Financial Analysis of Tesco PLC and Comparative Study with J Salisbury PLC - Example

Client’s Name] [Professor’s Name] [Subject] [Date] Financial Analysis of Tesco PLC and Comparative Study with J. Salisbury PLC Abstract Tesco’s financial performance in the light of the global economic recession is impressive, considering that it was able to curb the effects of the market condition. A closer investigation of the financial information released by the company, however, revealed a different story. Tesco’s growth is short-term caused by massive borrowing and risky strategic decisions. Moreover, the company’s ability to pay off its long-term debts is jeopardized by heavy borrowing. Investors are more likely to invest their money on J. Salisbury Plc whose financial performance is more predictable. Nonetheless, the riskiness of Tesco’s strategic decisions makes it either a potential goldmine or a probable disaster for investors. This paper investigates and analyzes the financial performance of both companies to evaluate which among the two can give investors a better return for their money. Tesco Plc is the world’s third largest retailer store operating in a global scale (Tesco, 2009). Established in 1919 by Jack Cohen, the company started with a retailing business in the early 1900s and gradually expanded to food and other non-food business. Tesco’s main base of operation is in UK but it has expanded to other markets across the world since 1997 to provide consumers better service and mainly to give a strategic direction to its growing business needs. Tesco gives more value to the money of their customers through Tesco’s clubcard membership program. This is evident in the ability of Tesco to produce profits and increase the number and value of its assets even during the most constraining market situation. Tesco’s sales and profits have seen gradual increase in the last five years (Appendix A). Tesco’s sales in 2009 have reached £59 billion from a mere £51 billion in 2008 (Appendix C). The company has opened 4,331 stores in 14 countries across the globe, employing over 470,000 people. While the rest of the world is cutting cost by laying-off employees, Tesco was able to add more than 700 people in UK and other global locations. Tesco’s performance in the local (UK) market is astounding. Sales in UK reached £41.5 billion (Appendix D), many percent higher than the sales in 2008 considering the market condition. While the company is aggressively pursuing global presence, it has not let go of its core business which is retailing in the UK market. Overall, the growth experienced by the firm in all of its business areas can be summarized into the following: 15.1% increase in group sales (including VAT), 10.0% growth in underlying group profit before tax, 5.5% increase in group profit before tax, 11.0% increase in underlying diluted earnings per share, 2.6% increase in diluted earnings per share, and 9.7% increase in dividend per share. Tesco’s UK sales alone is at £41.5 billion, an increase of 9.5% from last year’s sales with a like-for-like growth of 4.5% and 2.7% growth of new stores. Horizontal and Vertical Analysis The liquidity performance of the company or the ability of the company to pay off its short-term obligations has doubled from last year’s ratio. In 2008, the liquidity ratio of Tesco is 0.38 and this year, the ratio has increased to 0.63, almost double last year’s figure. In 2009, Tesco is more able to pay its short-term debts and obligations with a current ratio of 0.78. This ratio has increased considerably since it hit 0.57 in 2005 and got its lowest rate in 2006 at 0.52. Quick ratio analysis shows similar result as the ratio hit 0.73 from 0.51 in 2008. This increase in the liquidity ratios is attributed to the increasing cash deposits of the company in 2009 as well as the growing value of short-term investments which soared from mere £765 million in 2006 to more than £6 billion. This increase in the liquidity performance of the company is surprising considering that the economic environment it had to deal with was somehow unstable. Further analysis of the financial information provided by the company revealed strategic approaches on the financial scenario of the company. The company’s shareholders expect lesser equity for every pound invested at 0.86 in 2009 from 1.46 in 2008. This shareholder’s equity for 2009 is the lowest in the 5-year period having its highest ratio in 2007 at 1.71. In addition to that, the solvency ratio for 2009 reached lowest in five years after it has dropped from 44.13 in 2005 to 28.09. These ratios suggest that the company is either investing much of its earnings or borrowing more money to finance its operations. The gearing ratio tells it all. Tesco’s gearing ratio increased from 87.06 in 2008 to 147.14 in 2009 which means that the company is using borrowed money in order to cover for short-term losses resulting in a very risky financial position in the