Financial Analysis of Sainsbury PLC Essay
Financial Analysis of Sainsbury PLC
This report will focus upon the financial performance over a two year period of a FTSE 100 company. It will seek to ascertain how well the company has performed by scrutinizing profitability, liquidity, efficiency, gearing ratios and working capital. In addition to the aforementioned points, it will dwell upon economic factors to discuss the impact they have had upon the performance of the business.
The FTSE 100 started in the year of 1984 and was based upon the 100 largest companies on the London Stock Exchange, and it is seen as an emblematic indicator for the strength of the British economy (iforex, trading section). FTSE 100 companies represent about 81% of the market capitalization of the London Stock Exchange (Nationwide Building Society, glossary section). Within it lies a substantial contribution to the UK economy and the economic power of these firms mean they would have a fairly large ripple effect upon the nation’s economy should there financial performance reach a state of discontentment.
Subject company and history
The subject company for this report will be J Sainsbury Plc which was founded in 1869 by John Sainsbury and his wife, Mary Ann Sainsbury in London (Sainsbury Plc, history section).
The organization has grown to be one of the UK’s most eminent supermarkets. Some of its remarkable aspects include launching TU clothing in 2004, launching Try Something New Today in 2005 to promote healthy eating, and becoming the world’s largest fairtrade retailer in the year 2010 (it is understood that almost one in every four pounds spent on fairtrade products is at Sainsbury), in 2012 the organization became the proud sponsor to the Paralympic games (this will be diligently examined later in the report to see what effect, if any it has had upon the company’s revenue) (Sainsbury Plc, history section).
In an industry predominantly owned by Tesco (a market share of 29.9% as of January 2012 according to BBC Business News), Sainsbury has had to work hard to stay in competition. Its persistency has been a key component to its contrivance in the industry and other ventures to which Sainsbury has embarked upon, namely, its banking venture (a 50/50 venture with Lloyds TSB) which commenced trading on the 19th day of February 1997 (Sainsbury Bank plc).
The firm lost its position as market leader in the year of 1995 to its rival Tesco and subsequently dropped to third in market share after ASDA experienced a 5% rise in profits (BBC, Business News section). As at March 31 2012, Sainsbury’s has a total number of 440 convenience stores and 572 supermarkets which is currently due to increase (Sainsbury, Store Portfolio section). The question is, how much has its expansionary policy supported its profits whilst maintaining equilibrium with costs?
Within this report, diligent focus will be shown to the financial year of 2010 and the final year of 2011 as the profitability, liquidity, efficiency, gearing ratios and working capital is examined. The profit from disposal of properties in 2010 was £27m and £108m in 2011 which shows a dramatic appreciation in profit when compared. Moreover, the company also showed an increase in combined profit from £585m in 2010 to £640m in 2011 (Sainsbury, Income Statement 2011 section). This shows that the company’s overall performance has improved over the course of 12 months by 9.4%.
Further to the aforesaid points, the greater percentage of revenue was derived from the sale of products and services, standing in at £22,943m in 2011 (Sainsbury, Income Statement 2011 section). This shows an increase in product purchases and an increase in market share (an increase of 16.1%, Telegraph, September 2011) leading to more sales, demonstrating that the firm’s strategy has worked for the financial year when compared to the sales of 2010 of £21,421m (Sainsbury, Income Statement 2010 section).
Return on Capital Employed can be defined as follows: “Return on capital employed is a fundamental measure of business performance as it compares the operating profit with the total capital used to generate that profit.” (Black, 2009, p.212). For Sainsbury, this figure was 11% in the financial year of 2010 and 11.1% in the year of 2011 (Sainsbury, Annual Report 2011 section). Such a minor change doesn’t manifest a huge degree of progress. In the annual report for 2011 p4, the company does give an account for this and state that growth was lower than the previous year due to the cumulative effect of its accelerated investment in space growth which started June 2009.
