Sainsburys Supermarkets - Essay Example

J Sainsbury plc Reports: 2003-2006 A Brief Backgrounder J. Sainsbury plc owns Sainsbury's Supermarkets (hereafter Sainsbury's), the U.K.'s third largest retailer after Tesco and Asda. For many years since it opened for business in 1869, Sainsbury's was the country's biggest supermarket, the undisputed market leader. A series of mis-steps allowed competitor Tesco to catch up in 1995. In 2003, Asda passed Sainsbury's, relegating the latter to third position where it stays. Sainsbury's is now playing catch up, regaining market share one percentage point at a time. A publicly listed corporation since 1973, the company is on the renewal trail as it attempts to regain its leading position in the industry. Using a combination of common management tools in a wide range of areas, from stocking its shelves full with items customers want to buy to executing on a complete revamp of its information technology and supply chain management systems, a new senior management team is revitalising the whole organisation from top to bottom. This brief history helps us analyse the period 2003 to 2006, during which Sainsbury's hit the dust with their first-ever revenues slump in history (in the year ended March 2005) and then as nimbly picked itself up and began staging a comeback. We can learn how they are doing by studying the company's annual reports which are the "official" snapshots of the whole corporation each year. Just like any other company at the mercy of its stakeholders (Freeman, 1984), Sainsbury's is expected to behave to satisfy everyone. First Question Identify significant areas of the accounts for 2006 where judgment has been used in determining the appropriate accounting policy for the company (for example depreciation of fixed assets). Critically discuss how such judgments have materially affected the accounts in terms of valuation and profitability. There are several portions in Sainsbury's 2006 report indicating where judgment has been used to determine the appropriate accounting policies. Note 2 on Accounting Policies (Sainsbury's, 2006a, p. 56-59) is the second longest portion of the report's general section of Notes to the Financial Statements (p. 51-101), next to Note 42 which is on the financial reporting transition to IFRS (p. 91-98). From the long list of accounting policies, we note the following that in our opinion materially affected the accounts in terms of valuation and profitability: The 2006 reports are the Group's and Company's first financial statements prepared under IFRS and therefore, IFRS 1 'First-time Adoption of International Financial Reporting Standards' was applied. The last statements under UK Generally Accepted Accounting Principles ("UK GAAP") were for the 52 weeks to 26 March 2005. An explanation of the transition to IFRS is provided in Note 42. A comparison of the GAAP-based 2005 and IFRS-based 2005 reports showed that whilst non-current assets declined by almost 3 billion, total equity declined by only 33 million thanks to adjustments in net current liabilities of over 2.9 billion. This shows how numbers can surprisingly appear and vanish like magic. Early adoption of the standard Amendment to IAS 19 'Employee Benefits' is effective for annual periods beginning 1 January 2006, i.e. beginning 26 March 2006. However, Sainsbury's elected to early adopt this amendment and has applied the requirements of the amendment to the financial statements for the 52 weeks to 25 March 2006. This led to gross actuarial gains of 128 million (Note 42, p. 95), cutting the pension deficit from 672 million to only 375 million due to a deferred income tax asset. This allowed Sainsbury's to conveniently finance the pension fund and contribute towards improving employee motivation. The treatment of Subsidiaries and Goodwill allowed Sainsbury's to manufacture current year profits growth from its sale of Shaw's in 2004 by recycling 123 million of the goodwill write down from its 2005 results (p. 96), adding net 86 million to profits (See note on p. 95). Goodwill is now not allowed under IFRS. Intangible and tangible assets are carried at cost less accumulated amortisation and any impairment loss and amortised on a straight-line basis over their useful economic life (15 years for pharmacy licences and three to five years for computer software). Impairment loss is based on annual valuation, for which management utilises its own judgment. Note 13 (p. 66) shows that there was a total amortisation and impairment loss (thus, a decrease in book value) of only 53 million in 2006. The fine print at the bottom of the page details how this happened (for Goodwill, pharmacy licences, and computer software) and how management decided that there was no impairment of Goodwill in the year based on future performance. How they valued (or decided not to devalue) such an intangible asset is mystical but, we hope, generally accepted. Property and other tangible assets are stated at cost less accumulated depreciation and any recognised impairment loss. Depreciation is calculated to write down the cost of the