long run. This conclusion is supported by other financial trends in the company. Current liabilities almost doubled from £10 million in 2008 to over £18 million 2009. Long term debt has also increased from almost £6 million in 2008 over £12 million in 2009. Furthermore, fixed and long-term assets more than doubled from previous years with 34.13% (£7.7 bn) and 122.94% (£8 bn) in 2009 from 17.96% (£3 bn) and 37.67% (£1.7 bn) in 2008, respectively. Loans and long-term liabilities have tripled for this year as well, highlighting the long-term insolvency of the firm. Return on the capital employed for the company hits rock bottom in 2009 with 10.55%, the lowest in a 5-year period. This explains the decrease in long-term inability of Tesco to pay off its debts as suggested by the financial statement. As a result, the value of the company’s stocks decreased by 9.84%. On the positive note, this financial strategy of borrowing to offset the financial losses during the toughest period in the UK economy has been very effective. However, the extent of the financial success of Tesco is best analyzed by comparing it with another company from the same industry. A more appealing choice for comparison is J. Sainsbury PLC, the third largest chain superstore in UK. J . Sainsbury is significantly smaller than Tesco but its strong presence in the UK market makes it a worthy comparison. Established in 1869 by John Sainsbury, the family business has experienced tremendous growth in the next decades until the family became complacent with its pursuit for growth and progress. This complacency has resulted in a significant loss of market appeal. Adding to this is the fact that competitors are gaining strong advantage over the company by innovating management approaches and Currently, Sainsbury has 502 supermarkets and 290 convenient stores situated in UK. The company boasts of serving more than 18 million customers per week with a market share of more than 16% - making it the third largest retailer store in UK. Overall, the company is doing well considering the volatile condition of the UK market. Despite the hard times, Sainsbury was able to increase its sales from £19 billion in 2008 to £20 billion in 2009. However, its profit after tax is less than what it earned last fiscal year with only £289 million (Appendix D). Five year financial report (Appendix E) indicates that the growth rate experienced by the company is consistently low even before the global economic crisis was even a threat to UK consumers. Vertical and Horizontal Analysis J. Sainsbury’s financial performance, particularly its liquidity ratio, has experienced a steady decline in the last five years. In 2005, the liquidity ratio of the company is at 0.74 (with a current ratio of 0.85) but in 2009, it has dropped to 0.3 (with a current ratio of 0.54). The solvency ratio of the company has declined by almost 8% from 51.3% in 2008 to 43.62% in 2009. This solvency ratio is still bigger compared to the ratio in 2005 and 2006 where the figure falls below 30%. Shareholder’s equity has also dropped from 2.37% in 2008 to a mere 1.6% in 2009 with the decline of the average stock price of the year at 1.17%, a figure significantly less than the 15.42% average stock price in 2008. Despite this performance, Salisbury is able to maintain a low gearing ratio, establishing its safe position in the given market condition. Although the company’s current asset is still at a negative value at -8.83%, this is an increase in the five year trend which dropped in 2007 at -49.54%. There were also noticeable changes in the long-term liabilities and loans/overdraft of Salisbury. In the last two years, long term liabilities and loans/overdraft have negative values but in 2009, the value jumped from -£426 million to £658 million and -£245 million to £36 million. Despite this massive borrowing employed by Salisbury, other financial indicators suggest that its earning capacity did not change significantly. The profit margin of the company dropped from 2.69 last year to only 2.46 this year. The increase on the return on shareholder’s fund did not reach 1% and returns on capital employed decreased significantly as well. Overall, the global economic meltdown has very minimal effect on the financial position of J. Salisbury considering its gradually declining performance over the last few years. Conclusion J. Salisbury’s performance in the light of the global economic recession is impressive. The company’s losses did not go beyond the normal range of losses despite the market volatility. Tesco on the other hand used a lot of investors money as well as borrowed money to prepare itself from the negative impact of the recession. Because of the good credit status of the company, and because of the perceived ability of the company to pay its debts, it was able to deflect the negative effects of the market. From an investor’s point of view, it is very good to invest at Tesco because of its