  The page merely tells how the President and other non-director executives are appraised and remunerated.  This issue would tarnish the standing of the Board in corporate decisions since their compensation is not shown.  Anomalies that might be happening will not be obvious to investors and collusion might not be halted.  The good thing though is that two external directors chaired the Remuneration Committee which imposes strategic compensation to corporate officials.  However, this is organization is undermined by requirement of using the Board’s Work Plan as framework for the procedures of this Committee.  Independent intervention is reduced rather than supported.             Nomination of Directors is initiated by shareholders with at least 5% of the voting shares of the company.  A candidate will gain office if at least 50% of the voting shares favored in his/ her part.  This practice can have positive impact to gaining consensus of who will take the high posts in the Board.  This will also safeguard the majority of shareholders including those who have only minority stakes.  The absence of nomination committee, however, reduced the promotion of shareholder voting rights and optimal lists of potential director.  When it comes to external auditors, the company hires the PriceWaterhouseCoopers that received at least RMB140 Million during the reporting year.  It is a sign of impartiality as the selection of the external/ international auditor arises from the shareholder’s meeting.  However, there is much to do in the part of regulation committees to assure that collusion is not a threat.   Evaluation of Financial Strength and Weakness After increasing its liquidity in 2005, the firm experienced a drop in the most recent reporting year.  This means that it has minimal liquid assets to cover for sudden demands from short-term creditors.  Inventories may likely play the large role in filling-up current asset needs.  Both gross profit and operating profit margin declined during the three-year period.  It indicates that the cost of raw materials, managing operations and other expenses are increasing.  Although revenues are also rising, the rate of its increase is lower than expenses.  The same trend of liquidity is shown by ROA and ROE.  The decline in 2006 means that some assets or businesses are not earning optimally and this would result to reduced chance of increasing the wealth of shareholders.  In totality, profitability measures are not presently favorable.             As revenue increase, the efficiency of fixed assets is enhanced.  However, this improvement in fixed assets is primarily invoked by depreciation.  This is observed in the diminishing value of fixed assets from 2004 to 2006.  Thus, the rise of revenues aggravated the improvement in efficiency.  The firm is also deriving its value more on assets and equities rather than on debt.  This is an important position to the firm to avoid finance costs that can pressure its revenues.  This fact is supported by a stable, although reduced, interest coverage ratio.  It indicates that the firm has sufficient cash through its earnings to pay interest obligations.  In effect, its operations remain safe and not limited by financial obligations.  Although the percentage EPS fell in 2006, the dollar EPS continuously to increases.  This means that a dollar in earnings of the company will result to RMB 0.79 to every investor.  This trend is lucrative to shareholders.             From the stock price of HK$6 per share in 2006, the firm has been able to reach HK$15 per share in 2008.  This means that the firm faces an increasing demand from investors to buy corporate stocks.  This can also mean that its future forecast of performance is attractive.  This admonition has positive connection with the level of corporate governance of the firm which is enhanced by adopting several governance standards.  Distribution of dividends is affected by numerous conditions before declaration from the Board.  Main factors involve are general business conditions, financial results, capital expenditures, restrictions from contracts, company’s debt standing and others which are not explicitly but potentially identified by the Board in the future.  Due to this, shareholders are not assured of a specific payout will be made.             In the short run, as shown in the spreadsheet, stock price is very volatile.  This is the daily data from December 1, 2007 to January 14, 2008.  Serving zero as the mean for the price changes, increases and decreases seemingly have equal contribution to the current price.  Valuating through technical analysis, the changes in daily stock prices of the firm is justifiable.  Further, based on fundamental analysis, the increases in stock price have support.  The demand for oil in China will increase to the extent that it will replace Japan in the second rank for largest oil importers.  The volatile changes in price show the reaction of the market about the uncertainty on the part of the company to supply the needs of the country.  The volatility also indicates how corporate governance in the firm hedges the influence of government officials to its direction.  In effect, the improving leadership in the firm places investors in a “trusting stance”.              With market cap of at over 3 Billion and classification as one of the largest companies in China and Hong Kong, PetroChina and Sinopec are comparable to each other.  PetroChina overtake the profitability over Sinopec as the former has far higher margins than the latter.  This means that the business of PetroChina is more income-generating than Sinopec.  ROA and ROE is much like the same.  Sinopec is able to improve in the by-quarter performance against PetroChina but still below the latter.  PetroChina does not only invest on profitable assets but also holds its promise to provide wealth to shareholders.  