Sainsbury Plc's Financial Strategy - Essay Example

…………………………………………………………………..xxxxx ……………………………………………………………...xxxx ………………………………………………………………xxxxx …………………………………………………………………..xxxx @2012 Evaluate Sainsbury plc’s financial strategy Introduction The core focus of financial strategies is on the financial aspects of strategic decisions. Accordingly, this infers a close connection with the benefits of shareholders and therefore, with capital markets. For a corporate strategy to be successful, it must take into consideration all the external and internal participants in the corporate. Sainsbury’s Capital Structuring From recovery to growth, Sainsbury has exceptionally well regardless of the economic turndowns under the leadership of Justin King. Being the crown of United Kingdom grocer retail stores, there has been a lot of endless speculation on its financial performance. In spite of these speculations, it has risen to be the leader for the last two decades. Sainsbury has relied heavily on equity capital to finance its operations in the recent past. The management consists of the contributors of the needed capital. Being a company based in United Kingdom, where a company with more than 50% of its capital is considered highly geared, the management made a move in the year 2006 to incorporate high level gearing for the following reasons: It acknowledges the tax benefits associated with gearing in that tax is deductible; hence it does not pay tax on the borrowed finance. The shareholders of Sainsbury, who are the providers of equity finance, are not willing to accommodate new members thus debt finance was there ultimate option. Debt finance played a vital role in enhancing their operations in the year 2007 which was characterized by economic hardships globally. Dividend reinvestment plan This is another significant source of funds for Sainsbury Company. This dividend reinvestment plan allows stakeholders to reinvest their cash dividends through purchasing more shares in the market through a significant prearranged share dealing service. No new shares are allotted under this plan. It involves adding more value to the existing ones through a systematic way in order to achieve a balanced portfolio. The price and value of these shares fluctuate in response to the market waves. Stakeholders are fore warned of this possibility because the reinvested dividends in the form of shares may end up with a value or price that is less than the anticipated. Shareholders may then end up getting less than what they invested. Past performance is a guide to clear shareholders doubts and for those who are not sophisticated enough to understand the fir past performance are advised to seek the assistance of professional financial advisors. Dividend Policy Theories To aid in understanding of Sainsbury dividend policy, this paper acknowledges the importance of reviewing theories on dividend policies. With empirical research continuously being conducted by scholars on dividend policy, no consensus has ever emerged has scholars continuously keep disagreeing about the same empirical evidence. They all agree that dividend policy refers to management practices in making decisions on the criteria and amount of dividends to be paid to shareholders overtime. However, three dividend policy theories have emerged overtime; they are dividend irrelevance theory, low dividend theory and high dividend theory. These theories highly contradict each other, which leaves firms to decide which theory best suites their vision and thus incorporate it in their divided payment. Dividend debate is not limited to these theories. There are other minor approaches in advocated for by scholars. Dividend irrelevance approach Proponents of this theory argue that in a perfect market, dividend policy has no effects on the value of a firm or its cost of capital. Similarly, shareholders wealth is not affected by the dividend policy and as a result, both the firm and shareholders will be unconcerned amongst dividends and capital gain. The argument behind this hypothesis is that shareholders wealth and a firm value will be directly influenced by the investment decisions the management arrives at, and not how a firm distributes its gains. Consequently, dividend is irrelevant because regardless of how a firm distributes its financial gains, its intrinsic value depends on the basic earning power and its investment decisions. A firm dividend policy will have no effect on its share prices or the total returns to shareholders, which is the cash dividends paid out. This approach is based on the assumptions of a perfect market where, there are no expected differences in taxes and capital gains no transaction cost nor floatation costs are to be incurred in trading the securities, all market participants are assumed to have the equal access to all relevant information hence they are all price takers and that there is no conflict of interest between firm managers and security holders. High Dividends Theory This theory argues that, in the contemporary world of uncertainties and imperfect information, dividend will always be valued differently to retained earnings. This is because investors prefer specific cash dividends rather than uncertain future capital gains. Thus, holding all other factors constant, paying dividends results to an increase in a firm value. Payment of higher dividend reduces the uncertainty investors about the anticipated future cash flows. Thus, reducing the cost associated with capital, hence increasing the firm value. Graham and Dodd, argued that ‘a dollar of dividends has, on average, four times the impact on stock prices as a dollar of retained earnings’. Critics of this theory argue that the uncertainties or risks associated with firm future cash flows are associated with how a firm manages its operating cash flows, and not by how it distributes its earnings. In contrary, the proponents of this theory argued that firm risks is a contributing factor in the determination of a firm dividend payout, thus, dividend policy will have an effect on the value of the firm as well as shareholders wealth. Consequently, payments of higher dividends will not reduce or increase the risk of a firm, but riskiness of firm cash flows will influence the amount of dividends to be paid out. This signifies a negative relationship between a firm risk and dividend policy. Low Dividend Theory Dividend irrelevance theory assumes there is no difference in tax treatment between