Corporate Finance of Marks and Spencer - Case Study Example

Company Analysis: Marks and Spencer Company Analysis: Marks and Spencer This report is a case study of Marks and Spencer, which comprises a financial and market analysis in relation to its operations. After presenting a brief background, the report presents different sources of finance used by Marks and Spencer to raise its required finance for business operations. Based on the identification of sources used to finance its operations, an analysis of reasons to do so has been presented. After this, an analysis of Marks and Spencer’s market performance has been presented which undertakes analysis of market prices of stock, FTSE 100 index and sector index for a period from November 5, 2012 to January 25, 2013. In addition to this, a critical review of company’s performance in the last five years with respect to earnings per share and dividend policy is also presented which entails discussion of the same in theoretical connotations. At the end, an analysis of Marks and Spencer’s price earnings ratio with industry competitors has been presented. Company Background Marks and Spencer is a renowned retailer operating based in the UK and operating in the country and other parts of the world. The main products in which the company deals include retail business of clothing, groceries, home products, and other variety of retail items which include entertainment, electronics, cosmetics, furniture and decorative items, etc. The company has a long history and was established back in the year 1884 with its headquarters in London (Yahoo Finance, 2013). The company has more than 1100 retail outlets, out of which 731 are in the UK and the remaining are located in different parts of Europe and Asia (Yahoo Finance, 2013). Since its inception, the company has gone through major changes, which include both structural and non-structural areas. As for instance, the company changed its logo in the beginning of last decade and adopted a new logo to signal a new image of the company. Apart from this, the company has been under immense pressure recently as far as non-performing retail outlets and increasing costs of operations are concerned. In this regard, management at Marks and Spencer took a bold decision to shut down 22 of its non-performing retail outlets in the year 2009 and this closure of selected retail outlets has continued till last year. Apart from this, the company planned to revamp its retail outlets design and outlook in the UK and therefore has planned to make capital expenditures worth GBP 600 million from 2011 to 2014 (Yahoo Finance, 2013; Marks and Spencer plc, 2012). Marks and Spencer: Sources of Finance As far as the sources of finance for the company is concerned, Marks and Spencer maintain a mix of both equity and debt financing for its operations (Marks and Spencer plc, 2012). In this regard, there are a number of sources through which finance is raised. These sources generally include: Retained profits held by the Marks and Spencer Group, Borrowings from banks and other financial institutions, Short and medium term notes, Leasing agreements, and Other financing facilities available through banking institutions (Marks and Spencer plc, 2012). Following table shows extracts from balance sheet related to sources of finance and finance raised through these sources by Marks and Spencer for the year 2011 and 2012: Debt Financing 2012 (GBP million) 2011 (GBP million) Current Liabilities Borrowings and other financial liabilities 327.7 602.3 Partnership liability to the Marks and Spencer UK Pension Scheme 71.9 71.9 Derivative financial instruments 60.5 50.7 Non-Current Liabilities Borrowings and other financial liabilities 1,948.1 1,924.1 Derivative financial instruments 27.2 37.5 Equity Financing 2012 (GBP million) 2011 (GBP million) Issued share capital 401.4 396.2 Share premium account 294.3 255.2 Capital redemption reserve 2,202.6 2,202.6 Hedging reserve 14.8 (11.3) Other reserves (6,114.3) (6,042.4) Retained Earnings 5,991.4 5,873.2 Source: (Marks and Spencer plc, 2012) The table presented above shows a mix of debt and equity sources of finance for Marks and Spencer. However, to evaluate the gearing level of the company, following is the gearing ratio for Marks and Spencer for the year ended 2011 and 2012: Year 2012 2011 Gearing Level 0.88 1.00 Source: (Marks and Spencer plc, 2012) It can be observed from gearing level for year 2011 and 2012 that the company has focused on obtaining finance from equity sources rather than debt sources. In this regards, it is feasible to consider changes in company’s financing during 2012 and 2011. Upon analyzing the cash flow statement for 2011 and 2012 it is found that the company entered into following finance raising activities: Activity 2012 (GBP million) 2011 (GBP million) Issuance of medium term notes 295.5 - Issuance of shares on exercise of employee share options 44.3 8.4 Source: (Marks and Spencer plc, 2012) Although there are two activities showing increase in debt and equity financing of the company, but there is an overall decrease recorded in both years in relation to net debt of the company. Following table shows opening and closing net debt figures for 2012 and 2011: Changes in Net Debt 2012 (GBP million) 2011 (GBP million) Opening net debt 1,900.9 2,068.4 Closing net debt 1,857.1 1,900.9 Source: (Marks and Spencer plc, 2012) Rationale behind Preferred Sources of Finance The decision to determine an optimum capital structure is influenced by a number of factors, which according to theoretical propositions laid under various theories, such as pecking order, trade off and agency theory, vary from company to company and conditions in which a company is operating (Frank & Goyal, 2005). Among these factors, the most common include and influential ones include cost of capital, impact of obtaining capital from debt or equity on cash flows, impact of increased debt on returns for shareholders, management’s perceptions as to the effect of obtaining finance through sources other than those preferred by them, etc. (Frank & Goyal, 2005). In case of Marks and Spencer, it is observed that there is a mix of financing sources used by the company, although in 2012 the company has placed lesser emphasis on borrowing, i.e. debt financing (Marks and Spencer plc, 2012). One reason might be that the management does not want to get exposed to risks related to interest rate and foreign currency rates fluctuations. However, keeping in view the gearing ratios calculated for the company for the past two years, it can be observed that still there is a considerable amount of financing carried out by the company through debt financing (Marks and Spencer plc, 2012). This higher preference for raising finance through debt financing can also be attributed to the fact that Marks and Spencer has a better credit rating and thus can obtain financing through debt relatively easily. Comparing this financing approach, the concepts laid down in agency theory can be argued. According to agency theory, presented by Jensen and Meckling (1976), management of corporate entities do not prefer usually to raise finance through debt financing because they think that it will raise the financing costs and thus lower down the profits attributable to shareholders of the entity, which in turn would be problematic for management. Therefore, following this perception, management tends to focus on raising finance through equity rather than debt (Frank & Goyal, 2005). It is pertinent to mention here that Marks and Spencer has diversified the risks associated with its borrowings by making use of derivative financial instruments in both local and foreign currencies. By way of swapping the interest rates on borrowings and currency exchange rates with fixed ones, the company manages its risks in a more prudent and efficient manner. This policy in turn allows the company to forecast in a more effective and efficient manner