Financial Analysis of Meyers Holdings and Harvey Norman Holdings - Case Study Example

Introduction Potential investors, current shareholders as well as the management of a company use a number of methods to evaluate the company’s performance in order to make future investment and /or managerial decisions. One of such methods is financial ratios analysis. This where financial data is selected, evaluated and interpreted along with other relevant information in a bid to make informed financial/investment decisions. Internally, management uses financial analysis to evaluate efficiency of operations, employee performance as well as credit policies. Externally, financial analysis is of particular importance to potential investors as it helps them compare different companies financially and hence make informed decisions on where to invest (Susan, 2008). This paper conducts financial analysis of Meyer’s holdings and Harvey Norman holdings limited within an aim of advising potential investors on which company they should invest in. In addition, the paper will also discuss the potential limitations of using financial analysis before recommending for investors the best company to invest in. Myer holdings limited is an Australian based departmental store company offering eleven product categories which include men and women wear, home wears, electronics, youth and children wear, beauty and cosmetics, footwear among others. The company operates 67 departmental stores across Australia with its brand hierarchy being split into Meyer exclusive brands segment, international and national brands and concessions. On the other hand, Harvey Norman holdings limited. On the other hand, Harvey Norman a large Australian based retailer deals with electrical, furniture, computer, bedding goods and entertainment. The company has more than 230 stores spread throughout Australia, Slovenia, Ireland, Croatia, Singapore, Malaysia and New Zealand. Financial analysis Profitability analysis Profitability analysis is of great importance to potential investors since it portrays the company’s ability to generate profits by comparing income to expenses and other costs during a specific time period. As such, a rational investor would choose to invest in a company whose profitability is high holding other factors constant. The following ratios are analyzed in this regard. a) Gross profit margin The ratio evaluates how well the firm controls its inventory costs and subsequently passes the costs to the consumer. In other words, it looks at the cost of goods sold as a percentage of sales. In this respect Myers ability to control inventory costs improved from a gross profit margin of 42.67% in 2007 to 46.80% in 2012. However, there was a slight decline in 2009 and 2010 where the gross margin was 39.18 and 39.68 respectively. This was unlike Harvey Norman Holdings limited which saw its gross profit margin slightly reduce from 25.91% in 2007 to 29.56% in 2010 before declining to 27.43% in 2011 and 27.14% in 2012. The decline in both cases could be attributed to respective industries operating environment. It is worth noting that Myers gross profit margin is higher than that of Harvey Norman during the six years under review. Hence based solely on gross profit margin, Myer is more profitable. This is also strengthened by the fact that its gross profit margin rose while that of Harvey Norman reduced. b) Net profit margin This ratio compares net profit after tax to revenue and shows how much each sale dollar contributes to net profit after expenses. As such, the potential investor would be interested in a company with a higher ability to generate net profits all factors held constant. Myer Holding’s net profit margin increased from 5.96% in 2007 to 9.65% in 2011 before slightly declining to 8.80 in 2012. A similar case was observed in Harvey Norman where the net profit margin increased from 24.38% in 2007 to 28.74% in 2010 before declining significantly to 15.05% in 2011 and 14.07% in 2012. In this regard however, Harvey Norman is more profitable than Myer and hence potential investors would invest in it if decisions were to be based solely on net profit margin. It is also worth noting that Myer’s expenses are very high and hence the lower net profit margin despite having a very high gross profit margin. As such, the management should come up with cost reduction measures aimed at bringing down the expenses and hence improve the net profit margin. c) Return on Equity This ratio evaluates the company’s management ability to generate adequate return from the capital invested by the owners. A rational investor would invest in a company with a higher return on equity other factors held constant as this will enable the company pay them dividends while still investing for the company’s future growth. Myers return on equity increased significantly from 21.03 in 2007 to 62.05% in 2009 before declining significantly to 16.04% in 2012. On the other hand, Harvey Norman Holdings return on equity decreased significantly over the six years period from 18.60% in 2007 to 8.85% in 2012. As such, an investor would be more confident investing in Myer in this regard as they would be assured that the company will be able to pay dividends while still investing for future growth. d) Return on assets This ratio determines a company’s ability to utilize its assets efficiently and effectively in generating a good return. As such, it is the measure of the percentage and of profit earned per dollar of asset and hence measures the company’s efficiency in using assets to generate profit. The return on assets for