Target plc - Assignment Example

?Contents Introduction 2 Financial Highlight 3 Corporate Strategy 3 Competitive Analysis 4 Competitive Advantage 4 SWOT Analysis 5 Financial Analysis7 Profitability Ratios 7 Liquidity and efficiency ratios 9 Structure Ratios 11 Conclusion 13 References 15 Introduction Target plc is one of the largest companies based in America providing food ingredients and retail and grocery solution worldwide. The study provides the details financial analysis of the company. In the case study the financial and operational evaluation of the company in questions has been undertaken. For the purpose of operational capability of the company, its corporate strategy has been analyzed in addition to the competitive environment and other risks to which it is being exposed. Target Plc is not a new name in the retail, food and ingredients industry and is considered analogous to quality and premium branding. The company is a diversified conglomerate having five major strategic segments which are sugar, agriculture, retail, grocery and ingredients. As per the latest financial statements of the company for the annual year 2012, the company is operating in almost all of the major cities of the United States. The vision and mission statement of the company is to achieve strong leadership in the course of business which is sustainable and long lasting. The company always strives to provide quality products to the individuals and other consumers and to become a necessary brand in the people’s day to day active life. Financial Highlight [Annual report Target, 2012 , Pg2] As apparent form the above financial highlight, the company presents a strong financial outlook and appears to be a lucrative company for the investors to invest in. The company has various revenue centers through which the company generates most of its revenues. During the financial year 2012, the highest earning revenue center for the company was heath, beauty and households which constituted about 25% of the total revenue of the company. Corporate Strategy Target Plc is now actively involved in acquiring new stores in order to capture a significant market share in the industry. Currently the company is facing tough competition in the market as new entrants are entering in the market and taking advantage of the new and improved industry state. The company current corporate strategy is to refurbish the acquired stores and outlets so that they have fashionable, modern and attractive presented stores located in prime locations all across the region. The primary capital expenditure of the company consists of extending its stores portfolio. Competitive Analysis In order to analyze the financial outlook of a company, it is of prime importance that the cost leadership and differentiation strategies of the company are analyzed. In addition, the best method to assess the competitive advantage is through porter’s five forces model. The major competitors of Target Plc are as follows: Wal-Mart Stores Kmart Corporation Costco Wholesale Corporation Competitive Advantage Porter’s five forces model is an effective tool in exploring the competitive forces of the environment in which the organization operates. It allows the business to critically analyze its current business strategy and formulate one which can allow it to achieve a competitive position in the market. With the advancement in Information Technology, it has been prominently observed that the businesses are now focusing more and more on implementing information system in order to make the best use of their resources. In the mentioned case, Target Corporation has several functional units carrying out activities related to the manufacturing and delivering of Sports merchandise. By integrating these units using information system, Target Corporation can gain competitive advantage in the market which can by analyzed in the light of Porter’s five forces model. The first competitive force according to the model is the entry of new competitors into the market. New entrants might be able to capture some of the market share of Target Corporation and will adversely affect the profitability. With the implementation of Information System, Target Corporation can repel this threat to its business. The sales department can maintain a database of the orders which can significantly assist in identifying which type of merchandise is most popular among the customers. This information can be utilized in building different promotional activities for capturing market share and building brand loyalty. Information System can aid the accounts department in setting up an EDI (Electronic Information Interchange) with its suppliers through which specification regarding the raw materials to be supplied can be sent via network and thus saving time and cost. Threat of substitutes is another competitive force in the Porter’s model. For Target Corporation threat of substitutes in the market could mean cheaper merchandise and sport goods. Implementation of information system can help in improving the customer service in the organization by linking the functional department together and thus adding value to the business strategy. If the inventory management is computerized with the help of information system, cost of holding excess extra stock can be reduced and thus eventually the cost per merchandise is less. When Target Corporation merchandise, the cost of switching for the customer is higher and they will refrain from buying any other substitute. Target Corporation can maintain a database containing all the prices of the substitute products in the market. Regular Analysis of the database will