without taking into consideration any changes in interest and currency exchange rates (Marks and Spencer plc, 2012). Analysis of Marks and Spencer’s Market Performance Following are the stock prices of Marks and Spencer from November 5, 2012 to January 25, 2013. The prices presented in table below are all adjusted closing prices for the day. Date Adjusted Closing Price Date Adjusted Closing Price Date Adjusted Closing Price January 25, 2013 384.2 December 31, 2012 382.3 November 30, 2012 390.6 January 24, 2013 379.7 December 28, 2012 385.7 November 29, 2012 389.6 January 23, 2013 379.1 December 27, 2012 388.5 November 28, 2012 387 January 22, 2013 369.7 December 26, 2012 390.6 November 27, 2012 378.7 January 21, 2013 366.5 December 25, 2012 390.6 November 26, 2012 376.2 January 18, 2013 365.9 December 24, 2012 390.6 November 23, 2012 380.7 January 17, 2013 362.8 December 21, 2012 392 November 22, 2012 378 January 16, 2013 361 December 20, 2012 396.3 November 21, 2012 376 January 15, 2013 365.2 December 19, 2012 398.8 November 20, 2012 375.3 January 14, 2013 367.2 December 18, 2012 395.5 November 19, 2012 372.6 January 11, 2013 372.5 December 17, 2012 391.7 November 16, 2012 366.4 January 10, 2013 368.8 December 14, 2012 393.9 November 15, 2012 370.6 January 9, 2013 371 December 13, 2012 392.3 November 14, 2012 378.4 January 8, 2013 369.6 December 12, 2012 393.8 November 13, 2012 379 January 7, 2013 372 December 11, 2012 393.1 November 12, 2012 378.41 January 4, 2013 376.4 December 10, 2012 392.2 November 9, 2012 376.05 January 3, 2013 388.4 December 7, 2012 393.6 November 8, 2012 377.33 January 2, 2013 382.7 December 6, 2012 397.8 November 7, 2012 378.31 January 1, 2013 382.3 December 5, 2012 391.9 November 6, 2012 392.28 December 4, 2012 390.5 November 5, 2012 381.66 December 3, 2012 389.7 Source: (Live Charts, 2013) Trends noted in the market prices from November 5, 2012 to January 25, 2013 are graphically shown as follows: Source: (Live Charts, 2013) It can be noted that there are consistent fluctuations in the market price of Marks and Spencer in during the period under consideration. Although, there has been a sharp decline in the market prices since the middle of the month of December, the company has been able to register improvement after one month and a rising trend can be noted till the end of period under analysis. On January 23, 2013 Marks and Spencer ranked amongst top companies at FTSE 100 index owing to the rumors spread of its takeover after registering falling sales revenue (Live Charts, 2013). Since Marks and Spencer’s nature of business falls in General Retailer sector (Live Charts, 2013), therefore a comparison of Marks and Spencer’s share prices with General Retailers’ sector index is presented as follows: Source: (Live Charts, 2013) The trend lines indicated in the graph above shows that the market price of Marks and Spencer’s stocks is moving in line with the sector index, thus implying that the company is performing normally in terms of its market performance (See Appendix 1 for comparison of market prices and sector index). Moreover, this relationship noted between trends in sector index and market price of Marks and Spencer’s stocks indicate the efficiency of capital market. As noted that there are similar fluctuations in trends of market prices and sector index, therefore it implies that the investors and market players have excess to market information and therefore market is performing efficiently and prudently on the basis of such information (Bruetsch, 2009). On the other hand, a comparison of Marks and Spencer’s stock performance with FTSE 100 index shows that the stock performance of the company remained intact with the overall performance of FTSE 100 index, however the gap between the two trend lines is observed as widening after mid of December (Financial Times, 2013). Source: (Financial Times, 2013) Analysis of Marks and Spencer’s Earnings per Share and Dividend Policy Marks and Spencer’s earnings