capital gains and dividends. In the real world, treatment of taxes differs and may have significant influence on dividend policy and a firm’s value. Investors are interested in after tax returns, and this might influence their demands for dividends. Thus, in an attempt to maximize shareholder wealth and the firm value, managers will respond by increasing the retention ratio of earnings, thus, end up paying low dividends. Proponents of this theory argue that payment of low dividends will lower the cost of capital and increase the price of the stock. In other words, low dividend payout policy contributes to maximizing the firm’s value. The core assumption in this theory is that dividends are taxed at a higher rate than capital stock and that they are taxed higher while capital gains are deferred until stock is actually sold. These tax compensations will thus influence investor’s decision on the amount of taxes they are willing to receive. Sainsbury’s dividend policy In the understanding of Sainsbury dividend policy, this paper notes that there are different types of dividends eligible for distribution by companies: Cash dividends are the utmost common and in most firms, they are paid four times in a year. Stock dividends are not factual dividends and they do not distress the worth of the firm or a shareholders capital, they are paid out as capital stock. Share repurchases involves the company obtaining back the shares, and the stockholders are required to pay tax on capital gains only. Stock split is similar to stock dividends, the shares held by shareholders are split or multiplied twice and the value divided by two. They have no effect on the firm financial value or shareholders wealth. They only serve to multiply the number of shares held by shareholder without affecting the value of those shares. Sainsbury plc usually pays an interim dividend each December/January and a final dividend for the previous financial year in July. Frequency and amounts of dividends to be per share are decided by the Board of Directors. Interim dividends are paid at 30% of the previous year profit totals. Payment of these dividends is extremely valuable to Sainsbury shareholders because it represents their returns. Shareholders who have a dividend payment plan have their dividend deposited directly in their bank accounts on the payment date. Details pertaining the payment are than set to shareholders via a tax voucher. This enables the company to cut down on paper and postage costs. It also reduces the risk of the cheque getting lost while in transit. Sainsbury has pleased investors by accelerating their payout ratio by nearly 36.09% in comparison of 14.94% of other similar industry players. This has been made possible by its finance policy of reinvesting of dividends. From the year 2007, it has been able to achieve momentum over its dividend per share, which was possible mainly due to its capital structuring and its reliance on equity finance. Sainsbury per share dividend indicates financial health of the company. Dividends are not paid in extra of Sainsbury cash flow amounts to avoid the need of borrowing more capital to finance its operations. Being a global company based in United Kingdom; it has established guidelines to avoid conflicting interests of the company with the expectations of its owners stationed in different parts of the world. From the above discussion, it is evident that Sainsbury dividend policy is a mixture of the three dominant dividend policy theories. Sainsbury recognizes the effect of tax on capital gains, dividend and value of the firm. Thus, in its decision of designing its dividend policy, it must have incorporated all the above information. Owing to the fact that, in the recent years it has relied heavily on debt financing and dividends paid out have been on the increase, it is arguably that it has incorporated dividend irrelevance theory assumption that the firm basic earning power is vital regardless of dividend policy in practice, high dividend theory suggestion on investors preference of certain present cash in comparison to uncertain capital gains and low dividend theory basic arguments about the differential treatment of taxes to arrive at this policy. Conclusion Although various studies on dividend policy have resulted into conflicting results, their findings have enhanced understanding of this policy. The more studies are undertaken, the more complex it becomes in understanding the dividend policy. From Sainsbury case, it is clear that a firm financial structuring has direct effects on dividend payout policy. Considerations such as tax advantages and shareholders willingness to accept management decisions are essential in arriving at the appropriate strategy. The selection of an appropriate strategy is a complex issue as evidenced in the Sainsbury case above. Sainsbury incorporation of various theories in its dividend payout policy points out the importance of having a well-rounded basis by firms. No single theory is enough in designing out the appropriate strategy by firms. This paper concludes that firms’ decisions on capital structuring and dividend payout policy are under the influence of the prevailing economic conditions. In Sainsbury case, its relied on owners’ equity for financing until 2006, when taxes and interest rates began rising as the economy destabilized. In an attempt to remain in business, its changed it financing strategy and incorporated debt finance a feature which had never been observed in the past company’s’ life. As a result it was able to enhance its operations and compensate providers of equity capital adequately because of the opportunities presented by tax advantages on debt finance. In conclusion, this paper suggests that further research should be conducted on this interesting field of dividend policy. Scholars should incorporate firms’ financial strategies with dividend payout policies in order to strive to acquire a common ground after so many decades of contradicting empirical evidence and scholarly literature. This study argues that dividend irrelevance theory has no basis and should be eliminated in the study of this discipline because in the real world there has never been and will never be perfect market scenario as it assumes. This misleading assumption is a contributing factor to the lack of unison on various studies conducted in this field. References Allen, Franklin , Antonio E. 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