Financial Analysis of Tesco PLC - Case Study Example

Financial Analysis of Tesco PLC Table of Contents Table of Contents 2 Introduction 5 Company Overview 5 Key Competitor 6 Rationale for Choosing Sainsbury PLC 6 Financial Statement Analysis 6 Numerical Investigation 7 Profitability ratio 7 ROCE 7 ROE 8 Gross Profit Ratio 8 Profit Margin Ratio 8 Profitability Analysis 9 Liquidity ratio 10 Current Ratio 10 Acid Test Ratio 10 Liquidity Analysis 11 Cash Flow Ratio 11 Cash Flow Adequacy 11 Quality of Profits 12 Operating Cash Cycle 12 Cash Flow Analysis 13 Efficiency Ratio 13 Inventory Days 13 Asset turnover 14 Efficiency Analysis 14 Investment Ratio 14 Dividend per Share 14 Dividend Yield 15 Dividend Payout 15 Earnings per Share 16 Price Earnings Ratio 16 Investment Analysis 16 Solvency Ratios 17 Interest Cover 17 Solvency Analysis 18 Conclusion 18 Recommendations 19 Reference List 21 Introduction Financial statements form an extremely critical part of any company’s business. They represent the manner and the flow with which money movements take place. They have to be authentic, reliable and easily comprehendible. The financial ratios are tools that are used to judge the health of such money management by companies through the use and analysis of profitability ratios, liquidity ratios, cash flow ratios, efficiency ratios and gearing ratios. The following report is aimed at developing and investigatory study of the financial statements of two companies, Tesco PLC with its competitor Sainsbury PLC through a comprehensive ratio analysis and interprets the results obtained thereof over the past three consecutive years. Based on such analysis, the paper makes suggestions for improvement and development of strategic and business decisions to the company’s management. Company Overview Tesco PLC is a UK based multinational grocery retail chain established since the year 1919. The company was founded in east London by Jack Cohen while the management of its operations was taken forward by David Reid and Sir Terry Leahy. Tesco PLC has an extensive product range including groceries, consumer goods, telecoms and financial services. The company boasts about 6351 stores globally which bring in an impressive revenue of £64.826 billion for the year 2013. Tesco PLC has an overall market cap of about £24.4 billion over the London Stock Exchange (Tesco, 2014). Key Competitor J Sainsbury PLC is also a UK based supermarket retail chain with a global presence that can give stiff competition to Tesco PLC. The company is expanding rapidly and presently has about 1106 stores located within United Kingdom alone. Sainsbury Supermarkets Ltd. reported group profits amounting to £887 million, for the year ended 2013. Sainsbury is the second largest market capitalizing company in UK at 16.6% (Sainsbury, 2014) Rationale for Choosing Sainsbury PLC The company Tesco PLC is a UK based grocery retail chain. For the purpose facilitating comparison through shared similarities of market access and industry of operations, the researcher chose Sainsbury PLC which again is a UK based multinational grocery retail chain like Tesco. Both the companies are closest in terms of company size, profitability and operations and hence Sainsbury was found fitting and suitable for the following comparative financial analysis for Tesco PLC. Financial Statement Analysis The financial statement analysis for Tesco PLC presented that the company has been experiencing good times showing satisfactory growths and profits until 2013. The year 2013 saw a sudden and unexpected discontinuation of US operations for the company. Tesco has completely withdrawn from US leading to huge losses in terms of sales as well as assets. The company now plans to use up the funds that it would have otherwise used in US, to UK operations. They plan to expand and build giving stiff competition to the local payers in UK in the grocery retail chain business. Tesco PLC experienced a 6.7% rise in profits from 2011 to 2012 but saw a huge 47.6% fall in profit figures in 2013. The company did not run into losses owing to work stoppage. The gross rise in sales was only 1.6% in 2013 as compared to 5.7% rise in 2012. The loss in sales can again be largely attributed to US operation closure. In terms of dividend distributed, the company has maintain healthy dividend payout ratios but 2013 did not see a significant rise in dividend payout as compared to 2012 where the dividends increased by 8.9% (Tesco, 2014). Company share prices have also been disturbed by the fall in profits and saw an average fall by 14.3% as compared to 7.75% decline over 2011-2012 (Tesco, 2014). Numerical Investigation Profitability ratio The profitability ratio is aimed at making a