Figure 5 – Asset Turnover ratio figures for the past 5 years for both companies
Sainsbury’s have seen the number of times their assets have been used to produce revenue over the past 5 years with an average of 3.7 times asset turnover. This rate has steadily increased over the years since 2002. There has been a rise of 0.4 times since 2005. The figure of 2006 may be the result of the new management of Sainsbury’s and may bring further success in the coming years.
Furthermore, Tesco’s asset turnover had been on average 4.3 times in the last five years. However, the number of times the asset turnover has taken place has fallen over the years since 2002, but not any dramatic fluctuations. This shows that although the company is increasing turnover their assets required to fund the increasing turnover are reducing. This may possibly be due to its international investments and focus into different markets such mobile telecom, insurance, etc. However, this is not a cause for concern for a fairly profitable company as like Tesco.
Gross profit margin (GPM)
The gross profit margin measures a company’s manufacturing and distribution efficiency as a percentage of its sales revenue. It illustrates the percentage of gross profit over its revenue or sales left after subtracting the cost of goods sold. It also helps specify how proficiently a business is utilising its materials and labour. The higher the gross profit margin is, the better it is, as it shows that the company is making reasonable amount of profit on the sales made. But this will only be true if the company controls and keeps its overheads as low as possible.
If the company is not reaching its proper gross profit margin, it will be unable to provide for its expenditure. In essence, it is ideal for a company to earn gross profit that is consistent and that it doesn’t fluctuate from one period to another.
This ratios main use would be to compare against previous years performance profitability and be also used against competitors. Also, it is used to measure the efficiency and trading profitability of the company.
Looking below at figure 1 Tesco Plc has maintained a constant but steady incline of its GPM, with an average GPM for 5 years of 7.22%. This means that for every £ earned through sales, there is a gross profit margin of 0.72p. This is good, as it indicates that for every £ of expenditure, there is adequate amount of profit margin to cover the expenditure. However, the investor potential indication shows that the GPM is increasing from recent years.
Figure 6 – Shows Tesco Plc Gross profit margin for the past 5 years
Looking at J Sainsbury Plc’s figures below in figure 2, it shows the gross profit margin for the last five years has steadily decreased to 4.12% from the year 2002 to 2005, but has picked up by 2.52% since, as shown in the 2006 GPM figure of 6.64%. This sudden slump in 2005 in the steady figure suggests that the reason why the decline occurred was again due to the reorganization of the company, whereby sales had to be reduced, as were the prices of the products. The average GPM of J Sainsbury Plc over the last 5 years shows as it to be 6.75% (every £ of sale, there’s a gross profit of 0.68p).
Furthermore, the results below show that from 2002 to 2004 J Sainsbury plc was experiencing a steady increase. This can be considered as a positive sign for potential investors in following years to come. Overall, J Sainsbury Plc’s figure seems to be more promising than Tesco plc, as Tesco figures show an increase only and no fluctuations. This can be a dangerous sign for potential investors due to the fact that perhaps in the following years to come Tesco may experience a sudden drop in profits, as this theory is also backed by financial analysts who suggest that Tesco may not be at the top for long. But this is only a mere theory not based on any hard evidence. Although having said that, it is still difficult to say that the J Sainsbury Plc is in a better financial state than Tesco Plc, even after considering the overall performance of both of the companies. Although the gross profit margin is very useful in analysing retail companies by providing an investor with a direct analysis of management’s skill in buying and selling at the best price, further analysis will bring more light into this subject.
Figure 7 – Shows Tesco Plc Gross profit margin for the past 5 years
Net profit margin (NPM)
For further analysis of a company, another ratio called ‘Net profit margin’ is used. This ratio measures the performance of a company on the basis that whilst the company is achieving maximum sales as possible, costs are consistently kept to a minimum. It tells the amount of net profit earned through every £1 of turnover made.
This Net profit margin number indicates how effective a company is at cost control. The higher the net profit margin means the more effective the company is at converting sales into actual profit. The ratio is one of the main performance indicators for a business. The analysis of low profit margin helps a company under review take appropriate cost control procedures, which may be done by either reducing excess costs or increasing selling prices.
When comparing the performance between different companies within the same industry, using the Net profit margin is very useful. This is because such companies generally undergo similar problems and face similar issues being in the same business industry. However, the net profit margin ratio has also proven to be a good tool to make comparisons between companies in different industries. This enables a company performing this type of measurement to test which industries are comparatively more profitable.
The net profit margin for Tesco Plc has increased steadily over the past five years (see below figure 3) rising from 4.75% in 2002 to 5.66% in 2006; this must indicate that Tesco have managed their costs effectively, thus showing that they have potential effectiveness for converting sales into actual profit. The average Net profit margin for the past 5 years is 5.05%.
Figure 8 – Net profit margin for Tesco Plc for the past 5 years
However, J Sainsbury Plc’s Net profit margin shows a lot of inconsistently over the last 5 years (see figure 4), it has an overall average net profit margin of 2.17% over the last five years. The below results show that J Sainsbury has suffered a sudden decline in its Net profit margin since after the year 2004 of 3.34% to 0.09% in 2005. This decline again shows that productivity improvements may need to be put into act, as the new management made a lot of changes in the reorganization of the company, thus causing the huge drop in sales and profit.
Figure 9 – Net profit margin for J Sainsbury Plc for the past 5 years
Looking at both companies Net profit margin, Tesco Plc proves to be more unwavering as it shows a steady incline and a consistent positive percentage of the amount of profit made from its sales. As for J Sainsbury Plc, although it seems to show a slight negativity in its Net profit margin, there are hopes that in the coming years its financial state will improve, with its main aim being to improve its overall profits and sales.
Solvency & Liquidity Ratios
Current (Working Capital) Ratio
The current ratio is also useful for comparing companies within the same industry. It shows how many times the current assets of a company are covering the current liabilities. This ratio measures the liquidity of a company (its ability to cover its short-term liabilities quickly). The ratio should be expressed as ‘something:1’. Generally, the figure should be greater than 1 (e.g. greater than 1:1), although many companies usually prosper with a ratio less than this.