assets to their residual values, on a straight-line method ranging from zero (freehold land), 3 to 15 years (fixtures, equipment, and vehicles), or to 50 years (or the lease term if shorter) for freehold buildings and leasehold properties. The longer the depreciation period, the lower the expenses and the higher would be the profits, earnings, the valuation of the company, and its stock price. Voila! Incentives for managers and employees with stock options would improve. Capitalisation of interest for capital acquisition or construction and capitalisation of lease incentives are accounting tricks designed to convert interest and rental expenditures from an operating expense to a manner of inflating asset values. We find this similar to owning a part of the airline company every time we buy a plane ticket. Alright, it is unbelievable, but an accepted accounting manoeuvre. In the heat of the option back-dating scandals in many companies, we note with optimism the amount of forfeited stock options at Sainsbury's (50.2 million in 2006) due to poor stock price performance. The company stopped granting options under their Colleague Share Option Plan and then re-designed their stock incentives plan based not only on share price performance but on total shareholder returns in comparison with its industry peers. This is a good way of protecting other shareholders from greedy managers and the agency costs associated with executive compensation (Jensen and Meckling, 1976). Inventories are valued at the lower of cost and net realisable value using FIFO. This is another of those accounting tricks that inflate profits (assuming prices of goods rise with inflation). A more "conservative" inventory valuation practice is LIFO, which brings down profits and earnings, but if employee incentives are based on share price, which in turn is influenced by stated earnings per share, at least according to the Efficient Markets Hypothesis (Fama, 1998), then no management will use it. There are many other portions where the phrase "when such determination is made". See for example the note on 'Provisions' and 'Income taxes' to refer to future liabilities based on actual costs and timing of future cash flows. In all these cases, management (usually the CFO and the accountants) make these decisions and propose to management that these be approved. Why Companies like Sainsbury's want to increase the confidence of stakeholders on the management team's prudence and conservatism, thereby contradicting themselves by eschewing "conservative" accounting principles - LIFO, accelerated depreciation, etc. that minimise short-run reported earnings - to enhance the market value of their stock. Such a "quality of earnings" philosophy confuses investors already wary of companies magnifying reported earnings by using "liberal" accounting principles. However, some companies feel that lower reported earnings, using conservative principles, would temper employee requests for higher wages or avoid media charges of profiteering. In each case, management has the final prerogative to decide how best to exercise judgment. Second Question Critically review the extent to which the additional information and commentary contained in the Chief Executive's Operating Review and the Financial Review over the four years offers an objective and comprehensive assessment of the company's financial position and future prospects. Chairman Sir George Bull was upbeat in the opening statement to his 2003 report, reminding stockholders that everything was on track according to Sainsbury's Year 2000 Business Transformation Programme. CEO Sir Peter Davis highlighted Shaw's contribution to the bottom line in his report that same year. If we were to base our opinion of the company's future prospects on the 2003 Operating and Financial Reviews, the future was bright, problems were being addressed, and there was no cause for alarm. Looking at the financial reports, however, one could not help but notice that things were not going as well as the two top executives pictured them to be: revenue growth was very thin (1.6%) despite increases in the number of stores, selling space and workers. The Performance Review graph (2003b, p. 19) was a warning: the caption trumpeted that Sainsbury's outperformed the FTSE 100 in the previous three years, but the graph showed that Total Shareholder Return was going down faster for Sainsbury's than for the FTSE 100. Sure enough, a year later, Sir George was gone and Sir Peter was kicked upstairs (2004b, p. 3), Sainsbury's had a new CEO, Justin King. Sales grew very thinly (2.4%), profits (- 8.5%) and earnings (-12.3%) were way down, and Shaw's had been sold. What happened King's CEO Report said it all: they lost focus, "distracted by huge changes made to improve many behind-the-scenes activities", making them "inward looking rather than focused on servingcustomers" (2004b, p. 4). They simply forgot to stock the shelves! These small collections of elementary mistakes made Sainsbury's lose ground to Asda, which overtook them to be the second biggest retailer in the U.K. that