Financial Analysis and Risk Management of Kingfisher Plc - Essay Example

Financial analysis and risk management of Kingfisher Plc Company profile: Kingfisher Plc Kingfisher Plc is a British multinational company operating in the retail zone. The company is headquartered at London, United Kingdom. Kingfisher is also the largest retailer in home improvement sector in Europe. The company presently functions in nine countries in Europe and Asia with about 1100 stores. The current number of employees working in the organisation is 79000 and the management claims to serve around six million customers every week. The company deals with home improvement products such as, household appliances, garden supplies, tools and hardware (Kingfisher, 2014a). The major retail brands of Kingfisher Plc are B&Q, Castorama, Brico Depot and Screwfix. The company is also operating in Turkey in 50% joint venture with Koc Group. The market capitalisation value of Kingfisher Plc is £ 9100.92 million. The sales turnover of the company as on February 2014 was around £ 11.1 billion and the pre-tax adjusted profit was £ 744 million. Asia is its key sourcing market, along with Eastern Europe, Turkey, South America and Middle East. The main competitors of the company are Wolseley Plc, Homebase limited and Leroy Merlin (London Stock Exchange, 2014). The financing of the company includes a number of debt funding instruments such as, bank borrowings, leases, medium term notes and US private placement debt (Kingfisher, 2014b). The main purpose of doing this paper is to understand various leverages of international retail chains and analyse the financial position and risks associated with operating in different nations. Strategy Keeping in view the international nature of Kingfisher’s business and growing globalisation across the world, certain strategic factors need to be considered by the company regarding its geographical location, financing and its degree of completion. From competitive position, the company presently belong to one of the top-performing companies in retail sector and major strategic advantage of the company is its tendency to acquire small businesses. The company has undertaken joint venture to enter the Turkish market, which is considerably an important strategy. Hence, the company’s entry strategy differs from market to market. The SWOT analysis of Kingfisher Plc shows that the major strengths of the company are dominant market position, healthy business ratios and innovative products and services. The weaknesses include less investment in research and development and excessive dependence on France and UK market. The opportunities of the company are growth in e-retail and global home improvement industry while the company can face threats like slow economic growth of European market, rising cost of manpower and high competition. Financial trend analysis The financial trend analysis has been done on last five years, which is 2010-2014. The ratios included in the analysis are liquidity ratio, performance ratio and efficiency ratio. For calculation, refer to the excel sheet. The data related to financial statements have been collected from the company website (Kingfisher, 2011; Kingfisher, 2012; Kingfisher, 2014c). Table 1 (Source: Author’s creation) Liquidity ratio The liquidity ratio measures a firm’s ability to meet its short-term obligations. These obligations are generally met within a year’s time. One of the important liquidity ratios is the current ratio. The current ratio, which is also known as working capital ratio, helps in determining company’s capabilities to pay-off the liabilities, if and when they are due with the current assets. The accepted standard of current ratio is 1. In Kingfisher Plc, current ratio has been calculated for last five years and represented graphically in figure 1. Figure 1 (Source: Author’s creation) The current ratio trend of Kingfisher Plc shows that working capital position has been quite stable and has increased consistently 2012 onwards. It was further observed that the firm had negative working capital during 2010, 2011 and 2012. The reason for negative capital can be generation of quick cash; as a result, quick selling of inventory. Such a scenario is quite common in retail industry (Robinson, et al., 2008). Efficiency ratio The efficiency ratio measures effectiveness of a firm, in terms of its operational activities such as, collection from debtors, paying-off creditors and turnover of inventory. Efficiency ratios are important as increase in efficiency denotes better profitability. The important ratios under efficient ratio are creditor turnover ratio, debtor turnover ratio and inventory turnover ratio. Creditor turnover ratio explains the pace at which a company pays off creditors. If the ratio is declining, it indicates that the firm is taking longer time to pay off its creditors, whereas an increasing ratio reflects quick pay-off. The creditor turnover ratio is graphically represented in Figure 2. Figure 2 (Source: Author’s creation) The average turnover ratio for Kingfisher Plc in past five years is 2.76; if this is converted into number of months, then it will be a little above four months (12/2.76). The ratio has fluctuated considerably over the years, but not in extreme manner. Keeping in view the kind of bulk purchase that the firm undertakes, the ratio is acceptable. Debtor turnover ratio is a measure of efficiency of a firm’s credit and collection policy. The ratio is useful in determining time span within which the debtor will pay back. A lower debtor turnover period is preferred as with quick payment, scope or risk of bad debt and default is eliminated. Figure 3 represents graphically the debtor turnover ratio of Kingfisher Plc. Figure 3 (Source: Author’s creation) The graph shows that over years, the debtor turnover ratio has declined consistently, but the