keep the company inform about the changes in the prices of these products and how they should respond to it. Development of a website on which customers can place their orders and integrate it with all the other functional departments can also enhance the customer convenience. Bargaining power of suppliers is another factor which the Target Corporation must consider in order to operate effectively and profitably in the market. The purchasing unit of Target Corporation can maintain a comprehensive database of the suppliers in the industry and can short list the most suitable. Computer Aided Designs (CAD) can be used to design components with the suppliers in order for the transaction to be done more continently. Another important aspect in this regard is the switching cost. In order to tackle the bargaining power of the supplier, suppliers can be integrated with the firm’s administrative operations by a system of Electronic Data Interchange (EDI). It is of prime importance to curtail the bargaining power of the customer for acquiring competitive advantage. Installation of an Information System in the organization will enable the company in identifying the concentration of the buyers and also the major buyers. Targeting the customers through product differentiation will prompt the customers from switching to other suppliers. Since merchandising and retailing is a flourishing industry thus rivalry from the competitors is another factor to consider. Target Corporation can establish a comprehensive network with its Supply Chain and with its customer through information system. SWOT Analysis The SWOT analysis of Target Corporation is as follows: Strengths Celebrity endorsements Strong brand awareness and recognition Business and operations strategies Employee retention Design and innovation Weaknesses Low global presence Quality obsession Litigation Opportunities Global expansion Tapping the untapped Focus on private label products Threats Economic condition Fierce competition Financial Analysis Ratio analysis is considered to be a very accurate and reliable tool when it comes to analyzing and interpret the financial outlook and performance of an entity. The main reason for performing a ratio analysis is to quantify the results of the financial operations of an entity and analyze them in the light of financial performance of the prior year(s) in order to assess different aspects of the financial feasibility. [Peavler, R. (2001)] The financial ratios are usually divided into various sub categories such as profitability, gearing and liquidity, each put emphasis on a different area of the financial outlook of the organization. These analyses form an integral part of the financial statement analysis, especially from the investor’s point of view, which are always looking for avenues to invest in countries having strengthened and stabilized financial ratios and representing an upward trend. It is of great significance that the ratios must be benchmarked against a standard in order for them to possess a meaning. Keeping that into account, the comparison is usually conducted between companies portraying same business and financial risks, between industries and between different time periods of the same company. [Investopedia.com (2012] The financial ratio performance of Target Corporation has been evaluated for the last three years in order to draw attention to various financial trends and significant changes over the period. The analysis is divided into three main categorize namely Profitability, Liquidity and Gearing. Profitability ratios identify how efficiently and effectively a company is utilizing its resources and how successful it has been in generating a desired rate of return for its shareholders and investors. Liquidity ratios measure the ability of the company to quickly convert its asset into liquid cash to settle its short term liabilities.[ Cheng, A & McNamara, R (2000] Whereas, the Gearing ratios identifies the extent to which the company is financed through debt and to what degree the operations are being conducted from the finance raised through raising equity capital or otherwise. For the purpose of financial ratio analysis, the financial year from 2010-2012 have been evaluated in order to analyze the financial outlook of Target Corporation. The information has been extracted from the annual report of the company and the figure utilized in the financial ratio analysis is of the entire group. Profitability Ratios   2012 2011 Industry Average   Profitability Ratios Gross profit margin 31.01% 31.50% 23.359 Net profit margin 7.33% 7.62% 6.211 ROCE 32.44% 33.64% 9.969 Asset turnover 1.53 1.55 1.14 Return on assets 6.62 6.48 7.36 Interest coverage ratio 6.91 6.13 5.25 Free cash flow(% of sales) 4.66 1.53 2.66 Free cash yield(% of net income) 1.08 0.36 0.22 Gross profit margin is an analyzing tool which assists in identifying how effectively and efficiently the company is utilizing its raw materials [1], variable cost related to labor and fixed costs such as rent and depreciation of property plant and equipment. The ratio is calculated by dividing the sales revenue by the gross profit. If we analyze the gross profit margin trend of Target Corporation it appears that there is no considerable change in the percentage over the prior two financial years. This presents that fact that the company has been able to maintain its cost of sales and made sure that it remains in constant proportion with the revenue. The company has been able to manage the impact of inflation in the cost of material and labor. Net profit margin, on the other hand analyzes the profitability of the company