Decision Making for Managers: Marks and Spencer - Assignment Example

Decision Making For Managers: Marks and Spencer Executive Summary Before the onset of financial crises and economic slowdown, demand was high for the consumer goods and different departments were performing quite well with higher growth rate. But the crash of housing bubble in US disturbed economics of whole world and resulted in drastic fall in the stock prices of all the companies. Before making investment in any of the company, an investor should undertake an in-depth financial analysis. It is also recommended that share prices movement for at least 4 weeks should be considered for understanding mood of equity investors. When the market will recover, companies with better fundamental state will be the one to come as market leaders and they will yield better results to the investors. So an investor should analyse any company comparison with the industry standards before taking any major decision. In the below given section a research has been conducted to find out whether Marks and Spencer can be a good choice for an investor. Introduction of Marks and Spencer Markers and Spencer is a UK based retail company where around 21 million people visit its stores each week. Their supplies base comprises of more than 2,000 around the world who supplies stylish and high quality cloths, home products and food items. They have around 600 stores in UK where more than 75,000 employees are working in UK stores. The business is expanding at a faster rate in international market also. The retail business is divisible in two section; the cloths and home ware section which contributes 49 percent of the total revenue and food section from where the rest of 51 percent of the sale is generated. The company is also known for its “green credential” as they have taken a plan to reduce carbon emission and no waste to landfills by the year 2012 (Marks and Spencer, n.d.). Financial performance of the company from 2005-2009 Majority of company’s revenue is generated in UK and the remaining comes from international market. On analysing the sales data over last five years (2005-2009) it was found that the revenue is not showing a constant upward trend, but the good sign is it has increased 5.5 percent from 2008 to 2009 and with passage of time as the economical condition of UK will improve along with high demand in developing nations, revenues will go much higher. At present the company is taking more initiatives in diversifying the business in developing nations. In 2007/2008 the company adopted a strategy to attain a growth to 15-20 percent in its international business and soon it is going to touch the target with 25.9 percent hike in sales. Initially the company paid more emphasis on expanding their franchises in unexplored markets, but now it is planning to undertake partly or fully owned subsidiaries (Company Annual Report, 2009). To analyse the fundamental financial performance of the company, its profitability and investment aspects were analysed by calculating different financial ratios for the past five years (2005-2009). Profitability: the term profitability of the firm indicates how the firm performs as per its net sale or the capital employed. By analysing different profitable ratio, one can analyse the success of corporate management during that phase. For understanding the financial profitability of marks and Spencer, its gross profit ratio, net profit ratio, return on shareholders’ funds, return on capital employed are calculated (Lee, 2007, p. 252). Gross Profit Ratio is calculated as Gross Profit / Annual Sale (Turnover) * 100 Net Profit Ratio is calculated as Net Profit / Annual sale (Turnover) * 100 Return on Shareholders Fund is calculated as Profit Before Tax / Share Holders Fund * 100 Return On Capital Employed is calculated as Profit Before Interest & Tax / Capital Employed (TA-CL) * 100 The results obtained after calculating the data are given as follows: Ratio 2009 2008 2007 2006 2005 Gross Profit Ratio 37.21% 38.65% 38.90% 38.29% 35.49% Net Profit Ratio 5.59% 9.01% 7.68% 6.68% 7.39% Return on Shareholders Fund 33.92% 57.70% 56.88% 64.55% 142.94% Return on Capital Employed 14.44% 21.83% 24.81% 23.35% 24.88% The ratios indicates that from 2005 till 2007, company’s gross profitibility was showing a healthy growth ternd, but after that it went on declining and showed a sharp downward trend from 2008 to 2009. The net profitibility of Marks and Spencer was almost steady with a mild growth untill 2008, but it fell drastically from 2008 to 2009. It can be concluded that company’s net profit got affected more heavily as compared to the gross profit due to financial downturn. Though the company’s profitibility was increasing from 2006-2007, but return on shareholders fund was declining and it fell sharply from 2005 to 2006. One of the reason for such fall is increase in shareholders fund. From 2006 till 2008 it was more or less stable and then again showed a downward trend. On considering the Return on Capital Employed, it can be concluded that the company retained a steady return on its capital, but from 2007 onwards it started showing a downward trend. Before making investment in a company, the investors undertake certain ratios like Earning per Share, Dividend Payment Ratio and Price Earnings Ratio. It helps them to understand the current market condition of the company, its past as well as its future performance (Smart & Megginson, 2008, p. 49-50). Ratio 2009 2008 2007 2006 2005 Earnings per share 0.23 0.07 0.04 0.02 0.02 Dividend Payment Ratio 43.96% 24.39% 23.53% 23.89% 24.40% Price-earnings Ratio 1286.96 5532.14 16912.50 27825.00 17300.00 Earning of the investors per share is showing a constant upward movement. And it improved highly from 2008-2009. Reason behind such upward movement is increment in the profit available to the equity shareholders as well as decline in issue of shares. For an investor it is a positive sign. The company managed a constant dividend payout ratio for 2005 to 2008 and after that it showed an upward movement. Though the profitability of the company went