De La Salle University

Professional Schools, Inc.

Graduate School of Business

ACC5000
(Financial Accounting)

Term Paper
On Financial Statement Analysis

Subject Company:
Manila Electric Company
(MERALCO)

Submitted by:
Grp. 5

Darwin Clemente
Raymond Martinez
Jose Erwin Sebastian

Submitted to:

Prof. Virgilio Avila

Abstract

The ability to understand and carefully analyze financial

statements is key competencies needed by every manager. In fact, it
may spell the difference between business success and failure.

In many instances, managers tend to make decisions, which are

damaging to the company’s interest mainly because decision-makers
are not well equipped with the technical knowledge on financial
accounting.

This paper provides an avenue for the group members to apply

and showcase their understanding of the Financial Accounting
Principles learned during the discussions on the subject. For the
purpose of this paper, the group decided to make a comparative study
on the 2003 and 2004 financial statement/reports of Manila Electric
Company (MERALCO), the leading power distribution company in the
country today serving more than four million customers in all its
franchise areas.

Objectives

This paper seeks to achieve the following objectives:

1. To allow the group members to apply Financial Accounting

Principles in the analysis of Financial Statements.

2. To be able to make a comparative analysis of the 2003 and 2004

Financial Statements of MERALCO.

Data Gathering

Because of time constraints, the group shall rely on secondary

sources such as the company’s annual reports, news clippings, and
articles from the internet. Reports from related sources such as the
Philippines Stock Exchange shall also be considered in the analysis.

For the purpose of clarification, the group will be using the

figures for the Parent Company in all its computation and analysis.
Data Presentation
Some FIGURES from the Financial Report
2004 2003
in millions in millions

Total Assets 154,708 144,879

Total Current Assets 31,842 27,666

Total Non Current Assets 122,866 117,213

Stockholders Equity and Liabilities

Stockholders Equity 35,295 36,953

Non Current Liabilities 87,049 69,990

Current Liabilities 32,364 37,936

Total Stockholders Equity & Liabilities 154,708 144,879

Revenues 147,637 131,948

Operating Expenses 137,455 126,374

Interest and Other Charges (3,266) (3,052)

Net Income (2,610) 1,267

Monetary Current Asset 30,387 26,267

Gross Margin 358 5574

Market Price per Share in PESOS A 18.58 11.22

B 27.59 16.72

Cash Generated by Operations 9264 9046

Total Debt 21515 15404

 Financial Ratio 2004 2003 Remarks

Current Ratio 0.9839 0.7293 Improved, but indicated not

enough current assets to cover
current liabilities

Quick Ratio 0.9389 0.6924 Improved, but indicated not

enough current assets to cover
current liabilities

Asset Turnover 0.9543 0.9107 Improved, but indicated poor

utilization of assets

Invested Capital Turn-over 1.21 1.23 Decreased. Limited indicating

poor use of capital investment

ROIC -3.90% -0.70% Deteriorated.

ROSE -7% 3% Deteriorated - rate of return

very poor.

Gross Margin Percentage 0.24% 4.22% Decreased, Poor production

Profit Margin -1.77% 0.96% Decreased, Poor production

Price Earning Ratio A-Shares -6.78 9.47 Decreased in value

B-Shares -10.07 14.11 Decreased in value

Financial Leverage Ratio 4.38 3.92 Improved. Assets can fully

cover equity.
Debt/Equity Ratio Total 338% 292% Deteriorated. Liabilities cannot
Liabilities/Equity be covered
Long Term/Equity 247% 189% Deteriorated. Liabilities cannot
be covered

Cash Flow / Debt 43% 59% Deteriorated. Cash flow

generated by operations
cannot cover for Total Debt

Dividend Yield A Shares -15% 11% Deteriorated. Trend send a

negative signal to potential
investors.

B- Shares -10% 7% Deteriorated. Trend send a

negative signal to potential
investors

Working Capital Turnover -282.83 -12.85 Deteriorated. Working Capital

is not generating enough
revenue.
Analysis

I. Tests of Investment Utilization

Current Ratio = Current Assets/Current Liabilities

Table 1. Current Ratio

2004 2003
.9839 .7293

The current ratio is a measure of the company’s liquidity as well

as its margin of safety that management maintains in order to allow
for the unevenness in the flow of funds. In the case MERALCO, the
2004 current ratio showed signs of improvement from its 2003 figures.
This can be attributed to the decrease in the current portion of
customer’s refund. From Php 6,919 in 2003 down to Php 5,409 in
2004. Current portion of long term debt also showed substantial
decline from Php 7,668 in 2003 to only Php 2,111 in 2004.