Current Ratio= Current Assets : 1
Current Liabilities
Many analysts consider that a reasonable current ratio should fall between 1.5:1 and 2:1, but it is dangerous to be too dogmatic about this. The ratio will wholly depend upon the nature of the business and the direction of any trend. When calculating the current ratio, we should be looking for any trends. If a trend shows a decline in the years, it may well mean that the company cannot pay for its short-term obligations in the future. However, if a trend shows an incline over the years, this may not be positive in its entirety, as a high current ratio often indicates that a company may be typing up an increasing proportion of its resources in stock, debtors and bank, etc, instead of utilising them to expand the business by investing in fixed assets.
Figure 10 – Current ratio for the two companies in comparison for the past 5 years.
After analysing Tesco Plc account for the 5 year period shows that there has been a steady increase from the period of 2002 to 2005 this may show that Tesco’s was tying up an increasing amount of resources, since then there was a drop in the ratio by 0.07, this could be the result of an investment in fixed assets such as new branches spreading all over UK and overseas. However, this fluctuation of the current ration is not as worrying because Tesco has proved to be very successful and profitable in the past years and presently, experiencing a rising number of sales. This means that Tesco would be able to meet their short-term liabilities.
On the other hand, we see Sainsbury Plc’s current ratio quite stable, with an average of 0.83:1 over the 5 years. This may be the case as in recent years they have sold some overseas assets and provided an increased cash flow. As for sales, there has been a drop in sales, and the numbers of product being sold have also been reinstated so that they are in line with market competitors products. However, the rising value of the current ratio may be a result in overstocking, which is not good as it would prove to have a negative affect with the tying up of increasing proportions of resources. The action to be taken would be at this moment to increase sales dramatically as Tesco Plc’s overall profitability has been on an unstable trend through the years, as the previous ratio analysis has indicated.
Quick (Acid Test) Ratio
When using this ratio we should be looking in particular for any trends over the years. The Acid test ratio measures the liquidity of the company; it is a stricter method to calculate the profitability of any company. Current assets are also known as liquid assets; the definition of this type of asset is that they are assets that are cash or will be cash in the near future. Stock is considered the least liquid of the current assets, which is why when calculating the liquidity of a business inventory is excluded. The reason for this is because its liquidation price is most likely to be below its book value. The Acid test ratio measures the ability of the company of how quickly it can cover for its current liabilities with its current assets excluding stock.
The ideal quick ratio is from anywhere above 0.5:1, but the nature of the business must be taken into consideration due to the fact that certain supermarkets perform satisfactorily with liquid ratio of less than 0.5:1. However, if the ratio climbs quite high, around 2:1, this could mean that too many resources are tied up in a liquid form without earning profit. If a business fails to meet this test of liquidity, there could be a threat of a company facing insolvency.
Figure 11 – Acid test ratio results for Tesco Plc and J Sainsbury Plc of the past 5 years.
The results above in figure 6 show that Sainsbury’s had been developing a fairly positive quick ratio, above the standard 0.5:1 ratio. This shows that although Sainsbury seems as though, financially the company is doing well, in actual fact, the company has experienced a slump in its profits for the past 5 years and the rising acid test ratio only shows that Sainsbury Plc is tying up an increasing amount of debtors not repaying any outstanding amount fast enough and assets are not being liquefied (turned into cash fast enough). This may cause problems for Sainsbury as it may not be able to pay its short-term liabilities any faster if performance goes on this rate. In any case, Sainsbury Plc may be saved from any thought of insolvency because they have undergone new management and reorganization, and the City is looking in favor of Sainsbury Plc to make it succeed. So, although it seems as though the company is not so successful, they may be far from being scrapped and made insolvent.
Furthermore, Tesco Plc has a very low ratio, below the standard 0.5:1. Although this is the case, Tesco’s economy and growth in the market has been substantial, as it was clearly stated earlier, some companies, depending in the nature of their business can still be successful even with the acid test ratio results below the standard figure. As Tesco Plc market their products as the cheapest available to purchase, in actual fact profits are earned from losses in one way. This is their way of succeeding in the market; lower price = higher sales. So, the nature of the business is such that the acid test ratio will not give a negative result of the company’s financial position due to their high credit rating. Tesco Plc has proven to be highly profitable as the results of the ratio analysis so far have shown.
Activity Ratios
Stock Turnover Analysis
The Stock Turnover Ratio shows how many numbers of times the business has turned over or sold the value of its stock, during an accounting period. This is a very important aspect in the management of a company, as it provides an insight on the level of stock that should be held.
The ratio is useful in spotting stock deficiency, overstocking, stock obsolescence or the need for stock improvement.
It also allows companies to find out whether too much money is tied up in stocks, as the result gives the average number of days that money is held up in stocks. The longer this is it is worse for the business as the money is not available to be utilized elsewhere. Since the stock is part of the working capital it is essential that it is available for use promptly.
Usually capital is tied up in financing of raw materials, work in progress and finished goods. It is therefore wise to ensure that stock levels are kept as low as possible. However, if stock levels fall too low this can cause a problem, customer orders may not be met in time, resulting in loss of sales, possibly switching to competitors.
It must also be noted that the higher the stock turnover the better, as money is tied for less time in stocks. A quicker stock turnover also means that the firm gets to make its profit on the stock quicker, reflecting the firm’s competence in selling its stocks. A high ratio may indicate positive factors such as good stock demand and management.
In the retail sector it is essential that cost of goods sold be used rather than sales, as goods are generally valued at cost, not on sales.
Stock Turnover results for both companies are as follows:
It is usually denoted that the higher the stock turnover figure, the better it is for the company. In the supermarket industry, a company would want to achieve a high turnover, as this would mean higher sales.
As it is evident Sainsbury’s turnover has raised dramatically from 18 times in 2002, to 28 times in 2006 – an increase of 10 times. There has been a steady increase in turnover between 2004 and 2006, however the cost of sales and average stock have been on quite an imbalance – fluctuating from year to year - not on a trend.
Tesco’s annual stock turnover has remained steadily balanced, not fluctuating like Sainsbury’s.
A possible reason could be that Tesco has introduced a wider variety of products, rather than more of the same products, resulting in a steady turnover rate. If, however, the same products were still left the turnover rate may be significantly higher. They have possibly compromised the establishment of new products over delivering larger quantities of existing products. This may be true, especially for Tesco’s hypermarkets, such as that in Seoul, South Korea.