comparison of the overall success of the company through the measure. ROCE Return on Capital Employed (ROCE) = (Profit Before interest and tax / Capital employed + Reserves) *100 The measure is an anticipation of the portion of earnings that goes towards long term funding. ROCE 2013 2012 2011 2010 Sainsbury 0.127096 0.137443 0.14547 0.064399 Tesco 0.078527 0.13855 0.140596 0.089027 ROE Return on Equity = Net Income / Average Shareholder Equity The return on equity is a measure that tries to appraise profits that are to be made available to shareholders as a reward for their investments in the company. ROE 2013 2012 2011 2010 Sainsbury 0.267422 0.262396 0.28281 0.117801 Tesco 0.006973 0.163614 0.161536 0.159117 Gross Profit Ratio = Gross Profit / Revenue GP Ratio 2013 2012 2011 2010 Sainsbury 5.48% 5.43% 5.50% 5.42% Tesco 6.31% 8.44% 8.48% 8.10% The GP ratio is a measure of the efficiency of the operational performance for a business. Profit Margin Ratio = Operating Income / Revenue Net profit ratio is a measure of profits of a business that arise out of its primary operational activities (Needled, Powers and Crosson, 2008). Profit Margin 2013 2012 2011 2010 Sainsbury 2.63% 2.68% 3.03% 2.93% Tesco 0.19% 4.40% 4.42% 4.10% Profitability Analysis The analysis of above ratios presents a picture of the overall efficiency in the operational ability for Tesco PLC and it compared to its closest competitor J Sainsbury PLC. The ratios included in the analysis of company profitability include the gross profit ratio, the net profit margin, the Return on Capital Employed and the Return on Equity. An analysis of the ratio’s for Tesco PLC as compared to Sainsbury PLC between 2010 and 2013 represents that the ROCE for Tesco shows a declining trend after a rise in 2010. The fall is attributed a steep fall in company profits. However, the Sainsbury falling trend is meager and does not imply that the company has had a slight fall in the profits. The reason behind falling ROCE is that Sainsbury has been using a larger share of the profits as retained earnings for business investment and expansion purposes in its UK businesses. In case of ROE, Tesco experience a huge dip in 2013. This fall in ROE is due to the huge losses incurred by the company in shutting down and work stoppage of US operations raising the cost of sales for the company. Sainsbury pulled out of US to invest more in the UK businesses and to revamp its US re-entry (Sainsbury, 2014). The ROE for Sainsbury has shown a constant trend and is maintained within the acceptable level. In terms of company profitability, the gross profit and the profit margin ratios show that Tesco earns higher profits than Sainsbury. In this context 2013 can be an exception to his rule owing to US shutdown for Tesco which has driven its yearly net profit margin in 2013 to zero. Despite being a larger concern as compared to Sainsbury, Tesco has made huge losses towards US losses which drive its profits to the lowest levels. Liquidity ratio Current Ratio = Current Assets / Current Liabilities The current ratio is a measure of the management efficiency of the company’s short term liabilities. Current Ratio 2013 2012 2011 2010 Sainsbury 0.610273 0.647959 0.580557 0.643394 Tesco 2.223807 2.01425 0.67898 0.734624 Acid Test Ratio = (Current Assets - Inventories) / Current Liabilities Within the current asset category, it is deemed the inventories are among the least liquid assets and hence the removal of inventories provide with the acid test ration which measures the ability of a company to pay off for its short terms credits. Quick ratio 2013 2012 2011 2010 Sainsbury 0.293419 0.348852 0.304555 0.392052 Tesco 1.588046 1.45083 0.500649 0.616734 Liquidity Analysis The analysis presents that Tesco maintains a desired level of current ratio which states that it has almost twice of liquid assets than its short term credits. The funds are sufficient to pay off for its operational expenses. Sainsbury faces a cash crunch in the short term and runs largely into operational inefficiency in fund management. When inventories are eliminated, Tesco represents healthy cash status for short term operational fund requirements. However, there is a possibility that the company runs in excess cash which is also undesirable as Tesco might actually be losing out on further use of its current assets for business and operational purposes. Sainsbury has poor status of cash and has immense difficulty in managing operational finances. Cash Flow Ratio Cash Flow Adequacy = Cash Flow from Operating Activities / Average Annual Current Maturities The ratio is a measure of the company’s cash position to meet fund requirements of the business (Drury, 2008). Cash Flow Adequacy 