Analysis of Next Company and Mens WareHouse Company - Report Example

Methods of Analyzing Profitability Analyzing the profitability of a company is crucial in making investment decisions. The company management can use this tool to appraise their performance and to set future directions for improving the financial stability and the profitability of the company. On the other hand, the investors – current shareholders and prospective ones – can make more informed decisions on whether to keep (or buy) shares of the company or to find other companies to put their money in. There are various financial ratios computed based on the company’s financial statements that would adequately provide a picture of the company’s profitability. These include the Return on Assets (ROA) and the Return on Equity (ROE); they indicate how well the management has optimized the company’s assets and equity to deliver positive operating results. However, it has recently been noted that ROA and ROE can be misleading since these two ratios fail to consider the effects of financing. The Return on Net Operating Assets (RNOA) and the Return on Common Equity (ROCE), meanwhile, give due importance to financing and its effects on the company’s balance sheet and the boost that it can provide to the operational capacity for improved profits. RNOA distinguishes financing decisions from operating decisions and separately determines the effect of the latter on the company’s bottom line. These financing decisions will either result to ROCE being higher or lower than RNOA. If utilized right, the company’s liabilities lead to higher profitability; ROCE, then, is higher than RNOA. Thus, in the conduct of a comparative financial analysis of Next PLC and The Men’s Wearhouse, Inc., their RNOAs and ROCEs are computed to analyze the profitability of the two companies. In addition, an analysis of common-size financial statements as well as a trend analysis will further provide a substantial basis for evaluating the two companies. Common-size financial statements facilitate the analysis of two companies and clearly provide a comparison of their financial and operating performance regardless of their sizes. On the other hand, a trend analysis of the companies will reflect how specific items in the financial statements have changed (increased or decreased) through time. Overview of Next PLC and The Men’s Wearhouse Inc. 1.1 Next PLC Founded in 1864, Next PLC (or Next) is engaged in retailing clothes, footwear and accessories for men, women and children as well as gift items and homeware products. (Bloomberg Businessweek 2013) The company distributes and sells its products through three main channels. The first is the Next Retail, which has around 500 stores in the United Kingdom (UK) and Eire. The second is Next Directory, which caters to over three million customers worldwide via its home shopping catalogue and websites that serve about 50 countries. The third is Next International, with runs approximately 200 stores across the globe. Other than these three, Next also established Next Sourcing to cover designing, sourcing and buying products that will bear the Next brand. The UK-based retailer also ventured into the customer services management business. The latter, however, was profitably sold in January 2012 (Thomson ONE 2013) thereby increasing Next’s overall income and liquidity that year. As indicated in the company’s 2012 Annual Report, Next is primed to go for improved operating performance in the next years. The company has issued a new 10-year bond amounting to £325 million and redeemed £158 million worth of old ones. This translates to plenty of interest-bearing cash resources that the company must utilize in a way that will generate positive returns. This should be quite a challenge for Next in the light of the sluggish growth of the UK economy. 1.2 Men’s Inc. Headquartered in Houston, Texas, The Men’s Wearhouse Inc. (or Men’s WH) offers suits and corporate attire, sportswear and accessories for men and women as well as children’s apparel. Founded in 1973, the company is also into dry cleaning and laundry operations. (Bloomberg Businessweek 2013) As of January 2012, Men’s WH has a total of 1,166 retail stores – 1,049 in the United States and 117 Canada. Other than these stores, online shops at menswearhouse.com and kgstores.com enable the company to bring its products to customers in other countries. As a specialty retailer of suits for men, Men’s WH also provides tuxedo rental services in its store. The company, however, was not spared from the brunt of the financial crisis. In the fiscal year 2011, 25 of its stores were closed down. (Thomson ONE 2013) It can be noted that Men’s WH has not relied on additional funding from credit sources during the last two years (2011 and 2012) and has elected to strive for better financial performance with just the resources made available by its equity. Like Next, Men’s WH face challenging years as the US economy still reels from the devastating 2007-2008 financial crisis. Financial Analysis An analysis of the profitability of a company helps to identify the factors behind it. It is a tool for distinguishing operating profitability from the effects of additional financing and for pinpointing the exact factors that generated the operating profitability. (Penman 2013) The following formula will be used for this purpose: ROCE = RNOA + [FLEV X SPREAD] Where: ROCE Return on Common Equity RNOA Return on Net Operating Assets, computed