per share for the last five financial years is presented as follows: Item 2012 2011 2010 2009 2008 Earnings per Share (Basic) 34.9 pence 34.8 pence 33.5 pence 32.3 pence 49.2 pence Earnings per Share (Diluted) 34.6 pence 34.4 pence 33.2 pence 32.3 pence 48.7 pence Source: (Marks and Spencer plc, 2012; Marks and Spencer plc, 2010; Marks and Spencer plc, 2008) These figures, when plotted on a graph, show the following trend during the past five years regarding the earnings per share of Marks and Spencer: Source: (Marks and Spencer plc, 2012; Marks and Spencer plc, 2010; Marks and Spencer plc, 2008) As noted in the table and graph above, the earnings per share for Marks and Spencer have decreased considerably from financial year 2008 to 2009, possibly due to the emergence of financial crisis and fall in sales revenue. But at the same time, it can also be observed that the earnings have improved after falling to their lowest in 2009, i.e. 32.3 pence, steadily till the last financial year 2012. This steady rise indicates that the company has remained stable in terms of its operational performance and has recovered from the downfall in its earnings. As far as the payment of dividend is concerned, Marks and Spencer pays dividends to its shareholders on semi-annual basis. In the past five years, the company has paid dividends to its shareholders after every six months. Trends noted in dividends payments are shown as follows: Period Jan-13 Jun-12 Jan-12 Jun-11 Jan-11 Jun-10 Jan-10 Jun-09 Jan-09 Jun-08 Amount of Dividend Paid 6.2 pence 10.8 pence 6.2 pence 10.8 pence 6.2 pence 9.5 pence 5.5 pence 9.5 pence 8.3 pence 14.2 pence Source: (Marks and Spencer plc, 2013) The trends noted above show that the company has maintained a consistent policy of paying dividends to its shareholders after every six months period. Moreover, the policy includes payment of cash dividends to the shareholders, but shareholders are given an option that there dividends can be kept with the company and they may become entitled in return for equivalent shares. Modigliani and Miller (1958) have contended that investors are largely concerned with increasing their earnings and in this pursuit they do not give importance to the source of their earnings, whether it comes from cash dividends or from capital gains they receive when the company invests their money into new stocks and in return they get gains on those new stocks (Brealey & Myers, 2008). Keeping in view this proposition laid by Modigliani and Miller (1958), it can be stated that Marks and Spencer’s dividend policy is also based on this theory of irrelevance. Analysis and Comparison of Price Earnings Ratio of Marks and Spencer with Competitors In order to analyze how P/E ratio (price earnings ratio) reflects the market performance of Marks and Spencer from November 5, 2012 to January 25, 2013, an analysis of market prices and P/E ratio of Marks and Spencer and its competitors has been carried out. In this regard, following are the price earnings ratio for the market leaders. Company P/E Ratio Marks & Spencer 1256.58 Debenhams 1014.29 Dairy Farm Intl 819.89 Shoppers Stop ltd 183.24 Shopper Stop 183.06 Golden Eagle 161.21 Intime 143.94 Lianhua 93.83 Parkson group 81.56 Dairyfarm 36.69 Source: (Yahoo Finance, 2013) Source: (Yahoo Finance, 2013) As can be observed in the information given above, Marks and Spencer has led the sector as far as price earnings ratio is concerned. It can also be observed that this lead is significant when compared against other competitors. However, to further explore as to whether price earnings represent the market prices of Marks and Spencer, a comparison of the market prices of stocks for three top industry leaders, Marks and Spencer, Debenhams and Dairy Farm International Holdings, is presented below for the period November 5, 2012 to January 25, 2013: Source: (Debenhams: Yahoo Finance, 2013; Dairy Farm International: Yahoo Finance, 2013; Marks and Spencer: Financial Times, 2013) It