ability to grow the money invested in it. However, the borrowing scheme of Tesco makes it a very risky company. This makes J. Salisbury a preferred company for investment opportunities. Investors that are more risky might opt to invest their money with Tesco whereas the play-safe types might seriously consider J. Salisbury. Section B: The number of Board members comprising Tesco Plc as well as the qualifications of all the directors, both executive and non-executive is strategic considering that these directors are selected with strong emphasis on their wide experience in managing their areas of expertises. With a very small number of executive and independent non-executive directors, decision-making process is centralized and is easy to implement. Executive directors are given the control of corporate operations like the risk management and internal controls. This is because they have the capacity and a deeper understanding of how the internal processes works in the company. Similarly, selecting the independent non-executive members of the Board to function in the Remuneration and Audit Committees ensures the stakeholders that the financial data and information released by the company is free from flaw and financial manipulations. Moreover, the decision to hire PricewaterhouseCoopers as its external auditing body emphasizes the assurance it gives the clients of the reliability and the validity of its financial report. The outline of the Board’s purpose and function is very essential in any financial reports. Tesco’s outline highlights the important roles played by its Directors in the strategic movement of the company. Detailing the methods by which the Board is gauged and graded is also very important for various stakeholders to know. By knowing how each Director works towards the strategic direction of the company, future investors can make important inferences and opinions on the potential growth or risks that will be experienced by their investments in the long run. Detailed explanation of the remuneration of the directors allows stakeholders to look at how their money are being used and who are the people they are paying to do the job. This also assures the investors that the top people working for the company are highly qualified and are being paid handsomely for their contribution. Tesco’s decision to include the trespass it has made of one of the provisions of the Combined Code of Corporate Governance which is to have half of the composition of the Board be independent non-executive members is very well appreciated and the justification it has provided for the breach of this rule is understandable. This assures the major stakeholders that Tesco is in compliance with all the legal basis of its corporate structures and corporate form of governance. This revelation also makes the stakeholders feel that Tesco has got nothing to hide in its financial reports, erasing all doubts cast on the company, which is a strategic decision. Although the company is publicly listed, its financial report did not contain any information about its private owners, or the major stockholders of the company. However, it does contain the ownership schemes devised by the company to encourage its workers to perform better. With stocks as the primary incentive, Tesco employees will be encouraged to work hard for the company because the company’s growth would mean the growth of their personal wealth too. Tesco has two ownership schemes which are employee share ownership and the directors share ownership. The company boasts of its 170,000 UK employees that hold stock ownership of the company. This excludes the long-term executive share ownership characterized by its directors. Tesco’s audit report is comprehensive and contains all the details required by GAAP, IFRS, IFIRC, and EU reporting standards as verified by the external auditors before publishing. Both the financial statement report and the Directors’ Remuneration Report complied with the Companies Act 1985 and 2006 while the Group financial statement passed the requirements outlined by Article 4 of IAS regulation. The financial year represents the 53 trading weeks to February 2009 in UK, Republic of Ireland, and USA. The directors asserted their knowledge of the contents of the financial report as was detailed in the disclosure statement. As the independent auditors have discussed in their audit report, both in Tesco Group financial statement and in Tesco UK, gave a true and fair view of the financial affairs of the business in accordance to IFRS (as endorsed by the EU reporting standards) and that of the GAAP. Moreover, the directors explicitly made the claim that the report presented were reviewed and approved by them which gives weight to all the financial information indicated therein. Because of the stringent requirements set out by GAAP, EU financial reporting standards, and other international financial accounting standards that outlined the stringent