Myer has not been stable. It increased from 9.74% in 2007 to 11.74 % in 2008 before declining to 5.46 in 2009 after which it increased to 8.9.59% in 2011 before declining again to 8.55% in 2012. In Harvey Norman Holdings Limited, the return on assets increased from 10.15% in 2007 to 39.40 in 2009 before significantly declining to 5.93% in 2012. Although the two companies’ efficiency in using assets to generate profits reduced in 2012, its worth noting that Myer is more efficient than Harvey Norman and hence a rational investor would opt to invest in it if decisions are based on Returns on assets only. Financial stability analysis The ratios measure the financial stability of the company at a particular time and hence measure the company’s ability to meet both its long term and short term obligations. A rational investor would choose to invest in a company which is financially stable due to the risk posed by instability such as liquidation and lack of financing from financiers and creditors. The following ratios are analyzed in this regard. a) Current ratio This is a measure of the number of times a company’s current assets cover its current liabilities and hence measures the company’s ability to pay its debts in the short run (Eugene, 2009). A company with a higher current ratio is more likely to meet its obligations without difficulties and hence would be more attractive to potential investors. Myer’s current ratio declined from 0.95 in 2007 to 0.88 in 2008 before increasing to 1.1% in 2009 after which it decreased to 0.81 in 2011 before improving slightly to 0.88 in 2012. On the other hand, that of Harvey Norman decreased from 1.71 in 2007 to 1.13 in 2010 after which it increased to 1.64 and 1.63 in 2011 and 2012 respectively. Despite the slightly decline in Harvey Norman’s current ratio in 2012, this was obviously higher and shows a relatively stable company compared to Myer. As such, if a rational potential investor was to choose between the two companies based on current ratio only, they would choose to invest in Harvey Norman since it’s more financially stable. b) Quick ratio This is similar to current ratio but only uses liquid assets in its computation and is hence tighter as it only uses assets that are highly liquid to meet immediate demands for payment from creditors and lenders. As such, a rational investor would choose to invest in a company that has a higher quick ratio as it can better meet short calls for payments without difficulties or interfering with its day to day operations and hence profitability of ownership. Myer’s quick ratio decreased from 0.34 in 2007 to 0.11 in 2012. On the other hand, that of Harvey Norman decreased from 1.44 in 2007 to 0.94 in 2010 before increasing significantly to 1.35 in 2012. This portrays Harvey Norman as being more financially stable than Myer. Hence a potential investor choosing between the two companies using this as the basis would choose Harvey Norman Holdings limited. c) Debt Asset Ratio (Total Debt) This ratio indicates the proportion of the company’s assets which are financed by debt (Total debt- both long-term and short-term). As such, if this ratio is too high, it exposes the company from the threat of takeover or liquidation in case the company is unable to meet both its short run and long term obligations of principal and interest repayment. Myer’s debt asset ratio increased from 47.61 in 2007 to 56.31% in 2008 before improving to 27.59% in 2010. This later increased to 56.36% in 2011 before increasing to 54.29% in 2012 the proportion of assets financed through debt reduced. On the other hand, the debt asset ratio (total debt) for Harvey Norman Holdings improved significantly from 18.86% in 2007 to 5.95% in 2010 before increasing significantly to 44.34% in 2012. Although an increase in this ratio may not be desirable, the lower ratio of Harvey Norman compared to Myer indicates more financial stability and hence potential investors would prefer it in this regard. d) Debt equity ratio (Total debt) This ratio evaluates the use of debt and equity as capital source in financing the company’s assets using the capital sources book values. A relatively lower ratio in this regard may be desirable for potential investors. Myer holding had its debt equity ratio increasing from 2.19 in 2007 to 4.52 in 2008 before significantly decreasing to 0.63 in 2010. This later increased to 1.29 in 2011 and 1.18% in 2012. On the other hand, that of Harvey Norman decreased significantly from 0.35 in 2007 to 0.11 in 2010 before increasing to 0.7967 in 2012. However, Harvey Norman still provides a better option to potential investors as far as this ratio is concerned as a lower debt to equity ratio greatly reduces the risks associated with having most of company’s assets financed through debt. e) Times interest earned (Times) This is a ratio that compares the earnings available to meet the company’s interest obligations to lenders. A rational investor would thus prefer a company that has greater ability to meet its interest obligations. Myer’s time’s interest earned ratio increased from4.96 in 2007 to5.96 in 2008 before decreasing significantly to 2.87 in 2009 after which it increased to 7.73 times in 2012. On the other hand, Harvey Norman’s ratio increased from10.70 in 2007 to 16.77 in 2008 before declining to 11.03 times in 2009. This was followed by a slight improvement to 12.49 times in 2010 before decreasing significantly to 5.59 times in 2012. This may imply that the company acquired more debts and hence increase in debt obligations. However, Harvey Norman seems to be a better choice for a