Financial Analysis for Kroger Co - Research Paper Example

? Financial Analysis Kroger Co. 03/25 Table of Contents Company outlook 3 Liquidity Ratio 5 Profitability Ratio 7 Financial risk Ratio 8 Asset Utilization ratio 10 Valuation Ratio……………………………………………………………………………………………………………………………11 DuPont analysis of Kroger: 2012………………………………………………………………………………………………….13 Overall Financial position of the company……………………………………………………………………………………16 Bibliography 17 Company Outlook Kroger Co. was formed in 1883 by Bernard Kroger in the region of Ohio and since then it has become one of the largest supermarket chains of America. It is the second largest supermarket with Wal-Mart being on the top. Kroger operates in a highly competitive industry and its main competitors are Wal-Mart, Safeway, Supervalu and Whole Foods. For the first quarter which ended May 21 2011, Kroger had earnings of $432.3 million or earnings per share of 70 cents. Total sales also increased by 11% in the same year and were around $27.5 billion. (Reuters, 2011). The industry in which Kroger operates has major players such as Wal-Mart but these high profits indicate that Kroger is going head to head with Wal-mart. (Reuters, 2011) For an industry like Kroger’s, the most important factor for consumers is price. The products available in supermarkets are not differentiated and therefore they cannot be advertised heavily. Much of the advertisement that is done is carried out on the basis of attracting families to shop at Kroger because it is cost effective to do so. Apart from being cost effective Kroger also has products of high quality which makes it popular among American consumers. Kroger Co. has 42 manufacturing plants and including dairies, beverages and meat plants and all of these plants are of the highest standards. (Zahorsky) In the recent years there has been a tremendous increase in the fuel prices and the recent financial meltdown has made things worse for many industries including Kroger. The rise in fuel prices caused an increase in costs of the products sold by Kroger. Kroger is both a manufacturing company and a retail outlet and was therefore heavily affected by the increase in cost of fuel and other raw materials. According to Porter, there are 3 strategies a company can adopt to become competitive and Kroger has undertaken the “cost leadership” strategy which helps to differentiate it from the rest of the supermarket chains. The continuing increase in fuel prices will prevent Kroger from increasing costs and the strategy and it would be difficult to achieve goals. Kroger can shift to alternative sources of energy and reduce its costs that way. The recent financial meltdown meant that the demand for grocery products decreased to a large extent. In the past consumers would buy gourmet foods and other items from supermarkets but due to the credit crises that has decreased. Consumers have become more price conscious and buy only items that are necessary. Such a decrease in spending has affected the entire industry at large and profit margins have gone down since the past. In 2009 there was a 60.5% drop in consumer confidence index. (Zahorsky) Kroger has been taking advantage of the opportunities and developed its own brand called “Private Selection” and manufactures its own products under this brand name. Consumers often prefer branded products in place of national and Kroger has been successful in understanding this need. In 2009 Kroger earned around $1 billion in sales from this brand alone and the sales continue to grow today (Zahorsky). Such a step by Kroger would not only help the company but the industry as a whole. Liquidity Ratio Current ratio of Kroger Co. for the financial year 2012: = = 0.804 Current ratio for the year 2012= 0.804:1. The current ratio for the industry is around 0.8 which is the same as Kroger (Kroger Co. Ratios, 2012). The relatively high current ratio indicates good performance on part of Kroger because it is extremely important for Supermarkets to have ample amount of liquidity at all times. The nature of the industry is as such that cash should be available at all times either in the form of notes or in the form of short term assets. Suppliers have to be paid off and reordering also requires advance payments on part of the company. Although the current ratio is the same as the industry average Kroger can increase its current ratio up to 1 in order to break even with its liabilities. A current ratio of 1 or 1.5 is considered safe and Kroger can strive to achieve this in later years. It is important to realize that a very high current ratio does not necessarily indicate a company’s success and may result in too many resources being tied up in cash which increases the opportunity cost for the company. Profitability ratio Gross Profit Margin = = 1.41% Gross margin for the financial year 2012 is 1.41% The industry average for gross margin is around 0.22 which is much higher than that of Kroger (Kroger Co. Ratios, 