International Research Journal of Applied Finance ISSN 2229 – 6891

Vol. IX Issue – 1 January, 2018 www.irjaf.com

Case Study Series

Cost of Capital Analysis and Implications: Case of Agthia Group

Jocelyn Grira

Context
The food and beverage sector in the UAE is a cost driven sector where a firm can get a clear
competitive advantage on its rivals if it has lower financing costs. Many stakeholders recently
expressed their concerns regarding the management efficiency of Agthia Group and openly
criticized some of the recent decisions taken by the executives, namely the acquisition of Al
Bayan Water Company in October 2015. The acquisition was justified by the possibility to
support Agthia’s growth strategy and to enhance its distribution and warehousing capacities.
A second concern expressed by the company’s stakeholders is related to the corporate
governance of the firm. The approval and communication channels have necessarily to pass
through the CEO’s office, including important committees’ decisions, hence giving an unduly
higher control on firm’s activities to the CEO. A third and final concern is related to the
government subsidy of Agthia’s operations and to the expected monitoring role supposedly
played by the government as a major shareholder.

Agthia Group is a UAE-based company, whose principal activities include the establishment,
investment, trade and operation of companies involved in the food and beverage sector. The
Company is organized, along with its subsidiaries, into two business segments: (1) the Agri
Business Division and (2) the Consumer Business Division (CBD) which is structured into
two industries: (2.1) Bottled Water and Beverages and (2.2) Food.

Agthia Group was established in 2004. The UAE government owns 56% of the 600,000
shares through Senaat General Holding Corporation (51%) and Abu Dhabi Retirement
Pensions & Benefits Fund (5%).

The Company’s assets are located in the UAE, Egypt and Turkey. Agthia has a portfolio of
integrated businesses providing food and beverage products for consumers across the UAE,
GCC, Turkey and the Middle East. Agthia Group employs approximately 2,100 employees.

The following table presents important key figures related to the financials of the firm:

Table 1: Financial key figures of Agthia Group

Financial Results December 2013 December 2014
(AED x 000) (AED x 000)
Total Revenues 1,512,192 1,655,067
Net Profit 158,726 193,325
Total Assets 1,963,618 2,209,283
Shareholders’ Equity 1,249,832 1,379,713
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International Research Journal of Applied Finance ISSN 2229 – 6891
Vol. IX Issue – 1 January, 2018 www.irjaf.com
Case Study Series
The financial performance of the major companies in the food and beverage sector in the
GCC region is presented in the following table:

Table 2: Financial performance of the major food & beverage firms in the GCC region

Source: Zawya, Alpen Capital

Note: Figures in red indicate below-average performance and those in green suggest performance at par with
or above average
a
LTM ended September 2014; b average of LTM ended September 2014, December 2013 and December 2012;
c
LTM ended December 2014; d average of LTM ended December 2014, June 2014 and June 2013

The following table presents the valuation ratios for the major companies in the food and
beverage sector in the GCC region:

Table 3: Valuation ratios of the major food & beverage firms in the GCC region

Source: Zawya, Bloomberg, Alpen Capital

Note: Values in red are below the GCC average, those in green are at par with or above the GCC average, and
the numbers in black are excluded from the calculation of the GCC average

In the UAE, the key players in the food and beverage sector are:
 Al Khabeer Group
 Al Khaleej Sugar Co. LLC
 Food Specialties Ltd
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 International Foodstuffs Co.

Finally, the following graph shows the variation in Agthia stock price as well as the volume
from October 2015 to January 2016.
International Research Journal of Applied Finance ISSN 2229 – 6891
Vol. IX Issue – 1 January, 2018 www.irjaf.com
Case Study Series
Figure 1: Agthia stock price and equity information

Source: www.agthia.com

Cost of Capital
The cost of capital is the cost of funds used to finance a business. It depends on the mode of
financing used. If a business is financed uniquely by debt, the cost of capital equals the cost
of debt. If a business is financed uniquely by equity, the cost of capital equals the cost of
equity. Usually, firms use a combination of equity and debt to finance their activities. In such
case, the cost of capital is weighted average of all capital sources.

The following formula enunciate the cost of capital equation using the cost of equity, the cost
of debt, and the proportions of total assets financed by debt capital and equity capital.

Cost of Capital = WEquity . Cost of Equity + WDebt . Cost of Debt (1)

Where WEquity is the proportion of total assets financed by equity capital, i.e
WEquity=Equity/Assets
WDebt is the proportion of total assets financed by debt, i.e WDebt=Debt/Assets
Cost of Debt reflects the interest charges on the debt component.
Cost of Equity reflects the cost of financing firm’s activities using equity capital.

In September 2015, Agthia Group financed 18.55% of its assets using debt capital. The cost
of equity at the same period was 16.01% and the cost of debt was 4.91%.

