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Financial Analysis on Coles Myer & Woolworths Essay

Introduction

Coles Myer Limited (CML) and Woolworths Limited (WOW) are two major Australian companies with extensive retail interest and listed on the Australian Stock Exchange. They are Australian public companies which operate a number of retail chains.

CML is Australia’s second largest retailer, behind WOW. It operates a number of chains of retail outlets which are including Coles Supermarkets, Bi-Lo, Liquorland, Pick ‘n Pay Hypermarket, Kmart, Officeworks, Target, Harris Technology and Coles Express (Wikipedia, 2006) .

WOW is currently the largest retail company in Australia and New Zealand by market capitalisation and sales. WOW operates in Australia through several retail banners such as Woolworths and Safeway Supermarkets, BWS, Dan Murphy’s, BIG W, Dick Smith Power House and Dick Smith Electronics (Wikipedia, 2006) .

The purpose of this report is to analyse financial performances of the two publicly listed companies in last 5 years by using series of calculation tools include horizontal analysis and financial ratios. Also as a recommendation, we will advise investors to buy or not buy the two companies’ shares according to the results of the performance analysis.

Financial Condition

(See Appendix 1 & 2 for ratio details)

1. Overview

The WOW’s revenue has increased every year, one year as great as 149.90 % in 2005 (see appendix 11 for details). In 2001, revenues were 20915.1 million while in 2005 revenue has increased to 31352.5 million. Since revenue increased, the net profit obviously has increased as well. Net profit rose 84.70% from 2001 to 2005. The Horizontal Analysis (Appendix 11 &; 14) indicates WOW is a very successful company and earning money. CML’s revenue has increased 52% and the net profit rose 314% from 2001 to 2005, the growth was tremendous because it occurred in typical connection with the restructuring of the method of financing a foreign operation (Financial Report, 2005).

2. Liquidity

Current ratio

This ratio represents the financial liquidity of the company. ‘The current ratio compares the assets a company can quickly convert to cash to the liabilities it must pay in the near term’ (Vance, D. E. 2003). The higher the ratio, the more liquid the company is. For CML, there was a slight increase of 0.04 from 2001 to 2002. Then it followed by an obvious fall from 1.37 to 1.09 during period from 2002 to 2005. This represents that one-unit current liabilities is secured by 1.37 units of current assets in 2002 and 1.09 units, nearly one current asset for one current liability, in 2005. From the perspective of WOW, the ratio starts from 0.81 up to 0.84 then declined to 0.81 and finally dropped to 0.82 during this period of time. The current ratios are all less than one, indicating that one current asset will prepare for the payment of more than one unit current liability. That leads to high liquidity risk in the business operation. If there is an emergency to WOW, it will encounter the problem of repayment.

Quick ratio

Quick ratio is similar with current ratio, but more conservative than current ratio, because in numerator, inventory is excluded from current assets, and in dominator, bank overdraft is excluded from current liabilities. ‘The quick ratio addresses the issue of whether current assets could cover current liabilities if inventory were found to be worthless’ (Vance, D. E. 2003). WOW experienced a slight increase from 0.2 to 0.26 in this period of time. In contrast, CML experienced a modest fluctuation and end up with 0.28 in 2005, the lowest one in 5-year time and the highest one is 0.41 in 2003. Generally, the quick ratios of CML exceed the ones of WOW.

Cash flow ratio

Cash flow ratio will analyse the ability of repayment on current liabilities from the perspective of the operating cash flows. Vance, D. E. (2003) states that it is another way to think about the risk of leading to, or investing in a company. These two companies both experienced a drop on this ratio from 2004 to 2005, 0.35 for WOW and 0.3 for CML in 2005.

3. Financial leverage

Equity ratio & debt ratio

Equity ratio and debt ratio are both designing for capital structure and they are negatively related with each other. The cost of equity is higher than the cost of debt, but shareholders will not require companies to repay them dividends and principals any time. However, companies must pay the debt holders interests and principals each year. And increasing leverage ratio will result in increasing the return to shareholders, yet at the same time, it will increase the repayment commitments and then raise the risk to company and shareholders.

CML’s equity ratio increased to 0.4 and correspondingly debt ratio decreased to 0.15 from 2001 to 2005. Generally it is a good trend, even though there has been a decrease in equity ratio in 2005 from 0.45 to 0.40 and an increase in debt ratio from 2004 to 2005, it may be due to the acquisition from US group KKR. However, in 2005, equity is almost three times debt, which means the capital structure is still in good condition.

On the other hand, WOW experienced a different trend that its equity ratio has decreased from 0.30 to 0.25, and debt ratio has significantly increased from 0.13 to 0.32 between 2001 and 2005. WOW raised funds heavily on interest-bearing liabilities and consequently takes higher risk than CML due to higher leverage ratio.