Overall, the ratio implies that MERALCO’s current assets cannot

sufficiently cover for all its current liabilities. However, comparatively,
there has been significant improvement in its current ratio over the
two-year period (2003 to 2004).

Quick Ratio or Acid Test Ratio

= Monetary Current Asset/Current Liabilities

Table 2. Acid Test Ratio

2004 2003
.9389 .6924

The acid test ratio establishes the relationship between the

company’s Monetary Current Assets against its Current Liabilities. In
this case, MERALCO’s 2004 Acid Test Ratio shows improvement when
compared with its 2003 figures. Again this can be attributed to the
decline in the Current Liablities coupled with the improved figures on
the company’s Monetary Current Assets for the year 2004. However,
though there has been a substantial improvement in this aspect, still
the company’s Monetary Current Assets are not sufficient to cover for
its Current Liabilities.
Asset Turnover = Sales Revenues/ Total Assets

Table 3. Asset Turnover

2004 2003
.9543 times .9107 times

This ratio is a measure of how the company has been able to

utilize investments, more particularly assets. Based on table 3 figures
indicating the Asset Turnover Ratio for our subject company, the
figures indicate that the company had slight improvement in this area,
although the figures are not indicative of an ideal situation. The
implication of this is that the company has not been able to fully utilize
the revenue generation capacity of its assets. One important thing to
note on MERALCO’s Financial Statement is that it has some non-
performing assets in the form of Construction in Progress which
accounts for 3% and 4.27% of its total assets in the year 2004 and
2003 respectively. Items included in this account are the construction
of sub-transmission and distribution facilities which are needed in
order to service the continuously growing customer base of MERALCO.

Invested Capital Turnover = Sales Revenue/ Invested Capital

Table 4. Invested Capital Turnover

2004 2003
1.21 1.23

Invested capital turnover ratio is another investment utilization

ratio that measures the relationship between the company’s Sales
Revenue and Invested Capital. For the case of MERALCO, the
company’s ratio in this aspect showed a very slight decline, indicating
a need for a better management and utilization into revenue
generating activities of the company’s assets.

Working Capital Turnover = Sales Revenues/ Working Capital

Table 5. Working Capital Turnover

2004 2003
-282.83 times -12.85 times

The 2004 and 2003 figure both shows a dismal performance in

the aspect of working capital utilization. Basically, the figure shows
that MERALCO was not able to efficiently use its working capital to
generate revenue.
II. Profitability Measures

Gross Margin Percentage = Gross Margin/ Net Sales Revenues

Table 4. Gross Margin Percentage

2004 2003
.24% 4.20%

Table 4 shows significant decrease in the company’s Gross

Margin Percentage. Though the financial statement shows an increase
in Net Sales Revenues, the report also shows a substantial decrease in
MERALCO’s Gross Margin because of the inclusion in the accounts of
the account Provision for Probable Losses (p. 39 “2004 Annual
Report”) amounting to Php 9,824. The inclusion of the said account is
discussed further in the notes (Note 1,c) on the financial statement.

Profit Margin = Net Income/ Net Sales Revenues

Table 5. Profit Margin

2004 2003
-1.77% .96%

Profit Margin is the measure of overall profitability and

oftentimes, people see this as the most important measure of the
company’s performance. For MERALCO, profit margin can be said to be
way below the average. With a .96% margin in 2003, the company’s
profit margin further deteriorated in 2004 registering a –1.77% or zero
margin. Referring to the company’s financial statement, the increase in
the Operating Expenses by 8.7% from 2003 can well be considered as
among the major contributing factors that caused the decline in the
company’s profit margin.

Earnings Per Share = Net Income/ No. of Shares Outstanding

Table 6. Earnings Per Share

2004 2003
Php –2.739 Php 1.185

Earnings per share shows a decline from Php1.185 per share in

2003 to a dismal Php –2.739 in 2004 primarily due to the significant
decline in the company’s bottom line figure of Php 1,267 in 2003 to a
loss of Php –2,610 the year after.
III. Tests of Financial Condition

Financial Leverage Ratio = Assets/ Shareholder’s Equity

Table 7. Financial Leverage Ratio

2004 2003
4.38 times 3.92 times

MERALCO’s ratio in this aspect showed some improvement when

compared to the 2003 figure. This ratio indicates that the company, as
December 31, 2004 has enough assets (4.38 times) to cover for
shareholder’s equity. This gives investors some reasons not to worry
despite MERALCO’s poor performance in the aspect of profitability.
However, the need to make changes in order to make the company
profitable again is necessary.

