Marks and Spencer Plc Financial Performance - Essay Example

RUNNING HEAD: Marks and Spencer PLC Marks and Spencer PLC Financial Performance of Question A -Analyse the profit performance of the company. You may wish to compare this performance against competitors. 10 Marks ((400-450 words) The return on equity (ROE) of MKS at for the last six years from 2005 to 2010 averaged at 35%as against the industry average of 5.21%. MKS is also obviously more profitable than GAP and Next in terms of the return on equity as per Table A below. Such a show of superiority about its past performance could indeed motivate people or entities to invest with the company. A range of 24% to 42% return on equity definitely attracts investors in the last six years, as it would mean that for every £100 the investors expect returns of about £24 to £42. These rates could be viewed as something extraordinary for a company like MKS given the conditions of the economy during 2008 and 2009. See Table A below in relation to Appendices A, B, C and A-1. Table A – Comparative Profitability Ratios; Sources (MKS 2011; Next, 2011; Gap, 2011) It may be noted that return on equity uses the formula where net profit is divided by the total stockholders’ equity. When compared to an average rate of 0.50% if money was invested in a bank, its average ROE of 35% makes it to more than a seventy times and the rate is something very remarkable to find for investors. The 0.50% is the Bank of England base rate could represent the risk free rate investment in the UK (Housepricecrash, 2011). Aside from profitability, it is also appealing to know whether the company management is efficient. To measure the latter, this paper uses return on assets (ROA). The company’s average ROA of 9% for the last six years was higher than industry average of 1.6%. GAP appeared to have higher average ROA but ROE is more controlling from the point of view of investors (Van Horne, 1992). By comparing the two ratios, it appears that MKS is both profitable and efficient than industry. The understandable profitability and efficiency of the company is further proved by the company’s net operating margin and net profit margin. The resulting average operating margin and average net profit margins for the past six years are 11% and 7% respectively as against the industry averages of 2.02% and 1.13% respectively. Operating margin results after deducting cost of sales or services and operating expenses from gross margin (Helfert, 2001) MKS’s net margin for the latest twelve-month period was posted at 5.7% as against industry average of 0.23%. See Table A. If the rate is compared the operating profit margin, it could be found that net profit margin is lower. This means that MKS needed to spend other expenses to finance some of its borrowing. It further means that MKS is using other people’s money while improving profitability for stockholders. No wonder MKS had very high return on equity as earlier analysed. Question B - Does the company have a discernible dividend policy? Has this been explicitly articulated or is it apparent in the dividend decisions that have been made. What theories about dividend policy exist and do these seem relevant to this situation? Interestingly, Marks and Spencer appear to be capable enough to satisfy the need of its stockholder for their dividends as show in Table B below. The obvious decision of MKS based on the yield ratios and payout ratios shown in Table B below can only speak of clear dividend policy that not only premises but would appear to be a commitment to provide with a sense of continuing. With a pay-out ratio of yield averaging at 3.87 for the last five years as against industry average of 0.7, one can only infer a continuous desire to provide dividends to shareholders. Giving what is expected by its stockholders better than other players do could only build long-term relationship. The high dividend yield indicates MKS to be providing more to stockholders than competitors despite having lower growth rate of its revenues for the last four years. The pay-out for the last twelve-trailing month is more than twenty five times the industry average. The annual report for 2010 declared that it the company’s policy “to grow dividends in line with adjusted earnings per share.” (MKS, 2011) It dividend policy therefore is expressly stipulated as found in its annual report which is made available to shareholders. Such a policy on dividend would mean that the company would provide dividends in relation its earnings. This is closely related to constant dividend pay-out policy that subscribes to dividend relevance theory. In other words, the company is having such policy at it believes the policy has the effect of increasing shareholders’ value per share. However, given a higher leverage industry capital structure than industry average, its giving of high dividends continuously to stockholders may lessen its strength since this could make financial leverage or gearing ratio still higher. This may however just mean that there is lack of investment opportunities for the company for the last twelve trailing months which convinced management to just use the extra funds dividends to shareholders. Table B –Dividend Ratios; Source: (Reuter, 2011) A look at the return on equity which average at 35% for the last six years, it would mean that the high dividend pay-out was indeed an evidence extra earnings for the company, much higher than its average competitors. Although stockholders may expect dividends as a way of compensation them for their stock investment, the management through the board of directors can defer the giving of dividend for the better future financial health of the company. As far as the dividends are concerned, Performance Overview report of the finance and operations director declared that the dividend policy of the company which is to grow dividends in line with adjusted earnings per share. Since the company’s appears not to retain future earnings for the development and expansion of its business because of the policy, it may mean that the presumption it just to give them back to shareholders any excess funds unless the company has planned for capital investments. Does the dividend policy of the company puts its long-term health in danger of losing funds or not retaining any earnings for expansion purposes? This is not necessarily the case as the company has a good dividend cover of not giving dividends higher than earnings. Dividends cover the years 2006, 2007, 2008, 2009 and 2010 were recorded at 2.53, 2.57, 2.13, 1.32 and 2.38 respectively (MKS, 2011). Dividend cover is computed by dividing earnings per share to dividend per share. The said ratios would mean the earnings per share was always higher than dividends per share and this would imply that some earnings are still retained for expansion and other purposes. As to whether this is going good for the company may be analysed based on information in Table C below. Table C- Comparative Market ratios Source: (Reuter, 2011) The company has still lower beta at 0.87 than the industry average of 1.07. This means that it is less risky than