Financial statement analysis is a process which examines past and current financial data for the purpose of evaluating performance and projecting future risks and potential of a company.
Financial statement analysis is used by various people and companies for different reasons, e.g. investors, creditors, lending officers, managers, employees and many other parties who rely on financial data for making economic decisions about a company.
The objective of this David Jones financial statement analysis is to identify the company’s performance issues, to provide suggestions and recommendations by employing the Ratio Analysis method and analysing Profitability, Efficiency, Short and Long term Solvency, and by using Market Based Ratios.
The following report outlines the financial performance of David Jones Limited based on the FY2011 & FY2012 Annual Reports. The key measures used to assess company performance are Profitability, Efficiency, Short & Long-term Solvency and Market-Based Ratios. David Jones has performed well in a few areas which include having solid cash flows, low debt, a strong balance sheet and assets in prime locations; however there is definite room for improvement with regards to sales performance, and it needs to address the high cost of sales and sluggish inventory in order to turn around company profitability and performance.
We have studied your 2011 and 2012 financial reports and statements and can see that your company’s sales performance has been declining year on year. Sales revenue for FY2012 was down -4.8% when compared to FY2011, and FY2011 sales were down -4.45% vs. FY2010.
Your chairman and management have blamed this on the depressed consumer sentiment and increased global competition as a result of the strong Australian currency. “The uncertainty of Europe and USA and volatility in global equity market have contributed to a general feeling of uncertainty, the strong Australian dollar also contributed to price deflation and encouraged spending offshore.” (page 2, Annual Report)
In FY2012, all measures of profitability were considerably down on last year. Gross Profit was down from $767m to $670m, and the Gross Profit margin (GP %) was down 160bp to 37.5% (-4.2% on FY2011: 39.1%). The poor GP % has been the result of discounting in a competitive environment and dealing with excess inventory on hand at the commencement of FY2012 (page 5, Annual Report).
When compared to your main competitor Myer (Market Capitalization 1.59b1 Vs. DJS 1.477b2), there is a large variance between the Gross Profit Margins of the two companies (Myer GP % FY2012: 49.3%3, +160bp from previous year, DJs-FY2012: 37.47% -160bp). This can be attributed to Myer’s much lower Cost of Goods Sold (COGS) (Myer 56% Vs. DJs 62.5% in FY2012).
Myer has a competitive advantage in the marketplace with a larger network of stores and greater buying power. Their larger volume of purchases may mean they are able to obtain lower cost prices with suppliers. However, there are a few key areas you have identified in your Future Strategic Direction plan which we feel will assist in lowering your COGS and result in a better GP % rate.
Firstly, signing exclusive brands to your portfolio will ensure product differentiation to customers and better control over supplier trading terms and prices. Secondly, the Cost Price Harmonisation that you are engaging in with suppliers (page 3, Annual Report) is key to maintaining your GP % and ensuring that your COGS do not rise and prices do not become uncompetitive with international retailers. Thirdly, discontinuing lower margin categories and moving towards a greater product mix of higher margin categories (page 4, Annual Report) will increase your GP % in the long run and ensure you maximize the profit outcome from the inventory you carry. For example, introducing more private label house brands could be one strategy in which to increase the proportion of higher margin products in your portfolio.
The Net Profit Margin in FY2012 dropped drastically compared to FY2011 (-36.9%, $101 vs. $168 million), with sales revenue dropping -4.8% ($1.867b vs. $1.962b). It was however, on par with Myer at 5.4%.
The main factor contributing to the big fall in net profit were the high operating expenses over FY2012. Depreciation expenses were up by +13.23%, leasing expenses were up by +6.1%, advertising and marketing had gone up +19%, administration expenses were up by +29.4%, and finance costs were up +40%. Excess inventory during the clearance period also resulted in heavier discounting and contributed to the fall in net profit.
Whilst your company has noted Cost of Doing Business (CODB) Reductions as one of the points in your Future Strategic Direction Plan, there are many other areas that can be addressed to ease operating costs. For example, a reduction in the size of all or some of your retail stores will result in savings in store costs such as leasing, staff, utilities, and so on. This could be implemented in conjunction with the Omni Channel Retailing strategy as highlighted as the first point in your Future Strategic Direction Plan (page 3, Annual Report), as customers move away from traditional bricks and mortar shops and increasingly to online shopping destinations. The excellent growth rate in HY2013 of your online store4 highlights the opportunities in the online channel and the change in customer shopping behaviour.