The company also holds seventh place for volume market share in the clothing industry and now has clothing sales growing faster than food, 17% to be exact with year on-year growth (Sainsbury, Annual Report 2011 section). Celebrity fashion icon, Gok Wan has been a huge support in inciting growth of the TU brand by launching a clothing range at Sainsbury in 2011 which has been the main source of sales boost. (gok wan, Sainsbury TU section).
In addition to the appreciation of sales, the cost of sales rose from £19,964m in 2010 to £21,102m in 2011. Prominent contributing factors towards the rise in costs are the variation in Fiscal policy (Sainsbury’s, Directors report 2011 section) which increased the rate of VAT from 17.5% to 20% on the 4th day of January 2011 (HM Revenue and Customs, 2011) along with the increase of the company’s workforce due to its addition of 1.5 million square feet of space from 2011-2012 (The Independent, news section).
As the profitability of the organization is scrutinized, it is important to
look deeper into what has resulted in an increase in profit from the year 2010 to 2011. From an economic perspective, the Bank of England’s Monetary Policy Committee (hereinafter referred to as MPC) changed the discount rate to 0.5% on the 5th day of March 2009, positively influencing public spending and reducing the cost of borrowing (Bank of England, 2009). The concept upon the reduction in the cost of borrowing is that more customers have resorted to using credit to fund their purchases (According to a study conducted by Visa Vanquis, consumer spending on credit increased by 3% in September 2011 when compared with statistics for 2010).
It is understood that the variation eluded to above has been of support to the company in its financial borrowing, enabling it to fund its expansion referred to in the above paragraph. The downside is that it has had a fundamental impact upon its banking venture namely, profits attained are not what they could be if the discount rate was higher, notwithstanding the fact that, the bank reported a 9% increase in profits in 2011 (This is money, news section) possibly due to the abovestated research on consumer spending. A higher base rate would mean higher priced loans leading to greater profits accrued (other factors being equal).
Taking into consideration the above-mentioned point, the company had the opportunity to utilize the reduced interest rate in support of its expansion and other purchases to aid the loss of profit (due to low interest rates) from the sales of loans and credit cards. In criticism of the 0.5% base rate set by the MPC, Sainsbury’s Chief Executive stated it was the wrong decision to reduce it, the small businesses that supply Sainsbury were struggling to borrow and this of course had a substantial ripple effect upon the company’s financial performance (Daily Telegraph, news section). This gives a clear indication that the profit accumulated for 2011 could of been higher without the economic discontentment. It gives some direction to why the cost of sales were high due to the purchasing price of products from smaller businesses to which supply Sainsbury.
Having analyzed the profitability of Sainsbury, its within good reason to compare this data with that of its main competition, namely, Tesco for which happens to be a pivotal comparison due to them standing within similar grounds in terms of business models and future company goals. Tesco UK gained £56,910m in sales for the financial year 2010 and saw an increase for year 2011 with sales in at £60,931m (Tesco, Annual Report 2011 section). There is a substantial difference in sales, however Tesco have 3,054 UK stores in comparison to Sainsbury’s combined 1,012 stores, in addition it has the greater market share (Tesco, storefinder section).
Tesco’s Return on Capital Employed for 2010 stood at 12.1% and 12.9% for the financial year 2011 (Tesco, Annual Report 2011 section) and according to the directors report the company has set itself a target to increment this to 14.6% by 2014/15. This, together with its sales exhibits better performance than that of Sainsbury and epitomizes the comprehension to why the company holds the greatest share of the market. It shows clarity that Tesco did better with capital than that of Sainsbury, however Sainsbury used a large amount on expansion which the results of will be shown at a later date.
With liquidity being the second focal point, it is necessary to look at the credit facilities available to the organization in question. ‘Sainsbury has overall debt and credit facilities of £3 billion at its disposal’, the principle element of Sainsbury’s core funding comprises of two long-term loans of £1,069m due 2018 and £840m due 2031, secured over property assets (Sainsbury Annual Report 2011). Further to the previous stated loans, the company has unsecured debt of £180m and £50m due between 2012 and 2015 along with £190m of convertible bonds due July 2014 (Sainsbury Annual Report 2011).
