Tesco Financial Statement Analysis - Essay Example

? Financial ment Analysis – Tesco Plc No: Contents Contents 2 Executive Summary 3 Introduction 4 1 Aims and Objectives of the report 4 1.2 Historical evolution of Tesco Plc 4 1.3Methodology 4 2. Analysis 5 2.1 Profitability 5 2.2 Liquidity 7 (Source: Annual Report, 2006-2010) 8 2.3 Investor Ratio 8 2.4 Stock Beta 9 (Yahoo Finance, 2011) 10 Stock beta is used to assess the risk associated with the shares by measuring its volatility in relation to the stock market. Theoretically, market has a beta of 1.0 and the stock beta calculated show how much they deviate from the market. In 2006 and 2007, Tesco Plc stocks showed a high beta indicating a higher return but are riskier. Negative return is shown in 2008 as an effect of the share market plunge following the global recession but was slowly recovered from 2009. 10 2.5 Comparison with competitor 10 Conclusion 11 Appendix I 12 Appendix II 13 Appendix III 14 References 17 Executive Summary This report discusses the finance performance and position of Tesco Plc for the recent 5 years (2006-2010), analyzes the short term and long term prospects of Tesco Plc and the investment attractiveness in its equity shares. Based on the analysis, Tesco Plc showed a strong past track record with continuous expansion through acquisitions and new selling space. Growth was slow in 2008-2009 due to the economic storm experienced but has resumed quickly. The balance sheet is strong with healthy solvency position and shareholder returns are encouraging with 5 consecutive years of enhanced dividend and increased Group Earnings per Share. Comparison with its UK retail peer, Morrisons is conducted and the result revealed that Tesco Plc is still ahead of its competitor. It is discovered that Tesco Plc is currently facing challenge from the intense competition in the UK due to the great promotional offers and price cut from the discount retailers such as Asda and Aldi. However, strong growth is expected from its international retail and the future outlook of the Company remains positive. A strong buy recommendation is proposed after reviewing broker’s recommendations and the performance of the Company. 1. Introduction 1.1 Aims and Objectives of the report The aims and objectives of this report include: To obtain an overview of the financial performance and position of Tesco Plc for the recent 5 years (2006-2010). To analyze the short term and long term prospects of Tesco Plc and the investment attractiveness in its equity shares. This report would begin with the historical evolution of Tesco Plc followed by an in depth analysis on its financial performance for the recent 5 years (2006-2010) together with a comparison against its competitor and calculation on beta discussing on how the returns of the share is correlated to the returns of the stock market. Recommendation on whether to invest in its equity shares is suggested at the end of the report based on the comprehensive analysis done in terms on its short and long term prospects. 1.2 Historical evolution of Tesco Plc Tesco Plc is one of the world’s leading retailers founded by Jack Cohen when he started selling surplus groceries from a stall in the East End of London in 1919 and opened his first stall in 1929 in Burnt Oak, Edgware, North London. It was listed in the Stock Exchange with a share price of 25p in 1947 and continued to grow through acquisitions and opening of new stores in the 1960s with a chain of over 212 stores in the North of England. Tesco started to diversify its business by opening petrol stations in 1974. The first international retail unit was launched in Hungary in 1995 and today, its international operations cover China, Czech Republic, Hungary, India, Japan, Malaysia, Poland, Republic of Ireland, Slovakia, South Korea, Thailand, Turkey and United States. (Tesco Plc, 2011) The core purpose of Tesco Plc is to create value for customers to earn their lifetime loyalty and its success depends on people, both customers and employees and emphasize on a sustainable long term growth through the following: To be a successful international retailer To grow the core UK business To be as strong in non-food as in food To develop retailing services To put community at the heart of what we do (Tesco Plc, 2011) 1.3 Methodology Secondary qualitative data was used to compile the data for completion of this research which include electronic research on the Annual Report containing the background information, operations and financial performance of Tesco Plc and financial highlights and share price information from the Yahoo Finance and newspaper articles. 