by multiplying the Profit Margin (PM) by the Assets Turnover (ATO) FLEV Financial Leverage, computed by dividing the Net Financial Obligations (NFO) by the Common Share’s Equity (CSE) SPREAD RNOA less Net Borrowing Costs (NBC) Incidentally, the analysis of the components of ROCE is substantiated by the conduct of (i) the common-size financial statement analysis and (ii) the trend analysis, as illustrated. PM of Next and Men’s Wearhouse Compared to Men’s WH, Next has consistently reaped higher Profit Margins (PMs) for the years 2008 to 2012. The PMs of Men’s WH ranged from only 2% to 7% while those of Next’s ranged from 10% to 13% (see Appendix I). The common-size income statement similarly show that Next’s comprehensive income available to common shareholders for the years 2008 to 2012 were computed at 10.64%, 9.24%, 10.69%, 11.93% and 12.62% of sales (see Appendix II). Equivalent figures for Men’s WH were 6.96%, 2.98%, 2.40%, 3.19% and 5.00% (see Appendix III). Thus, Next is shown to have generated higher profits relative to sales as compared with Men’s WH throughout the five-year period. Both companies earned the least comprehensive income available to common shareholders in the year 2009. On the other hand, Next’s PM was lowest in 2009 while Men’s WH’s, in 2010. The drop in the profitability of the companies in 2009 and 2010 can be attributed to the decreased levels of sales that resulted from the financial crisis that occurred in 2007 and 2008. Next’s comprehensive income available to common shareholders for the period 2008 to 2012 have grown more compared to that of Men’s WH’s – trend analysis pegs Next’s income growth at 23% (see Appendix IV) while Men’s WH’s equivalent income has decreased by 19% (see Appendix V). These trends contribute to the material difference in the PMs of the two companies. AT of Next and Men’s Wearhouse The Asset Turnover (ATO) ratios of the two companies point to Next as the one with the higher efficiency in utilizing assets for its selling activities. Next, with ATOs ranging from 4.00 to 5.79, is capable of generating more sales with less assets as compared with Men’s WH, whose ATOs range from 2.01 to 2.49 (See Appendix I). The ATOs of Men’s WH from 2008 to 2012 turned out to be lower; this implies that it does not put its assets to optimal use. Trend analysis shows that Next’s Total Operating Assets during the 5-year period increased from £1.617 billion to £1.831 billion – an increase from 100% in 2008 to 113% in 2012, or 13% (see Appendix IV). Trend analysis further shows that Men’s WH’s Total Operating Assets have grown from $1.188 billion in 2008 to $1.404 billion in 2012 – an increase from 100% to 118%, or 18% (see Appendix V). The Total Operating Assets of Men’s WH have, therefore, grown more during the period. Meanwhile, the same trend analysis shows that the annual revenues of Men’s WH have increased from $2.113 billion in 2008 to $2.383 billion in 2012 – an increase from 100% in 2008 to 113% in 2012, or 13% (see Appendix V). Next’s equivalent revenues, on the other hand, increased only minimally from £3.329 billion in 2008 to £3.441 billion in 2012 – an increase from 100% to 103%, or 3% (see Appendix IV). The revenues of Men’s WH have grown more from 2008 to 2012. The foregoing details show from 2008 to 2012, Next’s Total Operating Assets grew by 13% while its sales grew only by 3%. In contrast, the Total Operating Assets of Men’s WH increased in the same period by 18% and its equivalent revenues increased by 13%. In spite of these seeming better performance of Men’s WH based on the growth of Total Operating Assets and revenues, Next still turned out to produce the higher ATO for the 5-year period. RNOA of Next and Men’s Wearhouse RNOA pertains to the profitability of the company’s operations and its capacity to utilize for optimum profits its operating assets. It, thus, makes sense to not include financial assets and financial income in computing RNOA. Given that Next has delivered the better PM and ATO for the period 2008 to 2012, it follows that Next also has the better RNOA. Appendix I shows that Next’s RNOA for the period range from 0.45 to 0.65 while Men’s WH’s range from 0.05 to 0.17. Next’s higher RNOA is due to its higher efficiency in using its assets to generate more sales and in securing more profits from out of its revenues. NBC of Next and Men’s Wearhouse NBCs are computed by dividing the Net Financial Expense (after tax) by the Net Financial Obligation. While Next has outstanding long-term obligations for the entire period from 2008 to 2012, Men’s WH has similar debts only from 2008 to 2010 and has none for the years 2011 and 2012. Of the two companies, Next has the higher NBC to deal with. While Men’s WH’s financing costs ranged from 1% to 3%, Next’s ranged from 3% to 6% (see Appendix I), as reflected in the following graph: FLEV and SPREAD of Next and Men’s Wearhouse FLEV, also called ‘gearing’, pertains to the use of debt to obtain a higher expected returns. (Brealey, Myers and Allen 2008:473) FLEV increases the ROCE, so long as the RNOA is higher than the net borrowing cost on the liabilities – the SPREAD must, therefore, be positive. If the SPREAD turns negative, ROCE is less than RNOA, then FLEV becomes unfavorable. (Penman 2013) FLEV is obtained by dividing the Net Financial Obligations (NFO) by the Common Share’s Equity (CSE). It signifies the level of the investment of the company’s creditors in the company’s operations as compared with that of the company’s