Financial Performance of Sainsbury Plc and Tesco Ltd - Essay Example

Introduction Making investment decisions is one of the delicate jobs as it requires a comprehensive understanding of different parameters which can be considered to evaluate the performance of the firm. One of the key tools to evaluate the financial performance of the firm and to assess whether the investment should be made or not is the financial ratio analysis. Financial ratio analysis provides a critical insight, trends as well as historical performance of the firm to evaluate as to how the firm has actually performed during a given period of time. Sainsbury Plc is a public limited company operating in the retail business and is one of the leading supermarket chains in United Kingdom. It is the parent company of Sainsbury Supermarkets Ltd involved in the retailing business in UK and other parts of the world. With a market share of over 16.5%, it is one of the leading chains in the market catering to the various needs of the customers. Tesco Ltd is the market leader in the retailing industry in UK with major share in the market. It is also the third largest retailer in the world in terms of revenue and has its operations outside United Kingdom also. Over the period of time, Tesco has served the diversified needs of its customers in UK as well as other global markets. This paper will evaluate the financial performance of Sainsbury Plc and Tesco Ltd for the year 2011 and 2012 and based on the evaluation would provide recommendations to the potential investor. Turnover, Cost & Profitability As compared to 2011, there has been a positive growth in the revenue of Sainsbury of 5.3%. Revenue for the year 2011 was £21,102(M) whereas for 2012, it was £22,294(M). As compared to Sainsbury, Tesco’s revenue however grew by 6.8% indicating that Tesco has been better at improving its turnover for the year. There could be different factors resulting into this higher growth of Tesco because it is a global firm with presence in more international markets as compared to Sainsbury. Tesco is present in countries like India and China thus offering it much needed leverage against the difficult economic situations prevailing in UK and other developed world. In order to effectively shield itself against market movements, Sainsbury therefore needs to diversify its market presence to generate more value for its shareholders. Gross Profit margin for Sainsbury has declined from 5.5% to 5.4% however this reduction may not be large. Tesco’s gross profit margin has declined too from 8.5% to 8.2% showing a relatively larger reduction in the gross profit margin as compared to Sainsbury. It may therefore be a result of higher level of inflation prevailing in United Kingdom and other global markets. Profit margin of Sainsbury has declined from 3.0% to 2.7% whereas the profit margin for Tesco remained same. Sainsbury’s profit decline may be associated with the increase in the costs specially an increase in the interest expense and tax expenses. Tesco however has been able to maintain its previous level of profitability. The above results indicate that Tesco’s cost and profit structure is relatively better as compared to Sainsbury. Tesco has not only been able to retain its profitability but it has been able to increase its revenue too. This increase in revenue however may be due to overall size of Tesco and its presence in global markets. What is also critical to understand that Sainsbury need to diversify itself in order to become more profitable and achieve the higher level of profitability on consistent basis? Liquidity and Asset Management Current ratio of Sainsbury is 0.65:1 which has increased from 0.58:1 in year 2012. This increase in current ratio may be attributed to the increase in the current assets of the firm. Current assets increased from £1721(M) to £2032(M) whereas current liabilities have declined during the same period. Major increase has been in the inventories of the firm suggesting that the Sainsbury may not be able to rotate its inventory fast. Quick ratio which is more conservative form of liquidity has increased from 0.29 to 0.33. It is important to note that the current assets are relatively unproductive assets and higher accumulation of the same may not result into optimal allocation for the firm. Higher accumulation of current assets increases the cost because firm has to pay higher costs for managing its inventories as well as receivables. (Ee, Lee, & Lee, C2009) Current ratio of Tesco has decreased from 2.04: to 1.93: 1 which may be a healthy sign. It is important to note that a current ratio of more than 1 is considered as good as indicates that a firm has more than £1 to pay off its current liabilities. Quick ratio of Tesco has also reduced to 0.97 from 1.14.however it is still in the higher range. Considering the above figures, it can be considered that the overall liquidity position of Tesco is better as compared to Sainsbury. It is also critical to note that both the firms are operating in retail business therefore they need to have higher level of liquidity. Receivable turnover of Sainsbury has increased from 61.5 to 78.0 times suggesting that the firm has been able to improve its receivable turnover. Higher receivable turnover means that the firm has been able to recover its receivables too quickly and further tightened its credit policy to extend the credit to its customers. Receivables turnover for Tesco however has declined from 25.9 to 24.3 suggesting that Tesco might have relaxed its credit extension policy in order to allow more sales to take place. Inventory turnover of Sainsbury has declined from 24.6 to 24.1 indicating that the firm may not been able to move its inventory relatively quickly. Inventory turnover of Tesco however has remained same during the period indicating that the firm has been able to maintain efficiency while turning over its inventory into sales. A better and higher inventory turn not only suggests that firm has been able to make quick sales but also indicates about the overall marketability and salability of the inventories held by the organization. Fixed asset turnover for both the firms has remained same during 2011 and 2012 indicating that the firms may be engaged into better utilization of their fixed assets while at the same time improving the turnover. The above analysis suggests that both the firms, in terms of their overall asset management and liquidity have performed in the similar range. Tesco however has a better liquidity position suggesting that the Tesco’s working capital management is relatively better as compared to Sainsbury. Improved working capital management not only reduces the reliance on external financing but it also helps the firm to manage and control the costs. Capital Structure, Gearing and Dividends Sainsbury’s total debt to total assets ratio has increased from 0.52 to 0.54 for the period. The total debt to assets ratio of Tesco however has remained at the same level of 1.07. Tesco therefore has clearly used more debt as compared to its own equity to finance its assets and therefore highly leveraged firm as compared to Sainsbury. It is critical to note that the high level of gearing also increases the risk for the firm. The overall dividend growth rate for Sainsbury has remained healthy however Sainsbury has shown a dividend growth of 5.52% as compared to 6.62% in previous year.1 As compared to Sainsbury, the dividend growth rate of Tesco is higher however it has also declined during the current year. In 2011, it was 10.8% whereas in 2012 it remained at 8.8% showing a decline of 2% in dividend paid by the firm.2 It is also important to note that the dividend per share of Tesco has increased indicating that Tesco has been able to pay off better dividends as compared to Sainsbury. It is also critical to note that the overall capital structure of Tesco is relatively riskier as compared to Sainsbury. This is due to the fact that Tesco has been enjoying higher levels of debts as compared to equity. Higher proportion of debt in the overall capital structure of the firm increases the overall risks for the firm and thus makes it more vulnerable to external shocks as compared to firms with relatively low level of debt as proportion of its capital. (Reilly, & Brown, 2012). Conclusion & Recommendations The above discussion suggests that Tesco is relatively large in size and presence in different markets. Tesco’s sales as well as profitability is relatively higher as compared to Sainsbury however, it has higher level of debts. Further, its overall asset management has remained satisfactory as compared to Sainsbury. It has been able to maintain its inventory as well as receivables turnover despite the fact that overall economic situation is relatively difficult. It has however achieved its sales targets through relaxing its credit extension policy to its customers. Based on the analysis as well as financial performance of both the firms evaluated, it is recommended that Tesco as a stock will be a better option to invest as compared to Sainsbury. References Ee, A. C., Lee, J. C., & Lee, C. F. (2009). Financial Analysis, Planning & Forecasting: Theory and Application. Singapore, World Scientific. Reilly, F. K., & Brown, K. C. (2012). Investment Analysis & Portfolio Management. Mason, Oh, South-Western Cengage Learning. Read More