2012). Kroger has lower gross profit margins due to increased costs of raw materials such as fuel and needs to cut down on its costs if it wants to compete effectively in the market. Sales have decreased in the recent years and costs have increased which have contributed towards this fall in gross margin. Gross margin is the best indicator of how a company is able to cover its costs and Kroger is merely covering its costs. Cost effective methods need to be adopted and advertising should be increased in order to boost sales and reduce costs. Kroger has major competitors such as Wal-mart and Safeway which are highly effective in terms of costs and if Kroger wants to keep up with the industry it needs to work on reducing its costs to a large extent. It has around 42 manufacturing plants for its products and plants that are inefficient should be closed down in order to reduce inefficiency and high costs. Financial risk ratios Debt to equity ratio for the financial year 2012 = = 3.43 times Debt to equity ratio for the financial year 2012 is 4.92:1 or 3.43 times The debt to equity ratio for the industry is 205 times and this is extremely high when compared to Kroger (Kroger Co. Ratios, 2012). One of the strengths of Kroger is that it was able to cope up with the recent financial crises and reported profits in the financial year 2009, when all the other industries were going in a loss (Zahorsky). A company’s debt to equity ratio indicates the amount of debt a company has relative to its equity and Kroger seems to have less amount of debt on its shoulders. It is important to note that this ratio has its limitations and it is possible that Kroger has its assets financed by debt, which also indicates a debt issue. Asset efficiency (utilization) ratio Return on assets = = 2.56% Return on assets ratio for the financial year 2012 is 2.56% The industry average for this ratio is around 5.94% which is quite high (Kroger Co. Ratios, 2012). Kroger needs to maintain its return on asset ratios because a low ratio indicates that the assets are not properly utilized to generate income. The assets are not being utilized efficiently and this may be the reason for the increase in costs for the company. Gross margins are also falling and this coupled with a fall in asset returns indicates that inefficiency exists at Kroger. Current ratio is relatively high and it is possible that the assets are mostly tied up in inventory. If this is the case then the tied up inventory may be the reason for inefficiency and increased warehouse costs. Kroger needs to properly maintain its inventory in order to avoid low returns on assets. Valuation Ratio Price/Earnings ratio = = 23.6 times Price earnings ratio for the financial year 2012 was 23.6 times The industry average for the price earnings ratio is around 24 times which is slightly higher than that of Kroger’s (Kroger Co. Ratios, 2012). The difference is not significant and Kroger has performed well as far as the price earnings ratio is concerned. A high PE ratio indicates that investors are expecting a higher growth in earnings in the future. This indicates that Kroger is considered by investors in a positive light and the future outlook is positive. The more investors consider Kroger positively, the higher the investment would be and the more the company benefits. It is extremely important for every company to satisfy its stakeholders and Kroger is able to do so with high earnings per share given to its shareholders. Growth in PE ratio indicates shareholder satisfaction which can be fruitful for the company in the future. DuPont Analysis for the Year 2012 The basic formula for the DuPont analysis ROE= Profit margin*Asset Turnover*Equity multiplier or Net profit/Sales*Sales/Assets*Assets/equity ROE= 602100/90374400*90374400/23475300*23475300/3966800 ROE= 0.0066*3.849*5.917= 15.2% Return on equity of 15.2% is good considering the industry Kroger is operating in and this figure is higher than the industry average of 13%/ (Kroger Co. Ratios, 2012). The formula mentioned above shows that the highest contributor towards return on equity is the equity multiplier or Assets/Equity. The figure indicates that Kroger has high amount of financial leverage as far as the assets are concerned and a large amount of assets are financed by debt alone. Thus the return on equity is high due to these assets which are financed heavily by the liabilities Kroger has. The debt to equity ratio calculated previously was lower than the industry average which indicated that Kroger has of its equity financed by debt but the equity multiplier shows that Kroger has its assets financed by debt. The high financial leverage can work both ways for Kroger and investors would take account of this. When sales increase financial leverages causes the income to increase more than the increase in sales and this is beneficial for the company. At the same time if net income falls the affect is the opposite and net income falls