It may come as a shock, that although Tesco by far are a larger corporation, when compared to Sainsbury’s, their turnover only differs by 2 times more.
There are a number of reasons for this:
Sainsbury’s, until 2004 consisted of Sainsbury’s Supermarkets, Homebase (now sold), JS Developments (now sold), Shaws Supermarkets (US, now sold) AND Sainsbury’s Bank.
Tesco, on the other hand, have supermarkets alone, in the UK, Czech Republic, Hungary, Poland, Republic of Ireland, Slovakia, Turkey, Japan, Malaysia, South Korea, Taiwan and Thailand. In some of these countries they are not only supermarket leaders but also hypermarket leaders i.e. In Poland they are hypermarket leaders, serving 1.9 million customers each week.
Although, the stock turnover figures differ very slightly between Sainsbury’s and Tesco, it is evident that Tesco have a high turnover rate. This is also expressed by their pre – tax profits of £2.06 billion for 2005 and J Sainsbury’s have not yet declared £1 billion of profits, something which Tesco had done so 3 years ago.
Debtors Collection Period
There is a close relationship between debtors and credit sales, as it has become established practice in British industries for sales to be made to clients via credit terms. Goods are supplied to clients; however, they are not paid for immediately but at an agreed period or date.
If sales increase, debtors will increase, and likewise, if sales decrease, debtors will decrease.
This policy therefore requires a portion of a company’s capital to finance unpaid sales. The outstanding balance at the end of the accounting year is recorded on the balance sheet as debtors.
The Debtors Collection Period varies from industry to industry and sometimes also between businesses in the same trade. The size of sales may be such that the business has to offer installment payment facilities, something resulting in bad debts which have to be written off. Over the counter cash sales would normally be included but as they do not create debtors, their inclusion means that the Debtors Collection Period is understated.
A good summary of the Debtors Collection Period would be to say that it measures the ‘quality’ of debtors since it indicates the speed of their collection. The shorter the collection period, the better the quality of debtors, as a short collection period implies prompt payment by debtors, this has a significant impact on a business’ cash flow. However, an excessively long collection period implies a very liberal and inefficient credit and collection performance.
A distinction of cash and credit sales is not usually given in published accounts, so therefore ratios have to be calculated using total sales figures. In the case of Tesco Plc and J Sainsbury Plc this includes revenue from subsidiary companies and acquisitions, which form the whole group of the company.
Debtors Collection Period results for both companies are as follows:
J Sainsbury has a good track record of collection from debtors, the most being 2 days. This increase from 1 day to 2 days may have resulted from making loans more available to customers or other personal finance arrangements from Sainsbury’s Bank.
However, interestingly Tesco do not have any results during the five-year period. A possible understanding can be derived from the methods of payment adopted by customers. Cash is often the preferred method by customers, resulting in no debtors.
Creditors Payment Period
Creditors Payment Period expresses the relationship between credit purchases and the liability to creditors. This affects the purchasing model of a company.
The ratio is important merely because of business survival. If a company delays payment to its creditors, except they are particularly dominant, eventually will face legal action from their creditors.
The Creditors Payment Period can be understated, as it does not take into consideration the company’s position on bank overdrafts.
A high figure reflects that the company may be facing liquidity or cash flow problems. This will deter new and existing suppliers from extending credit supplies to the company, as it may result in bad debt for them. However, a quick payback period reflects a lack of trust from suppliers.
Creditors Payment Period for both companies are as follows:
It is generally stated that, the longer the credit period achieved from suppliers the better, as the operations of the company are being financed by the suppliers’ funds – interest free. However, abusing this by taking too long to pay creditors can hinder the company’s credit rating, and also possibly face legal action from creditors, hence making it difficult to get supplies in future.
Both, the average collection period and the payment period are useful in highlighting how well a company’s short time finances are managed.
Sainsbury’s must be commended on keeping a low payment period. This will have created a good relationship with suppliers, allowing Sainsbury’s to enjoy the fruits of discounted purchases.
Tesco’s payment period, on the other hand, has increased by 5 days since 2002. But it must also be noted that credit terms for Tesco’s may differ from Sainsbury’s – even form the same supplier – due to credit history. They have also enjoyed the same benefits as Sainsbury’s, resulting in a positive credit history. This is evident in its investment overseas, which requires further agreements with existing and new suppliers.
Financial Ratios
Earnings per Share (EPS) & Dividend per Share
The “earnings per share” ratio is a measure of equity investors earning potential. It is frequently used in world markets and is alleged to give the best view of the performance of a company trading on the stock exchange. Business Week defines earnings per share as “the net after-tax income of a corporation applicable to each share of common stock” (Available at . Accessed at April 2005).
The ratio can be used to measure changes on an annual basis as the calculation is made on the basis of the number of shares is issue, and not the number of authorized shares. This ratio is often used as an indicator of a company’s profitability per unit of shareholder ownership and as a result, the EPS is a major driver of share prices worldwide.
The trend of the earnings per share over successive years gives a picture of the investor potential in the company shares. Looking at Tesco Plc’s figures, the earnings per share for the last five years has increased steadily. The overall increase for the five years stands at 40% and made a good increase of 8.67p which is good for the company.
On the other hand, Sainsbury Plc earns more per share, which is a positive investor potential sign. However, this is justified by the fact that Sainsbury have fewer shares in issue than Tesco. Unfortunately, the earnings per share of Sainsbury tend to fluctuate over the years, falling 17.2p from 2004 to 2006, rising 2p between 2002 and 2004. The last EPS has fallen by 55% to 3.8p in 2006, a fact that may not help the market attractiveness of the company and wont help the company to stay longer in the market.
Overall Tesco Plc appears to be the more stable and attractive of the two companies when measuring the investor potential using the EPS.
The figures of the two companies are as follows:
Dividend per Share
Another similar performance calculator is called dividend per share. Although not very commonly used, it can be useful for potential investors who are more concerned with returns in the short run, i.e. dividends. It is usually shown in published accounts of companies.
This time however, looking at the figures both the companies Tesco’s seems to be issuing a steady rate of dividend to shareholders, but Sainsbury’s had a inflation between 2002 to 2006.However it does not really effect the company performance. Not much can be deduced from the figures itself, as solely the dividend per share ratio is not a very useful indicator of performance; it is rather used as a supporting ratio in most instances.