potential investor based on times interest earned as it has been consistently higher although other factors should be considered before an informed decision is made. Efficiency analysis These ratios measure the financial efficiency of a company in converting or using the available assets to generate profits and hence better shareholders net worth (Weitzman, 2009). Rational investors choose companies that are more efficient other factors held constant. The ratios include; a) Inventory turnover (Days) This ratio shows the number of times the company’s inventory is turned over or sold to generate profits in a given period. As such, investors would prefer a company that turns over its inventory more times since this has a potential of generating more profits other factors held constant (Peterson, 2009). Myer’s inventory turnover decreased from 44.65 in 2007 to 38.74 in 2010 before increasing to 53.9 days in 2012. On the other hand, that of Harvey Norman increased slightly from 249 in 2007 to 257 days in 2011 before decreasing significantly to 240 days in 2012. Although Harvey Norman’s inventory turnover is influenced by its industry of operation, it is in no doubt very high and might not be preferred by potential investors. b) Debtors turnover (Days) This ratio indicates the company’s efficiency in collecting the debts it’s owed. Investors would prefer companies that are more efficient in debt collection as this avails cash for operations and debt repayment (Kiseo, 2006). Myer’s debtors’ turnover increased from 0.66 in 2007 to 1.1 in 2008 before declining to 0.64 in 2012. That of Harvey Norman reduced from 282 in 2007 to 255 in 2007 before increasing to 293 in 2010. This reduced significantly to 257 in 2011 and 240 days in 2012. However the difference in efficiency may be attributed to the industry of operation and the nature of goods. As such, other factors may need to be considered in deciding where to invest in. c) Creditors turnover This ratio measures the efficiency/rate at which the company pays its debts or obligations to creditors. Investors would prefer investing in a company that meets its obligations in time to guarantee smooth running of the business. Myer‘s creditors turnover ratio decreased from 60.26 days in 2007 to 48.98 days in 2009. This slightly increased in 2010 to 51.35 before decreasing to 47.9 days in 2012. On the other hand, that of Harvey Norman decreased from 174 in 2007 to 153 in 2008 before increasing to 212 days in both 2011 and 2012.. However, the differences should not be solely attributed to inefficiency but also on the industry of operation. As such, other factors may need to be considered in deciding where to invest in (Jeff, 2011). Limitations of the analysis Financial analysis should not be used alone in advising potential investors on the best company to invest in especially in this case due to its weaknesses which include; a) Companies use different accounting practices – the two companies may be using different methods of valuing inventory which may have resulted in inaccurate valuations (Kenneth, 2011). The methods of depreciation may also differ hence affecting financial statements differently and giving valid comparisons. b) The two companies operate in different industries and hence each has different operating environment (Kane, 2005). These are factors that can significantly affect the analysis hence giving misleading comparison between the two companies. c) Ratio analysis provides only numbers without revealing causation factors- the financial analysis conducted did not explain the cause of the different values obtained and hence such factors need to be revealed to the investors so that they can make more informed decisions. d) The analysis does not consider inflation – the figures reported on the balance sheet are different from real values and hence do not consider the effect of inflation on inventory and depreciation and hence profits (Jameson, 2010). As such, investors need to be aware of the extent inflation could have affected the analysis. Conclusion As has been established above, financial ratio analysis is a good method of deciding where potential investors should invest in. however, it should not be used solely but the factors mentioned above also need to be put into consideration. However, based on the financial analysis conducted above, Harvey Norman Holdings limited appears to be both more profitable and financially stable. Although, Myer holding is obviously more efficient than Harvey Norman, Harvey Norman’s inefficiency may be attributed to its industry of operation. As such, rational investors would opt for Harvey Norman but influence the management to take steps aimed at improving the company’s financial efficiency. This is because Harvey Norman has potential for higher dividends while the risk of liquidation is lower. References: Susan, F2008, Financial and managerial accounting, Rutledge, London Kane, A 2005, Essentials of investments, Oxford, Oxford University Press Kiseo, D2006, Accounting principles, New York, John Willeys Eugene, F2009, Fundamentals of financial management, Cincinnati, South Western College Publications Ehsan, N2010, Finance, London, Rutledge. Peterson, P2009, Financial ratios, Financial Management Journal, Vol.2, no.12, pp.5-7. Jameson, J2010, Accounting principles and basics, Oxford, Oxford university press Kenneth, W2011, Accounting and finance for non specialists, London, Rutledge Weitzman, P2009, Management accounting, Decision making and performance improvement, New York, John Willeys Jeff, S2011, Managerial accounting, London, Rutledge Read More