year. In his first message to shareholders that is remarkably short and straight to the point, King pointed to the challenges ahead and his eagerness to work on gaining customer confidence. Did he deliver The 2005 reports (2005a and 2005b) had a charming cover with the words: "What will it take to make Sainsbury's great again" The past year was tough: Sir Peter resigned in July, his tail between his legs, as shareholders revolted over his generous salary package in a troublesome year when shareholders lost money. Sales grew 5% but profits and earnings dove way down - profits collapsed from 610 million to 15 million whilst earnings sank from 23.4p to 9.0p. Further details of the disintegration surfaced in these opening reports. The new Chairman, Philip Hampton, indicated that they were moving to a sales-based strategy and talking once again to their stakeholders (employees, customers, suppliers, etc.). This meant that Sainsbury's in the past few years was squeezing costs and efficiencies to fatten the bottom line, and forgot to talk to the customer. Generating cost efficiencies may have been a good idea, but not if you have the likes of Tesco and Asda as competitors, cost-cutting wizards that are highly efficient at what they do without neglecting customers, a skill Sainsbury's lacked; as they have proven, it was good at one or the other but not both. This is why the new team of Hampton and King pointed out in their reports in 2005 that from then on, things would change for the better. Did it Yes. Sales grew almost as much (5.8%) but profits were positive this time, a considerable turnaround from the losses the previous year (restated to -187 million after tax). The Chairman's report was short and sweet, and King's was rather long, which showed how proud he was at the turn of events, the mix of bad and good news, mistakes and successes, of things done right and customers coming back. More than the pat in the back statements, the new CEO's candour and simplicity in admitting the company's mistakes like the poorly-executed outsourcing consultancy agreement with Accenture (p. 22) sends a reassuring message to stakeholders that Sainsbury's is working hard to get better. One can clearly notice the great but subtle differences between the ambitious statements and claims of the men of peerage (Sir George and Sir Peter) at the helm of Sainsbury's before the ordinary folk (Philip and Justin) with their ordinary claims moved in. Whilst the former team wrote of great things but failed to execute properly, the latest team currently tasked with the hard work of turning things around show their tempered enthusiasm as they go about their task, knowing that if they ease up one bit, the recovery work could still unravel and be undone. At least, the new management team acknowledges that at Sainsbury's, the customers are finally back on top. Third Question Critically discuss the extent that the information disclosed in the annual reports over the four years meets the needs of those stakeholders concerned with the social and environmental impact of the company. Sainsbury's has always been a good corporate citizen that knows how to take care of their stakeholders: suppliers, employees (colleagues), the community, shareholders, and customers. In fact, it was their effort to improve and add value to their stakeholders that got them in trouble, losing their focus on customers and shareholders in the process. Unlike other supermarkets Tesco and Asda that had run-ins with environmental groups over the sourcing of vegetables and apples from domestic U.K. suppliers, Sainsbury's has been complemented by groups like Friends of the Earth for their corporate social responsibility (2003b, p. 14; Stecklow, 1999; Friends of the Earth, 2005). The company could claim that it has been working closely with its stakeholders, giving support to its workers and suppliers, taking care of the environment, and promoting good health and diets amongst its customers. Each of their reports has a section on corporate social responsibility and what they are doing to the most neglected stakeholder: the customer. In 2004, it dawned on Sainsbury's managers that customers have began flocking to their competitors despite their having the best prices, a good selection of food and non-food products, and a great shopping environment. The company failed to deliver on convenience: long lines, stock outs, and delivery of mixed messages where Sainsbury's failed to tell customers that all the improvements they are doing are for them, much like what parents tell their children when they work so hard that they have no more time left for them: This is for your own good! As it was with neglected kids, so did Sainsbury's customers abandon them. At least, the company came out with a clear message fast (2004b, p. 15) to remind their customers that all their sacrifices are for them, which was timely as could be seen in the way sales and profits developed from thereon. To drive home the point further to its shareholders, the Performance Graph (2004b, p. 20) was right this time: Sainsbury's was really