“Using DuPont analysis to assess the financial performance of the top 3 JSE listed companies in the food industry”

This study attempts to measure the financial performance of the food industry taking the top three JSE listed companies Pioneer Foods, Tiger Brands and RCI for the period of 2013-2014. In order to achieve the objectives of this research, ratios such as return on equity (ROE), return on assets (ROA) have been calculated by applying the DuPont analysis. The DuPont analysis is an important tool to measure the operating performance of a firm (Sheela and Karthikeyan, 2012). The volatility of the stock market makes investment decisions a controversial issue for most investors. Investments of huge amounts of money need proper analysis in order to make an informed decision. Financial statements are indicators of the profitability and financial sustainability of the business. Ratios are tools used to quantify the risk element before making any strategic decisions, more especially, investment decisions. It has been reported to be one of the most important financial ratios, because it provides investors with a more comprehensive measure of performance (Demmer, 2015). A detailed financial analysis of all three companies using the DuPont system shows that investing in Tiger Brands would generate a higher return to shareholders than Pioneer Foods or RCI.


Introduction
In publishing their financial statements, corporate organizations fully disclose matters concerning their operations to aid investors in making investment decisions (Blessing and Onoja, 2015).The goal of corporate managers is to maximize the value of the firm, which is determined by the investment and financing decisions made by the managers of the firm (McGowan and Stambaugh, 2012).
Ratios are used to establish the relationship between two variables and how they influence one another, and ratio analysis offers a means by which the financial and operational ills of a business enterprise can be effectively diagnosed (Agala, Jadhav and Borhade, 2014).Ratios also point out areas for further investigation.To guide decision making, managers analyze financial statements together with the ratios given.Analysis and interpretation of financial statements is an important tool in assessing the company's performance and gives investors an indication of the level of risk associated with that particular firm.For an investor, this is important and relevant information.
Different ratios are used to measure different aspects of the business in terms of performance, liquidity, riskiness and profitability.Of these possible indicators, literature indicates that the most important measure of profitability and performance is the one which is calculated using DuPont analysis.Demmer (2015) notes that changes in profit margin provide incremental information for Mishelle Doorasamy, 2016.Mishelle Doorasamy, Lecturer, Department of Accounting, University of KwaZulu-Natal, Westville, Durban, South Africa.
predicting changes in future return on assets, and Soliman (2008) cites DuPont components as yielding important information about the operating characteristics of a firm.(Sheela and Karthikeyan, 2012).Modified twice after its initial conception, the original DuPont method of financial ratio analysis was developed in 1918 by F. Donaldson Brown, an engineer at DuPont in charge of understanding the finances of a company that DuPont was acquiring, who recognized a mathematical relationship between profitability and return on equity (ROE) that was determined by return on assets (ROA).
Since ROA impacts both profitability and efficiency, operating decisions of a firm in terms of planning and control will, thus, focus on increasing ROA, but the first modification of the DuPont model shifted the focus from ROA to ROE, incorporating debt or "leverage" as a third area of attention.This modification made the DuPont model a powerful tool for strategic decision making within an organization to increase ROE (Collier, McGowan and Muhammad, 2006).
The latest modification of the DuPont model incorporates a combination of five ratios to determine ROE.With the focus of annual statements from a managerial perspective being to assess a firm's financial performance, the significance of operating decisions (profitability and efficiency) and financing decisions (leverage) upon ROE continues to be important, and recent evidence has shown that this modified DuPont approach can be used to identify the causes of financial problems within manufacturing companies (Liesz and Maranville, 2008).
According to Rogova (2014), DuPont analysis effectively revealed factors of efficiency which had, in turn, impacted on the investment appeal of Russian oil-extracting companies.It was found that a strong advantage of ROE was the possibility of its disaggregation into different profitability ratios, with ROE indicating profitability and efficiency from the shareholders' point of view.
1.1.1.The DuPont analysis system.The DuPont system of financial analysis is based on return on equity, with the components of this ratio being the net profit margin, the total asset turnover and the equity multiplier (McGowan and Stambaugh, 2012).DuPont analysis is a preferred method to estimate the market value of a firm, indicating the leverage of a company to improve future profitability through more efficient utilization of its assets which will, in turn, improve the return to shareholders -higher leverage being preferable for potential investors.Demmer (2015) reports documentation in prior literature on the usefulness of DuPont disaggregation for predicting a firm's future profitability, operating income, and stock market returns and concludes that changes in profit margin provide important and relevant information on future return on assets.His findings also imply that DuPont components are partially influenced by the quality of the firms' expected earnings.He points to recent financial statement analysis (FSA) research which has shown the usefulness of change in profit margin for predicting year-ahead changes in RNOA (Demmer, 2015).