shareholders. Since Men’s WH has fully settled its long-term debts in the year 2010 and has not availed of any new financing packages in 2011 and 2012, its FLEV can be computed only for the years 2008 to 2010 and they range from 0.04 to 0.05 (see Appendix I). Men’s WH has gone on to continually decrease its financial liabilities year-on-year. A trend analysis on the company’s balance sheet shows that its financial liabilities decreased by 32% from 2008 to 2009. With 2008 as the base year, it further decreased from its 68%-equivalent in 2009 to only 47% in 2010 before zeroing out in the years 2011 and 2012. (see Appendix V) In contrast, Next has outstanding long-term liabilities for the entire 5-year period. Trend analysis shows that from 2008 to 2012, its highest long-term liabilities balance was attained in 2008 (see Appendix IV). Its FLEV ranges from a low of -9.64 in 2008 to a high of 4.31 in 2009 (see Appendix I). Thus, it becomes clear that between Men’s WH and Next, it is the latter that has higher indebtedness level and it is the latter that has the bigger chance to optimize additional financing provided by creditors by using it to further increase the company’s profits. In spite of the higher FLEV of Next, it turns out to have the higher spread for the years 2008 to 2012, as compared with Men’s WH. Appendix I shows that Next’s SPREAD for the 5-year period ranged from 0.40 to 0.61 while those of Men’s WH’s, from 0.04 to 0.19. The SPREAD of the two companies for all five years ended up to be positive; this means that the two companies are able to generate higher returns from their operations as compared with the net cost of financing that they have availed of. This further means that the two companies were able to infuse creditors’ funds into their operations and put them to good use. Of the two companies, Next has generated the higher SPREAD. It has delivered higher returns vis-à-vis the interest expenses and financing charges that are attached to the funds borrowed. ROCE of Next and Men’s Wearhouse Except in the year 2008, Next’s ROCEs were significantly higher than Men’s WH’s. While Men’s WH’s ROCE never breached the 0.20 level and stayed within the low range of 0.05 to 0.18, Next’s ROCE ranged from its low of -4.43 in 2008 to its high of 2.74 in 2010 (see Appendix I). The five-year average ROCEs are computed at 0.82 for Next and 0.12 for Men’s WH. Excluding 2008 when Next’s long-term liabilities were at their highest in the 5-year period, its average ROCE from 2009 to 2012 is increased to 1.95. Common-size income statement for the same period also show how Next’s comprehensive income available to common shareholders as a percentage of sales has increased from 10.64% in 2008 to 12.62 in 2012 (see Appendix II). These percentages are better as compared to Men’s WH’s which decreased from 6.96% in 2008 to 5.00% in 2012 (see Appendix III). Trend analysis reflect that with 2008 as base year, Next’s comprehensive income available to common shareholders increased to 122.65% or by 22.65% in the year 2012 (see Appendix IV). In contrast, Men’s WH income has decreased from 100.00% for the base year of 2008 to 81.01% for 2012 (see Appendix V). Conclusion Thus, the company that is identified through profitability analysis as the better-performing company is similarly the one that delivers better figures using the common-size financial statements and the trend analysis. Compared to Men’s WH, Next has delivered the better Profit Margin (PM), Asset Turnover (ATO), Return on Net Operating Assets (RNOA), Spread, and Return on Common Equity (ROCE). In addition, it is the company that has the higher Financial Leverage (FLEV) and the analyses have shown that Next has made good use of its financial debts to propel its operations into higher efficiency and profitability. Men’s WH can improve its bottom figures by utilizing resources provided by its equity and operations as well as the credit facilities that it can tap in its bid for increased profits and market share. The analyses have further shown that Men’s WH can learn from Next’s operational efficiency. As shown in the net income percentages in the common-size income statements generated for the two companies, Next’s operating income from sales range from 14.54% to 17.51% while Men’s WH lags behind with its equivalent range of 3.63% to 10.82%. APPENDIX I: APPENDIX II: NEXT COMMON-SIZE 2008-2012 INCOME STATEMENTS APPENDIX III: MEN’S WH COMMON-SIZE 2008-2012 INCOME STATEMENTS APPENDIX IV: NEXT TREND ANALYSIS APPENDIX V: MEN’S WH TREND ANALYSIS List of References Thomson Financial (2013) Next PLC Worldscope Company Profile Report Available from [accessed 17 March 2013] Thomson Financial (2013) Men’s Wearhouse, Inc. (The) Worldscope Company Profile Report Available from [accessed 17 March 2013] Bloomberg Businessweek (2013) Next PLC (NEXT:London) Available from [accessed 14 March 2013] Bloomberg Businessweek (2013) Men’s Wearhouse Inc/the (MW:New York) Available from [accessed 14 March 2013] Men’s Wearhouse (2013) Men’s Wearhouse Annual Report 2011 Available from [accessed 14 March 2013] Next PLC (2013) Next Annual Report and Accounts January 2012 Available from < http://www.nextplc.co.uk/~/media/Files/N/Next-PLC/pdfs/latest-news/2012/ ar2012.pdf> [accessed 14 March 2013] Brealey, R., Myers, S. & Allen, F. (2008) Principles of Corporate Finance 9th Edition. New York:McGraw Hill Penman, S. (2013) Financial Statement Analysis and Security Valuation 5th Edition. New York:McGraw Hill Read More