With regards to the Asset Turnover ratio, your company performed slightly better than Myer Holdings in FY2012 (1.5 Vs 1.34, Refer to Appendix B). Internally, there was an 8% drop that was due to sluggish sales performance (1.5 Vs. 1.63, Refer to Appendix A).
Since your Net Profit Margin dropped dramatically in FY2012, the Return on Assets (ROA) followed suit and decreased by -41% (from 13.96 to 8.23, refer to Appendix A); not a good result in asset management performance. Your company’s property portfolio consists of 4 buildings valued at $612 million (page 5, Annual Report). All of these buildings are in the prime locations, with two in the Sydney CBD and two in the Melbourne CBD. The rental income is assumed to be in the vicinity of $39 million per annum (page 5, Annual Report). If a reduced size store was considered, a potential income of $10-15 million could be generated per annum, increasing the net profit percentage by 9-14% (Net Profit FY2012 – $101,103,000). Your company’s re-development consideration is a long-term process and we believe it will be successful in generating positive ROA with the appropriate planning.
Improving the Gross Profit margin while maintaining current overheads will result in a positive increase in the Net Profit margin position and enhance the overall performance of the company.
Efficiency is more meaningful when compared to peers in the same industry and can assist in identifying businesses that are better managed relative to others.
By comparing your figures with Myer, your company performed better in Inventory Turnover (89 days vs 96 days, Appendix A & Appendix B), which means you have a better stockturn and are generating revenue from your inventory in a shorter period of time. However, 89 days is still a fairly high measure as it means you are sitting on stock for an average of 3 months before it is sold through. To improve your inventory turnover, you could consider dropping your bestselling items more frequently to stores, but with smaller quantities each time. This will ensure that the stores which are selling through the stock quickest remain in stock at all times, without a large amount of unsold stock building up in the slower performing stores and affecting your inventory turnover. It also means you will be generating sales and cash more quickly from your stock investment.
Myer performed slightly better on “Average Days Sales Uncollected” (DJS: 3.5 days vs. Myer: 2.5 days, Appendix A & B). To improve this measure for example, you could encourage more online sales to generate faster turnover into cash than store card sales which are monthly billings.
Internally, FY2012 performed slightly better than FY2011 in Average Days Sales Uncollected (FY2012: 3.5 vs. FY2011: 4 days) but worse in Inventory Turnover (FY2012: 89 vs. FY2011: 87 days). The differences were negligible.
David Jones has a good ability to meet its short-term financial obligations, with a Current Ratio of 1.05 in FY2012 (Appendix A) outperforming Myer at 0.88 (Appendix B). However, since the Quick Ratio is not high at 14.4% (Appendix A), short-term liquidity could be an issue. When compared with Myer at 11% (Appendix B), David Jones has performed better.
The Current Ratio performed better in FY2011 than FY2012 by 14.6% (Appendix A). The main reason for this is the 15.1% increase in Current Liability ($306 million Vs. $266 million), with the $40 million difference due to an increase in Account Payables. There is no change in the Quick Ratio from FY2011 to FY2012 (14.4%), i.e. on the low side and short-term liquidity can be an issue, should not allow it to be deteriorate.
The “Cash & Cash Equivalents” and “Receivables” figures totaled $36.935 million which represented around 14% of “Payables” in the 2012 Annual Report. In order to achieve a better short-term liquidity position, a more efficient ordering & inventory control system should be implemented. Less inventory on hand equates to more cash and liquidity. Excess inventory can jeopardize a company’s liquidity, in addition to causing stock problems and markdowns at the end of a season as was evidenced in FY2012.
You company performed much better than Myer Holdings in the area of Long-Term Solvency. Your company has demonstrated consistency in this area and long-term solvency should not be an immediate issue with your organization.
The Debt to Equity ratio showed that there was an increase of 11% in FY2012 compared with FY2011 (Refer to Appendix A), i.e. the liability has gone up relative to shareholders’ equity. The main contribution to the increase is due to the +22.3% ($265m Vs. $216m) increase in the Payables account. It is important to ensure that this trend does not continue and that debt does not continue to rise when compared to equity levels.