2. Analysis 2.1 Profitability (Source: Annual Report, 2006-2010) 2006-2007 Gross Profit Margin has improved considerably from year 2006 to 2007. The following key developments have enabled Tesco Plc for rapid growth despite the challenging political and economic conditions in some of the markets: Increase in group sales by 10.9% on a comparable 52-week basis due to aggressive expansions through acquisitions of 11 Carrefour stores in the Czech Republic in May 2006, 146 Leader Price stores in Poland in December and 8 large Makro stores in Malaysia in January 2007, all of which are performing well. - Contributed by the grew in the UK sales by 9% through delivering of improved shopping trip for customers such as implementation of new checkout technology process and keeping the lowest possible prices for customers. Substantial grow in non-food sales to ?10.4bn especially in the health & beauty segment where sales increased by 9% and news and magazines up by 9%. - Strong market position of Tesco Lotus in Thailand which allowed them to deliver good profit despite the political instability experienced in the second half of the year. (Annual Report, 2007) Increase in gross profit margin is also mainly due to the recognition of an exceptional gain of ?258m due to changes in pension assumptions following the Finance Act revision in April 2006 which allows members of the UK to gain additional pension flexibility mitigated by the impairment loss in respect of Gerrards Cross site as a result of a litigation following the tunnel collapse. Net Profit for the year ended 24 February 2007 rose 20.49% from ?1,576m to ?1,899m attributable to the increased productivity and efficient expense controls which enabled Tesco Plc to absorb significant external cost increases arising from higher oil-related cost and local business taxes. The rise in return on capital employed is wholly due to the strong business performance which has far exceeded that of the capital employed for the year 2007. (Annual Report, 2007) 2007-2008 Tesco Plc highlighted an excellent progress in its international operations, boosted by the launch of its Fresh & Easy chain in the United States and also the robust growth in Europe and Asia (Walsh, 2008). The international business contributed to 54% growth in Group sales and in Asia and Europe, sales grew by 27.2% and 23.9% respectively followed by the sales increased in UK by 6.7%. Despite the increase in revenue, the gross profit margin has dropped mainly due to the exceptional gain in pension adjustment recognised in 2007. The increase in net profit margin is duly caused by the decrease in net finance costs, down 50% from ?126m to ?63m. This is mainly caused by the substantial increase in interest received in 2008 amounted to ?128m (2007: ?82mil), a 56% increase driven by the short term investments and hefty sum of cash flow. (Annual Report, 2008) 2008-2009 Tesco Plc reported a slight increase in gross profit margin in 2009 mainly due to the strong rivalry faced from the discount retailers such as Aldi. The group sales were sustained by its new US Fresh and Easy stores which managed to post double-digit sales growth despite the tumultuous economic condition in the West Coast markets. (Wearden, 2009) The Group has also acquired the remaining 50% of the share capital of Tesco Personal Finance Group Limited during the year expanding its financial services business. However, the net profit margin show a decrease primarily caused by the significant increase in finance cost from ?362m (2008: ?63m) reflecting the increased average net debt levels linked to acquisitions and foreign exchange movements, higher coupon rates on commercial paper and unfavourable changes in the non-cash IFRS elements of the interest charge. (Annual Report, 2009) 2009-2010 Both the gross profit and net profit margin has increased between the years driven by its solid performance and continuous business improvements. Innovation