Strategic Finance Management of Sainsbury Plc - Assignment Example

Sainsbury Plc Case Analysis Background The London-based J Sainsbury PLC is a publicly traded firm listed at the London Stock Exchange. Its principalbusiness is grocery and related retailing, and belongs to the food service and convenience stores industry. However, it is also involved in banking and other financial services, such as insurance and credit cards. It used to be a family owned business surviving two world wars. In the 1970’s, it started offering stocks to the public. In modern times, for the last five years, the company’s performance exhibited a period of highs, lows, and renewed strength for a major comeback towards 2007. The Chairman of the Board, in his annual report for 2007, reported a strong recovery from previous performance, achieving targets as planned, and forecasting stronger sales growth brought about by a resurgence of customer interest on the company’s products and services. The following analysis of J Sainsbury PLC’s financial performance is based on the 2007 annual financial reports and other information obtained from the company’s website www.j-sainsbury.co.uk. Answers to Assignment a.) Discuss how successful the company has been at delivering value to its shareholders over the past five years. From the financial reports of J Sainsbury PLC published on its website, one could see the roller-coaster performance of the company from the year 2002 to 2007. For the year 2002-2003 as the base year of comparative analysis, J Sainsbury declared a dividend of 15.58 pence per share for its stockholders. The following year, it gave stockholders a dividend of 15.69 pence, growing by a meager 0.11 pence. In 2005, there was a marked decline in the dividends announced for its stockholders. For 2005, only 7.80 pence was declared. From thereon, it increased by 0.20 pence by 2006. In 2007, the company enthusiastically announced a rebound in financial growth, with an increase of 1.75 pence on its dividends from the previous year. In 2007, the company gave a total net dividend of 9.75 pence per share. While the latest dividend declared did not match the 2004 level of 15.69 (the highest in the last five years), it was nevertheless a welcome growth considering its stable pattern from 2005 and its on-the-track performance as targeted by the company. Table 1 indicates the dividends declared for common shareholders for the last five years. Table 1. J Sainsbury PLC, dividends declared, 2002 - 2007 Financial Year 02/03 03/04 04/05 05/06 06/07 Interim 4.22p 4.33p 2.15p 2.15p 2.40p Final 11.36p 11.36p 5.65p 5.85p 7.35p Total Net 15.58p 15.69p 7.80p 8.00p 9.75p Source: http://www.j-sainsbury.co.uk/index.asp?pageid=246 An ambitious three-year recovery plan to culminate in 2008 sets the company achieving a target of £2 billion in sales revenue. In 2006, it attained a £1.6 billion in sales, and growing by seven percent the following year, registering a £1.8 billion in sales. Its middle of the year forecast declared that it is near attainment of its targets for the financial year 2008. Another helpful indicator as to the value of the firm is its market share price. Theoretically, the value of shareholders’ investments increases through the “unlimited returns through dividends paid and through the appreciation in value” of their holdings by way of increases in share prices (Gitman, 1997, p.620). It is said that shareholders anticipate a regular cash dividends and “an increasing, or at least non-declining share value” (Gitman, 1997, p.620). In the case of J Sainsbury PLC, a high of 15 pence was given to shareholders during the years 2002/03 and 2003/04, a low of 7.8 pence the following year, and a steady, increasing dividends in the years that followed. While there was a hefty decline between 2004 and 2005 in dividends, investors’ confidence can be gleaned by its share prices. There was a continuing surge in the share prices, as indicated by its growth performance over the years. Table 2 indicates the share price of J Sainsbury sold in December of each year, showing how the stocks have performed year-on-year. An example of how value was delivered to shareholders can be illustrated by an investor who hypothetically purchased 100 shares in 2002 when stocks were selling at 275.50 pence per share. In 2003, the value of the investments increased by £12.75. In 2004, its value decreased by £14.50. In the years that followed, there was a steady increase in value from £20 to £173.75 by 2007. Table 2. J Sainsbury PLC, indicative share prices, 2002-2007 Year Share Price Increase in value of 100 shares holding purchased in 2002 2002 275.50 - 2003 288.25 12.75 2004 261.00 - 14.50 2005 295.50 20 2006 395.75 120.25 2007 449.25 173.75 Source: http://www.j-sainsbury.co.uk/index.asp?pageid=23&subsection=share_price_calculator Assuming that