Even with far larger employees of PetroChina compared to Sinopec (e.g. 400,000 versus 20,000 approximately), the former does not have any inefficiency signs.  On the other hand, Sinopec is seemingly overpriced as it has bigger P/E ratio.   Projection  The continued improvement in PetroChina’s control system will increase the marketability of its shares.  The gradual relaxation of capital market restrictions will also provide increase in marketability.  External auditor in the likes of a global player being PriceWaterhouseCoopers is also vital to create a positive impression from international and institutional investors.  However, the key to long-term success of PetroChina with respect to marketability of its shares is that transferring its leadership to the private sector.  As government can command investors and business partners, there is a looming consideration about competition in the oil industry which can reduce the potential of the company.  As example, oil prices in Hong Kong and China may be lower due to competition.              The financial ratio of the company will continue to be strong.  Its liquidity will continue to confront volatility as the value of its assets is stored mostly on its oil reserves.  It should be considered that oil stocks are products that can be used as hedging to normalize price.  As the company is controlled by the government, the prices are able to obtain stable prices because of playing the law of demand and supply field.  Profitability will also be volatile in the following years.  This is particularly true in the oil industry where changes in world prices affect the local prices including the conditions of the industry and also the bigger economy.  Thus the company must rely on its efficient assets to hedge the risks of these volatiles which would likely be delivered in the future.  Gearing and investment potential will serve as trade-off to each other.  When volatilities emerge and debt financing is hard, equity financing will be tapped.             Access to equity financing is not that hard because of the stock price of the company is attractive.  Although issuance of dividends is confronted with several issues, increasing stock price is somewhat within the promise of the firm to increase investor’s wealth.  In competition, the firm is superior to its closest rival that indicates its capital s well as its product market potential in the future.  Ensuring its competitive advantage in the industry that is likely provided by the protection of government, it can continue a favorable business and financial environment in the long-term.  It is however a caution for the investors not to consider the increasing role of free markets in socialists countries.  When China decided to encourage oil producers worldwide due to high demand, there is a big chance that the company will lose substantially in the market.       Recommendations Sustainable competitive advantage is a firm’s position wherein it creates and implements a value-creating strategy and competitors are unable to duplicate or find it costly to imitate.  On the other hand, stakeholder management consists of activities such as planning, organizing, controlling and evaluating individuals and groups who can affect or are affected by firm’s strategies with enforceable claims over its results.  Although stockholders or the investors in a firm serve as the key stakeholders for United States and United Kingdom corporations, there are times that other stakeholders are prioritized because of there impacts in the firm’s operations and strategy such as banks (capital market stakeholders), customers, major and minor suppliers, host communities, unions (product market stakeholders), employees, managers and non managers (organizational stakeholders). Effective stakeholder management is primarily an outcome of top-level managers’ ability to build, maintain and rebuild culture, ethics and reputation within the firm.  These activities, as a prerequisite, should be in line with organizational intent and mission that ultimately serve the purposes of stakeholders in general and shareholders in particular.  Installing sound stakeholder platforms will give managers the required flexibility and leverage to minimize the adverse impacts of trade-offs between two stakeholders.  For example, when the firm is known to be a good debtor as it perpetually pays its due obligation on time, banks and other capital markets will place the firm into more relaxed contracts that in turn aids the firm to easily finance projects.  The culture will mount the chain of behavior, ethics will polish it and reputation will keep it shining to lure stakeholders in reaching organizational objectives. Finally, stakeholder management towards sustained competitive advantage is the task of both top-level management and directors.  The CEO is highlighted in this veil because shareholders positioned him to function as the manager of the entire firm activities.  A new product in the market, a new supplier policy, allocation of funds to minimize environmental hazards and transparency of financial and business performance are engaged because of his decision-making latitude.  However, managerial opportunism lurks around the corner, which in turn, undermines sustainable competitive advantage in favor of self-vested interests.  Thus, directors, the trusted representatives of shareholders to oversee firm operations for them, are given the budget and authority to control the emergence of such.  Without these two groups involve in stakeholders’ supervision, stakeholders’ value will result to unnecessary and unintended grievance to another in favor of an isolated interest of few.

Annual Report Commentary : The Case of PetroChina

Corporate Governance The firm adopts internal control system to comply with listing requirements in Hong Kong Stock Exchange (HKSE) and ...