Earnings quantity and the influence on profitability forecasts. According to Dechow et al.
(2010), the quality of earnings is recognized as higher when they provide more information about the features of a firm's financial performance for decision making, which, in turn, depends on the specific situation.It has also been stated in prior literature that the accounting system influences both future profitability and market reactions of a firm (Demmer, 2015).
Investment decisions affect the operating leverage of a firm, and financing decisions impact the degree of financial leverage of a firm.These, in turn, determine the future cash flows of the firm (Collier, McGowan and Muhammed, 2006).According to Soliman (2008), a change in asset turnover is positively related to future changes in earnings, and he goes on to discuss the extent to which competitive forces differently affect the profitability of a firm, noting that large profit margins draw new entrants into the market place or result in existing rivals imitating the new ideas.However, he found that competition may be less threatening to an efficient deployment of assets.If production processes are efficient, it makes it difficult to imitate another firms ideas due to the large cost factors involved.Soliman's findings contribute to literature on the sell-side analyst use of accounting information.He argues that if DuPont components map into equity value, analysts could use this information when creating forecasts and reviewing prior literature about the future profitability of the firm (Soliman, 2008).Blessing and Onoja (2015) agree that profitability, assets, liabilities and equities are significant ways of evaluating performance reports of companies and for making investment decisions.They note a general belief that published financial statements have failed in their responsibility to provide credible information for investors and other users of financial statements.

Research objective.
The main objective of this study is to ascertain the role of financial statements on investment decision making.

Research methodology
To test the research hypothesis, this study used secondary data from financial statements for 2013 and 2014 of the top three JSE listed food manufacturing companies, centred on Pioneer Foods, with its two main competitors, Tiger Brands and RCL Foods, used as comparatives.The model used for this research is good for investment decision making by potential investors and for policy-making purposes by banks and other corporate organizations.
3. Financial analysis of the three companies 3.1.Cash flow analysis.While the statement of profit or loss and other comprehensive income relays important information about the inflows and outflows of money in the business (using accrual accounting), the cash flow statement (using cash basis accounting) gives the true representation of the actual cash movement of the business for the financial year (McClure, 2015).The operating cash flow/turnover ratio shows how much cash is received per R1.00 of turnover (Alsemgeest, L., DuToit, E., Ngwenya, S. & Thomas, K., 2014).Between 2013 and 2014 this ratio for Pioneer Foods rose from 8.79 percent (or 8.79c per R1.00 of turnover) to 12.17 percent, amounting to a 3.38 percent increase.This is beneficial for the company as more of its turnover is being converted to actual usable cash, and is also a good indicator for investors as it indicates a more liquid cash flow situation, with more money available to pay short-term debt.The ratio of cash generated from operating activities to total debts is 28.37 percent in 2014 and 25.66 percent in 2013 -an increase of 2.7 percent.This means that Pioneer Foods has generated sufficient cash to cover only 28.36 percent of its total debts.Although this ratio seems poor, in an industry-level comparison, it is 13.33 percent higher than its nearest competitor.Tiger Brands has a 15.04 percent ratio in 2014, 13.33 percent less than Pioneer Foods.RCL Foods has a 6.35 percent in 2014, 22.01 percent less than Pioneer Foods.

Interpreting cash flow.
However, it is still in the company's best interest for Pioneer Foods to improve this ratio, as in the event of a market collapse it will not be able to meet its current liabilities, if it cannot convert its current assets into cash (McClure, 2015).This would compromize the liquidity of the company.

