Sainsbury's Analysis and Valuation - Essay Example

?J. Sainsbury is a listed company in London Stock Exchange, which owns Sainsbury’s supermarket that operates its activities in the UK and in North Ireland. It was established in 1869 in London and was famous particularly for its bakeries in 1970s. The main activities they are in involved in are: 1- Sainsbury’s supermarket which is one of the third biggest retailers in the supermarket industry, that has a chain of 547 supermarkets. It generated ?595 million PBT in 2010, with a market share of up to 16% (J.Sainsbury FAQs 2011). 2- Sainsbury’s online which delivers food to homes. 90% of the houses in UK are in its range. 3- Sainsbury’s property that develops space for future that supermarkets with 297 freehold may need and rent for long term and 43 properties as joint arrangements to create a portfolio. It generated ?131 million PBT in 2010. 4- Sainsbury’s banking which is the result of a joint venture with Lloyds bank. It created such services as insurances, credit cards and loans and generated ?7 million PBT in 2010(j.Sainsbury our business 2011). According to J.Sainsbury RAQs (2011), there are different competitors of Sainsbury for each of its areas. For example, for supermarket, which is the biggest activity in the company, competitors are Tesco, Marks & Spencer and Morrison. However, the competitors for banking service are the traditional high street banks, Tesco and M&S financial services, Egg, MNA, Capital one, Direct Line and Cahoot. This paper will analyze the Sainsbury Company through a look into its macroeconomic environment, industry, five forces model, business model, and financial conditions. Business investors may use the recommendation made in this paper to see whether to buy, sell or hold Sainsbury’s share. Macroeconomic Environment: Interest Rate and Inflation Rate UK interest rate in March’ 2011 had been registered at 0.5% which is a record low (BBC, 2011). In February 2011, inflation rate of UK rose to 4.4% (BBC, 2011). Interest rate has a major impact on time value of money. Changes in the rate of inflation generally result in alterations in the interest rate. These two factors are the key factors employed in the decision making for investment since they have a direct impact upon the ‘investment yield’. In case of UK, the record low interest rate will support the investment on shares. Rising interest rates retard the growth of inflation. Lower rate of interest increases the borrowing from businesses, which can have an impact on Sainsbury’s. This can make investment in durable consumer goods products such as automobiles, capital equipments and buildings appealing. The lower rate of interest can also affect the value of currency by making the currency weak. This can in turn enhance the market value of Sainsbury’s for the foreign purchasers. This will also help to increase the profitability of the company (Economy Watch, 2009). Rise in inflation rate coincides with the increase in cost of fuel, food and clothing items. Rise in inflation generally takes place due to increase in wholesale price index, which can have an effect on retail spending of a consumer and can weaken the consumer demand. Inflation rise also increases prices of products and VAT (value added tax) on a product that generally affects the sales volume. Factors like high level of inflation, subdued growth of wage and indecisive economic viewpoint generally reflect in terms of consumer spending. Therefore, the inflationary scenario in the UK can have a big impact of the sales and profitability of Sainsbury (RTE News, 2001). 1-PEST analysis: Political According to Lawrence (2010a), the government intends to limit the role of the Food Standards Agency (FSA) and remove the ‘traffic light’ food labeling system, which has long been opposed by leading supermarkets like Tesco. As a result, the food industry will face little to no regulation for self and voluntary regulation (Lawrence 2010b). Leading supermarkets will have a ‘strong presence’ as far as accompanying the government on the forming of new policies is concerned. This alliance has been subjected to level of criticism with the head of one food campaigning group suggesting that “this is the equivalent of putting the tobacco industry in charge of smoke-free spaces” (Lawrence 2010b). Economy The UK economy continues to emerge from the recent recession, albeit slowly. However, an increase in the VAT to reach 20%, for the first time in history might have an impact in the sale volume and this may lead to lower profitability (BBC, 2011) Social The retail sector according to Finch and Wood (2010) is being affected by a drop in consumer