figures are quite close, which means that Kingfisher Plc has implemented an efficient credit collection policy. The turnover period was 17 days in 2010 and has increased to 19 days in 2014. Therefore, the scope default can be eliminated for the company (Romic, 2011). Figure 4 (Source: Author’s creation) The inventory turnover ratio expresses efficiency of a firm in selling and replacing (refilling) its inventory batch. It is considered that higher value is better for a firm. The inventory turnover has slowly improved over years since 2011, which is a positive sign, implying that the company has little accumulation of stock and its products are selling actively in the market (Subramanyam and Wild, 2009). Performance Ratio The performance ratio is mainly related to a firm’s profitability and is expressed using gross profit margin, net profit margin and return on capital employed ratios. The gross profit margin represents percentage of the sale, which is available after paying off costs related to sale such as, that of raw material, production, advertisement and promotion. Figure 5 represents the gross profit margin of Kingfisher Plc. Figure 5 (Source: Author’s creation) The company’s gross profit has been consistent around 37% over the span of five years, except for a minor fluctuation, which can be due to various costs. The net profit shows firm’s efficiency in achieving overall profitability. The net profit margin of Kingfisher Plc has been represented in figure 6. Figure 6 (Source: Author’s creation) A growing net profit margin shows that the company was able to reduce its operating expenses and other cost significantly, thereby exhibiting consistent growth in net profit. As per retail industry standards, ratio figures are good for the company (Zack, 2013). The return on capital employed ratio reflects efficiency of firm’s strategies involved for utilising the total capital in earning profit. Investors usually prefer growing return on capital when compared over years. Figure 7 (Source: Author’s creation) The graph shows that there is consistent growth in the return from 2010 to 2012. However, the return fluctuated in 2013, but exhibits growth again in 2014. Except for 2013, the company has been performing well, in terms of deploying capital, to generate profit (Subramanyam and Wild, 2009). Risk management Kingfisher Plc is one of the largest retailers in United Kingdom and is operating in a number of countries across the world. Hence, it is expected that the company encounters a number of risks such as, liquidity risk, credit risk, interest rate risk, foreign exchange risk and country and political risk (Busse and Hefeker, 2007). Multinational companies such as, Kingfisher Plc, are likely to face foreign exchange fluctuations and risks associated with operation in separate countries as political scenario varies accordingly (Clare and Gang, 2010). In foreign exchange risk, a company mainly faces two kinds of risks; translational risk and transactional risk. Translational risk exposure arises when companies purchase assets in foreign currency or record foreign assets in the balance sheet. The translational risk increases as a company purchases greater proportion of equity and/or asset denominated in foreign currency. Multinational companies try to minimise this risk by either purchasing currency swaps or hedging through future contracts. Transaction risk is associated with fluctuation of foreign currencies between entering and settling a contract related to purchase or sell of goods on credit, where price is in foreign currency; borrowing and lending transactions, where repayment is to be made in foreign currency; and so on and so forth (Kelley, 2001). Country risk is a bundle of different types of risk faced by a company while operating in a foreign market. These risks are political risk, economic risk, foreign exchange risk and so on. Country risk varies from country to country. Political risk is the impact of political instabilities or changes in a country on investment return of a company (Allayannis and Ofek, 2001). Exchange rate risk management The company is currently operating in United Kingdom, Ireland, Poland, Romania, France and other countries such as, Germany, China and Portugal. The principle currency exposures of the company are Euro, US Dollar, and Polish Zloty. Since the company owns retail businesses in Poland, France, Ireland and Spain, the Polish Zloty and Euro exposures are operational in nature. Kingfisher Plc generates considerable amount of profit by operating in the Euro zone; as a result, it is exposed to economic uncertainty prevailing in the member countries (Kelley, 2001). The company maintains a certain proportion of its debt in Euro so as to hedge euro translation exposure in the balance sheet. The company cannot take similar measures for its operations in other countries; implying hedging of translation of foreign currencies in sterling, as a part of its corporate policies (Kingfisher, 2014f). Kingfisher Plc purchases its inventories from different countries, where the payment is made in US dollar denominations. As such, the company faces certain amount of transactional exposure that is hedged by the company using forward foreign exchange contracts. In Kingfisher Plc, the risk management policy suggest that all subsidiaries of the company must hedge the committed inventory purchases, in addition to certain proportion of forecasted inventory purchases that will arise in future, generally within 12 months. The following section elaborates on the firm’s risk management activities, along with its foreign exchange gains and losses (Kingfisher, 2014d). In February 2014, Kingfisher Plc issued Medium term Notes (MTN) worth £ 73 million under its €2,500m MTN programme and swapped it to Euro based floating rate on 3 month EURIBOR using cross-currency interest rate swap. The company