FINANCIAL RATIO ANALYSIS OF TESCO PLC - Essay Example

? FINANCIAL RATIO ANALYSIS OF TESCO PLC Introduction Started as a small market stall in London’s East End in 1919 by Jack Cohen, today, Tesco Plc is the globe’s third largest supermarket with business operations spanning across 14 nations thereby serving millions of customers every week and offering jobs to more than 520,000 peoples around the world. In UK, Tesco is the largest retailer and in UK, it serves about 66% of the retailer market and occupies about 33% of the selling space. Jack marketed his own brand tea as Tesco tea as early as 1924 and he opened the first Tesco store in North London in 1929. The first ever modern food warehouse was established in UK by Jack Cohen in 1934. Jack expanded his business by buying stores in London suburbs in 1937. In 1947, the Tesco Stores (Holdings) was registered in London Stock Exchange with a share price of as low as 25 pence with today’s price of ?318. Headquartered at Cheshunt, UK, today, Tesco is engaged in retail grocery operations through 5000 retail stores both in UK and around the world. In 2012, Tesco’s turnover is ? 72 billion, its revenue is ? 42.8 bn and its UK revenue is ?2.5bn. Tesco stores offers groceries, food items, electrical and electronic products, apparels, general merchandisers and also engaged in insurance and financial services , retail banking , distribution , data analysis and property operations . “The Form and Content of Annual Report” Tesco Plc form of the annual report for the year 2012 is easily accessible and can be downloaded from their websites. It facilitates the researchers to look for general and exhaustive info about the company. The annual report is well structured and designed and includes 158 pages .It starts with the financial indicators for the year 2012. It commences with the Chairman’s statement, CEO’s review, directors report on corporate governance, Director’s remuneration report, and auditor’s report. For arriving at revenue prior tax from continuing business operations, the company employed IAS 32 and IAS 39 fair value remeasurements of financial instruments, IAS 17 for impacts annual increase in rents in leases transactions, IAS 19 for charge for pension for employee benefits, IFRS for amortisation charges for business combinations and IFRIC 13 for fair value of customer loyalty schemes. (Tesco’s Annual Report 2012:89). Auditors from PricewaterhouseCoopers LLP confirm that the financial statements are prepared in tune with applicable laws of United Kingdom and as per International Financial Reporting Standards (IFRS) as espoused by the European Union. The consolidated statements are also formed in accordance with the Article 4 of the IAS Regulation and Companies Act 2006. Besides, there are 35 notes to the financial statements in the annual report that elaborates all financial indicators in the statements. The annual report continues with the Tesco PLC parent company financial statements, and then with the short financial narration that covers the last five years. The annual report last page is devoted to shareholders. In their section, shareholders may get exhaustive information about annual meetings, financial calendar, dividends, record date, interim financial announcement date, interim management statement and so on. An Analysis of Financial Position, Performance and Prospects of the Company Financial ratios will trounce absolute value distortions and help to evaluate the company’s performance and hence ratios are very popular tools in the capital market analysis. As per Beaver (1966), if a company is in financial trouble, then one can identify the same from the financial ratios. As per Beaver, financial ratios help to predict the failure of corporate well before five years of their failure. Jen (1963) identified the capability to obtain credit is directly connected with some financial ratios. Financial ratios are also having direct impact on the stock prices of a company and it also impacts the investment decisions. As per Gibson (1997) , when analysts were asked to which they would give importance whether to liquidity or profitability ratios , they replied in majority that they would give more weight to profitability ratios with return on equity after tax as a significant ratio to find out the financial health of a company.