Financial Strategy for H&M Company - Report Example

Finance Strategy Analysis of H&M Name Institution Date Executive summary The focus of this report is on analysis of the financial strategy for H&M Company, which is headquartered in Stockholm, Sweden. H&M is among the leading global fashion retailer. The report covers analysis of financial and strategic positions of the company. Specifically, the report covered the following aspects; Raising & Sources of Finance, Capital Structure, Working Capital Management, Strategic Capital Investments, Dividend Policy, Risk Management and Financial Performance. The report further has identified the major strategic financial issues and suggested recommendations necessary for improving the company’s financial and strategic position. Table of Contents Executive summary 2 Finance Strategy Analysis of H&M 4 Introduction & Company Overview 4 Financial analysis 5 Sources of finances for H&M 5 Advantages and disadvantages of debt financing 5 Strategic implications 6 Financial issues 7 Strategic financial implications 8 Financial issues 8 Financial assessment 9 H&M financial performance compared to competitors and industry 9 Risk Management 10 Financial Risk 10 Return on equity 10 Liquidity ratios 11 Strategic implications 13 Financial issues 13 Strategic implications 13 Strategic issues 14 Overall Strategic issues 14 Handling resources changes 14 Global strategy problem 14 Global strategy problem 15 Handling resources changes 17 References 21 Delaney P & Ray W, 2008, Wiley CPA Exam Review 2009: Financial Accounting and Reporting, New York, John Wiley & Sons. 21 Daniel B, 2014, A Comparison Of Inditex And H&M, 21 Market Watch, 2017, H&M Hennes & Mauritz AB Series B 22 22 Finance Strategy Analysis of H&M Introduction & Company Overview H&M is a leading global fashion retailer that offers wide range of fashion. The company was established in Sweden in 1948 and was listed on the Stockholm Stock Exchange in 1974. The company has been expanding and has major stores worldwide including in European markets such as United Kingdom, Germany, Netherlands, and France. In 2006 H&M opened stores in U.S and launched several designer collaborations with major fashion stores including Karl Lagerfeld (The H&M Group, 2015). In 2006, the company began major expansion of online and catalogue sales. Until 2014, the company constantly expanded its operations to South America, Asia and Oceania. Currently, H&M is among the world’s major fashion organisations and is present in more than 38 countries and has more than 55 markets and 2220 stores worldwide. However, even though H&M has global presence, the company is comparatively concentrated in Nordic and German markets where it gets about 40 percent o its sales (The H&M Group, 2015). In 2014, H&M’s sales exclusive of VAT were SEK 109 billion. Profit after financial items totalled to SEK 18,096 million which was a 19% increase from the financial year, 2014. Basically, H&M is a 100 billion SEK organisation that engages in designing and retailing of fashion clothing and accessories. H&M offers diverse fashion clothing, accessories, cosmetics, footwear for both men and women and children as well. H&M headquarter is at Stockholm, Sweden and has about 53, 430 employees on full time basis (The H&M Group, 2015).   Financial analysis Sources of finances for H&M The most common sources of funding for H&M include debt financing and equity financing. The company also raises funds via trading stocks. For instance, due to the in store and online expansions, the stock-in-trade rose by 18% in SEK in 2015 when compared to 2014. But notably, most of the company’s funding is generated from debts. H&M gets it debt funding from bank loans. The company acquires loans from banks that have a minimum rating of AA. However, short term debts for H&M have remained steady with time whereas long term debts have increased. For instance, in 2015 maximum credit exposure totalled to SEK 18, 540 million while the average debt was approximately SEK 2,330 (Wortham, 2014). Advantages and disadvantages of debt financing H&M mostly uses debt financing as the source of its funding. Some of advantages that come with H&M using debt financing include retaining control of the business because lenders do not have a say on how the company should be managed. Another advantage is tax advantage because the amount paid in interest is tax deductible, efficiently decreasing the company’s net obligation. However, using debt financing as a source of funding might make the company to be overly dependent on debts which might make the company to be perceived as “high risk” by potential investors and this can restrict the company’s access to equity funding at some point (Wortham, 2014). Therefore, the analysis shows that H&M is more advantageous when using debt financing as opposed to equity funding. Moreover, the company is also likely to get government aid during financial crisis and this indicates that the company can take risky debt burdens because there is no likelihood of H&M going bankrupt. In addition, H&M uses the debts funding in fuelling its sales and this means that debt financing as a source of financing increases its sales and hence increases its profitability. H&M has managed to manage its debts effectively and this is indicated by the company’s maximum credit exposure of SEK 18,540 as at November 2015. In addition, the company’s average debt in 2015 was approximately 2, 330 and bad debts from accounts receivable have been insignificant. This indicates the company’s comparatively strong position regarding business and financial risks (Wortham, 2014). Strategic implications Using debt financing as source of financing ensure that the company is in total control of the company During positive economic conditions, H&M has good long-term debt load and hence the company is likely to expand and fuel its sales through debt financing