2013 2012 2011 2010 Sainsbury 0.935705 0.812972 0.7684 0.73862 Tesco 0.499736 0.707771 0.575638 1.002747 Quality of Profits = Net Cash Flow from operating activities/Operating Profits The ratio is an estimation of the profits received in cash by the business during a financial year. Quality of Profits 2013 2012 2011 2010 Sainsbury 1.105975 1.220824 1.003525 1.416901 Tesco 1.296618 1.054041 1.082206 1.372577 Operating Cash Cycle (Stock Day + Creditors Day + Debtors Day) / Sales The ratio is an estimation of the total time taken by a company to make sales and receive payment for it. Operating Cash Cycle 2013 2012 2011 2010 Sainsbury 3.412494 3.468106 2.505052 3.452218 Tesco 1.582597 1.479048 1.482783 1.088083 Cash Flow Analysis The analysis presents that Tesco runs very low cash position close to 0.5 and does not have enough cash for meeting the necessary business requirements. Sainsbury, on the other hand represents healthy cash flows. The quality of profits ration presents that Tesco’s cash profits are healthier as compared to Sainsbury. The cash management of Tesco can be ascertained to be poor where all cash goes into making business investments however, due to good liquidity position of other current assets, the business handles its operational needs well. The speed of making profits depends on the operating cash cycle reduction. A sustainable company shall try to keep such a ratio to the minimum. A comparison of the two companies presents that Tesco has a stronger cash cycle position than Sainsbury. This implies that the recovery of debts is well managed at Tesco and it runs good debit and credit terms that run favorably for the company. Hence despite the absence of any cash, Tesco manages to have a healthy and smooth daily business operations and cash management for the business needs. Efficiency Ratio Inventory Days = (Inventory*365)/ Cost of Goods Sold This ratio is a measure of the speed at which finished goods get converted into final sales. Inventory Days 2013 2012 2011 2011 Sainsbury 16.3559 16.23915 14.8621 13.57007 Tesco 22.49963 22.44177 20.85903 13.17553 Asset turnover = Net Sales / Total Assets The ratio represents the sales per every pound of the company worth. Inventory Days 2013 2012 2011 2010 Sainsbury 1.835605 1.806645 1.851215 1.839152 Tesco 1.293184 1.280984 1.280663 1.236556 Efficiency Analysis The inventory day’s observed that Tesco has a higher number of days in inventory as compared to Sainsbury. In the business of grocery retail, it is desired that companies maintain lower levels of inventory so as to provide fresh goods t their customers. Hence Tesco needs to improve on its inventory management systems. The asset turnover ratio shows that there is consistence in asset turnover ratios for both companies however; Tesco has a lower asset turnover as compared to Sainsbury representing scope for better management of company assets for increasing sales. Investment Ratio Dividend per Share = Dividend paid to shareholders/ Number of shares outstanding The ratio represents the amount received per unit investment made in the company by a shareholder as share of profits. Inventory Days 2013 2012 2011 2010 Sainsbury 0.115503 0.112983 0.104633 0.128739 Tesco 0.147008 0.146931 0.134601 0.120308 Dividend Yield = Net Income / Average Shareholder Equity Dividend yield measures the investor return value per unit shareholding. Inventory Days 2013 2012 2011 2010 Sainsbury 1.838323 1.973597 1.758242 1.762048 Tesco 0.365419 7.300937 6.393011 6.147368 Dividend Payout = Dividend/Earnings Dividend payout measures the amount actually paid as dividend when compared to earnings of the company. Dividend payout 2013 2012 2011 2010 Sainsbury 0.36645 0.364548 0.314063 0.411966 Tesco 9.866667 0.419332 0.405466 0.414384 Earnings per Share = Net income available to shareholders/ number of shares outstanding The ratio is a reflection of the amount of income that is available per unit shareholding. EPS 2013 2012 2011 2010 Sainsbury 0.315195 0.935705 0.812972 0.7684 Tesco 0.014899 0.499736 0.707771 0.575638 Price Earnings Ratio = Market Price per share/ Earnings per share Price earnings ratio is the potential a growth for a stock as compared to its market price. P/E Ratio 2013 2012 2011 2010 Sainsbury 0.543974 0.506689 0.56875 0.567521 Tesco 2.736583 0.136969 0.156421 0.162671 Investment Analysis The companies have represented a healthy case for dividend per unit shareholding and have been paying healthy dividends for shareholder satisfaction. Dividend yield for Tesco has been much higher than Sainsbury implying that the company is generating higher sales per equity holding than its key competitor. The market price for shares of Tesco has fallen owing to the shock in