outperforming the FTSE 100 in total shareholder returns over the previous three years. Suppliers also needed reassurance that with the surge in outsourcing, they would not be left behind, exchanged for some far-off orchard or farm producing goods more cheaply and efficiently. Sainsbury's was after giving customers value for their money, and instead of sharing their meagre profits with shareholders alone, they decided to cut dividends and pass it to their customers as savings and to their suppliers as part of technology transfer to help them be as efficient and economical as their overseas counterparts. In 2004, Sainsbury's developed more nutritious black tomato, allowed customers to trace organic goods to their farm of origin, and committed itself to offer products with high environmental and social standards (2004b, p. 9-10). This continued until the next two years, when the new team launched the "Making Sainsbury's Great Again by 2007-2008" campaign. Laying out the simple road map in the report (2005b, p. 9) was a stroke of genius, confusing perhaps to those who do not know what it was all about but reassuring to stakeholders who have been left out in the cold in the last couple of years. Employees were more involved, management adopted an in-the-trenches attitude, shops were beautified and fully stocked 24/7, and the customers came back. The 2005 reports contained a low-key reference to suppliers, but the company showed a new tack: kids. This is a long-term stakeholder development strategy where the company hits two markets: kids and their parents, showing other stakeholders that the company is serious about their business of developing future customers, a reassuring move. In 2006, the company finally adopted a tone of smug satisfaction as it highlighted photographs of workers, bakers, farmers, children, and shoppers enjoying the Sainsbury's experience as they stock shelves, bake bread, raise cows, and attract kids to shop. Their corporate social responsibility report (CSR 2004), updated regularly and available online, is a comprehensive resource material outlining in detail their stand on a wide variety of issues: organic food and genetically modified products for customers, working conditions and pensions for colleagues (employees), investments in the community, how they care for the environment, their support for suppliers, and a clear set of messages for investors that Sainsbury's is once again on the road to greatness. This gem of corporate disclosure gives stakeholders a template they can use to help Sainsbury's. The document is amongst the most complete we have ever seen and reflect the company's commitment to not once again lose sight of their stakeholders who would take them to task for commitments and promises made. Sainsbury's has raised the bar once again, setting stretch goals that are ambitious, knowing that unless they do so, they would remain the number three retailer in the U.K. For more than ten years, Sainsbury's has been out of the top. Perhaps, finding it lonelier to be out of it, the company is going back to its roots as a family grocery and is now doing what they used to do better than anyone else: if you want to keep your customers, make sure they find what they came for; a simple thing really, but one that even great companies forget from time to time. Availability of useful and helpful information in its reports is the positive sign that, at last, every time you shop at Sainsbury's you will find what you want. Reference List Fama, E. F. (1998). Market efficiency, long-term returns, and behavioural finance. Journal of Financial Economics 49, 283-306. Friends of the Earth. (2005). Tesco comes bottom of the class for apple sourcing. November 11, 2005. [online] Available from: [November 4, 2006] Freeman, R. E. (1984). Strategic management: A stakeholder approach. Boston: Pitman. Jensen, M.C. and Meckling, W.H. (1976). Theory of the firm: Managerial behaviour, agency costs and ownership structure. Journal of Financial Economics, 3, 305-360. Sainsbury plc (2003a). Annual report and financial statements 2003. Holborn: J. Sainsbury plc. ________. (2003b). Annual review and summary financial statements 2003. Holborn: J. Sainsbury plc. ________. (2004a). Annual report and financial statements 2004. Holborn: J. Sainsbury plc. ________. (2004b). Annual review and summary financial statements 2004. Holborn: J. Sainsbury plc. ________. (2005a). Annual report and financial statements 2004. Holborn: J. Sainsbury plc. ________. (2005b). Annual review and summary financial statements 2005. Holborn: J. Sainsbury plc. ________. (2006a). Annual report and financial statements 2006. Holborn: J. Sainsbury plc. ________. (2006b). Annual review and summary financial statements 2006. Holborn: J. Sainsbury plc. ________. (2004). CSR 2004: Corporate social responsibility. Holborn: J. Sainsbury plc. Stecklow, S. (1999). "Attempt at Clarity in Food Labeling Prompts Much Confusion in the U.K." October 26, 1999. Wall Street Journal. New York. [online] Available from: http://www.junkscience.com/oct99/stecklow.htm [November 4, 2006] Read More