Assignment 2 - Step 3 Commentary

ACCT13017 - Downer EDI Financial Statements.xlsx

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Ratio Commentary:

Profitability & Economic Value

Looking at Downer EDI’s numbers over the last few years, it’s pretty clear that profitability has been a real struggle. In 2021 and 2022, their Net Profit Margin and Return on Assets were technically in the green, but only just. Then 2023 hit hard, with a sharp dive into negative territory (-3.3% NPM and -5.3% ROA), which makes me wonder what really went down that year, was it a one-off impairment or deeper cost control issues?

There was a slight bounce back in 2024, but even then, profitability is still super slim. It feels like the business is surviving more than thriving.

This trend is mirrored in their economic profit, which swung from a decent $187.5m in 2021 to a loss of $43.0m in 2023. Yes, it recovered somewhat in 2024 ($32.2m), but the bigger picture is that they’re not consistently delivering returns above their cost of capital. That’s a bit concerning if we’re thinking long-term value for shareholders.

Operational Efficiency

Interestingly, Downer seems to be pretty good at using its assets efficiently. Their total and current asset turnover ratios have been improving each year, suggesting they’re doing a decent job at converting their assets into revenue.

But when I look at the reformulated Asset Turnover (ATO), things get a bit weird. It spiked to 15.8 in 2023 and then dropped right back down to 6.5 in 2024. That’s a huge swing, maybe a result of restructuring, divestments, or something off with revenue recognition? It makes me think there might be more happening behind the scenes.

Liquidity

Downer’s current ratio stayed safely above 1.0 every year, so they’ve consistently had enough current assets to cover short-term liabilities. That’s a good sign. But their quick ratio was always under 0.36, which tells me that if they had to rely just on their most liquid assets (like cash), they’d be in a tight spot. It’s something to watch, especially in uncertain economic times.

Debt & Financial Risk

One of the biggest red flags for me is Downer’s debt levels. Their Debt-to-Equity ratio peaked at a massive 215.5% in 2023. That’s seriously high and puts the business under pressure, especially when interest rates rise.

In 2023, their Times Interest Earned ratio actually dropped into the negative, meaning they weren’t even earning enough to pay the interest on their debt. Sure, it bounced back in 2024, but that kind of financial risk doesn’t go away overnight.

Market & Shareholder Returns

EPS followed the profitability rollercoaster: positive in 2021–22, negative in 2023, and a small recovery in 2024. Despite this, they still paid dividends in 2023, which is surprising. Maybe it was an attempt to keep shareholders happy, but it also raises questions about whether it was the right move, especially when money is tight.

Their Market-to-Book ratio stayed pretty high (above 4.4x), so the market seems to value them well, but the P/E ratio dropped from 18.6x to 12.1x over the period. That could mean investors are starting to get a bit nervous.

Key Questions I’m Left With:

• What really happened in 2023? It looks like a blowout year across the board. Was it a bad project, poor leadership, or external shocks?

• How long can they keep paying dividends without strong profits? Is this just about keeping investors happy, or is it risky?

• Is the debt level too high for comfort? Even with recovery in 2024, the firm is still seriously leveraged.

• Why aren’t good operational numbers turning into profit? They use assets well, but it’s not showing up in margins or returns.

• Is the 2024 recovery the start of something better or just temporary relief? I’m not fully convinced yet.

Final Thoughts

Downer EDI seems to be a company that knows how to operate but struggles to profit. They’ve got decent efficiency, but low margins and high debt are dragging them down. 2023 was clearly a rough patch, and while 2024 looks better, I’m still cautious. There’s potential, but unless they sort out profitability and reduce their debt reliance, long-term value creation will be a challenge. It’ll be interesting to see how they navigate that in the coming years.

Peer Ratio Comparisons

Rebecca Irving Blog

Kiyah Lacutone Blog

Comparing the three companies—Downer EDI (services), BSA Pty Ltd (infrastructure), and Breville Group Limited (household appliances)—revealed some key differences in financial health, performance, and risk.

