Comparative Financial Statement Analysis: J.Sainsbury and WM Morrison - Case Study Example

Comparative Financial ment Analysis Report of J. Sainsbury and WM Morrison of Contents Introduction 3 2.1 Brief Company Background of Sainsbury 3 2.2 Brief Company Background of Morrison 4 2.3 Core competencies, industry contexts and strategic issues 4 2.3 An accounting analysis assessing the quality of the financial information 5 2.4. Implication in terms of financial issues using financial ratios 6 3.1 Profitability Analysis 7 3.1.1 Decomposition framework 9 3.3 Solvency Gearing 11 3.4 Investment or valuation ratios 12 4. Conclusion 13 Appendices 14 References: 18 1. Introduction This paper aims to prepare a comparative financial analysis of J Sainsbury and one its competitors, WM Morrison (or “Morrison”) for the years 2009 through 2013. The financial analysis will basically start from the point of view of profitability and then linking the same with wealth maximization objective of the company. Towards these objectives, the paper will examine their core competencies, industry context, strategic issues and the financial issues which they imply. This paper wills also conduct and accounting analysis as a way of assessing the quality of financial information provided by Sainsbury and Morrison. In addition, a profitability analysis using decomposition framework will be used and relate the same with other group of ratios in connection with wealth maximization objectives. To accomplish these goals, this paper will evaluate following ratios: profitability, liquidity, and gearing and investment ratios. Inferences for each of the four groups of ratios mentioned above in relation to financial issues and strategic issues will take into account the viewpoints of all corporate stakeholders. 2.1 Brief Company Background of Sainsbury J Sainsbury plc is into the business or grocery and related retailing. Organized into three segments, including retailing, financial services and property investments, the company is operating more than a thousand stores. Under retailing is seen in its Supermarkets numbering more than 500 and Convenience stores numbering more than 400. Under financial services, it has its Sainsburys Bank joint venture while under Property investments; it has the British Land Company PLC joint venture and Land Securities PLC joint venture. It continuous to experience growth over the years some of its recent acquisitions include Global Media Vault Limited last October 2011 and HMV Group plcs holding in Anobii Limited, a social network and online retailer of e-books in June 2012 (Reuters, 2014b). 2.2 Brief Company Background of Morrison WM Morrison Supermarkets plc operates in Britain as a food retailer. As of January 2012, the Company is reported to have about a 500 stores across Britain, in different sizes to as low as 3,000 square feet for the smaller ones and to over 40,000 square feet for the bigger ones. It operates with its subsidiaries which are engaged in various business including manufacturing and distributor of food products, a meat processing. It has also Safeway Limited, as one of its subsidiaries, which operates as holding company, and Optimization Developments delivers goods and services for its property development (Reuters, 2014a) Like Sainsbury, it continued to expand every year as evidenced by opening more than 35 stores for the year ended January 2012. It continued also to make acquisitions, including its purchase of Flower World Limited. As the acquired company was engaged in a wholesale flower business, the same would show its growth strategy of vertical integration (WM Morrison, 2014) as way of expanding its business and ensuring better quality for customers. Acquisitions in 2011 include that of a multi-channel by the name of kiddiecare.com Limited (Kiddicare) 10% share in Fresh Direct (Reuters, 2014a). 2.3 Core competencies, industry contexts and strategic issues Since both Sainsbury and Morrison are from the retail industry, the same industry opportunities and industry threats may characterize the environment. However a company may be not assumed a competent or skilful as the other when it comes to reacting to the same industry opportunities and threats in the same way that each has its own priority. The sure thing is that every company has to generate value for their shareholders by the process of wealth maximization but within the context of broader societal and environmental issues. Companies are to have company strengths or sometimes called core competencies to be dealt with realities of competition as outdo they each other in trying to provide goods and services to their clients under a free market economy. Financial statements reports are evidences of what the companies try to accomplish and by investigating their financial report through the use of their profitability and other financial ratios in relation to other competitors in the retail industry, this researcher would have an objective view of which is better in managing each company‘s resources in relation to their wealth defined objectives in relation to external and internal environments with which they operate. 