Debt/Equity Ratio = Long-term Liabilities/Shareholder’s Equity

Or
= Total Liabilities/ Shareholder’s Equity

Table 8. Debt to Equity Ratio

2004 2003
Long-term/Equity 338% 292%
Total Liab./Equity 247% 189%

Using either formula, MERALCO’s debt to equity ratio is

deteriorating. In both years, the company’s ratio in this aspect is
already at a very alarming rate. This is primarily caused by the
Supreme Court decision dated November 15, 2002 that ordered
MERALCO to refund to its customers Php .167/kwh as reflected in note
1, d in the 2004 Annual Report.

Cash Flow/Debt = Cash Generated by Operations/ Total Debt

Table 9. Cash Flow/Debt

2004 2003
43% 59%

The cash flow over debt ratio of MERALCO for 2004 declined by a
huge 16% over the 2003 figure. This implies that the company’s 2003
operations only generated cash that is equivalent to 59% of its total
debt while only 43% in 2004. referring again to MERALCO’s financial
statement (Statements of Cash Flow) would show that this decline was
due to the significant increase in the company’s “Account Payable and
Other Current Liabilities.”

IV. Tests of Dividend Policy

Dividend Yield = Dividends per Share/ Market Price per Share

Table 11. Dividend Yield

Share 2004 2003
A -15% 11%
B -10% 7%

Dividend yield of MERALCO shows a declining performance for

both MERALCO A and B common shares. Again, this is the result of the
significant fall in the net income brought about by the Supreme Court
ruling ordering MERALCO to refund to its customers the Php .167/kwh
for the billing period covering February 1994 to December 31, 2002.

IV. Tests of Overall Performance

Price/Earnings Ratio =
Market Price per Share/ Net Income per Share

Table 12. Price Earnings Ratio

Share 2004 2005
A Php –6.78 Php 9.47
B Php –10.07 Php 14.11

Price earnings ratio of MERALCO shows a decline in value in its

common stock. The decline in market price may be attributed to the
poor financial performance of the company in recent years which
triggered a low demand for its shares. These are highlighted in
Appendix A, B, and C of this paper.

Return on Invested Capital = Net Income+Interest (1-tax

rate)/Long Term Liabilities+Shareholder’s Equity

Table 13. ROIC

2004 2003
-3.9% -.7%

Table 13 shows a declining Return on Invested Capital for

MERALCO over the period 2003 to 2004. Again, this measure is
significantly being affected by the net income figure making the 2004
figure far worst than the 2003 figure. What can be done to improve
this is to improve performance on revenue generation since it is in this
aspect that the company has greater control.

Return on Shareholder’s Equity = Net Income/Shareholder’s

Equity

Table 14. ROSE

2004 2003
-7% 3%

MERALCO’s ROSE is on a declining trend for the period 2003 to

2004. On the part of the investors, this may be a cause for alarm since
equity in the business is now going into the negative values, meaning
they are not getting any return for their investments.

On the part of MERALCO, future capitalization from Equity capital

may be impaired since many may opt to acquire shares from other
companies rather than from MERALCO.

Summary

Overall the present financial picture of MERALCO is not bright

and progressive. The company’s management is not efficient and
rather slow. It does not make efficient use of its assets as seen by the
fact that it does not even generate enough income to equal its assets.
It does not offer its investors any earnings for their investment. Its
usage of working capital is such that its does not create positive
returns but losses in operations. Most of all its earnings are not even
enough to pay for its liabilities requiring it to raise funds from outside
sources to maintain its liquidity. In such condition, the Company is a
poor investment for the present unless one is hedging for the future.
The idea is to buy when the prices of the stock is low in expectation
that it will rise.

MERALCO’s potential however is in the fact that it is a utility

company serving a market base that will presumably increase. In
short, it has a sure market. It is infrastructure intensive such that its
investment requirement is large but the returns will be continuous
once these infrastructures are already put in-place and utilized.
Secondly, much of its difficulty stems from the refunds to consumers
brought about by the decision of the Supreme Court. These refunds
are carried in its Current Liabilities and are therefore self-limiting being
only there for a short term. Though it is the main reason for its
difficulty, this liability will soon be consumed and with it comes the
possibility of going from red to black. Given that basis and maybe a
more creative management of its assets, MERALCO has good profit
potential and therefore may be a good investment.

Overall MERALCO’s Liquidity is improving though it is yet to

reach the ideal level. However, in terms of solvency, things must be
done to overturn the current trend, especially in relation with its
refund schedule to industrial customers in the coming years.
 Appendix A

this story was taken from www.inq7money.net

URL: http://money.inq7.net/breakingnews/view_breakingnews.php?
yyyy=2003&mon=08&dd=13&file=1

Meralco to face cash flow problem until 2005: ING

Posted: 4:42 AM | Aug. 13, 2003

AFX

THE 30 billion pesos in refund that Manila Electric Co. (Meralco) is giving customers for excess
charges and the maturity of most of its debts may cause a cash flow problem for the publicly
listed electricity distributor beginning this year up to 2005, ING Financial Markets said
Tuesday.