before deducting the taxation and finance charges from the earnings [2]. The ratio is calculated by dividing the profit after interest and tax with the sales revenue of the current financial period. The ratio highlights how well the company is managing its selling and administrative expenses it also highlights the other income generated by the company during the course of its operations. The net profit decreased marginally in the financial year 2012 as compared to the financial year 2010. The primary reason behind such decrease in the net profit margin is that the operating expenses of Target Corporation although increased in the financial year 2012, but they increased with a lesser proportion as compared to the revenue of the company. In the financial year 2011 the net profit margin has also shown an decrease though marginal. Return on capital employed (ROCE) is, according to the analyst, considered to be the most significant ratio in order to evaluate a company’s performance from an investor’s point of view. ROCE measures a company’s ability to earn a return on all of the capital that is being employed by the company [3]. The ratio is calculated as net income upon total capital employed, which is the sum of debt and equity financings. The return on capital employed is showing a fluctuating pattern as presented in the tabular representation. If we evaluate the tabular information, the ROCE decreased marginally from the financial year 2010 to financial year 2011. The net profit of the company increased during the financial year 2011 which resulted in a sharp incline in the return on capital employed. However, in the financial year 2012, the ratio shows a lesser incline. The primary reason behind such incline is the increase in the net profit for the company. There are several reasons for the incline in the net profit of the company. The operating profit of the company increased due to proper management of general and administrative expenses. The reason behind such hiked up administrative expenses is the cost expanded on the refurbishment and setting up of the acquired stores and outlets, which were acquired on account of the merger and acquisition transactions. In addition, the finance charge of the company also increased during the current year due to the fact that the company acquired additional financing facilities from several banks and financial institutions in order to finance its working capital requirements. Return on assets has also decreased in line with the ROCE. The reason behind such decrease is the decline in the profitability due to the increase in the cost of sales of the company. The company needs to curb its raw material and labor cost in order to further strengthen its financial outlook. Interest coverage ratio further highlights the impact of the interest charge on the profitability of the company. As per the debt equity ratio mentioned below, there is not much difference in the capital structure of the company. However, the company has been able to reduce its debt in the capital structure which is also represented by the increase in interest coverage. The cash flow forms an integral part of the financial statement of any organization. The primary purpose of preparing the cash flow statement is to let the users of the financial statements aware of the inflows and outflows of the cash flows. The cash flows are divided into three main sections as under: Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities The free cash flow of the company has also improved over the last two financial year which shows that company has been able to manage its operational activity quite well. A comparison with the industry figures will present the fact that when it comes to gross profit margin, the company is performing above the general expectations. This could be due to the fact that the company has been able to curtail its production cost and at the same time, has able to generate enough sales resulting in decreasing gross profit margin. On the other hand, the company’s net profit appears to be better than the industry average which is a positive sign showing that the company has been able to control and curtail its administrative expenses. The figure which appears most impressive is the return on capital employed which is significantly greater than the industry average. This might be the primary reason that the share price of the company is at an escalated price. Liquidity and efficiency ratios 2012 2011 Industry Average Liquidity Current ratio 1.17 1.15 0.80 Acid test ratio 0.60 0.60 0.60 Debtors turnover period 12.55 11.79 10.14 Inventory turnover 6.40 6.04 4.33 Days Sales Outstanding 31.56 35.53 25.63 Days Inventory Outstanding 58.61 57.88 60.15 Payable days 51.46 50.94 45.25 The liquidity ratio measures the company’s ability to pay its short term liabilities. The ratio illustrates that how quickly a company can convert its assets into cash and cash equivalent in order to pay off its short term liabilities [Investopedia.com (2012)]. The most commonly used liquidity ratio, the current ratio, which is calculated by comparing the current assets and current liabilities. The strengthened the current ratio the more ability the company has to pay its debts and short term obligations over the next 12 months. As apparent from the above financial ratio analysis, the current ratio of the company has always remained above 1 which shows that the company has the ability to discharge its current liabilities. The current ratio of the company has increased from the financial year 2010 to financial year 2011, which was primarily due to the increase in the accounts receivable balance of