The Current Ratio for Sainsbury in the financial year of 2010 was 0.64 and 0.58 in the financial year 2011. A Current Ratio may be defined as a measure of an organization’s ability to pay its shortterm debts, ideally it should stand in at 2:1 (Atrill & McAllen, 2008). The ratio for 2010 indicates that the company would be in a better position at paying off its obligations if they were due at that point in time. However due to the ratio for both years being under 1, it shows the company is not in a good position. Ironically however, having ascertained the available credit to the organization, this states otherwise.
In comparison to its competition, Tesco had a current ratio of 0.73 in the financial year 2010 and 0.65 in the financial year 2011. This is somewhat similar with Sainsbury as there is only a gap of .2 in difference. Both companies figures look worrying, however the ability to turn stock into cash is another focal point to which will be later scrutinized.
Having revisited the company’s balance sheet, its Net debt stood at £1,549m in 2010 and £1,814m in 2011 (an increase of £265m). This difference quintessentially indicates that the company has been expanding over the course of a year. In the firm’s annual report for 2011 it shows the increment was due to rapid estate development (the addition of new Sainsbury Convenience stores) which was to an incontrovertible extent funded by the sale of leasebacks and advanced working capital (Sainsbury Annual Report 2011, p5).
The appreciation in debt manifests the fact that Sainsbury hans’t cleared its existing debt, yet only continued to borrow more. Astonishingly however, the amount borrowed has been put to positive use in funding the expansion of the organization’s convenience stores. According to the Independent in March earlier this year, the company grew its market share of the convenience store market in 2011 with sales up 20% following the opening of 15 new stores.
Further to the above-mentioned points, the company pursued further borrowing to enhance its profitability by expanding (proven to be a remunerative venture), enabling the firm to pay back its source of funding when required to do so. The idea of this long-term investment is that Sainsbury will gain a larger market share (forcing other less competitive companies to abdicate there share of the market) and increased profits both short and long-term.
In criticism of the technique, the company should take into consideration the unforeseen changes in the market, namely demand for its products and services and of course future economic changes. How does it justify itself financially should there be a decrease in demand? The epitome lies with XL Airways, according to BBC News in 2008, the company hit financial discontentment after failing to secure further funding (up until that point it was in the process of expanding) due to unanticipated changes in the economy.
With regard to the organization’s efficiency, it is difficult to ascertain the overall effectiveness of performance without conducting in-depth research as it can be fairly arduous to gather enough data from ratio analysis. However, the business’s average inventory turnover (calculated by sales divided by inventories, Agyei-Boapeah, 2012) for the financial year 2010 was 30.5 (Sainsbury’s Income Statement 2010, p16), compared with 28.2 for the financial year 2011 (Sainsbury’s Income Statement 2011, p18) shows a minimal difference.
The figures imply a poorer performance from the company in 2011, yet sales had subsequently increased in that year, furthermore, it was part of the organization’s goals to increment the sale of non food products which gives an account for the less frequent replacement of inventories (Sainsbury’s Income Statement 2011, p2; Sainsbury’s Annual Report 2011, notes 16).
In order to gain a greater interpretation of the company’s efficiency its necessary to look at other ratios. Asset turnover (calculated by revenue divided by total assets, Agyei-Boapeah, 2012) for the financial year 2010 was 1.83 and 1.85 for the financial year 2011 (Sainsbury Group Income Statement 2011, p1). The higher the figure, the better. Having scrutinized these figures, it is clear to see a slight inclination in sales generated from assets for 2011. Although, the company has only seen a small contribution of profit accrued from the sale of assets. This may be understood by reviewing the firm’s growth policy once again and recalling that they have spent more on expanding and accumulating assets than selling assets (Sainsbury Annual Report 2011, p5).
A comprehension of the above-mentioned points give clarity that the company’s management have conducted there duties efficiently. The prominence lies within sales performance and the ever growing multitude of stores to which the firm has within its ownership. The increased space exhibits a positive rate of expansion (15.9% according to Sainsbury Income Statement 2011, p2), furthermore, only a small percentage in change on the sale of assets and a
lower inventory replacement.