confidence, which is said to impact the supermarkets. An increase in unemployment is said to trigger a further loss in consumer confidence which in turn is set to trigger an ‘all out price war’ between supermarkets in a bid to respectively restore consumer confidence (Finch and Wood 2010). Technology Sainsbury’s has capitalized on this area in particular and engages with consumers directly to “promote competitions and special offers, suggest recipe ideas and give online customer support and advice” (Maxwell 2010). The Industry Analysis: 1-The Five Forces Analysis: Diagram depicting the five forces effecting the competitive environment Competitive Rivalry According to King (2009), the UK supermarket sector is highly competitive, and is dominated by four key players, Tesco, Sainsbury’s, Asda and Morrison’s. In addition to the big four supermarkets, there are a number of ‘mid-tier’ supermarkets including Waitrose, Aldi and the Co-operative supermarket chains (TNS 2009, King 2009). The ‘big four’ supermarkets have grown exponentially in the last two decades, primarily through mergers and acquisitions with the most recent one being Walmart’s acquisition of Asda. Competitive rivalry was further enhanced in the industry with the advent of Marks and Spencer and Harrods that offered luxury groceries, as well as high street chain Boots entering a partnership with supermarket chain Waitrose (Faithfull 2010). As a result, Boots will stock Waitrose grocery products in-store thereby increasing rivalry amongst smaller outlets such as Sainsbury’s Local and Tesco Metro (Failtfull 2010). Threat of new entrants The threat remains low given the amount of supermarkets operating within the industry such as the ‘big four’ are leading a highly competitive environment. Sainsbury’s is an established supermarket with an already trusted brand (Maxwell 2010). Therefore, the threat of new entrants remains relatively low given the strength of brand and the risks of entering a highly competitive sector have already saturated as far as the supermarkets are concerned. Bargaining power of buyers Owing to the number of companies, which operate in this industry and the disappearing of the switching cost, the customers have strong power. The buyers can choose between the competitors whenever they want without any cost (Johnson at al 2008). Bargaining power of Suppliers The bargaining power of suppliers currently stands at medium to high as a result of the recent recession and a drop in inflation. The commodity prices are set to rise including those of fuel and wheat (Finch and Wood 2010), which will impact the price of raw materials. In addition, the move towards fair and ethical trading has also increased the bargaining power of suppliers as those within the global supply chain expect fairer prices as opposed to exploitative prices and practices. All of these factors serve to further heighten the bargaining power of suppliers. Threat of substitutes Because it is food and nothing can be used instead of food, it will be extremely difficult for alternative products to be sold in this kind of business. Consequently, the substitutes of goods that are provided by Sainsbury are difficult to be found. However, in terms of non-food products that are provided by Sainsbury, there are highly developed substitutes such as online retailers including Ocado and Amazon. This makes Sainsbury warred and try to improve its online service like what has TESCO done. 2- Industry life cycle: As a result of the five forces, the food retailer industry is on the maturity period in the life cycle. According to Johnson at al (2008), the maturity period shows high competition between the leaders in the industry and focus on competitive advantages such as low cost by obtaining cost leadership strategy. It gives more confidence to switching between suppliers. This can show a decline in the profit margin and might cause some difficulties to grow. The SOWT analysis: The internal: The strengths Buy now free next time is an offer, which Sainsbury launched instead of by one get one free. The difference that Sainsbury makes is to persuade customers to come back again and buy another thing they might be needing, which is advantageous for Sainsbury (The Telegragh 2010). The weakness Sainsbury is operating just in the UK, whereas, its competitors are operating internationally. This can be seen as a diversification for competitors, which reduces the microenvironment and economic risks and improves the business because of additional areas that they cover. The external: The opportunities Furthermore, the diversification that Sainsbury adopts makes it more powerful in terms of property business so that