Moreover, it is interesting to investigate how the cost of capital of Agthia Group evolved
through time. Time series of the different components of the cost of capital are extracted from
the financial database Zawya. The extraction covers the period from June 2009 to September
2015. The different times series are shown in the following table. The missing cells that need
to be filled are related to the cost of capital.
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International Research Journal of Applied Finance ISSN 2229 – 6891
Vol. IX Issue – 1 January, 2018 www.irjaf.com
Case Study Series
Table 4: Cost of Capital, Cost of Equity, and Cost of Debt - Agthia Group PJSC
Variables 30-Sep-15 30-Jun-15 31-Mar-15 31-Dec-14 30-Sep-14 30-Jun-14 31-Mar-14 31-Dec-13 30-Sep-13 30-Jun-13
Total Debt/Total Assets (%) 18.55% 21.89% 13.61% 16.77% 15.88% 22.87% 15.46% 21.61% 21.28% 19.77%
Cost of Capital (%)
Cost Equity (%) 16.01% 17.35% 16.51% 14.01% 15.03% 16.16% 15.01% 12.70% 13.17% 14.73%
Cost of Debt (%) 4.91% 2.44% 4.45% 2.96% 2.10% 1.78% 2.39% 2.65% 2.48% 2.98%
Variables 31-Mar-13 31-Dec-12 30-Sep-12 30-Jun-12 31-Mar-12 31-Dec-11 30-Sep-11 30-Jun-11 31-Mar-11 31-Dec-10
Total Debt/Total Assets (%) 22.09% 18.18% 23.56% 21.73% 22.55% 15.59% 16.13% 16.47% 17.55% 11.15%
Cost of Capital (%)
Cost Equity (%) 12.73% 11.05% 11.21% 10.49% 10.09% 8.34% 7.86% 8.12% 8.81% 11.75%
Cost of Debt (%) 2.80% 3.55% 2.86% 3.25% 2.71% 3.75% 3.24% 3.26% 3.65% 3.63%
Variables 30-Sep-10 30-Jun-10 31-Mar-10 31-Dec-09 30-Sep-09 30-Jun-09 31-Mar-09 31-Dec-08 30-Sep-08 30-Jun-09
Total Debt/Total Assets (%) 15.71% 14.14% 10.76% 8.45% 8.04% 15.02% 8.85% 11.46% 16.99% 16.99%
Cost of Capital (%)
Cost Equity (%) 11.15% 11.71% 11.80% 11.76% 14.22% 17.42% 22.07% 9.08% 9.29% 9.29%
Cost of Debt (%) 3.25% 2.59% 3.85% 3.37% 4.22% 3.20% 6.69% 5.16% 4.46% 4.46%
Source: Zawya, Thomson Reuters

Cost of Capital and Corporate Governance Issue

An increase in the cost of capital necessarily implies an increase in business risk according to
the risk-return fundamental principal in finance. Agency theory provides more insights on the
implications of the cost of capital in relationship with the corporate governance of the firm. In
fact, according to agency theory, the agents (the mangers) should work for the benefit of the
principal (the shareholders/investors) in order to maximize firm value. For publicly listed
companies as Agthia Group, firm value is reflected on the stock markets: it is equal to the
market price of to stock of Agthia Group that multiplies the number of shares traded.

Moreover, agency theory states that agents may take corporate decisions that may diverge
from the principal’s interests. In fact, the managers may pursue career building objectives or
may be driven by performance-based remuneration which may bias their management
decision, hence incurring additional costs for the firm, referred to as agency costs in agency
theory.

The following graph shows the reporting scheme in Agthia Group.

Figure 2: Organizational structure and reporting scheme

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Source: www.agthia.com
International Research Journal of Applied Finance ISSN 2229 – 6891
Vol. IX Issue – 1 January, 2018 www.irjaf.com
Case Study Series
Government Ownership and Monitoring Issue
A higher cost of capital jointly with a decrease in stock price does not create value for the
shareholders. Since the government owns 56% of the 600,000 shares of Agthia Group
(through Senaat General Holding Corporation (51%) and Abu Dhabi Retirement Pensions &
Benefits Fund (5%)), there is a negative valuation effect for the government.

The financial literature on government ownership shows that this type of ownership does not
necessarily help the companies to perform. From a financial point of view, the government
offers an implicit financial guarantee as a main owner of the firm. This helps the firm,
specifically start-up firms as was the case of Agthia in 2004, to earn a market share and to get
established in the sector. However, the government has to implement the appropriate
mechanisms in order to improve the performance of the firm.

Questions for Discussion

In relationship with the three concerns presented in the first section: (1) cost of capital, (2)
corporate governance, and (3) monitoring and large shareholders’ activism.

1. How do Agthia Group is performing in comparison with its peers?

2. How Agthia Group’s stock price is evolving thought time?
3. Compute the overall cost of capital given the cost of equity, the cost of debt, and the
proportions of total assets financed by debt and equity.
4. What is the impact of Agthia’s merger and acquisition strategy on its overall cost of
capital? Discuss this issue in relationship with the risk-return trade-off principle.
5. How corporate governance inefficiencies can impact the cost of capital? Discuss this issue
in relationship with agency theory.
6. How can we reduce the cost of capital? Refer to agency theory in your discussion.
7. How the government can reduce agency costs and maximize firm value?

Author

Jocelyn Grira
UAE University, College of Business & Economics, United Arab Emirates,
jocelyn.grira@uaeu.ac.ae

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