With strong non-current assets of $917 million & total assets in excess of $1.24 billion, the Debt to Total Assets ratio is healthy, with FY2011 at 35% and FY2012 at 37% (Refer to Appendix A) respectively. The extra 2% was due to the liability increase and it was the fallout of excess inventory as discussed in the short-term solvency section.
To calculate the Price/Earnings (P/E) Ratio, we used the share price on 16/5/2013 ($2.80). This equates to a PE ratio of 14.43, with the Earnings yield ratio at 6.93% and the Dividend yield ratio at 6.25% (dividend was 17.5c).
Myer Holdings’ dividend yield was around 7% (dividend of 19c with share price at $2.70). The market-based ratio is higher than your main competitor (Myer PE ratio is 11.8)5. However the Price/Earnings ratio indicates that today’s share price of the company is on the low side as it is below 15. The majority of analysts believe that the company is performing below par and do not recommend buying or holding David Jones shares at the moment.
Eva Brocklehurst of FNArean.com is quoted as saying in March 2013, ” David Jones (DJS) is transforming. For brokers it’s not a moment too soon, as department stores have been plagued by a soft consumer environment and a need to respond to new trends in shopping. In its first half results the company has flagged progress with its strategic plan, reducing costs and expanding margins. Earnings were ahead of expectations for the half but sales growth was not. What pleased was the increased margin. What concerns brokers? Most importantly, a lack of sales momentum.
There’s no Buy rating on the FNArena database. Two brokers have downgraded ratings to Sell in the wake of the results. There are five Sell ratings. There was one upgrade to Hold, and there are three Hold ratings. The consensus target price is $2.73, suggesting 11.5% downside to the last traded share price. A dividend yield of 5.5% is reflected in consensus earnings forecasts for FY13.”6
As highlighted above, your declining sales performance is the biggest concern for shareholders and needs to be addressed immediately. Whilst earnings were ahead of expectations, this was managed by cost reductions and a move towards increased margins. An improvement in sales in conjunction with the efforts you’re undertaking to reduce expenses and the cost of doing business will result in an improvement in the bottom line and signal confidence in the company and a turnaround for investors.
David Jones has been labelled as an up-market department store. Australia’s $12 billion fashion retail industry is forecast to grow by only 0.5% in FY2012 with only an average 1.2% annualised growth expected for the next 5 years, according to analysis group IBISWorld. Furthermore, IBISWorld says shoppers are now more likely to buy low to mid-range priced clothing which has contributed to the declining value of retail sales. In general, the outlook is not too positive for the industry.7
Greater differentiation is required between David Jones and Myer in order to attract and retain customers. Mark Ritson, Associate Professor of Marketing at Melbourne Business School commented, “David Jones and Myer are just two sides of same boring coin.” He says, “I still believe to this day that most people coming out of either David Jones or Myer on Bourke Street don’t know which one they just come out of.”7
Some of the issues have been addressed by your company’s Future Strategic Direction Plan, for example, a move towards Omni Channel Retailing, building a “Home of Brands” strategy which differentiates David Jones from Myer, and cost improvements including GP margin improvements, CODB reductions and Cost Price Harmonisation with suppliers (pages 3-6, Annual Report).
A thorough review of your company’s FY2011 and FY2012 Financial Report & Statements has indicated that David Jones has a strong balance sheet, solid cash flows, low debt, and assets in prime locations. David Jones has performed on par, or better than Myer in the areas of Net Profit Margin, Asset Turnover, Inventory Turnover, and Short & Long-term Solvency.
However, the company’s declining sales performance is the biggest area of concern. Almost all measures of profitability were worse than Myer and have been falling when compared to David Jones’ own performance in prior years. We believe that further differentiation from Myer, cost reductions & margin improvements, harmonization of prices to become more competitive with international competitors, better inventory management & a reduction in excessive stock, reduced retail floor space, and the move towards Omni-Channel Retailing will enhance the value of your company and result in better performance for all stakeholders.
We hope this report has provided insightful recommendations into improving the performance of your company.
This report has been generated for your company’s own reference and not for any other purposes. Other companies or individuals should not use or rely on any material contained within this report without the consent of our office.
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Topic: Financial statement analysis
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