2.3 An accounting analysis assessing the quality of the financial information The financial information contained in the financial statements is based on the Annual reports of the companies for the 2009 through 2013. The financial statements are audited by external auditors who both expressed unqualified opinion of the fairness of the financial statements. The preparation of the financial statements is the responsibilities of the management of the corporations. Said financial statements make use of accounting standards as standards for preparation. The 2013 annual report of Sainsbury contains the external auditor’s opinion stating among others, that the financial statements do give a true and fair view of state of company’s affairs as at March 16, 2013 and of the company’s profit statements and cash flows for the 52-weeks then ended. The same auditor’s opinion states that the financial statements are prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Unit and that the financial statements are prepared in accordance with the requirements of the Companies Act of 2006 (Sainsbury, 2014a) . The same statements are contained in the opinion of the auditor from the Morrison’s annual report for the same year (Morrison, 201a). Such opinions of the external auditors lend credibility of the financial information. The essential qualities of financial information basically include reliability and relevance as characteristics. Compliance with the IFRS essentially assures the presence of these qualities of good accounting information for decision making. There is therefore basis to rely from the financial statements appears from the annual reports of the two companies being compared. 2.4. Implication in terms of financial issues using financial ratios As financial statements are the result of past operations and status of financial affairs of companies as of a given time, checking the same could reveal whether the companies are effective in their strategies in accomplishing their defined financial and economic objective. By comparing the financial data, a conclusion could be derived for the purpose of seeing the implication of strategic issues and industry context to the two companies. Therefore, the combined ratios for analysis will lead to better analysis on how the companies compete with each other and in relation to in their performance within the retail industry. Each group of ratios has its significance discussed in relation to the wealth maximization and other objectives of the two companies. Wealth maximization objective satisfies the need to be compensated from the investments made by stockholders who had their opportunity costs before they made their investments in the form of stock of both companies. Stockholders need to have return or value from their investment after a certain period of time. 3.1 Profitability Analysis Profits are produced from the excess of revenues over expenses. This would necessitate the measurement of revenues and expenses which are available from the financial statements of the companies under study. There are different categories of expenses according to functions, which will be deducted from the revenues for purposes of computing profit or income. Direct cost which is called cost of sales or revenues is deducted first from revenues to arrive at gross profit. From gross profit, selling and administrative expenses will be deducted to arrive at operating income. From the operating income, non-operating incomes or expenses will be added/deducted accordingly from the operating income to arrive at net income (Johnson, et al, 2003). After arriving at different categories of income --- gross profit, operating income and net income, each result may be divided by the total revenues to determine how the company is performing. Net Income may also be divided by total assets or by total equity to determine the profitability level of the company. Hence, profitability ratios include gross margin, operating margin, net profit margin, return on sales and return on equity (Helford, 2011). However what is satisfactory to one may not be satisfactory to others. Profitability therefore connotes having an excess of revenues over cost and expenses of doing business. From the profit the same would in effect increased the book value of the company and should mean increased wealth of shareholders as the profits are accumulated overtime and would be called retained earnings. Table A below summarizes the comparative financial ratios of the companies for the past five years. Table A: Summary of Financial Ratios (Sainsbury, 2014a,2014b, 2014c, 2014d; Morrison, 2014a, 2014b, 2014c, 2014d; Reuters, 2014c) By investigating the gross margin of two companies, Sainsbury reflected 5% while Morrison averaged 7% for the 2013. This is indicative of lower profitability for Sainsbury, which is validated by having lower operating margin of 3% as against Morrisons 5%. Lower net profit margin for Sainsbury further confirms the lower profitability of the company. Please refer to See Table An above together with Appendices A, B and C for the formula and summary of extracted data from the financial statements of the two companies. It can be further observed that both of the companys gross margins are also below industry averages of 34.6%. Said lower profitability of the both are now however final as the same could still compared in other net profit margin or return on sales, which fortunately resulted to higher rates for the both companies compared with average of competitors at 2.65%. See Table A above. Companies’ performance ratios tell how they delivered well to their stakeholders in the same way that a doctor’s checkup results would tell health of a person at a certain point time. Gross profit margin which relate to 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 above 34 %. This would indicate wide latitude where companies could actually become more profitable. This was not however observed in the relationships with net profit margins and net operating margins of the two companies in relation to the industry, where differences were only slight. In fact both companies have higher net average net profit margin than the industry average of 2.65% for the past five years. See Table A above. 