shareholders measure the value of J Sainsbury PLC investment in the same manner that it measures the value of any other firm in the same industry, the price per earnings ratio, P/E ratio, of the industry can also be used as a guide to the firm’s value, whether its own P/E ratio closely approaches or is even better than the industry P/E ratio. It might be of interest to various stakeholders to know as well that the company’s profit for the financial years 2007 is £324 million, an increase of 458.6 percent from 2006’s profits. Basic earnings per share correspondingly increased by a whopping 405.3 percent, from 3.8 pence in 2006 to 19.2 pence in 2007. With such steady performance over the last five years, investors or shareholders are therefore given a good reason by the company to have a high expected returns on their investments, through the anticipation of cash pay-offs, either through dividends or capital gains arising from the appreciation of share prices. b.) Explain how and why the value of equity has changed over the past 12 months. Shareholders have certain expectations on the performance of their stocks over period of time. Several alternatives are likewise present in the market, which probably could offer better returns at an equally risky stocks or investments. Several factors contribute to the buying and selling of stocks by shareholders, such as the current stock price, and forecasts of future stock price and dividends. Share price reflected on the market more or less indicates the perceived present value of future earnings of the stock, either through future dividends or capital gains, or both. J Sainsbury stocks averaged at 336.58 in April 2006 and closed the year with an average price of 539.51 in March 2007. There were ups and downs in the monthly average share price in the last 12 months, but the growth was more or less stable. In a competitive market where J Sainsbury is actively traded, there is no other price that could be established in the market other than the actual share price recorded. When monthly average price of shares decline, it happened because shareholders see a lower expected rate of returns than “that on other securities (or stock) of equivalent risk” (Brealey et al, 2007, p.150). If share prices increased from previous month, investors could have seen a higher expected rate of return being offered by the J Sainsbury stocks than equivalent-risk securities. Everybody would be rushing to either buy or sell, forcing movements in the share prices over time. This explains the changes in the monthly average price of stocks in the last 12 months. Table 3 indicates the average monthly closing share prices of J Sainsbury in the financial calendar 2006-2007. Table 3. Average Monthly Closing Share Price, 2006 - 2007 Month Share Price April 336.58 May 334.73 June 321.31 July 337.94 August 356.76 September 371.30 October 390.58 November 404.48 December 404.12 January 425.75 February 510.94 March 539.51 Source: http://www.j-sainsbury.co.uk/index.asp?pageid=23 c.) Undertake a current valuation of the equity in this company, using the following methods: i) Net Asset Value According to Gitman, this valuation method simply measures the “amount per share of common stock to be received if all assets are liquidated for their exact book (accounting) value and if the proceeds remaining after paying all liabilities (including preferred stock) are divided among the common stockholders” (1997, p.359). Using this formula to obtain the net asset value of J Sainsbury results in the following: Total Assets – Total Liabilities £9,576 – 2,5061 Net Asset Value = = Common Stocks Outstanding 1,742.202 = £4.06 per share ii) Price/Earnings Ratio (or some other appropriate multiples) The Price/Earnings Multiple approach is a method or “technique whereby the firm’s expected earnings per share (EPS) are multiplied by the average price/earnings (P/E) ratio for the industry to estimate the firm’s share value” (Gitman, 1997, p.359). Applying this to J Sainsbury, the EPS in 2007 was multiplied with three industry P/E ratio averages. These P/E averages were obtained from industry report, sector report, and Standard and Poor’s 500 industry average. The following outcomes were obtained: P/E = EPS x Average P/E for industry = 19.2 pence x 36.463 = £7 per share industry = 19.2 pence x 25.284 = £4.85 per share sector = 19.2 pence x 21.635 = £4.54 per share S&P 500 iii) Discounted Cash Flow The first two formulas used above in stock valuation of J Sainsbury PLC are popular approaches, but are not widely accepted due to its “lack of sophistication” and due to its reliance on historical data from financial statements (Gitman, 1979, p.358). It does not consider future streams of potential earnings in the form of dividends. It also does not relate well to a firm’s value in the stock market. Discounted cash