Breville Group showed the most balanced and healthy financial performance overall. It reported strong profitability, healthy liquidity, and modest financial leverage. Its return on equity and economic profit suggest the company is effectively using investor capital to generate shareholder value.

BSA Pty Ltd reported impressive figures in some areas, such as return on assets and growth in operating income, but these were paired with extremely high debt levels and very low equity, reflected in an abnormally high debt/equity ratio of over 3600%. This may point to either financial distress or a data miscalculation worth double-checking.

Downer EDI, my chosen company, demonstrated high operational efficiency (strong ROOA and asset turnover), but these strengths were offset by low profit margins, declining operating income, and relatively high leverage. Despite this, Downer’s market valuation (P/E ratio) was very high, which may reflect investor optimism or expectations of recovery.

Accounting Drivers Commentary:

Looking into Downer EDI’s performance over the last four years gave me a pretty surprising picture. On the surface, there are some really solid numbers, like the return on net operating assets (RNOA) and asset turnover (ATO), but when it comes to actually generating economic profit or free cash flow, things are kind of… underwhelming. This got me curious about what’s happening under the hood.

Economic profit (also called abnormal operating income) tells us whether a company is really creating value after covering its full cost of capital. It’s a more realistic way to look at performance than just profit alone. Free cash flow, on the other hand, shows whether the business is actually bringing in spendable cash after covering operating costs and capital investment.

In Downer’s case, both of these metrics are positive, which is a good sign, but they’re extremely low compared to how much activity the company has going on.

The main formula I kept coming back to was:

Economic Profit = (RNOA – Cost of Capital) × NOA

Let’s break that down in Downer’s context.

Downer’s RNOA has actually been quite impressive over time, reaching 49.0% in 2024. This means the business is doing a good job of generating returns from its operating assets. This is definitely a strength for the company, and it has been trending up year-on-year.

Downer’s Net Borrowing Cost (NBC) sits around 1.7%, and implicit interest after tax is over $150 million each year. While this cost isn’t massive in percentage terms, the high capital demands of the business mean this still adds up and eats into profits.

Downer operates in the services and infrastructure space, so naturally it has a fairly large asset base. This means there’s a big capital charge to cover every year. Even when RNOA is strong, this eats away at the value being created—hence the small economic profit.

In 2024, Downer’s free cash flow was only $285, which is tiny. Even though operating income has recovered, the company seems to be investing a lot of cash straight back into working capital or asset reinvestment. Combined with narrow margins, there’s not much left over as “free” money.

Another factor is the decline in operating income during 2022 and 2023, which left a hangover effect on cash flow despite recent improvements.

Downer has a bit of a split personality when it comes to its operating ratios:

• Profit Margin (PM) has been very low throughout—hovering around 0.96% to 1%. This means that even though the company is generating revenue, not much of it turns into actual profit.

• Asset Turnover (ATO) has been incredibly strong—especially in 2024 (around 19.9x). This shows the company is very efficient at using its assets to drive sales.

In other words, Downer is doing a great job at being productive and efficient, but it’s not keeping much of what it earns. It’s like running on a treadmill at full speed and only getting a few steps ahead.

Looking at Breville Group and BSA Pty Ltd gave me a much better sense of where Downer stands.

• Breville had a solid RNOA like Downer but also higher margins and economic profit. They’re turning their efficiency into real shareholder value.

• BSA Pty Ltd had some pretty wild numbers—huge RNOA and asset turnover, but also an insanely high debt/equity ratio (3600%). That suggests high risk or possibly a data issue.

Downer kind of sits in the middle. It’s got the efficiency and strong asset use, like BSA, but it doesn’t convert that into profit the way Breville does.

Breaking this down has been a great reminder that being busy isn’t the same as being profitable. Downer is doing a lot right, especially in how it uses its assets, but slim margins and high capital costs are holding it back from delivering real value to shareholders.

For me, the biggest learning was just how important profit margin is. Even a small increase in margin could make a big difference to economic profit and free cash flow. I also saw that just looking at net profit or earnings isn’t enough, you need to look at the drivers underneath to get the full picture.