is embraced with the launched of its three innovative and popular iPhone applications which allow customers to scan their Clubcard on their iPhone, enabling consumers to search the nearest store with the Store Finder application and wine application which provide the product information of their favourite wine and ordering it from the phone. Additionally, the department store in Prague is re-opened in September 2009 after a major reconstruction. The economic downturn has not otherwise hit Tesco Plc as it earned customers loyalty by helping them to spend less during the downturn. Finance costs have reduced to ?314m (2009: ?356m) due to the decrease in the underlying interest charge. Group tax has also been reduced to an effective rate of 26.4% (2009: 26.7%) contributed to the overall increase in net profit margin. (Annual Report, 2010) Return on Capital Employed is hovering at 24%-25% for 5 consecutive years and remain on track to deliver the Group’s targeted ROCE improvements. (Annual Report, 2006- 2010) 2.2 Liquidity (Source: Annual Report, 2006-2010) Current Ratio Current ratio for the year 2006-2010 was below the thumb rule for retail industries, between 1:1 to 1:6 (Equifax, 2011). However, it did not indicate any symptoms of cash tied up or solvency issue due to efficient working capital management, tight control of capital expenditures and hefty cash generation. The current ratio in 2009 show a sharp increase from 0.58 to 0.74 due to significant fair value gain in derivative financial instrument recognized amounting to ?382m (2008: ?97m) signifying a 293% increase. Acid Test Ratio The Acid Test Ratio of Tesco Plc has met the thumb rule for retail industries, between 0.3 to 0.7 (Equifax, 2011) except for the year 2007. Acid test ratio gives a more accurate indication of the Company’s liquidity as it excludes stocks and this shows that Tesco Plc demonstrates a healthy liquidity position and would be able to meet its current obligations in an event of emergency even though inventories are not liquidated. 2.3 Investor Ratio (Source: Annual Report, 2006-2010) Gross dividend per share The gross dividend per share has risen constantly from 2006 to 2010 with a steady average increase of 1.12p each year. The continuous increase in dividend as shown in the graph is in conjunction with the Company policy of growing annual dividends. Nevertheless, it demonstrated its commitment in delivering shareholders return through enhanced dividend. Group Basic Earnings per share The group earnings per share showed an increase of 3.41p and 3.34p in 2006 and 2007 respectively due to the excellent performance of the Company. EPS in 2009 only show a slight increase as the Company experienced a tough year with only ?8m increase in net profit but is back on track with an increase of 2.19p in the following year outweighing the effect on increase in issued and fully paid share capital. (Annual Report, 2006-2010) 2.4 Stock Beta (Yahoo Finance, 2011) Stock beta is used to assess the risk associated with the shares by measuring its volatility in relation to the stock market. Theoretically, market has a beta of 1.0 and the stock beta calculated show how much they deviate from the market. In 2006 and 2007, Tesco Plc stocks showed a high beta indicating a higher return but are riskier. Negative return is shown in 2008 as an effect of the share market plunge following the global recession but was slowly recovered from 2009. Financial performance in 2010 Tesco Plc Morrisons Plc Gross Profit Margin 8.10% 6.89% Net Profit Margin 4.10% 3.88% Current ratio 0.71:1 0.50:1 Acid test ratio 0.54:1 0.24:1 Basic EPS (pence) 29.33 22.80 Dividend per share (pence) 12.28 8.2 Share Price (pence) as at balance sheet date 420.0 289.1 2.5 Comparison with competitor (Tesco & Morrison Annual Report, 2010) Morrisons Plc has been a stiff competitor to Tesco Plc in the UK food retailing industry and has ranked closely to each other. However, in terms of size, Tesco Plc is larger than Morrisons Plc with a paid up share capital of ?399m while Morrisons Plc is ?265m. Gross Profit Margin of Tesco Plc is 1.21% higher than Morrison Plc as Tesco is more reliant on its non-food sales than Morrison and has more profitable international retail floor space. The slight difference of 0.22% in net