can be noted in the graphical illustration of market prices of stocks of three selected market leaders that the company with highest price earnings ratio has remained on top in terms of market price of its stock (See Appendix 2 for detailed prices of stocks). It can be noted that for Dairy Farm International there is a striaght horizontal line which does not show any change in the market price of its stock. It is due to the fact that the company’s stocks are not being traded in the market and therefore stock prices have remained constant. However, the comparison between Marks and Spencer’s and Debenhams’ stock prices signify that price earnings ratio is representative of the market performance of companies’ stock. Favorable trends noted in the market price of Marks and Spencer’s stocks have translated into higher price earnings ratio, because with a signifiacnt increase in market price of stock and a comparatively lower increase in earnings per share, there is a significant increase in P/E ratio. List of References Brealey, R.A. & Myers, S.C., 2008. Principles of Corporate Finance. 9th ed. Boston: McGraw-Hill/Irwin. Bruetsch, M., 2009. From Capital Market Efficiency to Behavioral Finance. Norderstedt: GRIN Verlag. Financial Times, 2013. Marks and Spencer Group PLC. [Online] Available at: HYPERLINK "http://markets.ft.com/research/Markets/Tearsheets/Summary?s=MKS:LSE" http://markets.ft.com/research/Markets/Tearsheets/Summary?s=MKS:LSE [Accessed 8 February 2013]. Frank, M.Z. & Goyal, V.K., 2005. Tradeoff and Pecking Order Theories of Debt. In B.E. Eckbo, ed. Handbook of Corporate Finance: Empirical Corporate Finance. North-Holland: Elsevier. p.Chapter 7. Jensen, M.C. & Meckling, W.H., 1976. Theory of the firm: managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3, pp.305-60. Live Charts, 2013. General retailers - (NMX5370) Share Price History. [Online] Available at: HYPERLINK "http://www.livecharts.co.uk/share_prices/historic-data-NMX5370" http://www.livecharts.co.uk/share_prices/historic-data-NMX5370 [Accessed 8 February 2013]. Live Charts, 2013. Marks & Spencer Group Share price. [Online] Available at: HYPERLINK "http://www.livecharts.co.uk/share_prices/share_price/symbol-MKS" http://www.livecharts.co.uk/share_prices/share_price/symbol-MKS [Accessed 7 February 2013]. Live Charts, 2013. Stock Market News: FTSE 100 Movers: Tullow Oil and Unilever lead the way. [Online] Available at: HYPERLINK "http://www.livecharts.co.uk/share_prices/FTSE-100-movers--Tullow-Oil-and-Unilever-lead-news20642504.html" http://www.livecharts.co.uk/share_prices/FTSE-100-movers--Tullow-Oil-and-Unilever-lead-news20642504.html [Accessed 8 February 2013]. Marks and Spencer plc, 2008. Annual Report 2008. London: Marks and Spencer plc. Marks and Spencer plc, 2010. Annual Report 2010. London: Marks and Spencer plc. Marks and Spencer plc, 2012. Annual Report 2012. London: Marks and Spencer. Marks and Spencer plc, 2013. Your Dividends. [Online] Available at: HYPERLINK "http://corporate.marksandspencer.com/investors/shareholder/yourdividends/dividends_history" http://corporate.marksandspencer.com/investors/shareholder/yourdividends/dividends_history [Accessed 8 February 2013]. Modigliani, F. & Miller, M., 1958. The Cost of Capital, Corporation Finance and the Theory of Investment. American Economic Review, 48(3), pp.261-97. Yahoo Finance, 2013. Dairy Farm International Holdings Ltd. (DFIB.L). [Online] Available at: HYPERLINK "http://finance.yahoo.com/q/hp?s=DFIB.L&a=10&b=5&c=2012&d=00&e=25&f=2013&g=d" http://finance.yahoo.com/q/hp?s=DFIB.L&a=10&b=5&c=2012&d=00&e=25&f=2013&g=d [Accessed 8 February 2013]. Yahoo Finance, 2013. Debenhams plc (DEB.L). [Online] Available at: HYPERLINK "http://finance.yahoo.com/q/hp?s=DEB.L&a=10&b=5&c=2012&d=00&e=25&f=2013&g=d" http://finance.yahoo.com/q/hp?s=DEB.L&a=10&b=5&c=2012&d=00&e=25&f=2013&g=d [Accessed 8 February 2013]. Yahoo Finance, 2013. Leaders & Laggards in Department Stores. [Online] Available at: HYPERLINK "http://biz.yahoo.com/ic/ll/731per.html" http://biz.yahoo.com/ic/ll/731per.html [Accessed 8 February 2013]. Yahoo Finance, 2013. Marks & Spencer Group PLC (MKS.L). [Online] Available at: HYPERLINK "http://uk.finance.yahoo.com/q/pr?s=MKS.L" http://uk.finance.yahoo.com/q/pr?s=MKS.L [Accessed 7 February 2013]. Appendix – 1 Adjusted Closing Share Prices for Marks and Spencer Date Adjusted Closing Price January 25, 2013 384.2 January 24, 2013 379.7 January 23, 2013 379.1 January 22, 2013 369.7 January 21, 2013 366.5 January 18, 2013 365.9 January 17, 2013 362.8 January 16, 2013 361 January 15, 2013 365.2 January 14, 2013 367.2 January 11, 2013 372.5 January 10, 2013 368.8 January 9, 2013 371 January 8, 2013 369.6 January 7, 2013 372 January 4, 2013 376.4 January 3, 2013 388.4 January 2, 2013 382.7 January 1, 2013 382.3 December 31, 2012 382.3 December 28, 2012 385.7 December 27, 2012 388.5 December 26, 2012 390.6 December 25, 2012 390.6 December 24, 2012 390.6 December 21, 2012 392 December 20, 2012 396.3 December 19, 2012 398.8 December 18, 2012 395.5 December 17, 2012 391.7 December 14, 2012 393.9 December 13, 2012 392.3 December 12, 2012 393.8 December 11, 2012 393.1 December 10, 2012 392.2 December 7, 2012 393.6 December 6, 2012 397.8 December 5, 2012 391.9 December 4, 2012 390.5 December 3, 2012 389.7 November 30, 2012 390.6 November 29, 2012 389.6 November 28, 2012 387 November 27, 2012 378.7 November 26, 2012 376.2 November 23, 2012 380.7 November 22, 2012 378 November 21, 2012 376 November 20, 2012 375.3 November 19, 2012 372.6 November 16, 2012 366.4 November 15, 2012 370.6 November 14, 2012 378.4 November 13, 2012 379 November 12, 2012 378.41 November 9, 2012 376.05 November 8, 2012 377.33 November 7, 2012 378.31 November 6, 2012 392.28 November 5, 2012 381.66 Source: (Financial Times, 2013) Appendix – 2 Share Prices – Marks and Spencer, Debenhams plc and Dairy Farm International Date Marks and Spencer Debenhams Dairy Farm International January 25, 2013 384.2 105.3 305 January 24, 2013 379.7 104.5 305 January 23, 2013 379.1 101.3 305 January 22, 2013 369.7 101.5 305 January 21, 2013 366.5 102.5 305 January 18, 2013 365.9 101.5 305 January 17, 2013 362.8 102.8 305 January 16, 2013 361 101.8 305 January 15, 2013 365.2 105.6 305 January 14, 2013 367.2 105.1 305 January 11, 2013 372.5 106.2 305 January 10, 2013 368.8 104 305 January 9, 2013 371 106.4 305 January 8, 2013 369.6 108.1 305 January 7, 2013 372 117.1 305 January 4, 2013 376.4 117.9 305 January 3, 2013 388.4 117.2 305 January 2, 2013 382.7 115.1 305 January 1, 2013 382.3 114 305 December 28, 2012 385.7 113.6 305 December 27, 2012 388.5 115.2 305 December 25, 2012 390.6 114.8 305 December 21, 2012 392 114.7 305 December 20, 2012 396.3 115.3 305 December 19, 2012 398.8 116 305 December 18, 2012 395.5 114.2 305 December 17, 2012 391.7 115.5 305 December 14, 2012 393.9 114.7 305 December 13, 2012 392.3 114.2 305 December 12, 2012 393.8 112.8 305 December 11, 2012 393.1 114.8 305 December 10, 2012 392.2 113.4 305 December 7, 2012 393.6 114.9 305 December 6, 2012 397.8 114.8 305 December 5, 2012 391.9 113.6 305 December 4, 2012 390.5 113.2 305 December 3, 2012 389.7 114.57 305 November 30, 2012 390.6 115.55 305 November 29, 2012 389.6 114.47 305 November 28, 2012 387 114.57 305 November 27, 2012 378.7 111.24 305 November 26, 2012 376.2 110.65 305 November 23, 2012 380.7 112.81 305 November 22, 2012 378 111.93 305 November 21, 2012 376 110.75 305 November 20, 2012 375.3 113.69 305 November 19, 2012 372.6 113.2 305 November 16, 2012 366.4 111.44 305 November 15, 2012 370.6 113.98 305 November 14, 2012 378.4 115.65 305 November 13, 2012 379 117.61 305 November 12, 2012 378.41 115.36 305 November 9, 2012 376.05 115.26 305 November 8, 2012 377.33 117.32 305 November 7, 2012 378.31 116.43 305 November 6, 2012 392.28 118.3 305 November 5, 2012 381.66 117.32 305 Source: (Debenhams: Yahoo Finance, 2013; Dairy Farm International: Yahoo Finance, 2013; Marks and Spencer: Financial Times, 2013) Read More