Price Earnings Ratio
Simply, this is the measure of the value of a company’s stock and compares the earnings per share to the current market value of the shares. It is equal to the stock market’s capitalization divided by the after-tax earnings for a 12-month period. The P/E ratio expresses a lot about the future performance and market confidence of a business. A higher P/E figure means indicates greater investor confidence in the company and high profit and dividends expectations.
A simple explanation of the price earnings ratio is that where a company has a P/E ratio of 30, this implies that investors are paying the equivalent of 30 years earnings to own a share in that particular company. The P/E ratio varies from industry to industry and is usually influenced by market expectations many of them unrealised. Furthermore, where small patches of good expectation may cause the share price to rise, any negative expectation usually causes share prices to drop.
Tesco Plc’s figures portray a up and down nature of the P/E ratio. This is due to the fluctuating share prices throughout the five years. There was a slight decrease in 2003, thereafter it went steady and slight changed in the figures.
J Sainsbury Plc’s figures are not very different from their competitor’s as indicated by their P/E ratio which has increased over the last five years. In Present the P/E ratio improved considerably by almost 7.8p in 2006, it slumped by 35% in 2003 leading to a downhill motion in Sainsbury’s P/E ratio. Reminiscent of Tesco, Sainsbury’s share suffered a fall in 2003 of 38% causing the P/E ratio to fall by a substantial 51% even though made an increased in the price share by 46%. Tesco also faced a fall of 69% which is also not good for the company.
The fall in both companies share prices may have come from the instability in the supermarket industry in 2003 due to the takeover of another large supermarket, Safeway. Both Tesco and Sainsbury placed takeover bids for Safeway, but were blocked by the Competition Commission, which announced that the takeover of Safeway by Tesco or Sainsbury would be against public interest (Available at
).
This negative market expectation may have caused the significant drop in prices of the two competitors.
Overall, a potential investor is better off investing in Tesco Plc, as it has better P/E ratios over the last five years and is in a more stable and healthy position than Sainsbury Plc. As the P/E ratio measures market confidence, it seems that the market has more confidence in Tesco, which is also reflected by the 34% increase in its share prices in 2004
Dividend Yield
The dividend yield ratio is a comparison of the latest dividend that shareholders received and the current market value of the shares. It is an easy and simple way for investors to compare various companies’ shares in the same sector. A company with a low dividend yield compared to others in the sector may mean one of the two things:
- The share price is high as the market has confidence in the company and a low rate of dividend is allowable.
- The company is in financial difficulty and cannot afford to pay high dividends.
On the other hand, a high dividend yield may mean that the company’s share price is undervalued, due to a lack of confidence.
Tesco Plc has a dividend yield equal to 4.47% of the current value of its shares in 2004. Over the last five years, their dividend yield has remained very stable, hovering around 1.5% on average. The slight rise in 2003, 2005 and then 2006 is again because of the fall in share price, as explained previously. The steadiness is reflected by the consistent rise in the number of shares, and in the constant Dividend per Share figure of Tesco (which has been around 6p/share on average for the last five years). Although the dividend yield percentage may be low for Tesco, the consistency can encourage investors who are looking for a feasible long-term investment.
Comparatively, Sainsbury Plc has a much higher dividend yield percentage. This can be explained from the fact that they have almost 75% less shares in issue than Tesco, leading to a higher dividend per share ratio and thus a higher dividend yield, but having inflation in 2005 This is probably the only reason as the share price for both companies are similar except for in 2005 where Sainsbury experienced a higher fall in share prices.
Again, taking the consistency factor into play Tesco Plc emerges as a better option to invest in, although if taking only the dividend yield percentage Sainsbury Plc seems to be more rewarding if improved or remain stable in future rather facing than inflation.
Strategy and major features review, and profitability
Tesco Plc operates in one of the fastest growing business sectors in today’s world. Its operations are in the UK, Ireland, Eastern Europe (Slovakia, Hungary, Poland, Czech Rep, etc) and Far East Asia (Malaysia, S Korea, Taiwan and China) as well as most recently the U.S.A.
They also entered the Turkish and Japanese markets in 2004. Tesco is currently the UK market leader in supermarket chains expected to announce this week annual profits in the region of £2.5bnReportedly, Tesco invested around £200 million in the UK markets in this year and claim to operate 270 stores all over UK, covering an astounding 96% of the population. The annual review of the company states that this year it self it has added 21 Extra stores, 20 superstores, four Metros and converted 138 T&S stores to the Extra format. The international scene for Tesco Plc has been very bright, where they opened 37 hypermarkets worldwide.
Tesco has a very consistent and well-establish strategy for growth which is to concentrate on strengthening the core business whilst actively pushing expansion in to new markets. This strategy was defined by Tesco back in 1997 in four major points:
- To grow the core UK business,
- to become a successful international retailer,
- to be as strong in food as in non-food, and
- to develop retailing services – such as Tesco Personal Finance, Telecom and Tesco.com.
I will be looking at each of these areas of the business and discussing how well each of these objectives is being pursued or achieved. Overall Tesco is delivering strong performance in its sector compared to its rivals with all four major strategies contributing to this success. Below it can be seen group profits grown of the last 5 years at a very strong and consistent rate.
Source: Five year record, Tesco 2006 Annual report, p102
UK Core Business
It can be seen clearly above that the UK core business has had consistent profit increase over the past five years. UK sales have increased by 10.7% to £32.7bn in the year 2006. Tesco took on many initiatives to develop the core business; I will discuss some of them. During 2006:
1. Tesco tried to strengthen their image as the UK’s best value retailer by investing in lower prices for customers, resulting in price deflation of 1.8% (excluding petrol).
2. They have used new technology to cut costs, while providing a faster checkout service for customers through the self-scan checkouts, currently 1.5m customers at 200 stores use the check out system every week.
3. They have stocked many more items and lines to give customers greater choice in type and quality; they added 200 new ‘finest lines’ in 2006, over 100 new healthy living products, as well as hundreds more standard own brand and value products.
4. A total of 2m sq ft of new store space was opened during 2006, of which 600,000 sq ft was through extensions to existing stores. A lot of this new space was for Extra and Express stores.