profit margin indicates that Morrisons has a better expense control than Tesco Plc. On the other hand, Tesco Plc has demonstrated a healthier liquidity ratio and considerably higher EPS as compared to Morrisons. Both the Companies have been distributing dividends but Tesco Plc may be a preferred company as it has higher dividend payout. However, it has to sustain in its future performance in order to maintain the high dividend payout. The share price shown in the table suggests that there is higher shares demand for Tesco Plc than Morrisons revealing that investors seem to prefer Tesco Plc’s business model. Tesco Plc emphasizes on diversification into international expansion, new product and services launch for sustainable growth and earning customer loyalty with assured low price. Morrisons, on the contrary, is focusing on delivering fresh and quality products which are value for money and great services to customers. (Tesco & Morrison Annual Report, 2010) Conclusion The first aim and objective of this report is to obtain an overview of the financial position of Tesco Plc. Based on my analysis, Tesco Plc has been performing well from the past track record and have steered the business through recession. The balance sheet is strengthening and outlook for shareholders returns are encouraging. The second aim of the report is to discover the short and long term prospect of Tesco Plc and assess whether it is worthwhile to invest. In the short run, it will focus on helping customers to save money especially when the food prices have climbed. It also aims to contribute to solid returns to its shareholders by enhancing its dividend each year. The Chief Executive of Tesco Plc, Sir Terry Leahy expressed his optimistic view on the future prospect in view of the improving global economy and international expansions through acquisitions and new selling space would be carried on. Nevertheless, Bloomberg reported that Tesco is struggling in the UK as rivals close in and it has to convince investors that the UK offers a growth potential outside the grocery market. The UK Analyst, Panmure Gordon noted that Tesco Plc is currently trading at a discount to its UK peers as it failed to drive shareholder returns. However, he is in view that the phenomenon will change as it has higher returns from its international business, thus a “buy” rating and 500p target price is recommended. Appendix I Formulas: Profitability Ratios: 1. Gross Profit Margin = Gross Profit/Revenue * 100% 2. Operating Profit Margin = Operating Profit/Revenue * 100% 3. Return On Capital Employed = Operating Profit/ Shareholders’ equity * 100% Liquidity Ratios: 4. Current Ratio = Current Asset : Current Liabilities 5. Acid test Ratio = Current Asset – Inventories : Current liabilities Investor Ratios: 6. Group Earnings per share = Profit after tax/ Total no. of equity shares * 100% 7. Gross Dividend per share = Gross Divided/ Total no. of equity shares * 100% 8. Stock Beta = Covariance (Rate of Return of Stock, Rate of Return of Market)/Variance of Market Appendix II Group Income Statement – Tesco Plc (2006-2010) (Source: Annual Report, 2006-2010) 2010 2009 2008 2007 2006 ?m ?m ?m ?m ?m Continuing Operations Revenue (Sales excluding VAT) 56,910 53,898 47,298 42,641 39,454 Cost of Sales (52,303) (49,713) (43,668) (39,401) (36,426) Pension adjustment - Finance Act 2006 - - - 258 - Impairment of Gerrards Cross site - - - (35) - Gross profit 4,607 4,185 3,630 3,463 3,028 Administrative expenses (1,527) (1252) (1,027) (907) (825) Profit arising on property-related items 377 236 188 92 77 Operating Profit 3,457 3169 2,791 2,648 2,280 Share of post-tax profits of joint ventures and associates 33 110 75 106 82 Profit on sale of investments in associates - - - 25 - Finance Income 265 116 187 90 114 Finance Costs     (579) (478) (250) (216) (241) Profit before tax 3,176 2917 2,803 2,653 2,235 Taxation (840) (779) (673) (772) (649) Profit for the year from continuing operations 2,336 2,138 2,130 1,881 1,586 Discontinued operation Profit/(Loss) for the year from discontinued operation - - - 18 (10) Profit for the year     2,336 2,138 2,130 1,899 1,576 Attributable to: Owners of the parent 2,327 2133 2124 1892 1570 Minority interests 9 5 6 7 6         2,336 2,138 2,130 1,899 1,576 Earnings per share