it may generate profit and provide good places for stores without delay (J.Sainsbury our business 2011). The threats The customers can go to the competitors vary easily and without any cost. This can be seen as a risky environment because Sainsbury has to be updated in terms of price, locations and quality to beat its competitors and save its customers (Johnson at al 2008) Business level strategy (The strategy clock) : J. Sainsbury our goal (2011) claims that Sainsbury has focused on some areas in its work procedures to create good quality products and services on a fair price. These areas are healthy food like organic products, choosing sources honesty. These are some points that Sainsbury considers to create more value than competitors. As a result, Sainsbury could create the highest sales in last Christmas. In the Christmas week, 4.5 million were generated as compared to its competitors. Sainsbury had increased its market share to 16.6% (BBC news business 2011). This diagram is the strategy clock, which shows the company’s price and goods strategy According to Johnson et al (2008), the competitive strategy option for Sainsbury as shown in the strategy clock is number 4 (b), is differentiation in its products and services, though it also considers the price. Corporate level strategy: In terms of its corporate strategy, Sainsbury’s is currently very much concerned with the broadening of its product range and the concentration upon non-grocery related items. As such, Sainsbury's has, according to Wood (2010), aggressively pursued to the non-grocery market expanding the range of its clothing and home ware lines. Furthermore, through allocation of store space to non-grocery items, the organization is increasingly focusing upon online retailing and therefore increasing investment in its web based. As such, Sainsbury’s has pursued the latter strategy through launching new sales channels, which allow for the distribution of goods from tax-exempt regions such as the Channel Islands (Bowers 2010), and therefore, allow for competitive pricing strategies when compared to conventional high street retailers. Analysis of the financial statements: Financial position: 2010 2009 Non Current Assets 83% 9002m 84% 8422m Current Assets 17% 1853m 16% 1591m Total assets 10855m 10033m 2010 2009 Non Current Liabilities 48% 3096m 52% 2748m Current Liabilities 52% 2793m 48% 2919m Total liabilities 5889m 5657m According to Sainsbury Annual Report (2010), an increase in current assets of 1% between 2009 amd 2010 happened as the company tried to liquidate some assets to cover the increase of 4% in liabilities. However, covering 67% of the current liabilities by current assets is showing an improvement comparing with 55% of liabilities in the year 2009. This means that the company is strong in terms of paying its liabilities. Income statement: This graph shows the increase in gross profit in the last three years. This improvement in gross profit shows better performance in 2010 as compared to the last two years as a rise of 4.4% occurred between 2009-2010 and that of 3.4% occurred in 2008-2009. However, comparing with the competitors, the highest increase is shown by Morrisons of 16.3%. TESCO’s profit increased by 10.1% followed by Sainsbry. Finally, a decrease in the profitability of M&S occurred equal to -0.5%. This means that Sainsbury did not do well in terms of gross profit. Nevertheless, Sainsbury increased its net profit from 289M to 585M in 2010, which is a rise of 102% since last year. Sainsbury performed the best in this area. This was because of a gain from joint venture worth 138M in 2010 as compared to a loss of 111M in 2009. The fair value movement in investment in property became 123M in 2010 which shows a loss of 124M in 2009 (Sainsbury annual report 2010). The main financial ratios: Financial Ratios Sainsbury 2010 Sainsbury 2009 Sainsbury 2008 TESCO 2010 MORRSION 2010 M&S 2010 Liquidity ratios: current ratio 0.66 0.55 0.65 0.73 0.54 0.80 quick ratio 0.37 0.31 0.39 0.44 0.24 0.36 Cash Ratio 0.3 0.21 0.27 0.18 0.11 0.21 stock days 14 days 14 days 15 days 19 days 15 days 28 days Gearing ratios: Gross debt-equity ratio (excluding intangibles) 55.0% 53.27% 44.62% 74.9% 41.6% 74.1% Net debt-to-equity(excluding intangibles) 47.2% 38.94% 30.05% 68.2% 39.1% 68.1% Net interest cover 5.7 3.64 4.75 3.1 3.3 2.6 Efficiency ratios TAT ratio 1.8 1.88 1.76 1.2 1.8 1.3 FAT ratio 2.5 2.2 2.1 2.5 2.2 Profitability ratios GPM ratio 5.45% 5.47% 5.6% 8.2% 6.97% 9.09% OPM ratio 3.6% 3.14% 2.99% 6.1% 5.5% 8.9% NPM ratio 2.9% 2.16% 2.84% 4.1% 3.8% 5.5% Investment ratios EPS ratio 32.1 16.6 19.1 29.33 23.93 33.5 The above ratios indicate the financial