DuPont ratio analysis
In analyzing the performance of Pioneer Foods over the 2013-2014 time period, a suitable starting point would be a DuPont analysis (Correia et al., 2013) in which the following assumptions will apply (rand amounts shown in millions in each case): "Profit before tax" seen in the ratios is equal to the profits attributable to continuing operations.Average equity excludes non-controlling interests.
See Appendix A for the DuPont analysis ratios.
The 14.93 percent return on equity achieved by Pioneer Foods is highly satisfactory considered against the negative return on equity of -3.59 percent for RCL Foods.The poor performance by RCL Foods is chiefly attributable to strikes, coupled with a nationwide poultry industry crisis (News 24, 2014).Because Pioneer Foods has a diversified product range it was less affected by the poultry crisis.In addition, the company unbundled Quantum Foods, its poultryrelated division, and focused its resources on more profitable operations (Pioneer Foods, 2014).This strategy protected their returns in the face of a hostile market.
Tiger Brands achieved a return on equity of 15.33 percent, which is 0.4 percent higher than that of Pioneer Foods.Tiger Brands' performance can be attributed to its higher profit margin of 6.62 percent compared to a 5.35 percent profit margin for Pioneer Foods.Pioneer Foods is higher leveraged than Tiger Brands by only 0.01 times.The two companies thus, make similar use of leverage, yet Tiger Brands is more profitable.
The DuPont analysis shows that Tiger Brands would be more beneficial to invest in compared to either Pioneer or RCL Foods.

Liquidity.
Liquidity refers to a company's ability to honour its short-term obligations (Correia et al., 2013).Adequate liquidity means that sufficient current assets are available to cover the current liabilities (Correia et al., 2013).Although the quick ratio for Pioneer Foods has decreased from 0.85:1 (2013) to 0.76:1 (2014), the 2014 quick ratios for Tiger Brands and RCL Foods are 0.64:1 and 0.66:1, respectively, indicating that Pioneer Foods is above the industry norm, and, thus, more liquid in terms of the quick ratio.However, the decrease in the quick ratio is still disadvantageous to Pioneer Foods, firstly, because it shows a declining liquidity position, and, secondly, because it may indicate that the company is holding too much inventory, since the decrease between current ratio and quick ratio is the greatest for Pioneer Foods (44.92 percent).
Holding too much inventory implies that Pioneer Foods may be tying up too much money in inventory that it could, instead, be investing to receiving an investment return.Holding too much stock could also mean higher risk of obsolete stock (Correia et al., 2013).
The cash ratio shows how much cash the company has available to cover its current liabilities (Correia et al., 2013).Pioneer Foods' cash ratio has risen from 0.16:1 (2013) to 0.28:1 (2014).This is positive as it means money is available to pay off short-term debts.In comparison with industry competitors, Pioneer Foods has a much higher cash ratio than both Tiger Brands (0.12:1) and RCL Foods (0.12:1).
Pioneer Foods has shown to be slightly less liquid than in prior years, but still more liquid than Tiger Brands and RCL Foods.