Meralco, currently implementing the refund as ordered by the Supreme Court, needs to repay
76 percent of its debts of 33 billion pesos during that period, the Netherlands-based bank's
study said.

"In our view, the biggest challenge to management is how to address the debt maturities in
2003-2005, considering that the refund and capex [capital expenditures] are more pressing
requirements," the study said.

Nevertheless, ING is recommending a "buy" on Meralco shares and has projected a target
price of 23 pesos per share in the next 12 months, citing an "under-appreciated" price
increase and a regulatory environment that is beginning to show "clarity."

It said the clear solution to Meralco's liquidity problem was to either negotiate with creditors
for a terming out of existing debt or to find new sources of funds to refinance the debt.

Debt refinancing will entail higher borrowing cost following recent credit rating downgrades on
Meralco, the ING study said. It said it would cost the company about 12 percent to get five-
year, dollar-denominated financing, compared with its current average cost of debt of about
eight percent.

ING reiterated that Meralco would file a petition for a price increase in the next few weeks. It
said the petition would use the company's end-2002 asset base. It said the company had used
its end-2000 asset base for a previous price hike.

"We believe Meralco's return on rate base (RORB) at about 10 percent as of end-2002, and we
believe a 20-centavo per kilowatt-hour increase may be warranted to bring its RORB back to
its approved weighted average cost of capital of 15.5 percent," ING said.

"We assign a low possibility of Meralco being granted a rate increase so close to the May 2004
elections."
However, ING said the urgency of privatizing the National Transmission Co. and National
Power Corp.'s generation assets means that "the government needs to restore investor
confidence on the power sector quickly, and potential investors would undoubtedly refer to
Meralco when considering whether to invest in the Philippine power sector."

ING noted that under the Electric Power Industry Reform Act of 2001, the Energy Regulatory
Commission is given a maximum of one year and 75 days to decide on any rate increase
petition.

Failure to act on the petition will entitle the rate applicant to implement whatever rate increase
it has petitioned before.

"The regulatory environment, while still far from being benign and predictable, has taken small
but positive steps in restoring investor confidence in the power sector," ING said.

As an observation, ING said Meralco welcomed the appointment of ERC chairperson Manuel
Sanchez, and said Sanchez "has taken swift action on several regulatory issues, particularly
Meralco's tariff, less than two months after the Supreme Court ruled that RORB should be on a
pre-tax basis."

copyright ©2005 INQ7money.net all rights reserved

 Appendix B

Article:

Meralco posts R2.6-B loss in 2004

The uncertainties posed by court rulings have weighed down on the financial
performance of giant utility firm Manila Electric Company (Meralco) triggering it to
register a net loss of P2.610 billion last year, effectively wiping out its P1.267 billion
income in 2003.

"The significant change in Meralco?s financial performance was mainly due to the provision for
probable losses, for prudential reasons, in the event of a final and executory adverse decision on the
unbundling rate case currently pendi...
 Appendix C

http://www.manilatimes.net/national/2003/may/19/business/20030519bus7.html

Monday, May 19, 2003

Meralco sees recovery if ERC okays rate hike

The financial difficulty being experienced by the Manila Electric Co. (Meralco) would
be over possibly next month if it gets this June a rate increase from the unbundling
petition it filed with the Energy Regulatory Commission (ERC), said company
president Jesus Francisco.

“If we get a rate increase starting June 1 then maybe we will already be profitable in
the second quarter. No more net loss. We would just have to offset the 16.7
centavos a kWh rollback to the rate increase that we are banking on,” he said.

The ERC last week directed Meralco to stop collecting from its customers 16.7
centavos a kWh excess amount in its basic rate starting next month. The order also
included the regulatory body’s approval of the one-time cash refund proposal to
customers consuming 100 kWh and below.

The 16.7 a kWh rollback, according to Meralco officials, will result to P317 million in
revenue loss that it will incur starting next month.

The ERC approved last March a 4.0-centavo a kWh increase in the basic rate of
Meralco on top of the 8.75 centavos a kWh rate escalation that would account for its
deferred purchased power adjustment (PPA) charges which has already been allowed
for recovery. Meralco sought the ERC’s reconsideration days after the ruling came
out.

The power distribution utility firm originally applied for P1.12 a kWh in its unbundling
application based on the adjustment of its financial statement to year 2000 from its
last increase in 1994. But due to several disallowed costs in its unbundling
application, the resulting increase was significantly slashed.
-- Sheryll Casanova