has been undertaking similar measures in past such as, in May 2006, it issued $ 466.5 million of 7, 10 and 12 years fixed rate notes to private investors in US. The proceeds were swapped to floating sterling liabilities on the basis of 6 month LIBOR plus a margin using cross-currency interest rate derivative contracts (Kingfisher, 2014e). Furthermore, Kingfisher Plc uses constant currencies to measure financial performance. Constant currency exchange rate is a rate of exchange that is employed by multinational companies with greater share of foreign operations in order to nullify the effect of fluctuations on exchange rate. In France, company’s sale for first quarter of 2014 was £ 1077 million, where the constant currency change was 3.3% positive and Like-For-Like (LFL) change was 1.6% positive. In addition, retail profit of the firm was 9.8% positive in constant currency change. In UK and Ireland, the company experiences 12.5% and 35.2% positive change in constant currencies in sales and retail profit respectively, while the LFL change was 10.1% for sales. In Poland, sales value was 12.9% higher in constant currencies and grew by 11.9% in LFL value. However, in Spain, sales grew by 22.4% in constant currencies, but it was 3.7% low in LFL value. On the other hand, in B&Q China, sales declined by 5% in constant currencies, which resulted in 4.4% decline in LFL value. Even so, in case of Russia, Turkey joint venture and Romania, sales and profits were positive in constant currencies as well as in LFL values (Kingfisher, 2014f). Country and political risk Every multinational organisation face risk and resistance while operating in foreign nations and the same is applicable on Kingfisher Plc. Country risk including political risk, economic risk and market risk, are impossible to control by a company. It is a serious mistake on a company’s part to ignore or understate political risk. Crises related to Euro zone negotiations and debt ceiling debate of United States came with no advance warning and affected all companies operating in these regions. Kingfisher Plc should be prepared for such situation as these problems cannot be avoided, but can be managed with appropriate risk management measures. The company needs to adopt strategies that comply with foreign country’s cultural, economic and social framework for smooth functioning. It has been observed that political risks are taking different shapes with increasing time. The greatest problem faced by a company is that it can neither measure nor completely mitigate political risks (Forbes, 2012). To manage political risk, Kingfisher Plc can include the same in its ERM (Enterprise Risk Management) systems so as to enjoy potential benefits of reduced risk management cost through purchase of insurance and rational hedging. Prior navigating in a foreign country, the company should access the country’s business environment using SLEPT (Social, Legal, Environmental, Political and Technological) analysis (Accenture, 2012). In a foreign country, the company can face two kind of political risk; macro risk and micro risk. Macro risks are adverse actions such as, protest, license cancellation, regulatory change, expropriation and insurrection, taken by the host country’s government against all foreign firms. The micro risks are limited to a particular industry or sector such as, prejudicial actions, taxation, capital control and corruption charges against foreign companies. Both these risks can result in huge monetary loss for the company. To mitigate such risks, Kingfisher Plc can enter in negotiation with host country’s legal system regarding terms of compensation. In addition, the company should not enter a country, where risk is not worth taking. Nonetheless, if opportunities are adequately lucrative to take the risk, then the company should invest in purchase of political risk insurance. The premium of these kinds of insurances varies from one country to another. As such, in a riskier country, the company have to pay high premium and otherwise (Dewit, 2001). Conclusion and recommendations The paper was undertaken in order to critically assess Kingfisher Plc from financial as well as non-financial point of view. As the company is growing beyond the borders, it is expected to face complications such as, currency risk and political risks related to a particular country. As recommendation regarding currency risk, it can be suggested that the company can apply non-hedging techniques such as, transfer of exposure and netting the exposure (Brown, 2001). Transfer of exposure is a good solution, but netting of exposure is mainly undertaken by large multinationals who are involved in huge foreign transactions. In addition, Kingfisher Plc can further reduce transaction exposure by making payment and receipts in different currencies. Other methods of reducing short-term risk are cross hedging, options, forward and future contracts. In addition, the company can enter in parallel loan and currency swaps to mitigate long-term risks (Allayannis and Ofek, 2001). In order to manage political risk, Kingfisher Plc can undertake Global Risk Management initiatives, where risk managers identify the key political risks and measure their possible impact on company’s performance. This in turn helps to determine best measures for managing these risks (Accenture, 2012). There are a number of political risk control methods that the company can employ such as, portfolio diversification, asset security management, political risk insurance, joint venture initiatives, lobbying and prominent alliances, social responsibility initiatives and resilient global supply chain management (Dewit, 2001). Reference list Accenture, 2012. Managing political risk. [pdf]. Accenture. Available at: [Accessed 14 June 2014]. Allayannis, G. and Ofek, E., 2001. 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