from continuing and discontinued operations Basic 29.33 27.14 26.95 23.84 20.07 Diluted       29.19 26.96 26.61 23.54 19.79 Earnings per share from continuing operations Basic 29.33 27.14 26.95 23.61 20.20 Diluted       29.19 26.96 26.61 23.31 19.92 Appendix III Group Balance Sheet – Tesco Plc (2006-2010) (Source: Annual Report, 2006-2010) 2010 2009 2008 2007 2006 ?m ?m ?m ?m ?m Non-current assets Goodwill and other intangible assets 4,177 4,076 2,336 2,045 1,525 Property, plant and equipment 24,203 23,152 19,787 16,976 15,882 Investment Property 1,731 1,539 1,112 856 745 Investment in joint ventures and associates 152 62 305 314 476 Other investments 863 259 4 8 4 Loans and advances to customers 1,844 1,470 - - - Derivative financial instruments 1,250 1,478 216 - - Deferred tax asset 38 49 104 32 12 Total non-current assets 34,258 32,085 23,864 20,231 18,644 Current assets Inventories 2729 2,669 2,430 1,931 1,464 Trade and other receivables 1888 1820 1311 1079 892 Loans and advances to customers 2268 1918 - - - Loans and advances to banks and other financial assets 144 1541 - - - Derivative financial instruments 224 382 97 108 70 Current tax assets 6 9 6 8 - Short term investments 1314 1233 360 - - Cash and cash equivalents 2819 3,509 1,788 1,042 1,325 Total current assets 11,392 13,081 5,992 4,168 3,751 Noncurrent assets classified as held for sale and assets of the disposal group 373 398 308 408 168 Total assets   46,023 45,564 30,164 24,807 22,563 Current Liabilities Trade and other payables (9,442) (8,665) (7,359) (6,046) (5,083) Financial Liabilities Borrowings (1,529) (3,471) (2,084) (1,554) (1,646) Derivative financial instruments and other liabilities (146) (525) (443) (87) (239) Customer deposits (4,357) (4,538) - - - Deposits by banks (30) (24) - - - Current tax liabilities (472) (362) (455) (461) (462) Provisions (39) (10) (4) (4) (2) Liabilities directly associated with the disposal group - - - - (86) Total current liabilities -16,015 -17,595 -10,345 -8,152 -7,518 Net current liabilities 30,008 27,969 19,819 16,655 15,045 Non-current liabilities Financial Liablities Borrowings (11744) (12391) (5972) (4146) (3742) Derivative financial instruments and other liabilities (776) (302) (322) (399) (294) Post employment benefit obligations (1840) (1494) (838) (950) (1211) Other noncurrent liabilities - - - (29) (29) Deferred tax liabilities (795) (676) (791) (535) (320) Provisions (172) (200) (23) (25) (5) Total non-current liabilities -15,327 -15,063 -7,946 -6,084 -5,601 Total liabilities   -31,342 -32,658 -18,291 -14,236 -13,119 Net assets   14,681 12,906 11,873 10,571 9,444 Shareholders’ equity Share capital 399 395 393 397 395 Share premium account 4801 4,638 4,511 4,376 3,988 Other reserves 40 40 40 40 40 Retained earnings   9356 7,776 6,842 5,693 4,957 Equity attributable to owners of the parent 14,596 12,849 11,786 10,506 9,380 Minority interests 85 57 87 65 64 Total Equity   14,681 12,906 11,873 10,571 9,444 References 1. Equifax (2011) Financial Ratios. [Online] Available at: http://www.findoutinfo.com/direct/CD001?stylesheet=cd001.xsl [12 April 2011] 2. Morrison Annual Report (2010) Morrison Plc. [Online] Available at: http://www.morrisons.co.uk/Global/Images/Corporate/Annual%20Report/Morrisons_AnRep10.pdf [11 April 2011] 3. Shannon Sarah (2011) “Tesco's Clarke Faces `Big Struggle' in U.K. as Rivals Close In.” Bloomberg. [Online] Available at: http://www.bloomberg.com/news/2011-02-25/tesco-s-clarke-faces-big-struggle-in-u-k-as-rivals-attack-leahy-legacy.html [13 April 2011] 4. Tesco Annual Report (2006-2010) Tesco Plc. [Online] Available at: http://ar2010.tescoplc.com/ [11 April 2011] 5. UK Analyst (2011) From UK-Analyst.com: Thursday 7th April 2011. [Online] Available at: http://uk-analyst.com/shop/page-advice/action-advertorial.show/id-130011408 [13 April 2011] 6. Walsh, F. (2008) ‘Tesco Sales fell well short of forecasts’. Guardian.co.uk [Online] Available at: http://www.guardian.co.uk/business/2008/jan/15/tesco.supermarkets [12 April 2011] 7. Wearden, G. (2009) ‘Tesco reports weak sales growth’. Guardian.co.uk [Online] Available at: http://www.guardian.co.uk/business/2009/jan/13/tesco-weak-sales [12 April 2011] 8. Yahoo Finance (2011) Tesco Plc. [Online] Available at: http://finance.yahoo.com/ [13 April 2011] Read More