(Bini & Dainelli ,2011,p.20). Financial ratios can be very useful for comparing the businesses in the same industry and analyzing the numeric changes in financial statements between the consecutive years. Five main types of financial ratios are profitability, liquidity, efficiency, investment and financial gearing ratios. (Baker & Powell 2009:71). Profitability Ratios ROE Return on equity ratio falls under the profitability ratios category that evaluates the quantum of profit for the financial period available to shareholders of the company during that given period. If the value is high, then it is understood that business is performing well. Measurement of business performance can be evaluated through return on capital employed ratio. This ratio recognizes the relationship between the long-term capital invested in the company and the operating revenue of the business for a certain period. Tesco’s ROE 2012 2011 16.30 16.96 During the year, there has been reduction in ROE to the extent of 0.66% as contrasted to the year 2011.This connotes that increase in competitors’ activities and decline in profit may be due to high overheads of advertising and marketing. TESCO’S ROCE Target for 2014/15 2012 2011 14.6 13.3 12.9 In the year 2012,ROCE of Tesco has augmented by 0.40%. This is due to significant growth in Tesco’s operating profit in the last one year and Tesco is able to control its overheads during this year as compared to last year. Operating and Gross Profit Margin Ratio The relation between the sales revenue and the operating profit of a business during a given period can be known through Operating profit margin ratio. This ratio depicts the revenue from company’s trading operations and is frequently considered as the most pertinent ratio of operational performance. Ratio underpins the variances between two outputs of the business. The indicator might be varying within the various kinds of businesses. (Baker & Powell 2009:71). Tesco’s Operating Margin Ratio 2012 2011 6.4 6.1 There is a decline in Tesco’s operating profit margin ratio to the tune of 0.30% during 2012. The decline may be attributed to no flow of profits from its Japan operations and TESCO management has decided to sell its Japan’s operations. (Tesco’s Annual Report 2012:20). Tesco’s Gross Margin Ratio 2012 2011 12.27 11.80 (Tesco’s Annual Report 2012:94). Gross profit margin ratio indicates to what magnitude the selling price of products may be lowered without any financial losses on business operations. Tesco during the year is able to achieve 0.47% increase in its gross profit margin ratio and this indicates that Tesco is able to increase its selling prices of the products without corresponding increase in the cost of goods sold. Efficiency Ratios Thus, efficiency ratios are useful to measure how best the resource of the business is managed. Inventories Holding Period; Debtors Collection Period; Trade Credit Period The above ratios are connected with each other and typically articulated in days. The average period that inventories remain in the company between sale and purchase is indicated by inventory holding period ratio. Debtor’s collection period compares trade receivables with sales. Trade Credit Period states the association between trade payables and cost of sales (Alexander, et al, 2007). Tesco’s Payable Period 2012 2011 35.84 36.18 Efficiency TTM Days Sales Outstanding 15.85 Days Inventory 21.98 Cash Conversion Cycle -29.02 Receivables Turnover 23.02 Inventory Turnover 16.61 Source: http://financials.morningstar.com/ratios/r.html?t=TSCDY Since Tesco sales are made through online and also through swiping of credit cards, it has just 23 days receivable turnover that means it has adequate liquidity to meet its current liabilities. Asset Turnover Ratio The effectiveness of asset utilisation of a company is being depicted by the Asset Turnover Ratio. This ratio helps to offer the association between sales and assets. If this ratio declines, then it indicates that investment in assets of the company are producing a favourable return. (Sheeba 2011:130). Tesco’s Gross Assets Turnover Ratio 2012 2011 1.30 1.32 Tesco employs a weighted average footed upon the actual assets owned by the company and the anticipated return on the separate class of assets held by the company. Comparing to last year, there is slight improvement in the usage of company assets to generate higher sales. (Tesco’s Annual Report 2012:139). Liquidity Ratios The capability of the company to meet its short-term liabilities is depicted by Liquidity ratios. Current Ratio The quantum of liquid assets to meet the current liabilities of a company is calculated through Current ratio. The normal accepted current assets to that of current