A Research Designed for the Profitability of
Chinese Tobacco Companies
Li Zhe
Duan Yiwei
Jin Miaomiao
A Thesis Submitted
For Partial Fulfillment For The
FINAL EXAMINATION
University of Shanghai
Finance & Economics
June 2011
Abstract
Nowadays in this full of competition business world, companies must try their best as they can to survive. In other words, the company which earns the lower will fail, and the company which has higher income will become stronger. So, what are the main factors that affecting a company’s earning mostly? And how do they make an influence? Our group chose two of those causal variable “d ebt paying ability and region” to discover and explain how they affect company’s profitability. We use the data from Chinese tobacco companies to make two hypotheses: Those Tobacco companies that have better debt paying ability will be more profitable than their peers with relatively worse debt paying ability; To control the variable of the debt paying ability of Tobacco companies, those Tobacco companies that locate in east of China will be more profitable than their peers that locate in mid or west of China. After analyzing both of the hypotheses, we find out that debt paying has closely relationship with profitability as our conclusion.
Key Words: Tobacco companies, profitability, debt paying ability, region.
Table of Contents
Chapter One Introduction (4)
Chapter Two Literature Review (5)
Chapter Three Research Design (6)
3.1 Hypothesis (6)
3.2 Data (7)
3.3 Variables (7)
3.4 Models (8)
Chapter Four Results & Findings (9)
4.1 Analysis (9)
4.1.1 Comparison (9)
4.1.2 Results (11)
4.2 Further Analysis (11)
4.2.1 Comparison (12)
4.2.2 Findings (14)
Chapter Five Conclusion (15)
References (16)
Chapter One
Introduction
Today the production of Chinese tobacco has already taken up 35% of the world and it’s the No.1; the product ion of Chinese cigarette has taken up 32% of the world and it’s also the No.1. Nowadays there are more than 130 factories of tobacco and about 500 thousands employees in China. 6 millions farmers plant tobacco and more than 3 million retailers are selling cigarettes.
In《2007 China Manufacture Top 500 Enterprise Information Publish Report》published by the Chinese Industry Enterprise Information Publish Center, meanwhile the profits of Chinese industry top 500 enterprise were increasing uninterruptedly, the profits rate also rose up to 6.51% increased by 0.97% compared with the previous year. Among them the tobacco industry got the highest profit rate of 17.3%.
附件一：2007中国制造业500强（烟草）名单
However, what we are really interested in is which factors are affecting and resulting in its high profitability. Of course there are some obvious factors: just like monopoly, economic environment, institution, cost and region etc. But there are also some factors which are not so obvious. And perhaps these variables are the most important and are really affecting profitability. What we want to do is just to find them and to figure out the relation between them.
After discussing in our group, we finally choose the debt paying ability as our study object. We will study the relation between the profitability and debt paying ability controlling the region variable.
Chapter Two
Literature Review
Our group has collected and analyzed lots of relevant essays and materials concerning the relationship between the debt paying ability and profitability in a company and also the relationship between the region of the company and the profitability. We picked up some of the views and main points of those essays as follows.
Liu Ming, 2008 from her essay “A brief analysis on debt paying ability and profitability of a company”, she pointed out that high quality of debt paying ability often leads to high profitability. Mainly because that good debt paying means that the company’s assets structure is efficient, and in generally speaking, a good control of assets structure often leads to high profitability.
Li Ru, 2008 from her essay “A research on the relationship between financial operation and profitability”, she considered that debt paying ability and profitability are interactive. In her opinion, high debt paying ability enables the company to use risk taking strategy to get higher rate of return. Moreover, a good finance condition also can influence a company’s assets&debt proportion. For example, the rise of the company’s inc ome rate often tends to impulse the company to form a suitable and efficient assets-debt structure.
Zhang Ronglan, 2002 in her “Interpretation of profitability and debt paying ability of a company”, she gave an analysis of them from the aspects of cash fl ow’s risk and return. She pointed out that company’s profitability represents its finance condition and debt paying represents the finance risk. Both of them have an influence on the other.
Zhou Wenjie, 2009 from his essay “Analysis on finance safety and debt paying ability”, he explained how debt paying ability affects profitability in a way of affecting finance safety and stability indirectly.