performance of all companies. Sainsbury plc has performed exceptionally well during the last three years. The company’s performance has been reviewed through the financial ratios. Liquidity ratios help in ascertaining the survival of a company. This is basically a short term measure. Current ratio is one of the liquidity ratios which help in identifying a company’s ability to pay off its short term liabilities using its current assets. Quick ratio tells the status of a company to pay off its short term liabilities with the most liquid assets (cash ratio shows paying liabilities off with cash). Sainsbury plc’s liquidity position has improved in three years with its current, quick and cash ratios either improving or just remaining at the same level as they were in the year 2008. Although the liquidity position for Sainsbury might not be considered very good as compared to the benchmark but its current, quick and cash ratio are much better than its competitor Morrison. The company’s liquidity position is better than Morrison but if compared to other competitors, it may not seem good enough. As of 2010, Marks and Spencer and Tesco hold the better liquidity position, Tesco’s current ratio is 0.73:1, Mark & Spencer’s current is been 0.80:1, Morrison’s current ratio is 0.54:1 and Sainsbury’s current ratio is 0.65:1. Besides the liquidity position, the company’s gearing ratios are also analyzed. Gearing is an important aspect, which helps to decide the balance between debt and equity financing. The more highly a firm is geared, the harder it would be for the firm to increase more debt finance as high level of gearing denotes that the firm is highly involved in debt financing. The gearing position for Sainsbury during the years 2008 to 2010 shows that the company has highly indulged itself into debt financing rather than the equity financing mode. The gearing ratio has crept up during these three years for Sainsbury with its net debt-to-equity ratio increasing from 30.05% in 2008 to 47.2% in 2010. Tesco and Marks and Spencer hold the highest gearing ratio in 2010 of 68.2% and 68.1% respectively. Morrison, on the other hand seems to prefer equity financing over debt. The efficiency ratios are another means of analyzing a company’s performance. These ratios demonstrate how well a company uses its assets in order to increase its sales revenue. The efficiency ratios for Sainsbury have remained almost the same for the three years from 2008 to 2010. The only company in addition to Sainsbury that kept the same standard as that of Sainsbury in the year 2010 is Morrison. The profitability ratios for Sainsbury have improved during the three years from 2008 to 2010. This shows that the company’s profits have increased during these three years. Profitability ratios help in ascertaining a company’s performance with respect to the profits that the company/organization generates. Of all these companies, M & S seems to keep the highest profitability ratios (e.g. 5.5% Net Profit Margin). Investment ratios show the attractiveness of a company to potential investors and Sainsbury has kept steady earnings per share figure. The company’s EPS has improved in the three decades of 2008, 2009, and 2010 (M & S being the only other company to keep a matching EPS as that of Sainsbury). Company valuation: The multiple growth rate model     Dividend PV (discount .08) Dividend growth 1 d1 0.1491 0.14 5% 2 d2 0.156555 0.14 5% 3 d3 0.1659483 0.15 6% 4 d4 0.175905198 0.16 6% 5 d5 0.18645951 0.17 6% 6 d6 0.19764708 0.18 6% 6 v6 4.071529858 3.77 3%   Share Value   4.73   Price multiples valuation model   TESCO Morissons M&S MEAN Market / Sales 0.52 0.44 0.54 0.50 Market / Book 2.08 1.34 2.39 1.94 Market / Net Income 12.39 11.70 9.37 11.15   Actual Financial statement Data Mean market ratio Suggested value of equity Sale 19964000000 0.50 9,982,000,000 Book 4966000000 1.94 9,634,040,000 Net Income 585,000,000 11.15 6,522,750,000 Mean Market Equity Value     8,712,930,000 Ordinary Share 1,866,080,000 Share Price PMM 4.67 Free cash flow valuation module Terminal value Free cash flow@year 5 Growth rate WAAC Terminal value 671,098,189 2.00% 12.03% 6,823,762,693.67 Enterprice Value Free cash flow 609,872 620,921 634,895 651,657 671,098 Discount factor 1.1203 1.2551 1.4061 1.5753 1.7648 544375.51 494717.19 451525.75 413675.44 380265.48 Enterprice Value 2,284,559.36 Equity Value   Enter price value 2,284,559.36 Add indicial cash 837,000 Subs tract indicial debt 2,357,000 Equity value of Sainsbury 764,559.36 Number of share 186608.0 Share price 4.097 The average target price is ?449.9p and the current price on 13/4/2011 is ?342.90p (Reuters 2011), which means that the