competitors despite having a higher financial leverage than industry average. This higher financial leverage as measured in terms of debt to equity ratio would be discussed more in the next question upon examination of the company’s balance sheet. Question C- A cursory examination of the balance sheets for the company between 2005 and 2010 show an increase in Property, Plant and Equipment. Examine this increase and analyse possible ways in which any investment has been financed. An examination of the company’s balance sheet showed not increase each year between 2005 and 2010. This would mean that the company does make any expansion each year. See Table D below. Table D-Comparative Yearly PPE; Source (MKS, 2011) It was only in 2007, 2008 and 2009 that increases were noted. For analysis purposes the related debt to equity ratio should be compared per year. It may be observed that the debt to equity ratios during 2007, 2008 and 2009, were below the debt to equity ratio of 2005 a 4.35 and 3.37 of 2006. ON the surface it could mean that financing the investments or capital expenditure made in those years did not result to higher financial leverage or gearing for the company. It may be possible that the increase was financed the company’s equity. An investigation of the company’s cash statement in its 2008 annual report revealed that company has purchase plant property and equipment at the amount of £958.4 million for the year 2008 and at the amount of £666.9 million for year 2007. A further investigation however revealed that additions in plant property and equipment for 2008 amount to £23.5 million only and financed by new finance leases. This would therefore mean the big amounts of increases in plant property and equipment for 2007 and 2008 were also finance by old finance leases which the company capitalized as result of the entering into a contract. A finance lease does not legally bestows ownership to the company since it is just a lessor but under the existing accounting standards the finance lease is capitalized and in terms of company’s balance sheet any continuation of the old lease increases should not increase the accounts. A further investigation of the cash flow statement in 2008 does not tell how the amounts of £958.4 million £666.9 million for year 2008 and 2007 were financed respectively. This is reinforced by the fact the notes merely explained that additions to property, plant and equipment during the year amounted to £23.5m leaving the more than £500 million for 2008 and 2007 unexplained. This could be a case of an attempt to hide material information to the users of information. This inference is being made stronger by the fact the depreciation came more form owned properties rather than those leased. An explanation of how the company financed the purchase of properties may come also from the cash flow that the company has issued medium term notes of £631.7million and £397.5million for the years 2008 and 2007 respectively. This would mean the company used medium term to finance long-term needs. Further investigation revealed that medium term notes are part of its £3bn European Medium Term Note Programme where the company pays interest annually with interest ranging from 5 to 8% per year (MKS, 2011). The behaviour of the company’s Property, Plant Equipment as a sign of evaluating the company’s policy on making expansion or making long-term investments should be viewed in relation to the financial condition of the business which may require an examination of its financial gearing and liquidity position. Financial Condition Analysis Examination of the balance sheet also normally entails and examination of the financial condition of a company that may be further described by looking at the company’s liquidity and financial gearing. Table E below summarizes the information in relation to Appendices A and A-1. Table E- Summary of liquidity and financial gearing ratios; Sources: (MKS 2011; Reuters.com 2011). Liquidity is the capability to pay a company’s currently maturing obligations. The same is measured using the current ratio and the quick asset ratio. As applied to MKS, it’s computed average current ratio for the past six years is 0.63 as against industry average of 0.77. Quick ratio of the company on the other was reflected at 0.37 for the past six years as against industry average of 0.57. Both ratios are below 1.0 both are lower than the industry average indicating a less superior liquid position of the company. With the said level of the liquidity, the company may still be considered as acceptable because the company is in the retail industry and can easily generate funds. This was earlier complemented when the company efficiency was looked into. See Table F below. Table F- Comparative Efficiency Ratios; Source: (Reuter, 2011) MKS’s financial gearing connotes long-term capacity of a company to keep up it stability over the long term. Financial gearing should comfort investors that the company will not just survive the short term but it must also have a long life to recover long term investments which takes years to produce the needed returns. The average debt to equity ratio of MKS for the past six years is 2.89 as against industry average of 0.70. See Table D in relation to Appendices A and A-1. This could now be understandable as the company can issue bonds under its £3bn European Medium Term Note Programme. The financial gearing ratio of the company is less superior that the industry average and is an evidence of a highly leverage capital structure for MKS, as the company would be deemed too risky to able to make further expansions in the future compared with competitors. It means, in simple terms, that the company may be less able to manage its long-term risk despite is high level of profitability and efficiency. However, as seen earlier, the company has lower beta than its competitors and it has higher dividend pay-out for the last twelve-months. What get affected most are the low liquidity ratios of the company but as determined, that same was also not too low as the company can easily generate funds from the nature of business where sales can be made daily. In fact from Table F MKS’s inventory turnover is twelve times better than the industry. Appendices Appendix A- 1 Formulas used in the computation in Appendix A. Source: GAP (2011) Source: Next (2011) References: Brigham, E. and Houston, J. (2002). Fundamentals of Financial Management. Thomson South-Western GAP (2011). Financial Statement for the last five years. Retrieved 29 March 2011 from Helfert, E. (2001). Financial Analysis: Tools and techniques: a guide for managers. McGraw-Hill Professional Housepricecrash (2011)> Bank of England Base Rate. Retrieved 29 March 2011 Marks and Spencer (2011). Annual Reports from 2005 to 2010. Retrieved 29 March 2011 < http://corporate.marksandspencer.com/investors/reports_publications/2006> Next (2011). Financial Statement of Next for the last five years. Retrieved 29 March 2011 from Reuter (2011) . Industry Ratios. Retrieved 29 March 2011 from Van Horne, J. (1992) Financial Management and Policy. Prentice-Hall International. Read More