Tesco vs Sainsbury Finance and Accounting - Case Study Example

RUNNING HEAD: Finance and Accounting Tesco vs Sainsbury of Executive Summary This paper has found Tesco to be more profitable and efficient, but less liquid and less superior in financial leverage than Sainsbury. The evidence could be seen in terms of better ratios of profitability, efficiency and less superior liquidly and financial leverage ratiosas extracted from the financial statements of both companies. In relation to the respond of the investors to their financial performance, based on some of the valuation ratios, better indication of more increased stockholders’ wealth can be seen higher in Tesco over that of Sainsbury . This paper has found an evidence of a direct relationship between profitability and increase stockholders’ wealth using the valuation ratios. Aiming for profit maximization is therefore not inconsistent with aiming for maximized wealth for companies. However the increased in profitability may reach a point where there is increased risk in which case, the target profitability should be that point whether the company would not expose itself to greater risk that would increase its cost of capital and therefore would no longer maximize the wealth of stockholders. But based on available evidence and all other assumed equal, it would be better to choose Tesco over that of Sainsbury. The better perfirmance of Tesco may also give justification to getting into international markets by Tesco but not Sainsbury. 2. Introduction This paper seeks to prepare a business analysis report covering TESCO plc and Sainsbury of the United Kingdom (UK) by conducting a financial analysis from their financial statements using financial ratios in relation to the valuation to available market valuation rations for purposes of choosing which is better company for investment purposes. Both companies are from the retail industry and they are deemed to more or less bound by the same industry opportunuties and industry threats. However not two companies may be assumed a good as the other when it comes to responding to the same industry opportunities and threats and both companies try to generate value for their shareholders. By looking at their financial statements through the use of their financial ratios in relation to rest of the industry, this reseacher would have an objective view of how is better in managing each company’s resournces in relation to their objectives and and external environment with which they operate. Tesco plc (or “Tesco”) is an international retailer based in the United Kingdom (UK) while J Sainsbury plc (or “Sainsbury”) is focused mainly with the United Kingdom. The first company is now the leader in the grocery retailing in UK and considered as third largest retailer in the world in terms of gross sales (Reuters, 2011a). This should explain why J Sainsbaury which was earlier the biggest retailer in the United Kingdom until Tesco has over taken the company in terms of gross sales in the past. The first company though was originally UK-focused retailer too like the second. It had specialied in food and drink but events caused the compant to diversify by products and and geographical locations. The Sainsbury has remained with UK mainly with focused retailing with the related financial services, under threee operating segments in operating of not less than a total of 900 stores broken into more than 500 supermarket and not more than 300 converniece stores (Reuters, 2011b) Tesco’s retailing has reached China, the Republic of Ireland, Slovakia, South Korea, Thailand, Turkey, Malaysia, Poland Hungary, The Czech Republic, India, Japan and the United States (Tesco, 2011a). Is going internationally necessarily better for Tesco as compared with Sainsbury? This will be part of the questions to be answered in this paper. 3. Financial Analysis (1500) Financial analysis applies different ratios for purposes of determining and understanding the profitability, efficiency and solvency of the business organization (Helfert, 2001). Comparing yearly performances of a company against another company is expected and is in fact practiced to determine which is better between the two. But complementing the analysis by the use other statistics from the industry can have a better view in one aims to have a more objective basis for evaluating whether a company is superior one over the other. Retail industry where both Tesco and Sainsbury operates has other companies with them selling the similar and services to the public. Such retailing essentially entails buying finished goods from suppliers to be resold to the final or other customers. Thus retailing could actually cover wide range of products including clothing, apppliances, electronics, home products, grocery items and the like. The companies in the industry although selling similar products and services have different ways to compete and each one wants to not only to survive the competition but also to please their shareholders by maximixing the wealth of the latter. The most readily available and measurable way to acocmplish the same would be profitability and efficiency. The other would be liquidity while the third would be solvency. These ratios are discussed separately short and the interplay of one over the other to have appreciate their impact in the value generation for shareholders. 3.1 Profitability and Efficiency Profitability ratios measures companys ability to earn a satisfactory return on sales, total assets, and invested capital (Helfert, 2001) . However what is satisfactory to one may not be satisfactory to others. It would not be a sweeping statement to say that a company earning a 4% return on sales or net profit margin is superior to another company earning a 3% if the same ratio is supported with other related ratios of the companies. This may appear as the initial picture of Tesco and Sainsbury with first having the higher rate and the second company with the lower rate. By investigating the gross margin of two companies, Tesco averaged 8% while Sainsbury averaged 5% for the last three years from 2009, 2010 and 2011. The advantage of ratio in gross margin was again validated in in having net profit margin where Tesco exhibited 6% as against Sainsbury’s 4%. See Table A below together with Appendix A. Table A- Summary of Comparative financial ratios, Sources; (Tesco, 2011a, 2011b; Sainbury, 2011a, 2011b: Reuters, 2011c , 2011d) Profitability ratios are measurements to quantity the trend in the potential of these companies to repeat the performanace in the same way that a medical check up results would tell how healthy is the person at a certain point time. Gross profit margin which relatea gross income to sales tells on how much can the retail companies can get from selling the products and services by comparing the selling price and the cost of the product. It may be pointed out that both companies have below 10% gross margin but the rest of competitors are having 33 %. This would indicate a wide lattitude where companies could actually become moreprofitable. This was observed in the relationship of the gross margin in relation with net profit margins and net operating margins of the two companies. 