However, debt financing implies high and more interest rates that the company has to pay to its lenders and these expenses are passed to the company which may reduce the company’s profit margin H&M is flexible financially and this can be indicated by high cash reserves as well as low credit risk exposure Clothing industry has become very overcrowded and this has resulted to increased competition and hence H&M is likely to lose its market share Government aid during financial crisis can prevent H&M from going bankrupt bit this can harm the share price The company should consider using both equity funding and debt financing as sources of financing since this will prevent the company from being overly dependent on debt financing which comes with high interest rates Financial issues High interest rates from debt financing Long-term debt burden Capital structure In H&M, the capital structure is financed from equity and its debt is insignificant. Actually, the debt ratio at H&M has been nearly zero and this is as a result of the company being able to generate good cash flow and reinvesting back into the firm, opening new clothing stores and also focusing on expansion strategy. In 2016, H&M earned 23, 78 billion from its operations for a cash flow margin of 12.37%. Additionally, H&M utilised 13.50 on investing activities and in addition paid 14.07bn in financing cash flows (Wortham, 2014). Regarding the equity strategy of H&M, the company utilises little debt within its capital structure as illustrated by a debt ratio of 0.19% (IC Markets, 2017) which is insignificant. This is per Wortham (2014) who explains that some ratios are good when high but dent-to-equity ratio should be within logical range and less than 1 is suitable. Organisations have two choices for funding their businesses and they include; borrowing funds from lenders or acquiring funds from equity and issuing equity with a slight sum of debt and this reflects a company’s stability. Generally, the total amount of debt to equity that H&M hold is lower than the industry standard. The low debt to equity ratio indicates that H&M is able to meet its financial obligations in case of financial crisis. In addition, H&M’s business and financial risk are low (Wortham, 2014). Strategic financial implications A low equity debt ratio ensures that the company is able to access capital and funding for its business and also favourable lending terms Low equity debt ratio for H&M is likely to attract investors H&M’s business and financial risk are low and hence the company does not have the likelihood of going bankrupt H&M mostly depends on external funding and therefore the company spends a big percentage of its finances in funding loans and high interests which greatly reduces the company’s revenues Financial issues H&M secures all its loans and this reduces the company’s strategic flexibility The company spends a significant amount of its finances in funding its loans and other debts and this reduces its revenues Financial assessment H&M financial performance compared to competitors and industry Retailing industry, where H&M is a part of, is growing fast despite the hard times the industry has been going through in the global economy. However, in the specific case of H&M, the company has performed above the average within its industry and this is illustrated by different factors like varied age groups, varied market segments, “range diversification with diverse brands” as well as a business model that puts emphasis on global investments (Daniel, 2014). Generally, H&M is ahead of its rivals such as Inditex, NEXT plc or GAP, which are struggling when compared to H&M. H&M, had its sales increase from €19 billion to €22 billion and this is evidently a well financial performance under the present global financial situation (Hennes & Mauritz, 2016). H&M has been doing much better when compared to its competitors that are also doing well. For example in the year 2015 to 2016, H&M, had its sales increase from €19 billion to €22 billion while Inditex had its sales increase from €14 billion to €20 billion (Inditex, 2016). H&M still has its profits higher than its competitors. Likewise, it is important to note that H&M’s shares have remained stable within the stock market over the past years whereas competitors such as GAP have been experiencing a drop. According to Delaney & Ray (2008) the financial performance of H&M is superior and profitable when compared to its rivals within the industry. This indicates that the performance of H&M within its industry is better when compared to the average within the financial field (Delaney & Ray, 2008). Risk Management Financial Risk Some of the financial ratios used to examine the performance of H&M and the efficacy of the firms operations and investment policies include ration analysis and cash flow analysis. Therefore, comparison of financial rations in different years was done. Return on equity (ROE) was used in examining the company’s overall profitability because ROE captures how efficiently the invested funds are employed in returns generation (Weetman, 2013). Return on equity Overall, return on equity (ROE) for H&M increased from 44.5% in 2013 to 46.5 in 2014 and the operating ROA was the key driver. This percentage of ROE is good because investors want the ROE to be as high as possible. In 2016, H&M had a ROE of 38.97 and this is a strong indicator that H&M is performing well and likely to attract investors (Daniel, 2014). Liquidity ratios Liquidity ratios consist of the current ratio and the quick ratio. The current ratio shows the ability of a firm to pay its debt during its business cycle. The ideal value for current is 2:1. The higher the current ratio, the more the ability the company has to pay its debts. On the other hand, the quick ratio shows a firm’s short-term liquidity and this means the ability of a firm to utilise its quick assets in paying its current