The Financial Analysis on David Jones Company - Example

Contents Page Number Executive summary 2 1 Introduction 3 1.1 Background and Business 3 2 Company Analysis 2.1 Current Financial performance, economic outlook 3 2.2 Significant changes and impact 4 3 Ratio Analysis 6 3.1 Profitability ratios 6 3.2 Liquidity ratios 7 3.3 Efficiency ratios 8 3.4 Gearing ratios 10 . 4 Company Valuation 11 4.1 Limitations of financial ratios 11 4.3 Recommendations and overall assessment 12 5 References/Bibliography 14 Appendices – attached Excel Spreadsheet Executive summary This report performs a financial analysis on David Jones Company with the aim of establishing how the company performed financially during the year 2011 and 2012. The report gives a brief analysis on the company’s background as well as an analysis of the company’s financial performance during the years under review. A ratio analysis on the company’s financial statements is performed. The reports concludes that the company’s performance declined in 2012 compared to 2011 and then gives recommendation on steps that the company is undertaking in a bid to improve its performance in future. However, the report also discourages total reliance on ratio analysis in determining the company’s performance due to its inherent weaknesses. 1 Introduction 1.1 Background and Business Established in 1838 by David Jones, David Jones limited is an up market departmental store chain that operates 37 stores located across all states and territories in Australia excluding Tasmania and the Northern Territory. The company has more than 9000 employees and has its head office in Sydney. The company is listed in the Australian Securities Exchange as DJS. The company is operated through two divisions namely: Department stores- the company has 35 departmental stores and 2 warehouse outlets which supply product s such as Ladies fashion, cosmetics, men’s wear, children’s wear, toys, stationery and books, shoes and accessories, CDs and DVDs, consumer electronics, Furniture, whitegoods, food and luggage. Financial services- David Jones provides financial services which include the David Jones store credit card issued in conjunction with American Express (InvestSmart.com,2013). 2 Company Analysis 2.1 Current Financial performance, economic outlook A look at the company’s financial statements reveals a declining performance compared with the year 2011. The company realised a profit after tax of $101,103 in 2012 compared to $168,138 which it managed to realise in 2011. This was a 39.9% decline. Similarly, the company’s sales revenue declined from $1,961,744,000 in 2011 to $1,867,817,000 in 2012 which was a 4.8% decline. According to the company’s management, this decline in performance was occasioned by the challenging trading environment in 2012. This was also the reason behind the decline in the company’s gross profit from $767,269,000 in 2011 to $699,830,000 in 2012 representing an 8.8% decline. The management attributed the decline from discounting in a competitive environment as well as the impact of dealing with the excess inventory at the beginning of the year 2012. The cost of doing business increased from $568,500,000 in 2011 to 594,900,000 in 2012. The increase resulted from in creased investment by the company towards its future strategic plan, increased labor cost, property, utilities and increasing financing costs. The decreased sales volume further worsened the situation. Despite the overall poor performance, David Jones financial services business registered a 3.6% growth from $47.7 million in 2011 to $49.4 million in 2012. However, looking at the previous three years, this growth was lower but the management attributes this to investment in 2H12 in growing customer speed and balances. A focus on Earnings before Interest and Tax (EBIT) reveals a 37.4% decline from $236.5 million in 2012 to $154.3 million in 2011. The decline was occasioned by declining sales, lowering margins as well as increasing costs. It is also worth noting that the company’s closing inventory decreased by 3.4% from $288,850,000 in 2011 to $279,099,000 in 2012. This was in line with the management’s efforts at addressing the excess inventory at the beginning of the year. There was a 7.8% increase in David Jones operating cash flow from $182.4 million in 2011 to $196.7 million in 2012. There was also a slight increase in the company’s capital expenditure from $81.4 million in 2011 to $81.5 million in 2012. Shareholders were also paid dividends amounting to $110.6 million during the year. The company’s net debt also declined from $120.2 million in 2011 to $115.5 million in 2012 (David Jones Company Limited annual report, 2012). 