Solvency and financial leverage.
Solvency measures the ability of the company to pay its longterm obligations using the total assets of the company (Correia et al., 2013).The debt equity ratio compares the amount of debt capital with equity capital (Correia et al., 2013).In 2014, debt capital exceeded equity capital by 0.02 percent.This is a decline in Pioneer Foods' solvency, with an increase in debt equity ratio from 0.71 in the prior years to 1.02 in the current year.Thus, in 2014 Pioneer Foods (at 102 percent) had a weaker solvency position compared to Tiger Brands, which had 78 percent of debt capital, and a better solvency position than RCL, which had 111 percent of debt capital.An increase in the use of debt is a concern as it increases the financial risk that a company faces, as well as the finance charges, with adverse effect on profit (Alsemgeest et al., 2014).The finance cost coverage ratio indicates whether there are sufficient profits available to pay the finance cost charge (Correia et al., 2013).In 2014, the finance cost coverage ratio is sufficient, as an amount of R11.14 is available to cover each R1.00 of finance cost that needs to be paid.This is an improvement from 2013 (where the corresponding cost coverage ratio was 8.48 times) and 2012 (where it was 7.83 times).This ratio suggests that Pioneer Foods has a better solvency position than Tiger Brands and RCL, for which cost coverage availability was only 7.28 times and 0.66, respectively.The gross profit margin is an indication of the portion of the company's turnover that is realized as gross profit after the cost of sales has been subtracted (Correia et al., 2013).This ratio decreased from 2012 (30.11 percent) to 2013 (29.02 percent) and increased from 2013 to 2014 (30.38 percent).This fluctuation is attributable to change in revenue growth, above the rate of inflation.In 2014, revenue from continuing operations increased by 9 percent to R17.7 billion, mainly due to increase in the mix of selling prices, exports and sales (Pioneer Foods, 2014).Notably, this favorable increase occurred despite the discontinuation of Quantum Foods which took place subsequent to the 2014 year end.Pioneer Foods has a higher gross profit margin than RCL Foods (24.40 percent) which suggests that it is more profitable, and, perhaps, has more buying power that allows it to request cheaper materials from suppliers.
However, Tiger Brands is slightly more profitable than Pioneer Foods as it makes a gross profit of R31.70 for every R100 worth of sales.Tiger Brands' performance is expected as it has the highest revenue, while still apparently able to control its cost of sales efficiently and consistently.The return on ordinary shareholders equity measures how much the ordinary shareholders earned for their investment in the company (Alsemgeest et al., 2014).Pioneer Foods' return on ordinary shareholders equity for 2014 is 14.93 percent, which is 3.98 percent more than 2013 (10.95 percent).This improvement was mainly caused by a substantial increase in profits, further assisted by a decrease in equity.This higher ratio indicates that management is more efficient in utilizing its equity base, ultimately leading to better return for investors.
Tiger Brands has a higher return on shareholders' equity than Pioneer Foods, as for every R100 investment in Tiger Brands, ordinary shareholders receive a return of R15.33 as compared to a return of R14.93 from Pioneer Foods.However, the Pioneer Foods' return is greater than the RCL Foods' negative return of -3.59 percent.The fixed asset turnover ratio measures the utilization of all the company's operating assets in relation to sales revenue (Correia et al., 2013).This ratio is of particular interest as Pioneer Foods falls within the manufacturing industry.The ratio has shown a favorable increase from 2013 (2.98 times) to 2014 (3.28 times).This means that the company has over the years used its assets to generate higher returns.This ratio is 1.26 times and 1.46 times higher, respectively, than those of Tiger Brands (2.02 times) and RCL Foods (1.82 times).This means that Pioneer Foods utilizes its fixed assets more efficiently than its competitors.

Trade payable days. Trade payable days are calculated according to the formula:
Trade payable days = average trade payable* / cost of sales × 365, where * is calculated using trade payable as found in the Notes to the Financial Statements.
Measure the number of days on average, it takes a company to pay its creditors (Correia et al., 2013).Pioneer Foods has taken, on average, 1.15 days longer to pay their trade creditors in 2014 (49.76 days) than in 2013 (48.61 days).The increase in trade payable days indicates that the company is taking advantage of the credit that is available to them, allowing themselves a longer time to recover the funds to pay creditors (Correia et al., 2013).This ratio is certainly favorable as it is higher than the average collection period of debtors calculated above to be 32.36 days in 2014.This means that Pioneer Foods is receiving money owed to it before having to pay their creditors -a favorable cash flow position.
This has not put the company at an increased risk of incurring interest on overdue accounts, since perusal of its financial statements reveals that it has not incurred any interest on trade payables (Pioneer Foods, 2014).The Pioneer Foods ratio is 19.66 days longer than that of Tiger Brands (30.10 days) and 1.84 days longer than that of RCL Foods, thus giving Pioneer Foods a better cash flow position than the industry at large, which is a positive indicator for investors (Correia et al., 2013).Notes: * The Pioneer Foods dividend per share for 2014 excludes the dividend in specie declared with the unbundling of Quantum Foods.# The share price utilized in all market ratio calculations is the price at year end for all the companies.Year ends as follows: Pioneer Foods and Tiger Brands year end: 30 September; RCL Foods: 30 June.This affects analysis as market forces and conditions prevailing on 30 June 2014 differ from market conditions on 30 September 2014.
Dividend yield shows how much a company pays out in dividends each year relative to its share price (Investopedia, 2015a).The dividend yield for Pioneer Foods decreased by 0.64 percent in 2013 (1.51 percent) from 2012 (2.15 percent), but shows a favorable increase of 0.36 percent in 2014 (1.87 percent).This means that shareholders received a higher return on their investment in the form of dividends in 2014 compared to 2013.
The return received by Pioneer Foods shareholders is 0.6 percent higher than the return for RCL Foods (1.27 percent), but is 1.11 percent lower than the return for Tiger Brands (2.98 percent).This indicates that Tiger Brands is likely to be the most favorably viewed of the three companies by investors as its shareholders receive the highest return on their investment.The earnings yield achieved by Pioneer Foods for 2014 is 0.88 percent lower than that achieved by Tiger Brands (5.76 percent).In relation to RCL Foods, Pioneer Foods has an earnings yield that is 7.9 percent more favorable.The dividend cover ratio measures the earnings that are being paid out in the form of dividends (Correia et al., 2013).In 2012 and 2013, the dividend cover ratio remained constant for Pioneer Foods at a factor of 2.95, and, then, declined by 0.35 in 2014 to 2.60.A larger percentage of earnings is, thus, being retained by Pioneer Foods for future reinvestments, which may not discourage investors as their longterm wealth is being taken into account.
Pioneer Foods also retains more of its earnings, in comparison with its competitors.Tiger Brands (1.93) and RCL Foods (-2.39) have ratios that, respectively, are 0.67 times and 4.99 times lower than that of Pioneer Foods.This is indicative of the competitors adopting different strategic approaches to that of Pioneer.The price-earnings ratio is the inverse of the earnings yield ratio.It is ratio of a company's current share price compared to its per-share earnings (Investopedia, 2014).Pioneer Foods' ratio has shown a positive increase by a factor of 6.73 in 2013 (22.45 times) from 2012 (15.72 times).The price-earnings ratio (P/E ratio) declined by a factor of 1.94 in 2014 (20.51