Further to the aforesaid point referring to replacement of inventories, it could be interpreted that as the firm sees a continuity of expansion, more goods are purchased through economies of scale (greater sized orders at lower prices, meaning less reordering) as is it the case that the company is introducing further non food products, namely televisions which aren’t everyday purchases. Yet of course it is likely to be the latter having previously identified company intentions (Sainsbury Annual Report 2011, p2).
Finally it is prudent to take the ratios and compare them with that of Tesco. In the financial year of 2010, 20.8 was Tesco’s inventory turnover ratio and 19.2 in the financial year of 2011 (Tesco Annual Report 2011, p94). Again these figures represent an even poorer performance, but Tesco as do Sainsbury, sell a number of non food-products, 22% of sales are non-food products and the company is the UK’s largest non-food retailer (Tescopoly.org, Our Business section).
Asset turnover for Tesco in the financial year of 2010 was 1.56 and 3.18 for the financial year 2011 (Tesco Annual Report 2011, p106). This shows some disparity in business efficiency and shows the company performed better in the year of 2011 when compared with 2010 and it also performed much better than Sainsbury (however it is mandatory to consider the company’s goals in comparison to that of Sainsbury).
Asset Turnover comparison of Sainsbury with Tesco.
The gearing ratios (Long-term liabilities) for Sainsbury on the 20th day of March 2010 were 32.86 compared with 30.79 on the 19th day of March 2011 (Telegraph shares, p1). This implies the company’s rate of borrowing to fund its activities was higher in the year of 2010 and as a result of the increase in profit for 2011 as eluded to above, activities were self-funded more often.
The ratios referred to in the above paragraph doesn’t have the greatest of difference, meaning there was still a substantial amount funded by borrowed funds in 2011. A contribution to the high rate of borrowing is carefully examined by looking at the Office of National Statistics for 2010 and 2011.
According to the Office of National Statistics, Consumer Price Index (hereinafter referred to as CPI) in the 12 months up to September 2010 saw a 5.2% increase in alcohol and tobacco products, a 5.1% increase in food and non-alcoholic beverages, 4.4% increase in communication and a 2.5% increase in other goods and services, including fuel (Office of National Statistics 2010/2011 Report, p1). Such increases may have caused customers to abstain from certain purchases or make less frequent purchases, this as a ripple effect would significantly impact upon the organization’s functioning.
Ironically however, in 2011 CPI was at 5.2% in September, compared with 3.1% in September 2010 (Office of National Statistics 2011 Report, p1). A significant increase would anticipant further borrowing, yet this isn’t the case due to above-mentioned facts in this report. Sainsbury’s strategy to invest in expanding has given support to its profits for 2011 and enabled the business to reinvest these into its activities. This therefore negates the argument/concern over economic impact upon trading for 2011 and shows a return on investment when compared to company sales and profits with an amalgamated comparison of 2010/2011 financial performance (Sainsbury Income Statement 2011, p1-p5).
Working Capital Management
Moving on to the final focal point in this report, working capital. This is the measure of both a company’s efficiency and its short-term financial health (Agyei-bopeah, 2012). The working capital of the organization has seen a substantial increase in the financial year of 2011. The firm’s working capital increased by £78m for 2011, which it states was primarily due to increased inventories which is £110m higher than that at March 20th 2010 (Sainsbury Annual Report 2011, p1).
An examination of ratios will help to ascertain the effectiveness of the firm’s working capital management, however it appeared difficult to derive this information from Tesco due to discrepancies to way in which data was laid out. Working Capital to Sales ratio can be calculated by taking working capital and dividing it by sales X 100 (Agyei-Bopeah, 2012). In the financial year of 2010 this figure was 1.5.7 and 1.2.8 for 2011. This manifests a less appreciated rate of performance for the year 2011, however the company did introduce a substantial number of non-food products.