2.2 Significant changes and impact As observed above, David Jones experienced a declining performance during the year 2012. A look at the last five years also reveals a declining trend in its performance. The declining performance is generally attributed to decreasing sales while operating costs such as rent, labor, utilities and financing costs have been on the increase. In addition, its financial services business although has been experiencing increasing earnings before interest and tax, this has been on a decreasing trend and if this trend continues, the division might also start experiencing reducing profits. This is as a result of the division’s exposure to the operating environment’s weak discretionary retail spending. However, the company has undertaken significant changes that are expected to address the above concerns which will positively impact on the performance of both of its divisions in future. (David Jones Company Limited annual report, 2012) a) Transformation The company aims at transforming into an Omni Channel Retailer (OCR) that will be modeled on international departmental store best practice. The company has further invested in customer services and experience aimed at differentiating it from its competitors. The company has also engaged in an aggressive pricing through collaborating with its suppliers to enable it offer globally competitive prices. The company is further enhancing its technological capabilities through increased investment in areas such as a new POS system, new traffic analytics, a staff rostering and a scheduling system among others. All these changes are aimed at reviving customer experience at David Jones through unrivaled which will result in more customers hence more sales and improved profitability (Macquarie Private Wealth Research, 2013). b) Expansion of its store networks Six new stores are set to be opened in high value locations in a bid to boost the company’s footprint to 42 stores across Australia which will increase EBIT by $30 million annually once they are operational. The company will also open several smaller format stores and they are expected to contribute $2 million each annually in terms of EBIT. c) Strengthening of its core business The company will reduce its cost of doing business by $30 million in the next three years in a bid to offset the unexpected increases in costs. The company will also restore its gross profit margins to a long-term sustainable range of 40% while undertaking steps to increase sales and EBIT via refurbishments. The company’s financial services business will also be refurbished in a bid to improve revenues. As such, the company has a bright future (InvestSmart.com, 2013). 3 Ratio Analysis 3.1 Profitability ratios Profitability Ratios 2012 2011 Return on assets 8% 14% Return on equity 18.54% 30.47% Net profit margin 7.70% 12.20% Gross profit margin 37.47% 39.11% Cash flow to sales 10.53% 9.30% Discussion Returns on assets – The Company’s return on assets greatly declined from 14% in 2011 to 8% in 2012. Though there was a slight decline in the total assets during the year, the decline in return on assets can only be attributed to the significant decline in net profits from $ 168, 139,000 in 2011 to $101,103,000 in 2012. This is the cause of the great decline in the number of dollars returned for every dollar of assets. Return on Equity- the company also experienced a significant decline in the return on equity from 30.47% in 2011 to 18.54% in 2012. Similar, this decline is largely attributed to the huge decline in the company’s profitability since the decline in the shareholders equity could not have caused such a great impact. Hence, the company returned less for every dollar of the shareholders’ investment. Profit margin and Gross profit margin- The Company experienced decreasing profit margins during the year. The net profit margin significantly declined from 12.2% in 2011 to7.7% in 2012. On the other hand, the gross profit margin declined from 39.11% in 2011 to 37.47% in 2012. The declining level of margins is greatly attributed to the unstable operating environment hence causing significant price changes which impact on the level of revenues as well as the increasing cost of operation. Cash flow to sales – This is the only aspect of profitability that improved in 2012 from 9.3% in 2011 to 10.53%. This is attributed to the company’s increasing operating cash flows in line with its policy as well as the reduced revenue in 2012. General discussion As depicted above, the company’s profitability generally declined in 2012. The decline could only be attributed to the conditions in the operating environment which caused the revenues to decline. In addition, the company’s cost of doing business /operating costs generally increased hence exerting a lot of pressure on the already declining revenues. This calls for the company to come up with ways of increasing its levels of revenues as well as means of reducing its cost of doing business. This way, its margins and hence profitability will improve in future. The declining level of margins is greatly attributed to the unstable operating environment hence causing significant price changes which impact on the level of revenues as well as the increasing cost of operation. Though there was a slight decline in the total assets during the year, the decline in return on assets can only be attributed to the significant decline in net profits 3.2 Liquidity ratios 2012 2011 Current Ratio 2.7:1 2.8:1 Quick Ratio 0.144:1 0.143:1 Cash flow from operating activities 0.642:1 0.686:1 Discussion Current Ratio -the Company’s current ratio declined from 1.23:1 in 2011 to 1.06:1 in 2012. This decline is attributed to the significant increase in current liabilities as