3.1.1 Decomposition framework To apply the decomposition framework to the analysis at hand, there is need to know the breakdown of the companys profitability ratios particularly the return on equity. ROE is actually broken down in return on assets with the formula of dividing net income by the average total assets and multiplying the same by the equity multiplier, the formula of which is total assets divided total equity. It can be observed that the higher the equity multiplier, the higher would be resulting return on assets. This means that if there is high equity multiplier, there would be more debts than equity to finance the activity of company but this would mean higher risk by the company. The implication would be that the higher ROE was caused by effective or strategic financing by the company. In other words it was able to take advantage of higher leverage by increased borrowing and benefiting from the tax shield as a result of the deductibility of interest expense in the computation of the net income of the company. The Return on assets (ROA) is actually broken down into return on sales or net profit margin (total net income divided by total sales) multiplied by total assets turnover (Total revenues divided average total assets). The higher the asset turnover, the higher would be the resulting ROA (Helfert, 2011). As applied to both companies, it could be observed that ROA was almost maintained on a yearly level as both were almost maintain their financial leverage in terms of total asset turnover. See Table A in relation to Appendices B and C. 3.2. Liquidity ratios Profitable companies are not assured that business will not get bankrupt. There must be a way to measure whether a company could go bankrupt and this through liquidity (Helfert, 2011) .Companies need to have good liquidity ratios to show that they are able to pay current obligations. Capable management of companies needs to demonstrate its ability to meet currently maturing obligations to prevent the fear or actual bankruptcy which is bad for said investors. Good liquidity is similar to having a well-conditioned car which can convince its owner freedom from trouble at least in a given period of time, which is usually one year. If a company can pay timely the salaries of its employees, then the latter could continue rendering services to the company as they assist management in delivering value to customers. If accounts payables with outside suppliers are paid on time, then the latter would continue delivering goods to put in the shelves of the stores and supermarkets of both companies. Liquidity also presupposes that other accrued expenses are settled at the right time to assure continued flow of activities in a regular manner. As to whether the companies under study have liquidity, the ratios should confirm the same. Sainsburys average current ratio for the past five years at 0.61 was higher than Morrison with 0.55. Both ratios are below the industry average of 1.02. The same could be said in terms of the quick assets ratios, where Sainsbury exhibited higher ratio of 0.29 while Morrison showed 0.22. Both ratios again are below industry average of 0.87. See Table A above. 3.3 Solvency Gearing A company may be profitable yet may be too risky. One way to measure risk is the use of gearing ratio. Said gearing ratio is similar to solvency which measures the financial leverage of entities by signifying the degree of how the company is funded from shareholder as against creditors (Higgins, 2007). Companies basically manage assets as they engage in producing profits which are partly financed by shareholders and creditors. The need to borrow or have additional investment from stockholders is two competing options for every company. Companies operate via the board of directors and shareholders, with the latter electing the former. The board of directors sometime wants additional investment from these owners but they can opt to incur debt or loan agreement to have more assets to be used in business. The increased in assets is geared toward increasing revenues pursuant to growth strategies of companies. Companies need grow overtime as proof at that they can address the industry threats and that they can take advantage its industry opportunities. The choice to borrow or have stockholder make additional investment must be connected strategically to wealth maximization as may be evidenced by increasing prices of companies’ stock in the stock market. This will be addressed in the valuation or investment ratios to be discussed later. Companies need to know when to limit its borrowings or debts from creditors by the use of gearing or solvency ratio. This can be accomplished through the debt to equity ratio computed by dividing total liabilities with the total equity of the corporation. Using said ratio, Sainsbury reflected debt to equity ratio for 2013 of 1.19 as against Morrison at 0.82. Sainsbury ratio was higher than industry average of 0.82 while Morrison has the same as industry average. See Table A above. This means the Sainsbury is worse in leverage compared with competitor Morrison and the rest. Note that the higher the ratio, the higher is the leverage. But since the two companies appear to have survived the financial crisis of in the past years, their continuing into a business is an indication of their capacity to withstand temporary financial and economic challenges that may occur expected on expectedly as economic factors change in the environment. Their resiliency to crisis is evident. 