times).
Despite the decrease in the P/E ratio, investors are still willing to pay more per rand of reported profits for Pioneer Foods than for its competitors.Tiger Brands has a ratio (17.37 times) that is lower than that of Pioneer Foods by a factor of 3.14, while the ratio for RCL Foods (-33.1 times) is lower than that of Pioneer Foods by a factor of 53.61.This shows that Pioneer Foods is perceived as having high growth prospects in the future (Investopedia, 2014).
Using the P/E ratio, it should, thus, be noted that investors would pay more money to receive R1.00 of Pioneer Foods earnings than for earnings from either Tiger Brands or RCL Foods.Market to book value ratio compares the market value of the firm's investment to its costs (Firer, Ross, Westerfield and Jordan, 2004).The ratio for Pioneer Foods increased year on year by 0.88 times in 2013 (2.43 times) and by 1.13 times in 2014 (3.56 times).This indicates that Pioneer Foods has been increasingly able to create value for its shareholders (Firer et al., 2004).
Pioneer Foods' ratio is 2012 times higher than that of RCL (1.44 times) which indicates that Pioneer Foods has been more successful in the creation of shareholder wealth.Tiger Brands, however, has a ratio 0.28 times higher than that of Pioneer Foods.This is indicative of shareholder being willing to pay more for a share in Tiger Brands than for Pioneer Foods.One significant measure of a company's industry impact is its market cap, which is the total market value of the company's outstanding shares in rand value, calculated by multiplying the total number of outstanding shares by the current market price of the share (Investopedia, 2015).Of the three companies under discussion, Tiger Brands has the largest market cap (R52 billion), followed by Pioneer Foods (R42 billion) and RCL Foods (R16 billion).