well as a decline in the amount of current assets. Quick Ratio –The company’s quick ratio slightly increased from 0.143:1in 2011 to 0.144:1 in 2012. The slight improvement is attributed to the slight decline in the amount of inventories in 2012. Cash flow from operating activities – The Company’s cash flow from operating activities declined from 0.686 in 2011 to 0.642 in 2012. This decline resulted from the increased current liabilities amounts in 2012. General discussion Generally, the company’s liquidity declined in 2012 as compared to 2011. This decline can only be attributed to the significant increase in the amount of current liabilities during the year. The company will therefore need to come up with strategies to reduce its current liabilities so as to evade the risk of plugging into liquidity problems in future as this is not healthy for normal business operations. 3.3 Efficiency ratios 2012 2011 Asset Turnover Ratio 1.51times 1.62 times Inventory Turnover 88.74 days 87.27 days Fixed Asset Turnover 2.04 times 2.21 times Times Inventory Turnover 4.11 times 4.18 times Creditors Turnover 47 days 42.9 days Fixed Asset Turnover 2.04 times 2.21 times Discussion Assets t turnover ratio – There was a decline in David Jones asset turnover ratio from 1.62 times in 2011 to 1.51 times in 2012. The decline was occasioned by the fact that while total assets increased, the amount of revenue decreased during the year. As such, this caused the decline in the amount of revenue generated for every dollar of assets the company owns. There is need to strategize on how to increase the company’s revenue if the assets turnover is to improve. Inventory turnover –the company’s inventory turnover slightly increased from 87.27 days in 2011 to 88.74 days in 2012. This was occasioned b y the decline in the amount of inventories during the year in line with the company’s policy. Times inventory turnover- there was a slight decline in the company’s times inventory turnover from 4.18 times in 2011 to 4.11 times in 2012. This was caused by the decline in both cost of goods sold as well as the reduced inventory. However, the decline in inventory was in line with the company’s effort. Average collection period – there was a slight improvement in the company’s collection period. This is generally attributed to declining amounts of receivables which h is a positive improvement. Creditors’ turnover – the company’s creditor’s turnover increased from 42.9 days in 2011 to 47 days in 2012. The increase is attributed to the significant increase in the amount of creditors. This shows a decreasing efficiency. Fixed-Asset Turnover Ratio –There was a slight decline in the company’s fixed asset turnover ratio from 2.21 times in 2011 to 2.04 times in 2012. This decline resulted from the decline in the level of sales although the amount of assets increased. Generally, the company’s efficiency declined during the year. The decline is associated with decreasing revenues while liabilities and assets increased. Such, there is need for the company to strategize on how to reduce its liabilities while increasing its revenue if the efficiency is to improve. This is because decreasing efficiency is not healthy for the company’s performance. This was occasioned b y the decline in the amount of inventories during the year in line with the company’s policy. This was caused by the decline in both cost of goods sold as well as the reduced inventory. However, the decline in inventory was in line with the company’s effort. This is generally attributed to declining amounts of receivables which h is a positive improvement. 3.4 Gearing Ratios 2012 2011 Debt to Equity 59.97% 54.63% Debt Ratio 37.49% 35.33% Equity Ratio 62.51% 64.67% Earning Per Share $0.194 per share $0.336 per share Price Earning Ratio 13 times 10 times Debt Coverage 0.64 times 0.69 times Payout Ratio 90.21% 83.33% Discussion Debt to Equity Ratio –the company’s debt to equity ratio increased from 54.63% in 2011 to 59.97% in 2012. The increase resulted from the slight decline in the amount of equity and the significant increase in the company’s debt. The decrease in the amount of assets as well as the increase in debts should be discouraged since if it continues, it might increase the company’s threat of takeover from the creditors. Debt Ratio and Equity ratio –David Jones debt ratio increased from 35.33% in 2011 to 37.49% in 2012. On the other hand, its equity ratio declined from 64.67% in 2011 to 62.51% in 2012. These changes resulted from increases in the amount of debt and declining amount of equity. This is unhealthy for the company’s future and should be discouraged as it exposes the company to the threat of takeover eventually if it continues. Debt coverage –the increase in the company’s current liabilities during the year caused its debt coverage to decrease from 0.69 times in 2011 to the current 0.64 times. This is despite the fact that the company’s cash flows improved during the year. This should be discouraged as it may expose the company to short-term liquidity problems in future. Earnings Per Share – As a result of the decline in the company’s earnings during the year, its EPS declined from $0.336 per share in 2011 to $0.194 in 2012. The