price is likely to increase by 23.7%. Summary: This analysis shows sharp increase in the net profit as a result of the joint venture and a very high record sale in the Christmas as along with a 0.6% rise in the market share. This leads to an optimistic outlook to the Sainsbury’s shares. (THE RECOMMUNDATION IS BUY THE SHARE) Appendix: Dividend Discount Module 2010 TESCO Sainsbury morrsions M&S Book Value 399000000 532000000 266000000 395500000 M.C 3,145,273,998,231.30 684,986,314,827 760,115,452,096 531629192104.2 Sales 56910000 19,964,000 16479000 95366000 net income 2,327,072,000 585,000,000 598,000,000 526300000   TESCO Morrsions M&S MEAN Market / Sales 0.52 0.44 0.54 0.50 Market / Book 2.08 1.34 2.39 1.94 Market / Net Income 12.39 11.70 9.37 11.15   Actual Financial statment Data Mean market ratio Suggested value of equity Sale 19964000000 0.50 9,982,000,000 Book 4966000000 1.94 9,634,040,000 Net Income 585,000,000 11.15 6,522,750,000 Mean Market Equity Value     8,712,930,000 Ordinary Share 1,866,080,000 Share Price PMM 4.67 466.9108506 1.31746854 404.2304253 0.878211975 -0.121788025 Free Cash Flow Valuation Module changes in % 2009 2010 2011 2012 2013 2014 2015 Operating Revenue / Turnover 18968000 19991000 20390820 20798636 21214609 21638901 22071679 2% Costs of Goods Sold -17473000 -18435000 4078164 4159727 4242922 4327780 4414336 20% Other Operating Items -421000 -400000 -10195410 -10399318 -10607305 -10819451 -11035840 50% Depreciation/Amortization -468000 -479000 -502950 -528098 -554502 -582227 -611339 5% Financial Revenue 52000 33000 32670 32343 32020 31700 31383 -1% Financial Expenses -148000 -148000 -130240 -114611 -100858 -88755 -78104 -12% Other non Oper./Financial Items -44000 171000 179550 188528 197954 207852 218244 5% P/L before Tax 466000 733000 13852604 14137208 14424840 14715800 15010359 Taxation -177000 -148000 -1662312 -1696465 -1730981 -1765896 -1801243 12% P/L after Tax 289000 585000 12190292 12440743 12693859 12949904 13209116 Extraord. & Oth. Items 0 0 0 0 0 0 0 P/L for Period 289000 585000 12190292 12440743 12693859 12949904 13209116 Depreciation/Amortization 468000 479000 502950 528098 554502 582227 611339 Net after-tax interest payments 85862 72396 60577 50209 41115 Increase/Decrease in current assets 21060 20428 19815 19221 18644 Free Cash Flow     609872 620921 634895 651657 671098 2009 2010 2011 2012 2013 2014 2015 Current Assets 1591000 1853000 1831940 1811512 1791696 1772476 1753831 Stock 689000 702000 680940 660512 640696 621476 602831 -3% Debtors 49000 71000 71000 71000 71000 71000 71000 Others 853000 1080000 1080000 1080000 1080000 1080000 1080000 Cash & Cash Equivalent 627000 837000 837000 837000 837000 837000 837000 Fixed Assets 8442000 9002000 8591850 8202208 7832047 7480395 7146325 Tangible Fixed Assets 7821000 8203000 7792850 7403208 7033047 6681395 6347325 -5% Intangible Fixed Assets 160000 144000 144000 144000 144000 144000 144000 Other Fixed Assets 461000 655000 655000 655000 655000 655000 655000 Total Assets 10033000 10855000 10423790 10013719 9623744 9252870 8900156 Current Liabilities 2919000 2793000 2793000 2793000 2793000 2793000 2793000 Loans 90000 67000 67000 67000 67000 67000 67000 Creditors 1728000 1782000 1782000 1782000 1782000 1782000 1782000 Other 1101000 944000 944000 944000 944000 944000 944000 Non Current Liabilities 2738000 3096000 3025290 2956701 2890170 2825635 2763036 Long Term Debt 2177000 2357000 2286290 2217701 2151170 2086635 2024036 -3% Other Non Current Liabilities 561000 739000 739000 739000 739000 739000 739000 Shareholders Funds 4376000 4966000 5171740 5389044 5618451 5860530 6115879   Capital 501000 532000 516040 500559 485542 470976 456847 -3% Other 3875000 4434000 4655700 4888485 5132909 5389555 5659032 5% Total Shareh. Funds & Liab. 10033000 10855000 10990030 11138745 11301622 11479166 11671915 References: Annual Report, Sainsbury plc, 2011 [Online] Available at http://www.jsainsburys.co.uk/files/reports/ar2010_report.pdf [Accessed 1march 2011] BBC, 2010. GDP Growth In 2011 To Be Slower Than Thought, Says IMF. Business. [Online] Available at: http://www.bbc.co.uk/news/business-11482589 [Accessed April 06, 2011]. BBC, 2011, Sainsbury ‘record’ Christmas sales. Business. [Online] Available at http://www.bbc.co.uk/news/business-12169175 [Accessed April 01, 2011]. BBC, 2011. UK Interest Rates Held At Record Low Of 0.5%. Business. [Online] Available at: http://www.bbc.co.uk/news/business-12700649 [Accessed April 06, 2011]. BBC, 2011. UK Inflation Rate Rises To 4.4% In February. Business. [Online] Available at: http://www.bbc.co.uk/news/business-12815228 [Accessed April 06, 2011]. Bowers, S. 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