Liu Qiaoru, 2009 from “The control of logistics cost in manufacture”, she pointed out that the company’s locat ion can affect the rate of return. The reason is that company’s location has a very close relationship to the company’s costs. Therefore, by selecting an ideal location the company can minimize the logistic cost, which helps to make higher profit.
Generally speaking, higher debt ability tends to lead higher profitability. However, this opinion can not always be true, because there are many other causal variables influence company’s profitability. From these many causal variables, our group picked up “company location” as our control var iable to analyze how these two variables have an influence on the company’s profitability.
Chapter Three
Research Design
3.1 Hypothesis
As mentioned before, we are interested in the relation between the debt paying ability and profitability of the tobacco companies in China. In terms of this original intention, we build a hypothesis as below.
Hypothesis 1: In China, those Tobacco companies that have better debt paying ability will be more profitable than their peers with relatively worse debt paying ability.
3.2 Data
The dataset for the study is complied from Tobacco Industrial Enterprises in the different regions throughout China. The dataset reflects the performance of these tobacco companies by many various economic indicators. However, some companies have got unique characteristics. Such as the tobacco companies in Tibet and Qinghai, which have no value of the indicators at all. In order to achieve more reliable statistical results, we first exclude abnormal information of these kinds which have missing values in the variables we will use. Then, we select some indicators from the dataset and combine them into a new ratio which is useful for our study. The Current Ratio is calculated from the current assets and the current costs which is used to measure the debt paying ability. The Profit Margin is calculated from the prime operating revenue and the total profit which is used to measure the profitability. As a result, our sample includes 206 tobacco companies along with their performances of the debt paying ability and profitability. For convenience, these 206 tobacco companies are finally divided into 26 groups by province and city.
3.3 Variables
Dependent Variable: Profitability is the main dependent variable. Our research interest is focused on the fact that the tobacco companies always achieve high profit rates. So we are intended to find some inconspicuous factors behind this fact. The Profit Margin is quite suitable for measuring
prof itability, so we’d like to use the data of profit margin selected from the dataset to be the measurement of earning power.
Independent Variable: Debt paying ability is our main independent variable. According to the DuPont Analysis, the debt paying ability can be reflected by
the current ratio. Because high current ratio means that the firm can quickly converts the current assets into cash which can be paid for the debt in the short term. Thus, we use the data of current ratio selected from the dataset to measure the debt paying ability. What’s more, with the purpose of comparison, we divide the independent variable into four categories: High, Higher, Lower and Low.
Control Variable: Not surprisingly, there is variation across regions of China with respec t to this effect. It’s necessary for us to take the region variation into account. So controlled comparison is needed in our study and “Region” is sure to be the control variable. In view of the economic development, we separate the region into 3 categories: Coastland, Midland and Western. The 26 different provinces and cities just fall into the categories. The category of Coastland includes Tianjin, Liaoning, Jilin, Heilongjiang, Shanghai, Jiangsu, Zhejiang, Fujian, Shandong, Guangdong, Hainan. Midland includes Beijing, Hebei, Shanxi, Henan, Hubei, Hunan. Western includes Guangxi, Chongqing, Sichuan, Guizhou, Yunnan, Shanxi, Gansu, Xinjiang.
3.4 Models
We use a model called “least square regression line” to estimate the coefficients to verify whether some relations really exist between the different variables. During this procedure, we may also find some other partial effects.
Chapter Four
Results and Findings
4.1 Analysis
To test the hypothesis, analysis is needed. We will use controlled comparison and regression to help ourselves analyze the data.
4.1.1 Comparison
First, we control the region” Coastland” constant and then use the linear regression to fit the relation between IV and DV. Figure 1 illuminates some key findings tied to issues suggested in the discussion above. We obtain from this scatter diagram surprisingly that the goodness of fit “R2” is as high as enough to support the relation between IV and DV which is 0.7921. For the slope of the linear function is positive, the correlatio n coefficient “R” can be evaluated nearly 0.9. This value implies that the degree of the relation between IV and DV is great enough. It’s a guarantee for us to reach the conclusion that in the coastal areas, the tobacco companies’ earning power is quite co rrelated with their ability of debt repayment. What’s more, the correlation is positive.