the company. The accounts receivable of the company increased in line with the revenue. Although from one point of view, it appears to be a positive sign for the financial outlook of the company that its current assets are increasing in the form of accounts receivable. But on the other hand, this shows that the company has been slower in recovering in cash from its customer thus resulting in a higher accounts receivable to revenue percentage. The acid test, which is also regarded as the quick ratio, is calculated by subtracting the inventory balance from the total current assert balance. Out of the current assets mentioned, inventories are regarded as the one which takes comparatively more time to be converted into cash or cash equivalent. The acid test ratio has followed the same trend as the current ratio and only marginal change has been experienced in the acid test ratio. Receivable turnover represents how quickly the cash is received from the debtors. The ratio is calculated by dividing the revenue generated from the sales by the receivable balance as mentioned in the balance sheet of the company. The formula calculates the number of times the debtors are turned over during a year. The higher the value the more efficient the management is or it could also mean that the debts are more liquid. The accounts receivable turnover ratio has remained constant over the past three financial years. Inventory turnover represents how quickly a company’s inventory is sold, which can be calculated by dividing the sales revenue by the average inventory balance as at the year end. High inventory level is not beneficial for the company as it represents that the company’s investment is tied in inventory and currently it is not generating any income. A lower inventory turnover period represents that the sales are poor and there is excess inventory in the storage. Whereas a higher turnover period might represents that sales are comparatively higher. An inventory turnover period can also decreased due to the shift in the operation policy of the management e.g. if the management decides to increase the level of ‘safety stock’ then the balance of closing inventory would be greater and thus inventory turnover period would decrease, although the sales would have increased during the period. The inventory ratio has also remain constant over the past few years and the level which it is on currently presents the fact that the company is able to recover cash from its inventories at a quick pace. Both the current asset and acid test ratio of the company is greater than the industry average which presents the fact that the company has more than enough liquid assets to discharge its current liabilities. Structure Ratios 2012 2011 Gearing Ratios Equity ratio 0.34 0.34 Debt ratio 0.66 0.66 Debt : equity ratio 0.66:0.34 0.66:0.34 The gearing ratios and indicate the level of risk taken by a company as a result of its capital structure [Peavler, R. (2012)]. These ratios are a great source of determining the level of financial risk to which the company is exposed and thus helps in reducing it to the optimum. The equity ratio indicates how much of the entity’s assets are financed through the finances generated through the revenue generated from the operations of the entity and raising financing through equity issue rather than acquiring debts or other financial institution. The debt to equity ratio of the company has remained almost the same throughout the period. If we analyze the statement of financial position of Target Corporation for the current financial year, it will present the fact that the long term debt has increased during the current period. This is a bit negative for the company as it shows that majority of the company’s non-current assets and the working capital is financed through long term capital, for which the company would have to incur interest cost every year. A brief glance on the income statement will also prove the fact that interest expense has also increased during the last three financial years. The impact of debt on the capital structure can be analyzed from two different perspectives of financial accounting and financial management. Educated investors only invests in companies analyze several ratios such as current ratio, quick ratio and debt to equity ratio. Current ratio is quite important from the investor’s perspective as it tells the state of liquidity of the company and would it be able to pay off its long term debts in the future. The most commonly used liquidity ratio, the current ratio, which is calculated by comparing the current assets and current liabilities. The strengthened the current ratio the more ability the company has to pay its debts and short term obligations over the next 12 months. The asset test, which is also regarded as the quick ratio, is calculated by subtracting the inventory balance from the total current assert balance. Out of the current assets mentioned, inventories are regarded as the one which takes comparatively more time to be converted into cash or cash equivalent. The gearing ratios indicate the level of risk taken by a company as a result of its capital structure. These ratios are a great source of determining the level of financial risk to which the company is exposed and thus helps in reducing it to the optimum. The equity ratio indicates how much of the entity’s assets are financed through the finances generated through the revenue generated from the operations of the entity and raising financing through equity issue rather than acquiring debts or other financial institution. In addition to the above, the cost of raising funds in the form