5. They opened another 18 Hyper stores; most of which were done by extending existing stores, there is now a total of 118 in the UK.
6. 115 new Express stores opened over 2005/06 to bring the total to 650, they had another 130 planned this year.
From the above actions it is clear that Tesco have been working hard to expand their UK core operations which have resulted in the strong growth in profitability of core UK business.
International Retailing
From the above tables and graphs it is clear that Tesco’s international operations have been consistently growing in profits over the last 5 years, although this not necessarily mean that every part of the international operation is earning a profit yet. I will cover below most of Tesco’s developments in 2006 of their major operations abroad:
Japan – Sales grew although profits decreased mainly due to the cost of integrating remaining Frec stores with 8 Tenekin stores aquired in Oct 2005.
Korea – They opened 8 new hyper market stores, conversion completed of 12 stores bought from Aram-Mart in March 2005. Rollout of 11 Express stores. They have 47 new stores planned this year. This growth has resulted in trading space increasing by 29% in 2006 over 2005 records.
Malaysia – They have moved closer to break even point in 2006. They opened 7 new stores during the year including the first Express format store in the country.
Thailand – They have a total of 219 stores trading in four different formats, including 139 Express stores, 14 Value stores and 10 new supermarkets. In 2006 there was growth in sales, profits and returns.
Czech Republic – Sales area has been increased by 20% in 2006 through 10 new store openings.
Hungary – 18 new stores were opened during 2006. A further 30 stores are planned for this year.
Republic of Ireland – In 2006 they reported increase in profits and sales. They opened 6 new stores during 2006 and have a further 8 planned for this year.
Slovakia – Sales and profits have increased in 2006. They have 18 compact hyper markets with 5 more planned for this year. A new central distribution depot at Beckov is fully functioning and helping to reduce costs and better quality products.
Turkey – In 2006 sales grew while profits doubled. They currently have 8 hyper markets trading with 8 more planned for this year.
Development of non-food business
Sales growth in the UK was over 13% during 2006 with sales increasing to £6.8bn from £6bn. Health and beauty increased sales by 10%, stationary, newspapers and magazines by 17%, clothing sales up by 16%, consumer electronics were up by 34%, sports goods 31% and books up by 52%.
Most of these non-food goods are mainly available through Extra stores which are only accessable by a quarter of UK households. They are looking at other ways to make their nnon-food goods available to more people. They are currently considering if they can consider a strong non-food business online following the success of Tesco.com. They have also carried out successful trials of Homeplus stores which are non-food stores, they are planning to role out more of these stores over the coming year.
Retailing Services
There are currently 3 main arms of the retailing services strategy, they are; Tesco.com, telecoms (mobile phone service) and Tesco Personal Finance.
Tesco.com
Sales in 2006 grew strongly up by 31.9% resulting in sales reaching close to £1bn. Profits increased by 54.9% to £56.2m. It currently represents 3% of sales in the sector.
Tesco Personal Finance
This joint venture operating profit of £205m in 2006 of which Tesco’s share was £103m. They currently have 5m customer accounts of 1.8m are credit card accounts and 1.4m are motor insurance policies. Customer numbers have increased by 200,000 for 2005/2006.
Telecoms
They currently have 1.5m customers. They are now offering a wide range of telecom services from home phones to pay as you go lines and line rentals.
Profitability
Profitability is clearly one of the key parts of the analysis. Under this section the profitability of the company will be measured and the factors affecting it analysed. It is obviously an area of interest for potential investors, as they would want to know about the shareholder added value. The bigger the value added the better for the company and shareholders.
One of the major measures to evaluate under profitability is the return on capital employed (ROCE). An adequate return on capital employed is primarily why people invest money in a business rather than capital gains.
Tesco has a ROCE of 12.7% in 2006, which is a reasonable increase from the previous year of 11.8%. Although their profits increased by 18%.
Tesco operates in a sector of the economy that is experiencing strong growth. The retail scene is gradually finding a place for internet-based industry and Tesco can legitimately claim that they have 70% share of all online retailing in the UK. By the year 2000, almost 30% of the UK population had bought online. This was less than in America during the same time where more than 50% of the population used digital commerce. Thus, Tesco was able to utilise this untapped potential by adopting earlyand they reaped huge benefits from it. Although they faced steep competition from rivals such as Sainsbury’s, Tesco specialised home delivery system meant they were able to deliver products to a customer anywhere in the UK in two hours, giving them a competitive edge.
If profitability ratios of Tesco are examined, it can be seen that they have had a very stable record over the last five years. All ratios show a gradual rise in profitability. Thus, as the chief executive of Tesco stated, the company seems to have passed the stages of greatest risk and now has a diverse presence in the UK and worldwide, allowing them to reap economies of scales in production. Therefore, even though their profit ratios may be not very high, they are still in a very strong position due to their substantial sales. This week it has been reported in the press that Tesco are to declare profits of £2.7bn.
The operating profit per employee is a key ratio for analysing profitability. Similar to the other ratios the operating profits per employee has gradually fluctuated over the last 5 years.. However, the obvious explanation for that is Tesco’s number of employees increased by 19% between 2003 and 2004 due to their massive expansion program, which is explained earlier in the “strategic and major features review”. Nonetheless, the operating profit is much higher than Sainsbury’s, suggesting efficient cost and employee management in place.
Overall Tesco Plc is by far the most profitable company in its industry.
Operating Efficiency
There has been a huge increase in profit between year 2000 and 2006, of over £1bn.
Although Tesco is moving into non-food products such as toiletries and health and beauty to target a wider market and for matters of consumer convenience that benefit Tesco, it is clear that the food and household goods is still at the heart of Tesco’s business,
An increase in new stores will meet the need of customers who wish to purchase goods beyond food and household goods. Through the use of customer loyalty schemes, existing customers will be inclined to stay with Tesco and potential new customers will be enticed by the idea of new food and non-food products which are good quality and competitively priced and possibly cater for new niches such as organic produce and healthy eating products or high quality ready meals.
“The principal activity of the Group is the operation of food stores and associated activities in the UK, Republic of Ireland, Hungary, Poland, Czech Republic, Slovakia, Thailand, South Korea, Taiwan and Malaysia. During the year, we entered the Turkish and Japanese markets.” (Quote in the Directors Report.)