3.4 Investment or valuation ratios As stated earlier companies aim not only for profitability, they also aim for wealth maximization (Brigham and Houston, 2011). Generally, companies which generate more profits should generate more wealth. The factor that would explain the exception is due to assessment of long-term risk from the investor. It is basic in finance that the higher the return, the higher would be risk and vice versa. As to how these happen, a comparison of the profitability and investment ratios must be done. It is in the investment ratios that investors’ response to how the companies performed are measured. Some of these investment ratios include price-earnings ratio, price to sales, price to book ratio, price to tangible book and even price to cash flow. Please refer to Table B below. It was found earlier that Sainsbury was less profitable than Morrison, but it has better liquidity than the latter. In terms of gearing, Sainsbury was also more risky. As to whether investors trust one company over the other is measured in terms of valuation ratios and investors gave more favour to Sainsbury as against that of Morisson. In terms of P/E ratio for the last twelve months Sainsbury reflected higher ratio. This means that despite lower profitability of Sainsbury compared with Morrison, investor could assume a higher risk with Sainsbury over that of Morrison. The same is evident even that for the last five years. Table B- Comparative Investment Ratios (Reuters, 2014c) 4. Conclusion This paper has found less profitability and more risky position of Sainsbury compared to that of Morrison. However, in terms of wealth maximization strategies, what is employed by Sainsbury appears to be better than that of Morrison on the average for year 2013. In addition, it has shown higher liquidity as against Morrison and its other competitors in the industry. It less superior financial leverage compared with Morrison, was still taken positively by investors as investors are more than willing to assumed risk with Sainsbury compared with Morrison. Sainsbury has responded better to its strategic issues Sainsbury’s secrets in arriving with better results liquidity better valuation ratios would indicate in being able to identify opportunities for profitability as it responded to the changing needs of its customer. Although it appears that between Sainsbury and Morrison , the latter is better than the former in terms of profitability and leverage ratios, the higher gearing ratios and better investment ratios of the former raises a question as to weight of relevance of ratios for profitability and solvency ratios alone. Compared however with rest of competitors in the industry the two are not better when it comes to price-earnings ratios. The higher ratios of the industry point to the non-maximized wealth-generation potential of the two companies. But between two of them Sainsbury is definitely better. From the point of investors, there is better basis to invest with Sainsbury. Appendices Sources: (Sainsbury, 2014a, 2014b, 2014c, 2014d; Reuters, 2014c) Sources: (Morrison, 2014a, 2014b, 2014c, 2014d; Reuters, 2014c) References: Brigham and Houston (2011). Fundamentals of Financial Management, Concise Edition. Cengage Learning Helfert, E. (2011). Techniques of Financial Analysis: A Mode. McGraw-Hill Education (India) Pvt Limited Higgins (2007). Analysis for Financial Management, Eighth Edition. Front Matter Quick Reference URL Guide. The McGraw−Hill Companies Johnson, et al (2003). Financial Accounting. Tata McGraw-Hill J. Sainsbury (2014a). 2013 Annual Report. Retrieved March 2, 2014 from < http://www.j-sainsbury.co.uk/media/1616189/sainsburys_ara.pdf > J. Sainsbury (2014b). 2012 Annual Report. Retrieved March 2, 2014 from J. Sainsbury (2014c). 2011 Annual Report. Retrieved March 2, 2014 from J. Sainsbury (2014d). 2010 Annual Report. Retrieved March 2, 2014 from http://www.j-sainsbury.co.uk/investor-centre/reports/2010/annual-report-and-financial-statements-2010/ Reuters (2014a). WM Morrison Company Profile. Retrieved January 31, 2014 from Reuters (2014b). J Sainsbury Company Profile. Retrieved January 31, 2014 from Reuters (2014c). Industry Ratios. Retrieved March 2, 2014 from < http://www.reuters.com/finance/stocks/financialHighlights?symbol=MRW.L> WM Morrison (2014a). 2012/2013 Annual Report. Retrieved March 2, 2014 from < http://www.morrisons-corporate.com/Documents/Annual-Report-2012-13.pdf > WM Morrison (2014b). 2012/2011 Annual Report. Retrieved March 2, 2014 from WM Morrison (2014c). 2011/2010 Annual Report. Retrieved March 2, 2014 from WM Morrison (2014d). 2010/2009 Annual Report. Retrieved March 2, 2014 from 1. Read More