liabilities (Weetman, 2013). The ideal value for current ratio is1:1. A quick ratio that is higher than 1:1 shows that the company has the ability to meet its current financial duties with the available fast finances on hand. On the other hand, a quick ratio that is below 1:1 might show that the company depends too much on inventory or other assets in paying its short term liabilities. H&M has current ratio of 1.99 and this shows that company can pay its debts effectively. H&M’s quick ratio is 0.95 and this shows that the company depends too much on its inventory and other assets in paying its short term liabilities, which is not a good indicator. However, H&M has good liquidity cash and hence it is not exposed to significant liquidity risk since it has sufficient cash to meet outflows (Weetman, 2013). Strategic implications Clothing industry has forceful competition H&M does not have significant liquidity risk. However, the quick ratio shows that the company depends too much on inventory to pay its short term liabilities (Oktemgil, 2016) Financial and strategic issues The company relies too much on inventory to pay its short-term liabilities Working Capital & Cash Flow Management Working Capital Management H&M has a working capital of 11.45 (The Wall Street Journal, 2017). Generally, H&M working capital is relatively high when compared to its competitors. Because the company can use its working capital in financing its debts as well as a source of internal funding, the working capital can further reduce. It is therefore advisable for the company to reduce its working capital cycle in order to free up some funds to reduce the financial debt load, and hence reduce its financial risk (Daniel, 2014). Figure 1: Per share data Cash Flow Management Even though there were fluctuations, cash flows have been increasing progressively throughout 2016 as indicated by the figure below. In addition, H&M cash flow from operations has been relatively stable throughout 2016 and this indicates absence of any business risk for the company. H&M can still improve the cash flow in order to be able to compete more effectively with its competitors and also reduce debts (Market Watch, 2017). Strategic implications The company can improve how it uses its working capital in order to improve cash cycle and further reduce financial risk It is important for H&M to stabilize and improve its cash flow position in order to be in the same position with its rivals H&M should improve cash flow to ensure that it covers all major interest expenses and also cover its short term obligations (Oktemgil, 2016) Financial issues The company is not using its working capital efficiently to fund its debts and other internal needs Cash flow from operations might not be adequate to fund all the companies debt obligations and this is the reason the company mostly depends on debt financing to fund its financial obligations Dividend Policy H&M has had its dividend policy fluctuating. For instance, H&M board of directors has proposed the dividend of SEK 9.75 per share which should be paid in two instalments. The first instalment is set to be paid on May 2017 while the second instalment is set to be paid on November 2017. Taking the firm’s relatively weak cash flow, investors and shareholders should not consider maximising shareholder wealth by purchasing more dividends (Market Watch, 2017). Strategic implications The company is likely to continue increasing dividends in order to ensure the shareholders are satisfied The company should increase dividends steadily to ensure that H&M weak cash flow position improves Strategic issues H&M increasing the dividend in order to maximise shareholder wealth strains the company Due to competition from its rivals, H&M has been forced to maintain its dividend policy Overall Strategic issues Handling resources changes Because of economic and resources changes, in an event H&M decided to gain sustainable profits, the company should fit the environmental changes. Therefore, the company should take into consideration problems like climatical changes, working conditions as well as payment for supplier factories (Jackson & Shaw, 2004). Global strategy problem The company’s global strategy is centralising and tailoring its product strategy to fit the United States, market. The company has focused on more upscale malls as well as busy downtown locations and opens smaller local stores. Nonetheless, H&M has not been able to meet different needs of customers with every individual market, and hence there is a likelihood of the company to lose competitive forces and market share when compared to its competitors. In addition, it is hard for H&M to maintain social and environmental standards within different geographical locations, for instance fair payment and overtime (Johnson, et al, 2014). Strategic Options & Evaluation Global strategy problem Option 1 Invest more on advertising and product improvement and distribute dividend once a year. H&M has unstable cash flow. The company should ensure there is stable cash flow in order to reduce its business risk and have more available cash for more investments. H&M distributes its shares twice a year and thus the company can opt to be distributing shares once a year in order to have more cash at hand. The availed cash can be used for further investments and improving its competitive position, perhaps by availing more cash for advertising and product improvement. Option 2 H&M should take advantage of the current trends towards more fashionable clothes and other products. The company needs to meet the standards of all customers in order to gain market share in the industry and maintain competitive edge. Option 3 H&M needs to constantly continue evolving its products. This is because consumer preferences globally are always changing and hence the company should produce products that match and satisfy consumer’s changing