Growth:
The growth of Tesco over the last two or three decades has involved a revolution in strategy and image. Its initial success was based on the "Pile it high, sell it cheap" style of the founder Jack Cohen.
In the late 1970s Tesco suffered from a very poor image with middle class customers as the consultants advised the company to change the name of its stores, but the company did not accept this advice. By early 2005 Tesco was the largest retailer in United Kingdom and also it is one of the top three international retailers in the world. It has a 29% share of the UK grocery market.
Their main source of growth has been the increase in its customer base, today nearly 41% of all households in Britain visits Tesco at least once every four weeks. In a recent BBC report, it was reported that £1 in every £8 spent in the UK retail market goes to Tesco.
Tesco appears to be on an unavoidable march towards victory in the battle of the supermarkets. This week it announced profits of £2.7bn.
There are reasons that can be considered to be the cause of this success, which are;
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An ‘inclusive offer’ ; used by Tesco to describe its objective to appeal to upper, medium and low income customers in the same stores, examples of these ranges are ‘Finest range’ aimed at middle to upper class customers, as well as the ‘value’ range for low income customers. In contrast, ASDA’s marketing strategy is seriously focused on value for money, which can undermine its appeal to upper market customers who have large dispensable incomes, even though they sell a wide range of upmarket products. Wasitrose on the other hand has marketed itself to mainly upper-medium income customers.
- Tesco’s use of its own brand products; such as the upmarket, ‘Finest’ range and the low price ‘Value’ range is one of its advantages in image.
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Tesco is a highly effective money making operation, but Sir Terry Leary, chief executive since the mid 1990’s, has taken the bold step of trying not to focus on the usual corporate mantra of ‘maximising shareholder value’. The company’s mission statement shows ‘our core purpose is ‘To create value for customers to earn their lifetime loyalty’. We deliver this through our values, ‘No-one tries harder for the customers’, and ‘Treat people how we like to be treated’’’. The underlying aim obviously is to maximise profits, but there is a clear focus on customer service. As it can be seen in the quality level of their products that; our promise-‘if you are not entirely satisfied with this, or any other Tesco product, we will gladly replace it or refund you. This does not affect your statutory rights’.
Liquidity
Liquidity ratios can be used to predict business failure. If a company has a current ratio below 2:1 or a quick ratio (also called the acid test ratio) below 1:1, there may be higher risk of company failure.
You can look at liquidity ratio results for the last five year in the ratio analysis section of the report.
The main drawback of this types of ratio analysis is that they only measure liquidity at a single point in time. If they showed it over a period of time, it would be more useful. As the liquidity of the company is always changing in response to cash inflows and cash outflows, the ratio simply reflects liquidity at a balance sheet date but may fail to capture the real relationship between the inflows and outflows.
Finance
Tesco Plc has access to a very wide range of funding, which is a combination of retained profits, long and medium term debt capital market issues, commercial papers, bank borrowings as well as leases. In the annual report 2006 of Tesco shows that, its objective is to ensure continuity of funding and its policy is to smooth the debt maturity profile, to arrange funding ahead of requirements and to maintain sufficient un drawn committed bank facilities as well as a strong credit rating so that maturing debt may be refinanced as it falls due.
As the cash flow statements shows net cash flow from operating for Tesco Plc have continued to generate cash up to the period February 2004 which is increased to £282m.
The group’s long term credit rating was confirmed as stable during the year 2004. The long term funds ratio shows how much of its total assets have been funded by the long term sources.
(were unable to get latest numbers up to 2006 in time)
The fixed assets to total assets ratio indicates the percentage of the total assets is fixed.
At the year-end of 2004, net debt was £4.1bn, which was £4.7bn in 2003, and the average debt maturity was nine years.
The long-term funds to total assets shows; that 42.8% of the total assets are financed by long-term sources. Since there is also a long-term element in the financing of current assets as it is considered to be prudent.
Further the fixed assets total assets ratio tells us what percentage of total assets is fixed and what percentage is current. 83.1% of Tesco’s assets are fixed and their asset turnover ratio for 2004 states that they turn their assets over 2.38 times that year. Only 42.8% of their fixed assets are financed by long-term funds compared to the five years prior when it was 48.3%, which shows that Tesco is prudent about investing too much finance from loans in assets. So, it seems that Tesco have a good financial position where they are able to afford to have money tied up in fixed assets and further, they have utilised these assets to achieve revenue.
The dividend cover and interest cover is good; at 2.14 and 7.20 respectively. Again, the interest cover shows that although it may be a high-geared company, it is more than capable of meeting its interest payments, which would keep shareholders content.
Investment
In order for a company to ensure future or greater profitability, they must ensure that they are investing enough capital into their activities.
The capital expenditure to turnover ratio provides a very good insight into the level of capital expenditure utilised to achieve the level of sales.
From 2000 to 2001 there was a rise of capital expenditure in sales by 17% and sales increased by 11%. Although capital expenditure in fell by 7% in 2002, 5% in 2003 and 8% in 2004, there sales increased by 12%, 10% and 17% respectively. This shows that they were expanding internationally, which required investment in fixed assets, labour, goods etc they saw the benefits of greater discounts on larger quantities of purchase and cheaper labour abroad, such as Thailand and South Korea, when compared to the UK.
During course of dealings the company will acquire large quantities of equipment and fixed assets, such as premises, machinery and vehicles for the movement of goods, to name but a few.
However, these fixed assets overtime become obsolete or require repair, so the company makes a provision for depreciation, where they set aside a fraction of their profits in order to replace them at the end of their limited useful life.
The capital expenditure to depreciation ratio indicates the replacement rate of new for old assets, however, it can be said that it is understated as it does not take into consideration price fluctuations or corporate growth.
Capital expenditure to depreciation ratio, capital expenditure to tangible fixed assets ratio tell us the rate, in years, at which the company on average is replacing its fixed assets.
From the figures we can see that this has decreased from 20.3% in 2001, to 16.2%, showing us that, on average, capital expenditure is replacing fixed assets once every five and a half years i.e. (100/ (20.3+16.2/2))
The capital expenditure to employees ratio gives us an insight into the level of investment, by the company, per employee. This has fluctuated from £1,103 in 2000, to £1,277 in 2001 and £1,023 in 2004.
