Question

If you conduct a long-term horizontal analysis of a publicly traded construction company, you can see that the markets are cyclical. What do you think are good strategies for softening the effects of boom and bust on a construction company’s financials and employees? Why?

Answer 1

Answer:-

The horizontal analysis of the construction companies are generally done by looking at the sales of the previous years and finding the Y-O-Y growth rates.

The analysis of the key ratios leverage ratios like the Debt / Equity , Debt / Total capital along with interest coverage ratios which gives the picture of the balance sheet and the financial heath. The interest coverage ratio ( EBIT / Interest expenses) gives us the ability of the company to repay debts.

Thee comparison of liquidity ratios like the current ratio, quick ratio and the cash ratio will help us to see how the company will be able to repay the  debt on the loans it has raised.

The profitability ratios like net profit margin and EBIT margin are also analyzed over the years and the improvement in them is taken as they indicate that the company's bottom line has improved. The ratios like EV / Sales and EV / EBITDA are also important as the construction industry is a capital intensive industry and hence carries lot of debt on the balance sheet.

The best strategies that needs to be adopted that can soften the effects in the boom and bust cycle are   

1) The inventory levels are to be maintained properly as the projects that are undertaken should be completed in stipulated time period.

2) The timing of approvals should be reduced with proper documentation and should have all clearances in place before the inception of the project.

3) The company should be able to retire or replace the debt that have high interest rates. The debt debt during high interest rate regime should be replaced by the low interest rate debt in order to reduce the interest expense.

4) The projects which take years to complete should be undertaken after proper evaluation as the cash flow generation takes time to start.

5) The employees who are good performers should be paid incentives and  stock options during boom periods so that they can be retained and they in turn be loyal to the company and perform well wit motivation.

6) The company should keep an eye on the credit ratings so that they can get the loans and can raise loans easily and at lower rates.

7) The company should abide with the covenants and should not default on the bonds on maturity and also compensate the equity holders with dividends.