of loan acquired from the bank or financial institutions is substantially less as compared to the cost of raising financing through shares or bonds. The cost of raising equity comprises of printing of shares, cost of listing the equity shares on the stock market and the legal and professional charges paid to the consultants for the due diligence of floating the new shares in the market. When it comes to raising finance through debt, very little or minimal cost is involved for the sanctioning of the loan whether it is long term or short term. However, with so many disadvantages for raising fund through issuance of equity, the biggest advantage of raising funds through issuance of shares is that no subsequent cost arises in such respect. For raising funds through debt financing, the company has to pay interest charges to the financial institution based on a predetermined rate. The interest rate is usually depended upon the tenure of the loan. The longer the period the higher the interest rate is expected to be. Moreover, there can be a situation where the company is not able to discharge its liabilities, for example the case where the company is short of liquid assets. No payment of interest charge can label the company as defaulter by the bank or the financial institution and it would not be able to secure financing from the very same financial institution in future. Another factor which the investors consider, while making investment, is the imposed debt covenant that the company must comply. Banks and financial institutions, while sanctioning long term finances to companies impose certain restrictions such as maintenance of debt equity ratio, ensuring that the current ratio level does not fall below a specific level, the profitability of the company does not decrease below a specific level etc. [Investopedia, 2013] Conclusion Based on the above financial analysis of Target Corporation, it appears that financial outlook of the company is strong and the company has a positive future. The share price of the company has been inclining in the recent history and the shareholders can gain both from the dividend income and the capital gain if investment in the company is made. If we analyze the financial ratios, the company’s financial outlook looks stable. All of the profitability ratios of the company are better than the industry average and the company appears to managing its resources quite effectively. In order to assess the investment opportunities of the company, it is also important to analyze the American retail market.The growth in the American retail market for the financial year 2012 saw an escalation as compared to the previous financial years. During every quarter of the financial year, the retail industry in USA experienced a growth of 1%. The analysts are of the view that this particular growth in the industry is a definite positive sign if it is compared to the last two financial years. The retailing conditions in the past two years remained quite adverse for the companies but now the situation appears fruitful and lucrative for the companies. A Comparison of financial year 2012 with the financial year of 2011 presents that fact that the volume of sales in the retail industry in USA increased by 2.7 percent. Changes in reported retail sales between August 2011 and August 2012 standard reporting periods (by size of business)     Pre-dominantly food Non-specialized pre-dominantly non-food Textile, clothing and footwear House-hold goods Other non-food Non-store retailing Pre-dominantly automotive fuel Total All Retailing including automotive fuel                     increase 107 32 138 72 375 64 23 811 All decrease 97 33 104 77 306 46 50 713   Total 204 65 242 149 681 110 73 1524                     Large increase 66 32 110 42 158 30 n.a. 438 decrease 56 33 73 47 107 19 n.a. 335   Total 122 65 183 89 265 49 n.a. 773 Small increase 41 n.a. 28 30 217 34 23 373 and decrease 41 n.a. 31 30 199 27 50 378 medium Total 82 n.a. 59 60 416 61 73 751 [Ons.gov (1999) Retail Sales: August, 2012] With respect to the sports merchandise business, there were certain hardships that were faced by the retailer. During the year 2012, costs of both cotton and fuel increased, particularly of fuel which resulted in an escalation in the manufacturing cost of the merchandise. Target has in place an import team which constantly monitors the fluctuation in prices of cotton. For the purpose of reducing the cost of fuel, the retailers are now acquiring the help from the appropriate technology to manage the distribution in the most cost effective manner. References Investopedia.com (2012) Profitability Indicator Ratios: Profit Margin Analysis | Investopedia. [online] Available at: http://www.investopedia.com/university/ratios/profitability-indicator/ratio1.asp [Accessed: 24 Oct 2013]. Investopedia.com (2012) Understanding Financial Liquidity. [online] Available at: http://www.investopedia.com/articles/basics/07/liquidity.asp [Accessed: 24 Oct 2013]. Investopedia.com (2012) Equity Financing Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/e/equityfinancing.asp [Accessed: 24 Oct 2013]. Peavler, R. (2001) Profitability Ratio Analysis. [online] Available at: http://bizfinance.about.com/od/financialratios/a/Profitability_Ratios.htm [Accessed: 24 Oct 2013]. Peavler, R. (2013) Debt and Equity Financing. [online] Available at: http://bizfinance.about.com/od/generalinformatio1/a/debtequityfin.htm [Accessed: 24 Oct 2013]. Qfinance.com (2010) Gearing Ratios - Definition of Gearing Ratios - QFINANCE. [online] Available at: http://www.qfinance.com/dictionary/gearing-ratios [Accessed: 24 Oct 2013]. Read More