Second, we control the region “Midland” constant. However, Figure 2 shows us that result of the linear regression is not valid for the reason that the “R2” is only 0.121. So it appears that in the provinces such as Hubei, Hunan, Hebei, Henan which fall into the category of “Midland”, the tobacco companies’ good debt paying ability doesn’t necessarily mean that their profitability is also high or low. So the relation between IV and DV is defined as “nonexistent”.
Third, we control the region “Western” constant and then to see whether the relation between IV and DV can be found. Figure 3 tells us the answer should be yes. We can observe from the scatter diagram that there is a distinct linear relation between IV and DV, on account of the high goodness of fit which is 0.7995. This result is just as similar as the consequence of Figure 1. The relation is also positive, so with regard to the tobacco companies in the
Western, good ability of debt repaying can lead to a relatively high profitability.
4.1.2 Results
As we examine from the controlled comparison above through the three figures, we can reach to the determination which pattern comes closest to the relation between IV and DV. Depending on our analysis, we find that the relationship is interaction. In the Coastland and Western, we find a positive correlation between the debt paying ability and profitability for the tobacco companies while in the Midland, the relation is nonexistent.
4.2 Further Analysis
The result we observe above raise the interest of us to find that if there is a relationship between the region and profitability. That is, whether the tobacco companies locate in the Coastland will be more profitable than their Midland or Western peers. This time, Dependent Variable is still Profitability while Independent Variable is Region and Control Variable is Debt paying ability. Since the comparison process may be similar as the former one, it will be
somehow simpler explained. We use the dummy variable to represents for the region. Coastland is 1, Midland is 2 and Western is 3. Also, we build another hypothesis.
Hypothesis 2: To control the variable of the debt paying ability of Tobacco companies, those Tobacco companies that locate in east of China will be more profitable than their peers that locate in mid or west of China.
4.2.1 Comparison
First, we control the debt paying ability “low” constant. Then we find a positiv e relation between IV and DV from Figure 4. The midland tobacco company posses a higher rate of return than the coastland tobacco company.
Second, we control the debt paying ability “lower” constant. Although the goodness of fit of the regression line is 0.667, it is still enough for us to make the conclusion that there also a positive relation between IV and DV from
Figure 5. The coastland tobacco company owns the lowest profitability compared to the midland and the western.
Third, we control the debt paying ability “higher” constant. As a result, Figure 6 illuminates us a negative relation between IV and DV. Reversely to the result above, the coastland tobacco company owns the highest profitability compared to the midland and the western.
Finally, we control the debt paying ability “high” constant. As we can see from
Figure 7, there is no relation observed from the IV and DV for the R2 is too low which is only 0.189.
4.2.2 Findings
The further analysis leads us to another interesting finding. Due to the comparison above, it explains the matter that the region where the tobacco company locates also influences the earning power in some cases. We can conclude that for the tobacco companies with low debt paying ability, the Western’s profitability is higher than the Midland’s and the Midland’s profitability higher than the Coastland’s. While for the tobacco companies with a relatively high debt paying ability, the conclusion is opposite and the Coastland’s p rofitability is the highest. There is another situation, for the tobacco companies with most high debt paying ability, no relation is found between profitability and regio
Chapter Five
Conclusion
In our coastal and west regions, we find that there is a positive correlation between the profit margin from main operation and current ratio. So if you want to enhance your profit rate you have to increase your current assets and decrease the current debt. Enhance your debt paying ability without hesitation.
In a low scope of current ratio, the relationship between the profit margin and region is that the tobacco enterprises in coastal region have lower profit rate. But in a higher scope of current ratio, the coastal is higher than the west.
So the tobacco enterprises in coastal region must try to increase their debt paying ability to prevent the outcome of low profitability because of the fierce competition. Otherwise your competitiveness will be lower than the western tobacco enterprises and you maybe lose your midwestern market.
References
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Li Ru(2008) A research on the relationship between financial operation and profitability
Liu Ming (2008) A brief analyze on debt paying ability and profitability of a company
Liu Qiaoru. (2009) The control of logistics cost in manufacture
Shao Min, Li Junxia (2008) The Roles and Performance of State Firms and Non-State Firms in China’s Economic Transition
Zhang Ronglan (2002) Interpretation of profitability and debt paying ability of a company
Zhang Yifan (2009) Creative accounting or creative destruction
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Zhou Wenjie (2009) Analysis on finance safety and debt paying ability