5.2.
Month-to-month share price.Refer below for the share price graph (Figure 1).
Over the five years leading up to 30 June 2015, Pioneer Foods has been at frontier of growth in the industry.In comparison with Tiger Brands and RCL Foods, Pioneer Foods' share price grew by 349.6 percent in this time period, while the corresponding growth for Tiger Brands and RCL Foods was, respectively, 62.54 percent and 6.75 percent (Moneyweb, 2015).
In the period 1 January 2015 to 30 June 2015, Pioneer Foods' share price showed a positive appreciation of 28.03 percent, while share prices for Tiger Brands and RCL Foods declined by 25.14 percent and 11.5 percent, respectively.This is mainly attributable to the fact that Pioneer Foods does not deal in poultry.Tiger Brands and RCL, on the other hand, both have interests in the poultry industry, which is under severe strain after passing of the AGOA (African Growth and Opportunity Act) agreement allowing the United States to export 650 000 tons of chicken into the South African market and leading investors to be wary of potential saturation of the chicken market (News 24, 2015).
In a sign of growing investor confidence in the new board of directors, Pioneer Foods closed the second quarter (months ending 31 March 2014) favorably with a share price of R83.50 per share.The share price rose substantially over the remainder of the year, reaching a financial year high of R128.07 on 3 September 2014, before closing the year strongly on R118.00 per share, a 48.89 percent increase in share price from 24 February 2014.
Although the appointment of a new board of directors had a positive effect on the share price during the 2014 financial year, the true effect of the appointment is seen more clearly during the 2015 financial year, when the share price grew even further, with the company expanding both locally and internationally.
It is evident that investor confidence increased in Pioneer Foods.Overall, the stock market reacted favorably to the decisions made by the company's board of directors and to external, macro and global factors affecting the company (Business Day, 2012).This, in the opinion of Moneyweb analysts, it was due to the fact that the company implemented valueenhancing initiatives focused on cost reduction and efficiencies which were expected to continued riving the group's earnings (Moneyweb, 2015).What is certain is that the company had shown considerable growth, and there was no evidence to suggest that this growth might stop.
Source: Moneyweb Click-a-company, 2015.implemented value-enhancing initiatives (unbundled Quantum Foods in 2013, acquired Future Life and a Nigerian company, and appointed a new board of directors) focused on cost reduction and efficiencies which were expected to continue driving the group's earnings (Moneyweb, 2015).
Taking into account all the above-listed considerations, long-term investors should invest in Pioneer Foods, as the pros of the continuously increasing share price attributable to growth initiatives coupled with the impact of the new board of directors outweigh the cons of a lower dividend and return on shareholders' equity, compared to Tiger Brands.What is certain is that the company has had considerable growth and there is little evidence to suggest that this growth may stop in the near future.
It should, none the less, be noted that short-term investors would prefer an investment in Tiger Brands, as they would be receiving higher returns immediately.This paper presents an exemplar of the DuPont system of financial analysis as applied to the top three firms in the South African food industry.

1. Literature review 1 . 1 .
Development of the DuPont model.The DuPont model was created in the early 1900s to assess the profitability of a business

Table 1 .
Operation cash flow/turnover

Table 2 .
Free cash flow

Table 3 .
Operating cash / total debt

Table 4 .
Current ratio 1. Current ratio = current assets: current liabilities

Table 4 (
cont.).Current ratio greater than RCL Foods (0.91:1).This indicates that Pioneer Foods is more liquid than the industry in relation to current ratio.

Table 5 .
Debt asset ratio

Table 6 .
Debt equity ratio

Table 7 .
Finance cost coverage ratio

Table 8 .
(Alsemgeest et al., 2014)s discussed in the DuPont analysis (Appendix 1), the financial leverage ratio compares the average amount of total assets with the average amount of equity capital included in the company's capital structure(Alsemgeest et al., 2014).Pioneer Foods' financial leverage in 2014 was 1.94, an increase from 1.76 in 2013, which indicates an increase in portion of debt capital utilized by the company.

Table 9 .
Gross profit margin

Table 10 .
Net profit margin

Table 11 .
Return on ordinary shareholders' equity Return on ordinary shareholder's equity = profit after tax-non-controlling interest-preference dividends / average ordinary shareholders equity

Table 12 .
(Correia et al., 2013)ement ratios are designed to determine how effectively the assets of the company are being utilized(Correia et al., 2013).Fixed asset turnover ratio

Table 13 .
Working capital cycle 4.6.Market value.Market value ratios provide an indication of the market perception of the company's past performance and future prospects (Correia et al., 2013).

Table 14 .
Dividend yield ratioDividend yield ratio = dividend per share* / price per share #

Table 16 .
Dividend cover ratio

Table 18 .
Market to book value ratio

Table 19 .
Earnings per share (in cents)Notes: * Pioneer Foods' headline earnings adjusted for the impact of the share-based payment charge on the B-BBEE Phase 1 transaction due to volatility and non-repetitive nature of the Quantum Foods effect on profits (non-recurring item).