Tesco realised that to have motivated workers who are enthusiastic and dedicated to the success of the company they must provide them good benefits, in order to keep them happy, as they are the frontline workers; as with any retail company, interacting with the public, providing an impression.
This requires good management and attractive rewards for their efforts, both long and short term benefits.
They offer a considerable discount rate of 10% on purchases of all products, including food, cookware, clothing and electrical, to name just a few.
They also offer share options to employees after two years of service as well as a pension scheme.
Management of financial Risks
In the modern market, companies face many types of risks. This risk will depend on the nature of the business operations and how the business is financed. The management of these uncertainties is called ‘Financial Risk Management’. usually, companies such as Tesco face a greater financial risk due to the expansion into foreign markets.
The Tesco Board has overall responsibility for internal control, including risk management and it sets appropriate policies in relation to the objectives of the group. They have mandated the treasury function to manage the financial risks that arise in relation to underlying business needs. The board routinely reviews its activities, which are subject to regular audit; this includes identifying, evaluating, prioritising and reviewing risks, determining control strategies for each significant risk and consideration of how each risk might have an impact on business objectives.
The Board of Tesco is particularly concerned with the risks relating to the following issues:
- Funding and Liquidity
- Interest Rate Risk Management
- Foreign Currency Risk Management
When considering borrowing money companies have to take in to account changes in interest rates and the impact it will have on the company. There is two types of interest rate; fixed and floating. As the names imply a fixed rate interest rate will remain unchanged even when the market rate of interest fluctuates. While, the rate of return payable to lenders at a floating rate of interest will rise and fall in correlation with the fluctuation of the market rate of interest. A company with a large floating rate of interest may find that increases in interest rates will have a negative consequence with regards to cash flows and profitability.
A company may use many methods to limit risk, one such mechanism is hedging. Hedging provides a variety of options. Tesco’ attempt to achieve a desired mix of fixed and floating rate debt by using forward rate agreements, interest rate swaps, caps and collars.
A swap is a deal between banks or companies where borrowers switch floating-rate loans for fixed rate loans in other countries. These can be in either the same or different currencies.
The benefit is that one company may have access to lower fixed rates and another company may have access to lower floating rates; so they trade. If firms in separate countries have comparative advantages on interest rates, then a swap could benefit both sides.
It is common for businesses to make the following transactions in foreign exchange:
- buy goods overseas that need to be paid for using foreign currency
- sell goods overseas and be paid in foreign currency
- invest in overseas businesses and therefore hold assets in other currencies
- borrow money from overseas banks on the basis it is to be repaid using foreign currency
Most businesses are not really interested in exposing themselves to foreign exchange risks; it is too risky and endangers the survival of their core business. They therefore try to minimise their risk level by taking out a foreign exchange contract with their bank at the same time as agreeing to purchase or sell goods at a certain price on a foreign exchange. This way they fix the exchange rate for their transactions at a rate that guarantees them a profit. This is called "hedging" your currency exposure.
Tesco’s foreign currency management objective is to limit the risk to short–term profits by exchange rate volatility. Transactional currency exposures that could significantly affect the profit and loss account are hedged, typically using forward purchases or sales of foreign currency and currency options. Tesco’s hedged the balance sheet by borrowing (either directly or via foreign exchange transactions) in matching currencies where this is reasonably cost effective. Tesco’s strategic objective is to maintain a minimum cost of borrowing and maintain a minimum cost of borrowing and retain some potential for currency-related appreciation while partially hedging against currency depreciation.
2.2 Further Analysis
SWOT Analysis
The table below explains the Strengths, Weaknesses, Opportunities and Threats (SWOT) of Tesco Plc and Sainsbury’s Plc.
3. Conclusion
As stated earlier, the aim of the report was to analyse the financial situations of Tesco Plc and J Sainsbury Plc, in order to advise whether or not to purchase shares in Tesco.
In order to better understand and compare the financial situations of the companies we did various types of variance analysis, in this report we have calculated the variances and then explained what they mean to us.
We also conducted a SWOT analysis to help us look at the various aspects of the two businesses beyond just financial analysis, it is excellent way of comparing the two companies. Furthermore SWOT allows the reader to have a better understanding of which opportunities and difficulties may exist for the company, this will help them to judge the level of risk and ultimately to help to decide whether it is a worth while investment or not.
Both have diversified their food and non-food ranges and both have had differing success. Tesco Plc is thriving in non-food related products, such as clothes and financial products; for the year 2006 they reported £139m profit from financial services from which their take was £70m. J Sainsbury’s Plc market share has dropped considerably, perhaps because they have not lead the market like Tesco, rather they have been following behind.
Tesco has not only developed successfully new types of products and services such as healthier food choices, personal finance, mobile phone services and home delivery; but they have pushed through aggressively a strong policy of opening new stores including hyper stores and small local stores, or huge homeplus stores. Furthermore they have continued to invest in their international businesses which have continued to grow in size and profitability. In relation to international business; this is an area Tesco is doing very well, while Sainsburys is failing considerably in comparison as they have sold off most of their international operations in the past such as Shaw and JS Developments to ease cash flow problems and thus have to only concentrate on their UK business as stated in previous Sainsburys company annual reports. Tesco has operations in many countries all over the world as mentioned earlier in the report.
Both companies are in the same race and clear competitors, yet Tesco is clearly fairing better than Sainsbury Plc in more than one aspect.
4. Recommendations
Tesco Plc and J Sainsbury Plc are competitors in the UK retail market; in both food and non-food items, so they can be fairly compared.
Taking into consideration the financial and non-financial factors, we recommend that you purchase shares in Tesco rather Sainsburys. Using in depth ratio analysis and comparison of future projections as well business development strategies and targets in place by both companies it is clear to us that Tesco is in a superior position and is definitely the better investment option. Tesco is clearly in a much stronger position in relation to its international section of the business as well as in many non-food markets they are in such as clothing and financial services. Tesco in most respects is far ahead of its competition. In our opinion as well as many authoritative commentators believe investment in Tesco is a minimal risk investment. Over the past five year Tesco has managed to maintain strong and steady growth as well as strong diversification.