The company successfully managed to make cost savings of £50m in the year 2011 (Sainsbury Interim Results 2011, p1). In an argument against this successful business practice, is it ethical for the company to pay farmers the minimal amount per gallon of milk to keep its customer want’s satisfied? Herein lies a problematic issue to which the organization faces in its ever growing desire to reduce costs. As a result it has led to pragmatism in critics of the firm’s fairtrade brand image and to what extent it coincides with the image.
British farmers are forced to pay the price of supermarket price wars (The guardian, Saturday 2 July 2011, p48). With such concern over how much the firm should be saving on costs to attain a better position with working capital, it fails to take into consideration its ethos on fairtrade. It transpires to be the case that in order to make huge savings to support its growth in working capital, the company must continuously force its suppliers to drive the price of their products down as other factors change (cost of production, economic variations, energy/fuel prices and the cost of raw materials).
On a more positive note, the company has managed to increase its working capital from the financial year of 2010 to 2011, this indicates positive changes in its business activity and demonstrates that it has good working capital management. As a result of the increase, £12m in debt was paid off in the year of 2011. Yet as this section happens to coincide with efficiency, it epitomizes the effectiveness of the company strategy for 2011.
Sainsbury has set itself a fair number of targets to which are laid out in the company annual report for 2011. One being to increase space growth of 15% in two years set in the year of 2009 (Sainsbury Annual Report 2011, p1).
The company exceeded this target percentage by .9% (Sainsbury Annual Report 2011, p1) which indicates its able to meet its targets, yet it also indicates more capital was spent on expanding and possibly more than it intended.
As eluded to in the above sections, Sainsbury’s decision to rapidly expand has proven to be a remunerative venture and shown a slight increase in company profits for short-term comparisons between the financial years 2010 and 2011 where sales have grown by 9.4% (Sainsbury’s Income Statement 2011, p1). Such developments in the business will only give adequate comparisons after a greater interval enabling the researcher to comprehend as to how much the accelerated growth has had on the firm.
In addition to the company’s growth in size it saw a huge appreciation in demand for its clothing brand, TU. It is understood that since fashion icon Gok Wan introduced a range of clothing, sales saw a growth of 17% as a year on year comparison for 2011 (Sainsbury’s Media, Latest Stories, p1). It is likely that this will continue to grow and complement the company’s expansion.
Further to the above points, the liquidity ratios of the company are poor at this point in time which is due to accelerated growth (therefore negates the argument of poor performance). However when the firm finishes its expansion it is highly likely that the ratio will improve which is subject to no further large projects. Further to information ascertained from the company Annual Report of 2011, the company should be capable of repaying its loans as of there due dates thanks to its increased number of stores accumulating further profit.
In addition to aforementioned points in the beginning of the conclusion, Sainsbury’s have five focus areas, great food at fair prices, accelerating the growth of complementary non-food ranges and services, reaching more customers through additional channels and growing supermarket space (Sainsbury’s Annual Report 2011, p3). Having already acknowledged the prosperity of its space growth, this also happens to coincide with its focus on reaching customers through additional channels as 37 new convenience stores were opened in the latter part of 2010 to the beginning of 2011 (Sainsbury’s Media, Latest Stores section).
Since analyzing the company gearing ratios and how much it has in long-term debts, it is clear to see it could be a perilous problem for Sainsbury. The firm has made an audacious decision to invest in expanding in the hope for substantial returns in the not to distant future, yet this is not guaranteed income. If demand falls for the company’s products and services or there is a problem to which later impacts upon its brand image (the company is disproved to be a fairtrade retailer for example) the firm may find itself being liquidated if it is unable to repay the loans.
Points eluded to in the above paragraph are a matter of deep concern to the organization and from research administered it doesn’t transpire to be the case that the firm has a contingency plan to support them with potential depreciation in demand. A contingency plan and in addition, a contingency fund is something to which Sainsbury should take into the highest of consideration should one not have already been devised (yet it is unlikely this would be the case). It will be of support to the firm in planning for unforeseen changes.
In this report the following sources were dwelled upon for guidance in ascertaining facts, extracting data and for the purpose of comparison.
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