Times interest earned & fixed charges coverage

‘Times interest earned ratio examines the ability of the business to meet its regular financial commitments’ (Harvey, McLaney and Atrill 2001). Fixed charges coverage ratio is very similar to Times interest earned ratio. These two ratios assess the profitability of company and the ability of interests and principal repayment. CML experienced a significant increase on these two ratios from 3.48 to 12.04 and from 6.81 to 16.64, even though there was a slight drop between 2004 and 2005. However, WOW experienced an obvious fall to 11.82 and 12.25 on times interest earned and fixed charges coverage respectively. In 2005, compared with WOW, CML showed a better financial performance on the ability to repay the interests and principal.

Average payment period

CML experienced a decreasing trend on average payment period from 45.29 to 38.69. In contrast, WOW experienced an increase from 19.41 in 2001 to 37.78 in 2003, and a decrease to 34.77 in 2005. Compared with WOW, CML has a longer payment period. It means CML can hold its money more time and do some investments.

4. Assets management

Sales turnover

This ratio indicates assets management efficiency that one unit asset can generate how much sales. From the perspective of CML, the sales turnover gradually increased from 2.9 in 2001 to 3.94 in 2005. On the other hand, WOW maintained stable on about 4.5 sales turnovers. We can see that WOW managed its assets more efficiently than CML did.

Average inventory turnover period

This ratio assesses the efficiency of inventory management whether company reduce the inventories as fewer as possible. The fewer inventories, the more free cash flow company has to invest on other assets. Both WOW and CML experienced a decrease on inventory turnover period from 39.64 to 29.64 and from 59.45 to 41.38 respectively. It indicates that CML managed its inventories less efficiently than WOW did.

5. Profitability

Return on sales

WOW return on sales remained constant, 4% of sales. For CML, it maintained stable, nearly 2% of sales. Obviously, WOW has a higher operating profit margin, and then a better profitability performance maybe due to the more efficient costs control.

Return on assets

‘It is used to measure whether assets are being productively employed’ (Vance, D. E. 2003). This ratio indicates how much profit one unit asset can generate and how profitable company is as a whole. WOW and CML are both in the increasing trend, 0.17 and 0.1 respectively in 2005. In term of this ratio, it showed that WOW is more profitable than CML

Return on equity & earning per share

These two ratios reflect the return to the shareholders and the value increase for the shareholders. WOW and CML both experienced an increase on the return to the shareholders, yet the WOW’s increase of the return is more stable than CML’s. In 2005, in term of return on equity, WOW stayed with 37% of the equity, yet CML just 16%.

Conclusion

The two companies have been doing quite well in recent years as can be seen from the increasing profitability. The table in Appendix 15 indicates a comparison of the two companies according to the above discussion. CML has a better performance on liquidity and financial leverage but WOW managed Assets and Profitability better than CML.

Recommendations

On 8th September 2006, WOW’s closing share price is $20.80 and CML is $13.70. Based on the financial analysis above, we can conclude that WOW has maintained a constant financial performance in last 5 years, but their growth is not rapid. However, Simpson (2006) states that ‘At present Coles Myer is earning a 13 per cent return on capital invested in stores, compared with 24 percent by Woolworths.’ Therefore, I recommend potential investors buy shares from WOW for a short-term. According to CML news released in March and June, CML had acquired Sydney drug stores Pty Ltd (CML News Release, 2006) and Hedley Hotel Group (CML News Release, 2006). CML will expand the pharmacy business further more and have a different strategy than WOW if the regulations change in the future becomes true. CML also will expand their liquor business to compete WOW as well. Thus, I believe that the potential financial growth of CML will be a lot higher than what it is right now and I suggest investors put their money on CML for a long-term investment.

References

1.Wikipedia 2006, Coles Myer Ltd, Wikipedia Free Source Organization, viewed 10 September 2006

2.Wikipedia 2006, Woolworths Ltd, Wikipedia Free Source Organization, viewed 10 September 2006

3.Financial Report, 2005, Coles Myer Ltd., pp 19

4.Vance, D.E. 2003, Financial Analysis and Decision Making, McGraw-Hill, United States of America

5.Harvey, D, McLaney, E and Atrill P 2001, Accounting for business, Butterworth-Heinemann, Oxford

6.Simpson, K. 2006, Market waits for higher Coles bit, The Age, 8 September 2006, front page of Business Section

7.News Release 2006, ‘Coles Myer Acquires Pharmacy Direct’, Coles Myer Ltd., 31 March 2006

8.News Release 2006, ‘Hedley Hotel Acquisition Complete’, Coles Myer Ltd., 14 June 2006


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