company should therefore strategize on increasing earnings so as to rectify this situation. Price earning ratio- the company had an improved price earning ratio of 13 times in 2012 compared to 10 times in 2011. However, this does not mean improved performance but is as a result of significant decline in its shares market price owing to its declining performance. Payout Ratio – the company’s payout ratio increased from 83.33% in 2011 to 90.21% in 2012. This was occasioned by the decreasing amount of EPS and DPS. It also implies that little earnings were retained which might not be good for the company’s future financial needs. As noted, most of the company’s gearing indicators performed poorly during the year. This was occasioned by increasing amounts of debts and the poor profitability reported by the company. This may not be healthy for the company since if the trend continues, the company will face a threat of takeover eventually. As such, the company should come up with strategies of increasing its profitability while decreasing its liabilities if its future is to be secure. 4 Company Valuation 4.1 limitations of financial ratios Financial ratios are effective tools in gauging a company’s financial performance as well as managerial effectiveness. However, they ought to be used only as a component of managerial toolkit since they just give an indication of strong and weak points in the business. They do not give us the reason for in stance why David Jones performed poorly in 2012 and what should be done about this but only point out that the company’s performance is declining. (Gregory, 2007,) Secondly, ratio comparison across businesses or in the industry does not take into consideration that different companies may use different formulas in arriving at the ratios hence giving different results. As such, it may be concluded that a company is performing poorly compared to similar companies even though different apparatus were used to arrive at the results. This may be misleading. Companies like David Jones also operate different divisions in different industries. It may therefore be difficult to find a meaningful set of industry average ratios. Financial ratios may also be distorted by seasonal factors. Hence, one needs a detailed understanding of the seasonal factors to avoid misinterpretations and hence misjudgments. A company like David Jones also has a set of both good and bad ratios which makes it difficult for one to decide whether or not the company is a strong one or a weak one. In addition, it is difficult to generalize whether a ratio is a good one or a bad one. For instance, the improvement in the company’s price earning ratio or dividend payout ratios does not imply that the company is doing well. The price earning ratio for instance has been greatly affected by the decline in the company’s stock price (Davidson, 2011). 4.2 Recommendations and overall assessment The financial ratio analysis undertaken above indicates that David Jones limited’s performance declined in 2012. This has been explained by the declining revenues and increasing cost of doing business hence resulting in declining profitability. There has also been increasing levels of liability which has also affected the company’s efficiency. This calls for the company to strategize on how to reduce its cost of doing business while increasing its revenue levels if it is to remain financially healthy. Luckily enough, the management have undertaken significant steps towards addressing these issues of concern as explained above. These steps include; a) Transformation through investment in modern technology in a bid to serve the customers better and hence change their experience at David Jones. This includes transformation into Omni Channel Retailer among other types of transformations. This is hence expected to result in more sales due to the improved customer services. b) Expansion of its store networks which is expected to greatly boost the company’s profitability as explained above. c) Strengthening of its core business which will include reduction in the company’s cost of doing business by 30 million dollars, restoration of the company’s gross profit margin to a long-term sustainable range of 40% as well as reviving David Jones financial services division. These undertakings are expected to have a great positive impact on the company future financial finance and hence the company should have a bright future if the strategies succeed. 5 References/Bibliography Gregory, B2007, Financial statement analysis, London, Rutledge. David Jones Company Limited, Annual Report 2012, retrieved on May 15 2013, From: http://www.davidjones.com.au//media/Files/Corporate/Presentations/2012/David%20 Jones%202 012%20Annual%20Report.ashx Macquarie Private Wealth Research, David Jones: Fixing model, waiting on results, Retrieved 15 May 2013, from: http://au.finance.yahoo.com/q/hp?s=DJS.AX&a=05&b=1&c=2012&d=06&e=31&f= 2012&g=d InvestSmart.com, David Jones Limited, Retrieved 15 May 2013, From: http://au.investsmart.com.au/shares/asx/DAVID-JONES-LIMITED-DJS.asp Davidson, H2011, Balance sheet basics, International Accounting Journal, vol.52, no.2, pp.85- 87. Appendices – attached Excel Spreadsheet Read More