5. Bibliography
PENDLEYBURY, M. & GROVES, R. (2004) Company Accounts-Analysis, interpretation and Understanding, 6th Edition, Thompson
.
http://news.bbc.co.uk/1/hi/business/4435339.stm
.
6. Appendices
6.1 Minutes of Meetings
Minutes of Meetings
Details
Date: Thursday 5th April 2007
Time: 11am
Location: London South Bank University
Group Members
Abdul Quayum (2471166)
Nozmul Hussian (2489240)
Farid Ameen (2489284)
Nazia Khalique (2500403)
Khurram Shahzad (2500878)
Ihsan Alsaraf (2490452)
Topics
- Looking at different companies
- How were going to be communicating
- Our meeting plans
- Confirming and agreeing with all the group members
Looking at the different Companies
From the coursework specification, we have been asked to compare two companies, within the same sector and then make an analysis on both of them. These are the following list of possible companies which we will be comparing and analysing:
- Orange and Vodafone
- Tesco and Sainsbury’s
- Argos and Harrods
How were going to be communicating
We have all agreed, that if we need to communicate outside our meeting times then we will use the following methods:
Nozmul Hussain:
Tel: 07951 774 580 Email:
Abdul Quayum:
Tel: 07960 262 779 Email:
Khurram Shahzad:
Tel: 07960 345 445 Email:
Farid Ameen:
Tel: 07951 546 554 Email:
Ihsan Alsaraf:
Tel: 07954 546 776 Email:
Nazia Khalique
Email: [email protected]
Our Meetings Plans
We all decided that we will be meeting up once every week in London South Bank University for reports and feedbacks.
Confirming and agreeing with all the group members
We have all agreed to get equal marks for the assessment and that all group members will do their work according to group instructions.
Minutes of Meetings
Details
Date: Wednesday 11th April 2007
Time: 10:30am
Location: London South Bank University
Group Members – that attended
Abdul Quayum (2471166)
Nozmul Hussian (2489240)
Farid Ameen (2489284)
Nazia Khalique (2500403)
Khurram Shahzad (2500878)
Ihsan Alsaraf (2490452)
Topics
- Getting feedback and reports on progress
- Making a final choice of the companies to compare
- Main tasks which need to be done
- Allocation of work
Getting feedback and reports on progress
Each members were giving feedback on their respective research work, they have done on the possible list of companies. Also have been looking at some of the ratios which need to completed by the respective individual group members.
Making a final choice of the companies to compare
After careful consideration we all overall agreed and decided to use Tesco and Sainsbury’s as our two companies for this project.
Main tasks which need to be done
We were discussing among our selves the main tasks, which need to be carried out. We have concluded them as follows:
- Need to research on Tesco and Sainsbury’s
- Need to do look the different ratios, their formulas and calculations
- Need to get much detail on shares and other financial information on Tesco and Sainsbury’s
Allocation of work
Nuzmul Hussain - Introduction:
Including - aims and objectives, background research on both companies
Ihsan Alsaraf and Nazia Khalique - Analysis of information:
Including – different ratio calculations and other analysis work
Abdul Quayum - Conclusion:
Including - recommendations, and minutes of meetings
Farid Ameen and Khurram Shahzad - Company Accounts and ratio anaysis:
-Which will include details of both companies
Minutes of Meetings
Details
Date: Thursday 19th April 2007
Time: 9:30am
Location: London South Bank University
Group Members – that attended
Abdul Quayum (2471166)
Nozmul Hussian (2489240)
Farid Ameen (2489284)
Nazia Khalique (2500403)
Khurram Shahzad (2500878)
Ihsan Alsaraf (2490452)
Topics
- Getting feedback and reports on progress
- Different problems encountered
- How the problems were solved
Getting feedback and reports on progress
Each group member was giving feedback on the progress of their work. We also discussing if there were any issues, which had to be raised up i.e. if anyone facing any difficulties and any suggestions that can be made. There were some problems raised up with some of the group members.
Different problems encountered
The main problems, which were encountered, were tackling some of the ratios. These were mainly:
Profitability ratios, solvency ratios, liquidity ratios and financial ratios.
How the problems were solved
When it came to solving the problem, we got together and used each others ideas and explanations to tackle the calculations. In this way we were able to tackle the calculations.
Minutes of Meetings
Details
Date: Monday 23rd April 2007
Time: 9:30am
Location: London South Bank University
Group Members – that attended
Abdul Quayum (2471166)
Nozmul Hussian (2489240)
Farid Ameen (2489284)
Nazia Khalique (2500403)
Khurram Shahzad (2500878)
Ihsan Alsaraf (2490452)
Topics
- Progress of ratio analysis
- Progress of SWOT analysis
Progress of ratio analysis
With the ratio analysis, we are nearly finished. However, we still have a few more calculations to work out, which we are currently working on now.
Progress of SWOT analysis
For the Strengths, Weaknesses, Opportunities and Threats analysis, we are still working on this. However this will be finished very soon, after we get the necessary feedback from all group members.
Minutes of Meetings
Details
Date: Wednesday 25th April 2007
Time: 11:30am
Location: London South Bank University
Group Members – that attended
Abdul Quayum (2471166)
Nozmul Hussian (2489240)
Muhamed Farid Ameen (2489284)
Nazia Khalique (2500403)
Khurram Shahzad (2500878)
Ihsan Alsaraf (2490452)
Topics
- Getting feedback and reports on progress
- Putting everyone’s work into place
- Making a printout of the coursework
Getting feedback and reports on progress
From this feedback, we were able to tell, that everybody had more or less finished their respective part of the coursework. This meant that we were now near finishing off the coursework and making a portfolio.
Putting everyone’s work into place
From this we were collecting all the group members’ work and then putting it in order, so it can be printed off.
Making a printout of the coursework
After all the work was put together we were able to print out a hard copy of the coursework to hand in.
“Sainsbury on the long haul back”, Guy Dresser, This is Money, 18 May 2005 http://www.thisismoney.co.uk/news/article.html?in_article_id=400620&in_page_id=2
Advanced Accounting for A2, Ian Harrison Page 195 – Performance Evaluation.
http://news.bbc.co.uk/1/hi/business/6557187.stm
See Tesco Operating Financial Review, pg 9