What is the Impact of Operating Leverage on a Business?
Price to earnings ratio (P/E), return on equity (ROE) and free cash flow (FCF) are some of the most popular methods used in evaluating a company’s well-being and risk level for investors. Operating leverage, which is not so popular, is used to know the relationship between a company’s fixed and variable costs.
In bad times, operating leverage can crush a company’s profits and in good times, it can increase the profit exponentially.
The formula for operating leverage is:
Degree of operating leverage = Contribution Margin/ Profit
It can also be stated as:
Degree of operating leverage=Q*CM/ (Q*CM-Fixed Operating Costs)
Q= Unit Quantity
CM= Contribution Margin (Price- Variable Cost per Unit)
Let’s look at one example:
Company X sells 100,000 products for a unit price of $5 each. The company’s fixed costs are $300,000. It costs $0.10 in variable costs per unit to make each product.
A 10% increase in revenue would boost operating income by 25.7%.
Let’s have a look at some of the financial stocks listed on ASX.
OFX Group Limited (ASX: OFX)
OFX Group Limited is into the provision of international payments and foreign exchange services.
OFX Reports 1H FY20 Results; Transaction Up by 5%
Recently, OFX announced its half year results for the period ended 30 September 2019. The company reported turnover of $11.5 billion, down by 5% on 1H FY19, with transactions up 5.2% year on year to 547.9k. During the reported period, transactions per active client grew by 9.3% to 7.0 with active clients of 154k and Average Transaction Values (ATVs) down 9.3% to $21.1k.
- Statutory NPAT decreased by 7.7% to $8.3 million, due to $0.4 million corporate action costs, $0.4 million increase in software intangible amortisation and $0.3 million increase in lease depreciation;
- Net cash flows from operating activities stood at $7.2 million;
- The company declared an interim dividend of 2.35 cents per share (70% franked).
Outlook for 2H FY20
In 2H FY20, OFX would continue to build a more valuable business by increasing investment in capabilities that support enterprise clients and in improving corporate client onboarding; accelerating growth in its corporate business. Moreover, the company would make further investments in corporate sales and marketing; and in North America, while regaining momentum in the UK, Asia and ANZ.
The company is expected to deliver annual positive operating leverage on an EBITDA basis and maintain stable NOI margin.
The stock of OFX was trading at $1.367 per share on 13 November 2019 (AEST 03:16 PM). The company has a market capitalisation of $344.29 million and approx. 248.59 million total outstanding shares, while its 52-week low and high is $1.255 and $2.240, respectively. The company has given a total return of 3.36% and -6.42% in the time period of 3 months and 6 months, respectively.
Australian Ethical Investment Limited (ASX: AEF)
Listed on the Australian Securities Exchange in 2002, AEF manages $3.64 billion for more than 45k super members and investors.
Highlights of AGM
The Funds Under Management (FUM) went up by 21% year on year to $3.42 billion and profit attributable to shareholders grew by 29% year on year to $6.5 million during the financial year ended 30 June 2019. The company paid a dividend of 5 cents per share for FY2019, up 25% from the same period a year ago.
Moreover, in FY2019, revenues reported an increase of 14% to $41 million and operating expenses went up by 11% on the previous year which was below revenue growth. The company has strong balance sheet with no debt, a strong cash position and surplus above regulatory capital requirements. AEF has industry leading superannuation client retention rates and its super outflow ratio continues to be the lowest across all retail funds.
The company expects that if the net flows achieved in the first quarter of FY20 were repeated in the remaining quarters, this would result in approximately 30% increase in net flows above FY19. This would lead to a fantastic result but will be difficult to achieve. But it won’t be impossible to achieve as there are many factors working for the company.
The stock of AEF was trading at $3.410 per share on 13 November 2019 (AEST 03:16 PM), up by 0.888% from its previous closing price. The company has a market capitalisation of $378.87 million and approx. 112.09 million outstanding shares, with 52-week low and high of $1.582 and $3.400, respectively. The company has given a total return of 50% and 63.78% in the time period of 3 months and 6 months, respectively.
Pacific Current Group Limited (ASX: PAC)
Pacific Current Group Limited is a multi-boutique asset management firm devoted to delivering excellent benefit to investors, shareholders and partners.
Update on FUM
Pacific Current Group unveiled that on a like-for-like basis total Funds under Management (FUM) controlled by boutique asset managers within the group grew by 10.4% during the quarter ended 30 September 2019. Total FUM grew 17.6%, when the new investment in Proterra Partners is also considered.
The increase in FUM over the quarter was widespread across Pacific Current Group’s portfolio and reflects another quarter of large inflows at GQG as well as strong growth in Carlisle and Victory Park Capital, and favourable movement in the AUD – USD currency exchange rate.
The stock of PAC was trading at $7.310 per share on 13 November 2019 (AEST 03:17 PM), up by 0.137% from its previous closing price. The company has a market capitalisation of $347.79 million and approx. 47.64 million outstanding shares, with 52-week low and high of $4.230 and $7.400, respectively. The company has given a total return of 32.01% and 50.21% in the time period of 3 months and 6 months, respectively.
Bell Financial Group Limited (ASX: BFG)
BFG is a provider of financial advisory, investment and stockbroking services. The company’s client base belongs to the institutional, private and corporate sectors.
Highlights of 1H 2019 Results
BFG reported a first half profit after tax of $15.9 million for the period ended 30 June 2019, a 63% increase on the previous corresponding period. Revenues stood at $120.6 million, 21% ahead of the pcp.
EPS stood at 5.0 cents per share, increased by 35% on 1H 2018 notwithstanding the expanded capital base following successful entitlements offer completed in July last year. The company declared a fully franked interim dividend of 3.5 cents per share, a 27% increase on the 2018 interim dividend.
All businesses were profitable with major contribution from both Wholesale and Retail divisions including Institutional and Retail Equities, Portfolio Administration Service, Bell Potter Capital and Third-Party Platform.
The stock of BFG was trading at $1.015 per share on 13 November 2019 (AEST 03:25 PM), up by 2.01% from its previous closing price. The company has a market capitalisation of $319.14 million and approx. 320.74 million outstanding shares, while its 52-week low and high is $0.730 and $1.090, respectively. The company has given a total return of -1% and 29.22% in the time period of 3 months and 6 months, respectively.
Tower Limited (ASX: TWR)
Tower Limited is an insurance provider based in New Zealand.
Completion of Rights Offer
The company confirmed that on 18 October 2019 its pro rata renounceable rights offer closed with solid shareholder support.
- Shareholders took about 75.8 million new shares;
- This represented ~90% of the new shares available under the offer.
Tower Limited also stated that underlying net profit after tax for the financial year 2019 is expected to be in line with the guidance provided to the market during late-September 2019. TWR, which is focused on driving growth, is expecting positive growth and pricing environment to continue.
The stock of TWR last traded at $0.650 per share on 12 November 2019. The company has a market capitalisation of $274.07 million and approx. 421.65 million outstanding shares. The company has given a total return of -2.90% and -8.15% in the time period of 3 months and 6 months, respectively.
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