liabilities ratio is ‘2:1’. However, this is not a strict measurement and it wholly relies upon the type of the business and it may vary from industry to industry. Tesco’s Current Ratio 2012 2011 0.67 0.68 Tesco has a current ratio of 0.67 in 2012 which is not a preferable indicator since Tesco is having more than double as much liability with fewer assets to meet it. This can be regarded as not a good pointer from the investors’ angle since the Tesco’s current liabilities are not supported by an adequate quantum of current assets. Tesco should rethink of its credit policies and should try to offer lesser credit period to its customers to enhance its current ratio. Acid Test or Quick Ratio Though this ratio is almost analogues to that of the current ratio, but it underpins the liquidity of a business more precisely. The preferred level for this ratio is 1: 0 which connotes that current assets’ excluding inventories is equal to current liabilities. Tesco’s Acid Test Ratio or Quick Ratio 2012 2011 0.12 0.14 As compared to last year, there is slight decrease in Tesco’s quick ratio. However, during current year, Tesco is having adequate current assets to support their current liabilities and Tesco is able payback to the investors their dividend even during the global economic crisis. This rising trend is what attracts the investors to Tesco. Gearing Ratios Gearing ratio is the best indicator whether a business can pay-off its long-term liabilities .Gearing is referred also leverage and is employed to denote the association between non-interest bearing finance like shareholders’ funds and reserves and surplus with that of long-run debt on which a fixed rate of interest is payable . Low gearing ratios indicates where there is more capital and very less interest bearing debt and vice-versa. High gearing ratio will always have a greater risk and hence it should be averted. Hence, in decision making procedures for managers, financial gearing plays a crucial role. (Gruen 2005:161). “Tesco’s Gearing Ratio” 2012 2011 38.40 40.80 (Tesco’s Annual Report 2012:29). Tesco appears to have a balanced gearing ratio as it is having a debt of 39% and equity of 61%. In 2009, Tesco had a higher gearing ratio of 74.4% which was regarded as higher financial risk. In the year 2009, it raised €6,438 million as long term debt. However, it has managed to pay back its debt portion within two years and this is regarded as a good indicator. Indebtedness of Tesco (Tesco’s Annual Report 2012:30). As we have already seen, the indebtedness of Tesco was its peak in 2009 and it dramatically reduced its debt within two years and is now having a good gearing ratio. The performance of shares of a company is depicted through the investment ratios. This ratio calculates the returns to equity shareholders against their investment in a company. “Dividend payout ratio” The quantum of dividend paid out of profits of the company is being indicated by this ratio. This ratio relates the dividends to the profit for the year. Tesco has paid an interim dividend and final dividend in the year 2012 .As compared to earlier year, there is increase in dividend payout ratio of 2.1% “Tesco’s Dividend Payout Ratio” 2012 2011 14.76 p 14.46p (Tesco’s Annual Report 2012:48). “Dividend yield ratio” The cash return to the shareholders’ investment in the company can be measured with the help of this ratio. Tesco’s Dividend Yield Ratio 2012 2011 4.1 3.5 (Tesco’s Annual Report 2012:133). As compared to the last year, Tesco’s shareholders have received higher return on their investment. “EPS (Earning Per Share)” The quantum of profits after tax for the year divided by the number of ordinary shares is depicted through this ratio. With the aid of this ratio, analysts can evaluate the investment competency by investors in a company. Tesco’s Dividend Yield Ratio 2012 2011 2.1 10.8 (Tesco’s Annual Report 2012:29). A slight increase in basic diluted earnings per share mirrors the meek progress in earnings in this year as compared to last year. The planned whole year dividend increased by 2.1%, in tune with this, to 14.76p which indicates the Tesco’s prolonging its unparalleled record of successive years of dividend growth in the FTSE 100 company shares. The performance results of discontinued operation at Japan of 37.41 p were not included in the underlying earnings per share for the year 2012. (Tesco’s Annual Report 2012:72). P/E ratio P/E- profit/ earnings ratio is calculated with the present share price of the company divided by the earnings per share (EPS). Companies with the highest growth features will have higher PE ratios. For instance, if a pharmaceutical company with good R&D prospects together if there is a chance of discovering a blockbuster drug will have higher PE ratios. (Beynon & Porter 2000: 60). “Tesco’s P/E Ratio” 2012 2011 9.09 12.27 The sharp decline in Tesco’s P/E ratio indicates that the investors are more worried about the uncertain future due to recent economic crisis and hence they are hesitant to pay much for Tesco’s future earnings. To address this, Tesco management is planning to forego some short-run revenues to re-invest in the long-run progress of the business. Tesco UKs performance was poor and this is mainly due to declining real income and high petrol prices which impacted discretionary spending pattern of consumers in the year 2012. (Tesco’s Annual Report 2012:3). The Past Five years Key Ratios of TESCO PLC 25/02/12 26/02/11 27/02/10 28/02/09 23/02/08 P/E Ratio 9.1 12.27 14.31 12.12 14.85 PEG (Historical Growth} 1.17 1.2 1.76 1.55 1.08 ROCE 10.92 10.8 9.58 9.92 12.77 Turnover per Share 8.046 7.597 7.174 6.913 6.002 Operating Margin 4.35 4.36 4.09 3.98 4.49 Return on Assets 6.38 6.45 5.94 6.44 8.43 EV/BIT 8.11 10.35 11.57 11.57 12.49 Gearing (Long Term Liab) 39.76 39.98 47.48 55.87 40.36 P/BV Ratio 1.44 1.98 2.3 2.02 2.65 P/Cash Flow Ratio 6.02 8.18 8.99 7.4 9.37 Quick Ratio 0.43 0.44 0.52 0.56 Source- http://shares.telegraph.co.uk/fundamentals/?epic=TSCO Conclusion Tesco is one of the top food retailers on international level. Tesco is the 3rd largest grocery retailer on the international level .In UK; Tesco has become number one retailer. Now, it has expanded its operations in Asia and across Eastern Europe. From the above ratio analysis, we can understand that Tesco is having a steady financial performance in the last years and is able to survive through the recent global financial crisis. Though, Tesco performance is steadily increasing, but it is still have many Achilles' heel which need to be improved. Though ratio analysis has many limitations and may not reveal the true status of Tesco’s operational performance, but there are some strong signals that it has to correct the same to have bright future ahead. In the year 2012, Tesco group sales are ?72 billion and there has been an increase of 7.4% of group sales growth as compared to last year. Tesco profit before tax is ?5.8 bn which denotes an increase of 5.3% of group profit before tax as compared to last year. Tesco’s UK’s profit growth was diffident thought it had good international performance in 2012 but this was offset by the decline in UK performance. The sharp decline in Tesco’s P/E ratio indicates that the investors are more worried about the uncertain future due to recent economic crisis. Growth in before tax revenues is just 1.6% in the year 2012 as compared to “12.3% in the year 2011.” Tesco’s current year profits is impacted by Hungary crisis tax payment of ?38 mn and payment protection insurance (PPI) in Tesco bank amounted to ?57mn. During the year, Tesco discontinued its Japan operations. Despite the fact that Tesco’s UK performance was somewhat weaker than projected, there has been sight increase in “ROCE 0.40% in the year 2012. “ (Tesco’s Annual Report 2012:29). Despite of global economic meltdown and crisis in the EU, Tesco is able to demonstrate increased sales, revenue, dividend payout and return on capital which highlights for its overall pliability. Despite of all these weakness and negative signs, Tesco is a preferred stock for the investors and future of Tesco is also bright as it is the 3rd largest grocery retailer on the international level References Alexander, D., Nobes, C. (2007) Financial Accounting 3rd ed. Essex: Pearson Education Limited. Baker, HK & Powell, G. (2009). Understanding Financial Management: A Practical Guide. New York: John Wiley & Sons. Beynon& Porter, A. (2000). Valuing Pharmaceutical Companies. New York: Woodhead Publishing. Bini, L & Dainelli (2011).The Informational Capacity of Financial Performance. London: Maffioli Editore. Gruen, R. (2005). Financial Management in Health Services. New York: Open University Press. Morning Star Financials. (2012). Growth, Profitability and Financials of Tesco Plc. [online] available from [accessed 27 November 2012] Sheeba, K. (2011). Financial Management .New Delhi: Pearson Education India. Tesco Plc. (2012). Annual Report 2012. . [online] available from < http://www.tescoplc.com/files/reports/ar2012/index.asp > [accessed 27 November 2012] Read More