drastically. Kroger already has high costs and it is possible that the reasons for these high costs are the assets. Assets are an important component of a firm’s equity and contribute greatly towards it but assets in isolation are not beneficial for a firm. These assets need to be utilized such that they produce the maxim returns for the firm. The return on asset ratio indicated that the assets are not being utilized effectively and hence the net profit margins and gross margins are not the major contributors towards equity. This might indicate a warning for Kroger because the assets are not being affectively utilized for the operations of the firm. The margin for net income is quite low and this means that any change in revenues would drastically affect net income. The gross margin is also extremely low and the affects are being felt by net profit margin due to high costs. As indicated above Kroger needs to cut down its costs in order to compete effectively in the market. The giant retailer Wal-mart has the lowest costs and if Kroger wants to compete it needs to focus on cost leadership. Inefficiency of plants needs to be reduced and plants that are not in use should be shut down in order to reduce overhead costs. Lastly, the sales/asset ratio is also quite high and is an important contributor towards equity. This shows that sales are also contributing towards assets but since net profit margin was low, it shows that sales are not being translated into higher net profits. This needs to be considered and again, Kroger needs to reduce its costs to compete effectively in the market. Overall, the return of 15.2% is good on part of Kroger and Kroger only needs to focus on reducing its costs. Moreover the assets are mainly financed by debt and this poses severe financial risks for the company. The debt to equity ratio is low but equity multiplier is high which indicates that much of the return on equity is due to assets which are financed by debt. This may be beneficial for Kroger in the short run but can have serious consequences for the company in the long run. Kroger needs to pay attention to the rising costs and the amount of assets it is holding. Since the returns are low Kroger should ensure that the assets contribute towards its primary operations. It is possible that these assets are lying idle and not being used for production or retailing purposes. Such idle capacity can lead to high costs for the company (which is indicated by lower gross profit margins and lower net profit margins) and decreased asset utilization. If this issue is solved Kroger would be able to offer competitive prices to its customer and also have enough cushion of net profit to benefit it in the future. Financial position of the company Overall the financial position of the company is healthy. The company has high liquidity since the current ratio is the same as the industry average. This will help Kroger because the nature of the industry is such that liquid cash is needed at all times to pay off suppliers. The debt to equity ratio is also low when compared to the industry average and this will save Kroger from facing debt crises. Kroger has always been able to manage its debt quite affectively and was able to earn profits in the financial year 2012 when other companies experienced losses. (Zahorsky). The main area where Kroger needs to focus on is cost. Costs have been rising rapidly for Kroger and this has impacted the gross profit margins and net profit margins. If this persists the high costs would have to be passed on to consumers and this can harm the cost leadership strategy of Kroger. The return on equity is higher than the industry average and the major contributor are assets. However these assets are not contributing towards returns such return on assets are lower than the industry average. This needs to be taken into consideration by Kroger in order to increase the efficiency of assets. Assets are also financed mainly by debt and this can pose severe financial risks for the company. Bibliography Co., T. K. (2012, March 1). Kroger reports fourth quarter and full year Financial results. Retrieved from Yahoo Finance: http://finance.yahoo.com/news/kroger-reports-fourth-quarter-full-131500635.html Kroger Co. Balance Sheet. (2012). Retrieved from Forbes: http://finapps.forbes.com/finapps/jsp/finance/compinfo/FinancialIndustrial.jsp?tkr=KR Kroger Co. Income Statement. (2012). Retrieved from Forbes: http://finapps.forbes.com/finapps/jsp/finance/compinfo/IncomeStatement.jsp?tkr=KR Kroger Co. Ratios. (2012). Retrieved from Bloomberg Businessweek. Reuters. (2011, June 16). Kroger raises full year outlook as Earnings rise almost 16%. Retrieved from The New York times: http://www.nytimes.com/2011/06/17/business/17kroger.html?_r=1&adxnnl=1&adxnnlx=1332620658-FT09K0ffUBb2qMvB3wt5XA Zahorsky, D. (n.d.). SWOT analysis of Kroger Co. Retrieved from About: http://sbinformation.about.com/od/marketresearch/a/swotkroger.htm Read More