3.2 Liquidity ratios Good liquidity ratios would equal to good capacity to pay curent obligations. Such ability to meet such currently maturing obligations is demanded from companies or they could could be viewed to be near or going into bankruptcy which is bad investors. Good liquidity is akin to having a well-conditioned car which can assure the car owner lack of trouble with a short period of time. A liquid company pays the salaries of its employees, accounts payable with outside suppliers who keep on delivering goods to put in the shelves of the stores and supermarkets and other accrued expenses that must be settled at the right time so that they could also conduct their daily activities. Do the companies have these characteristics? Tesco’s average current ratio at 0.65 was higher than Sainsbury with an average of 0.58 for the last three years. The same could be said in terms of the quick assets ratios, where Tesco exhibited an average of 0.44 while Sainsbury had a lower average of 0.27 Would the ratios tell that they can survive in the short-term? The answer of course may still in affirmative considering that the company’s current ratio is no very far from 1.0 level. If they fail, the consequences could be bankruptcy and possibly it could cause either company to stop doing business and let creditors take money and resources (Helfert, 2001). 3.3 Financial leverage or Debt utilization ratios Companies do need to borrow in additional to investment made by stockholders. As legal entities working through the board of directors and shareholders companies can enter into debt or loan agreement to have more assets to be used in business. Said increased assets are need to fund the growth the company in terms of revenues which must increase every year as normal part of business. A firm not resorting to borrow may find itself maximizing the value generation by the company. Although it may choose to ask for additional investment from existing shareholders, latter would ask management if they could be compensated with the additional risk. Thus corporations resort to borrowing to maximize value generation since capital generated from debts could entitle the company for deductibiity of interest expenses from these debts for tax purposes. However, borrowing by companies cannot be assumed unlimited and this could increase the risk of bankruptcy in case of slowdown in the expected revenues. A barometer is provide a benchmark on how should the company limit its borrowings or debts from creditors. The balance can generate the so called debt to equity ratio computed by dividing total liabilities with the total equity of the corporation. In getting the ratios of the two companies, the same can be taken from their total liab lities and total equity per year for three years. Tesco reflected debt to equity ratio average of 1.85 as against Sainsbury with an average of 1.10. Both the said ratios are higher than the industry average of 0.45. This means the the two companies are already highly leverage compared with competitors. But since the two companies appear to have survived the financial crisis of 2008-2009, their continuing into a business is an indication of their capacity to withstand tempory financial tsunamies that may occur from time to time as economic factors change in the environment. 3.4. Market valuation ratios The investorss response to the companies involved can be checked from the valuations rations in terms of price-earning ratio, price to sales, price to book ratio, price to tangible boo and even price to cash flow as shown in Table B below. However due to more riskly position of Tesco than Sainsbury, the same exlpain its higher beta. Table B: Sources: Reuters (2011c, 2011d) 4. Conclusion and Recommendation This paper has found profit maximization strategies employed by Tesco to be better than that of Sainsbury on the average for the past three years. Tesco has however shown lower liquidity as against Sainsbury and its other competitors in the industry. It has also higher financial leverage compared with Sainsbury. Tesco Company has been wonderfully outperforming also Sainsbury in terms of wealth generation as measured by valuation ratios. Tesco secrets in arriving with better results would indicate in being able to identify opportunities for profitability as it responded to the changing needs of its customer. It has lowerered its prices and introduced affordable products and made louder promotions. By doing business outside UK compared with Sainsbury, the former may have taken more the opportunities and has managed its risk better. By so having higher financial leverage its better profitabiliy and reacted to by investors by having higher prices in relation to earnings, Tesco can be chosen as the better company for purposes of making an investment. 5. Bibgliography Reuters (2011c). Industry Ratios With Tesco. Retrieved 19 November 2011 from < http://www.reuters.com/finance/stocks/financialHighlights?symbol=TSCDF.PK> Reuters (2011b). Company Overview – J. Sainsbury < http://www.reuters.com/finance/stocks/overview?symbol=SBRY.L> Helfert, E. (2001). Financial Analysis: Tools and techniques: a guide for managers. McGraw-Hill Professional Tesco (2011a). Annual Report 2011. Retrieved 19 November 2011 from < http://www.tescoplc.com/media/417/tesco_annual_report_2011_final.pdf> Tesco (2011b). Annual Report of 2010. Retrieved 19 November 2011 from < http://ar2010.tescoplc.com/~/media/Files/T/Tesco-Annual-Report-2009/Attachments/pdf/tesco-annualreport.pdf> Sainsbury (2011a). Annual Report 2011. Retrieved 19 November 2011 from < http://www.j-sainsbury.co.uk/media/171813/ar2011_report.pdf> Sainsbury (2011b) Annual Report 2010. Retrieved 19 November 2011 from (2001b) < http://www.analist.be/reports/Sainsbury_2009.pdf> Reuters (2011d). Industry Ratios With Sainsbury. Retrieved 19 November 2011 from < http://www.reuters.com/finance/stocks/financialHighlights?symbol=SBRY.L Reuters (2011a). Company Overview – Tesco. Retrieved 19 November 2011 from < http://www.reuters.com/finance/stocks/companyProfile?symbol=TSCDF.PK> Appendices Appendix A- Summary of Financial Data for Tesco; Sources (Tesco, 2011a, 2011c; Reuters, 2011c) Appendix A-1 Summary of data and ratios for Sainbury (2011A, 2011B) Appendix A-3 Formula used; Source (Helfert, 2001) Read More