flow model values stock by taking into consideration the expected future dividends. Using this model, stock value takes the form of present value of all dividends that will be paid “over the investor’s horizon plus the present value of the expected stock price at the end of that horizon” (Brealey, et al. 2007, p.151). A constant-growth dividend discount model, also known as the Gordon growth model, is used to calculate the value of J Sainsbury stock: DIV1 PO = r - g where PO is the price of the stock, DIV1 is the expected dividend growing at a constant rate, r is the expected rate of return, and g is the growth rate of dividend. r was computed by taking the last dividend paid, 9.75 pence, and adding the difference between the current market share price of 449.256 and an estimated future share price of 549.25. The resulting amount was divided by the current market price. From this formula, the expected rate of return was computed at 24.43 percent. g, on the other hand, was computed by computing the growth rate between the dividends declared in 2006 (8 pence) and 2007 (9.75 pence). The g got the value of 21.87 percent, which will be used as the constant growth rate. Substituting these values in the formula, the following value is obtained: DIV1 11.88 PO = = = £5.94 per share r – g 0.24 – 0.22 In summary, the share prices of stocks of J Sainsbury PLC using the different valuation methods are indicated in the table below: Table 4. Share price obtained using different valuation method Valuation Method Share Price Net Asset Value 4.06 P/E Multiple Approach Industry Sector S & P 500 7.00 4.85 4.54 Discounted Cash Flow Model 5.94 Current Market Price 4.49 d) Attempt to reconcile any differences in value that you obtain by using these different methods and state (with reasons) what value you think is correct for the company. It is needed to ascertain why there may be a difference in the different valuation methods. As stated before, the net asset valuation and the P/E multiples are less sophisticated method of stock valuation because they did not consider the future earning potentials of the stock, while accounting only its historical performance. As explained by Brealey et al, historical costs, which are largely the basis of financial statements, never consider market values. Brealey et al further explains: Investors know that accountants don’t even try to estimate market values. The value of the assets reported on the firm’s balance sheet is equal to their original cost less an allowance for depreciation. But that may not be a good guide to what the firm could sell if it sells its assets for today… A successful company ought to be worth more that liquidation value. That’s one goal of bringing all those assets together in the first place (2007, p.147). In other words, the first two methods did not consider the “extra earning power” of the stock, or the “value of future investments”. This goes to show that market price is never really the same as the book value, as market price “treats the firm as a going concern”, and not as an end it itself (Brealey et al, 2007, p. 148). The discounted cash flow model more accurately gives the true value of the stock as it considers the present and future earning potentials of the investment. Shareholders make investments on these bases. A firm is likely to be valued on its current potentials to make profits, and on its future earnings that it is likely to make out of the opportunities it can take on using its current resources. The strong performance of J Sainsbury PLC in the stock market may be attributable to the high expectations of the market on its growth performance. The discounted cash flow method indicates that the current stock is undervalued. With a high expected returns and an undervalued market price, it is anticipated that share price will continue to rise until true value is reflected. This is further supported by analysts that have advised against selling current shareholdings, as while other market factors are considered in the current lows in the stock market, it is better to ‘hold on the J Sainsbury stocks” for the moment. This view is widely supported by analysts who participated in a survey conducted by www.thomsoninvestortools.com. References Brealey, R.A., Myers, S.C., Marcus, A.J. 2007. Fundamentals of corporate finance. New York: Mc Graw Hill. Gitman, L.J. 1987. Basic managerial finance. New York: Harper & Row Investor Reports. 2007. J Sainsbury PLC. [Online]. Available: http://www.j-sainsbury.co.uk/index.asp?pageid=20 [08 December 2007] Stock Quote. 2007. J Sainsbury PLC (London Stock Exchange). [Online]. Available: http://stocks.us.reuters.com/stocks/overview.asp?symbol=SBRY.L [10 December 2007] __. 2007. Investor Tools. [Online]. Available: http://www.thomsoninvestortools.com/component/firm/aol/view.asp [10 December 2007] Read More