demands. Option 4 H&M should not rely on Government Bailout during financial crisis. This is because in case of a financial crisis, government bailout may not be of so much help because the company might end up losing its shareholders and the share price dropping drastically. SAF table evaluates the two options to determine which is the most appropriate Strategic options Suitability Acceptability Feasibility Invest more on advertising and product improvement and distribute dividend once a year Avail more cash Improve competitive position Shareholders likely to reject reduced dividends Financially possible H&M needs to constantly continue evolving its products Attract more customers and hence increased cash flow Grow cash flow Does not require shareholder’s investment Financially possible Reduce company’s financial risk From the SAF evaluation, the second option of constantly evolving the products is accepted because it is more acceptable because of its suitability, acceptability and sustainability. The first option is to reduce dividends and invest more on advertising is rejected. Action plan The below action plan provides steps that H&M should take in a duration of 5 years in order to constantly evolve its products to ensure increased acceptability 1.1 Years H&M should forge the right partnerships in order to leverage valuable access to accomplish its objectives. This will include establishing regional capacity and increasing knowledge of market to identify the customers’ needs and evolve the products accordingly. 2.3 Years H&M should conduct market research to find out the current trends and suit its products accordingly. 3-5 years H&M should ensure that in 5 years it is the leading fashion company worldwide. This can be done by performing broad market research to determine future consumer preferences and regulations. Handling resources changes Option 1: Reduce debt funding H&M has been focusing on debt financing to fund its undertakings. However, using debt financing as a source of funding might make the company to be overly dependent on debts which might make the company to be perceived as “high risk” by potential investors and this can restrict the company’s access to equity funding at some point. In addition, debt financing comes with high interests which further reduce the company’s cash flow. Therefore, H&M should consider equity funding as a complementary source of funding. Option 2 H&M should bring to an end its cash flow fluctuations. In order to achieve this, the company needs to completely stabilize its cash flow. This is because unstable cash flow for the company is an indication that there is a strategic problem with the company. Option 3 The company should avoid putting too much of its finances in funding high interest rates from lenders. This is because H&M’s interest expense is likely to continue increasing. Option 4 H&M should focus on stabilizing its credit’s business model in order to ensure that the amount of debts the company is manageable. In addition, the company should ensure the debt decreases in order for it to be in a position to secure adequate funds and outdo its competitors when it comes to being credibility. Strategic options Suitability Acceptability Feasibility Stabilizing its credit’s business model Avail more cash Manageable debts Sustainable results Improve H&M’s competitive advantage Financially possible Reduce debt funding Reduce cash spent on high interests Attract potential investors Does not require shareholder’s investment Financially possible Decrease financial profiling as “high risk” From the SAF evaluation, the second option to reducing debt financing is accepted because it is more acceptable because of its suitability, acceptability and sustainability. Action plan The below action plan provides steps that H&M should take in a duration of 5 years in order to stabilize, improve its debt position, have a competitive edge and increase cash flow from operations. 1.2 Years H&M should continue working with the same capital structure and equity strategy because it has been financially successful and meets the expectations of the stakeholders 1.2 Years H&M should open a slight percentage of its shares to diverse shareholders since the current shareholders consist of the same group 2.4 Years The company need to consider also using equity financing to fund its debts rather than concentrating on debt funding 3-5 years H&M should ensure that in 5 years it is the leading fashion company worldwide. This can be done by performing extensive market research to determine future consumer preferences and regulations. This can also be achieved through extensive advertising. References Delaney P & Ray W, 2008, Wiley CPA Exam Review 2009: Financial Accounting and Reporting, New York, John Wiley & Sons. Daniel B, 2014, A Comparison Of Inditex And H&M, < https://seekingalpha.com/article/2735425-a-comparison-of-inditex-and-h-and-m> IBP. Inc, 2016, Indonesia Clothing and Textile Industry Handbook Volume 1 Strategic Information and Contacts, London, Lulu.com. Jackson T & Shaw D, 2004, The Fashion Handbook, New York: Routledge. Johnson, G., Whittington, R., Scholes, K., Angwin, D., & Regnér, P., 2014, Exploring Strategy: Text & Cases, Harlow, England: Pearson Higher Education. Market Watch, 2017, H&M Hennes & Mauritz AB Series B Oktemgil, M, 2016, E-book on Finance & Strategy. Birmingham: University of Birmingham The Wall Street Journal, 2017, H&M Hennes & Mauritz AB Series B, http://quotes.wsj.com/SE/XSTO/HMB/financials/annual/cash-flow Ray W, 2012, Wiley CPA Exam Review 2013, Financial Accounting and Reporting, New York: John Wiley & Sons. The H&M Group, 2015, H&M Annual Report 2015, H&M. Wortham, H., 2014, H&M produces Eco-friendly Clothing for Conscious Consumers. Weetman, P., 2013, Financial & Management Accounting: An Introduction, Harlow, UK: Pearson. Appendix Cash flow in the year 2016 H&M most recent share price Read More