profit of the company. Despite this the company has paid healthy dividends. This has also driven down the P/E ratio for the company which otherwise was much higher than Sainsbury. Solvency Ratios Gearing Ratio = (Long Term Loan + Preference Share) / Equity This ratio is a measure of the ability of company’s assets to meet company liabilities (Brealey and Myers, 2011). Gearing ratio 2013 2012 2011 2010 Sainsbury 0.398326 0.404868 0.419617 0.474627 Tesco 0.730328 0.674737 2.173488 2.258462 Interest Cover = PBIT / Interest Payable The ratio analyses the ability of company profits to meet its interest expenses. Interest Cover 2013 2012 2011 2010 Sainsbury 6.246479 6.333333 7.336207 6.396396 Tesco 4.766885 10.17518 8.109731 5.010145 Solvency Analysis The above analysis presents that Tesco’s gearing experienced a fall in 2012 which revived in 2013. However, the gearing ratio is still low to fully meet company liabilities. Sainsbury has relatively better gearing ratio than Tesco but this also shows that Sainsbury has a very conservative financial management policy. The slump in gearing ratio for Tesco has brought it to a more stable position from vulnerable position of loans in 2010. As for interest cover, Tesco observed a huge fall in interest cover ratio owing to the huge slump in profits. It is however still healthy at 4 times. For Sainsbury, the interest cover remains constant at a healthy 6 times. Conclusion Tesco is a larger concern as compared to Sainsbury PLC however; both the companies have their own competencies that make them comparable for competitive analysis of financial statements. In the above ratio analysis of financial statements, the companies prove the fact. In a recent pull out of Tesco from US operations, the company suffered a major blow in operational costs which also put a big dent on company profits. Tesco now plans to invest the money into developing its strengths in UK operations before re-thinking over investing into US again. This is a serious threat for Sainsbury which also has majority of its operations within the country. There are tough times ahead of both the companies in terms of competition. Tesco has it strength in managing operations but is slightly weak in cash position management and inventory days. Sainsbury, on the other hand provides tough competition in terms of efficient cash management and good cash availability for company funding requirements but lacks strength in short term liquidity management. If the exceptional case for 2013 was to be ignored, both companies have been working towards improving company profits and also giving healthy dividends to keep shareholders happy. Recommendations Tesco has to make swift changes in its strategies in order to regain control over losses made in US operations and its discontinuations. It is desirable that the company makes efforts towards regaining investor confidence in order to revive its share prices in the market. This can be done by ensuring efficient management of company inventory and cash positions in order to utilize cash and company funds better towards investment avenues. Despite a healthy management of liquidity, Tesco has to improve upon its cash management policies in order to ensure sufficient fund availability for daily business needs. Sound management of operational cash flow makes more funds available for investment purposes. In addition to this, Tesco shall face stiff competition from Sainsbury which is strong in its cash management systems and has a better inventory management policy. The company might face competition in terms of providing fresh good to its clients from Sainsbury. This could be a major threat. In order to manage the situation, Tesco PLC needs to improve over its inventory day’s ration and reduce it to match the standards set by Sainsbury. This can be done by enabling better operational management systems and just in time replenishment technique for total quality management of company operations. Tesco has to seek improvement in managing its assets more efficiently as suggested by the asset turnover ratio. The company requires putting its assets to more efficient use so as to increase net sales per asset unit of the company. Reference List Brealey, R. A. and Myers, S.C., 2011. Principles of Corporate Finance. New Delhi: McGraw-Hill. Drury, C., 2008. Management and Cost Accounting. Connecticut: Cengage Learning EMEA. Needled, B. E., Powers, M., and Crosson, S. V., 2008. Principals of Accounting. Connecticut: Cengage Learning. Sainsbury., 2014. Annual Report 2013, 2012, 2011. [pdf] Sainsbury Plc. ] Available at: [Accessed 15 May 2014]. Tesco., 2014. Annual Report 2013, 2012, 2011. [pdf] Tesco Plc. Available at: [Accessed 15 May 2014]. Read More