and advance requirements of any financial reports, the report published by Tesco is undoubtedly accurate. Adding to the fact that the format of the report details every financial aspect of the business, starting with the group financial report which include various financial reports on different businesses, different locations, and different trends and patterns in the financial performance of the company and finishing with the performance of Tesco UK, the company did a very good performance in presenting all the relevant financial information it has made in the previous fiscal year. With this format, Tesco was able to provide various stakeholders the comprehensive and logical flow of financial information, highlighting the strengths of the firm while at the same time being transparent with its report. Moreover, the transparency of the report and the fairness of view it presented (as verified by an external auditor) suggests that the report was independently made and that there were no pressures, both internal and external, that influence the report of the internal auditor. This is a very important thing since any flaw in the financial reporting would cost a lot to Tesco and when this flaw goes public, the confidence of both the consumers and stockholders will plummet, costing a lot to the company. As was previously mentioned, Tesco’s Audit committee is composed of the independent non-executive individuals whose stake in the organization is based primarily on their ownership of the stocks of the company and secondly on their capacity to function as an integral part of the company’s success. The choice of the members of the audit committee is not only logical but is also ethical and strategic. This is because non-executive directors do not participate in the decision making for the day-to-day operations of the company. This further implies that their observation and evaluation of the company’s financial performance is independent of the decisions made by internal and risk management teams (which are mainly composed of executive directors) which means that there would not be any connivance of sort to manipulate financial information based on the preset target of the operations. Moreover, the internal auditors care primarily for their investments and so anything unusual going on with the financial activity of Tesco can be checked, verified, and corrected before the actual publication of the report. Moreover, the Audit committee is free from the pressures, insinuations, and influence of the external auditors in compliance with the existing laws on financial reporting. With an audit committee that does not have any role in the preparation and the implementation of business strategy, and whose major concern is the movement of the stock value of the company, the validity and reliability of Tesco’s financial performance is what matters to the auditors. This also means that there is a very narrow window for the internal and external pressures to influence the result of the financial report. The financial report made by Tesco Plc for fiscal year that ends in February 2009 contains only one disclosure on the ethical and legal basis of the structure of the company’s Board of Directors. As was previously mentioned, the report contained an explanation of the breach in one of the provisions held by Combined Code of Corporate Governance by having more than half of the executive directors in its Board composition. Their stance to keep this decision public despite the technical illegality of the decision has actually helped bolster the stakeholders’ confidence towards the company. While there is nothing damaging about the revelation, considering that there was no oversight and the decision made is for the immediate benefit of the company, this revelation has actually stressed the importance of honesty and integrity of Tesco. Informing stakeholders of this seemingly insignificant decision assures the shareholders that bigger decisions that could affect their interests are also made public. Appendix A: Tesco 5-year Sales and Profitability report Appendix B: Tesco PLC 2009 Group Income Statement Appendix C: Tesco PLC 5-Year Group Financial Record Appendix D: Tesco PLC Sales Distribution by Region Appendix D: J. Sainsbury Sales and Profitability Figure Appendix E: J. Sainsbury 5-year Financial Report Appendix F: Comparative Analysis of 2009 Profitability Ratios Tesco PLC J. Salisbury PLC Current Ratio 0.78 Current Ratio 0.54 Liquidity Ratio 0.63 Liquidity Ratio 0.30 Shareholders Liquidity Ratio 0.86 Shareholders Liquidity Ratio 1.60 Solvency Ratio (%) 28.09 Solvency Ratio (%) 43.62 Asset Cover 3.72 Asset Cover 4.61 Gearing (%) 149.14 Gearing (%) 66.09 Shareholders Funds per Empl. (Unit) 35,542 Shareholders Funds per Empl. (Unit) 44,974 Working Capital per Employee (Unit) -5,711 Working Capital per Employee (Unit) -10,175 Total Assets per Employee (Unit) 126,514 Total Assets per Employee (Unit) 103,114 Read More