low, but it managed distribution of higher dividend payout. The strategy adopted by the company indicated that they are more interested in distributing the company’s profit to the shareholders, rather than accumulating it for further growth and development. So if any investor is more interested in shorter returns, it is a positive sign but the long term investors are more concerned with company’s higher growth. Price earning of the company indicates the price one in investing to earn one doller. Higher value of Price Earning Ratio gives an indication that in future the price of share are going to be higher. The P-E ratio of Markes & Spencer gives a random movement along the five year period. But taking the upward trend formed in 2008 to 2009, an investor can assume prices of the stock are going to increase in future. So overall the company’s profitability state is in a weak state from 2007 onward, but as the market conditions are improving after injection of liquidity by the government (in form of stimulus in economy), there are high chances that Marks and Spencer will be back on the profitability track soon. Even the investor’s ratios are showing a positive sign (Brigham Young University, n.d.). Liquidity, efficiency & Gearing analysis For any company, its liquidity state plays a vital role as higher liquidity indicates that capital might not be getting properly utilised and is at ideal state resulting in opportunity loss; whereas lower liquidity indicates poor cash and receivable management that might result in short term solvency (Bridge & Dodds, 1978, p. 88). To determine the liquidity state of Marks & Spencer its Current Ratio and Quick Ratio/Acid Test Ratio was calculated for the last five years. The summary of all the liquidity ratios are given below: Ration 2009 2008 2007 2006 2005 Current Ratio 0.60:1 0.59:1 0.53:1 0.57:1 0.65:1 Quick Ratio/ Acid Test Ratio 0.37:1 0.35:1 0.27:1 0.38:1 0.39:1 This ratio helps to understand if the current assets present in the company are sufficient enough to cover its current liabilities. As per the thumb rule current assets should be twice the current liabilities. On comparing Marks & Spencer’s current ratio it was found to be always below 1, but it maintained constant range of 0.50-0.65. This was due to higher current liabilities maintained by the company. Quick Ratio or Acid Test ratio gives a better picture of company’s cash and cash like assets position and a comparision to undertake short term liabilities. While calculating Quick ratio more liquid (cash or cash like) assets are taken into consideration. It was found that the company’s Quick Ratio gave a trend that is very much similar to the current assets ratio. Undertaking both of these ratios it can be conluded that Marks & Spencer (M&S) liquidity state is not giving a positive indication. This might be due to poor cash and receivables management. To reduce the liquidity risk, short term liabilities should be reduced otherwise chances of short term solvancy remains high and might result into a poor market image. Efficiency of a company measures how effectively the business is utilising its resources for genarating sales and profit (McConnon & French, n.d., p. 2). For better understanding of efficiency, turnover ratio for all the important resources are being calculated for the last five years. The important efficiency ratios are Inventory turn over ratio, Age of recievable and Age of payables. A summary of these ratios are given below: Ratio 2009 2008 2007 2006 2005 Inventory Turnover Period 34 days 32 days 29 days 28 days 24 days Age of Receivables 3 days 3 days 3 days 2 days 1 day Age of Payables 14 days 9 days 11days 11 days 9 days Inventory turnover ratio represents how many times in a year does the inventory rolls. It is represented in days, so lower the value higher is the effeiciency in inventory utilisation. The five year records of M&S indicated with passage of time, company’s inventory management efficiency is reducing. This has happened due to reduction in net sale and on the same time accumulation of inventory. If this trend continues to be the same, profitibility of the company runs the risk of getting adversely affected. Age of recievable helps to scrutinise how effectively the company is in managing its debt. A poor receivable management results in insufficient cash inflow so the possibility of facing short term solvancy goes high and company’s risk inceases. The five year ratios of M&S reflects a risky state as age of recievables is increasing. But it managed to be in a constant phase from 2007-2009. As the market conditions are improving, so it might happen that company undertakes its age of recievables for realisation of working capital. Many companies consider higher age of payables better for their financial condition because by enhancing the age of payable, company can retain liquidity for longer phase. But many other companies consider higher age of payable bad for their market reputation. While credit rating, a very small value of age of payable is considered as a negetive factor. Though M&S maintained a stable age of Payable Ratio but it showed a hike from 2008 to 2009. So it can be concluded that M&S’s efficiency is reducing year on year basis and this will hider the company’s profitibily in coming future. Gearing ratio are undertaken by the investors to determine the financial leverage in the company’s structure and the risk associated with it. For unstanding the degree of financial risk in M&S’s financial management, its Gearing ratio, Debt Ratio and interest cover Ratio for the last five years was calculated and determined. Ratio 2009 2008 2007 2006 2005 Gearing Ratio 57.43% 62.16% 114.43% 63.68% 82.60% Debt Ratio 32.05% 27.77% 29.84% 38.71 % 30.09 % Interest Cover/ Time Interest Earned 5.60 times 15.52 times 9.89 times 8.43 times 3.21 times Gearing Ratio is also known as debt equity ratio as it assists in determing the company’s financial leverage. It indicates the proportion of long term debt to total shareholders fund. Higher value of debt equity ratio indicates a higher risk for the company (Westerfield & Jaffe, 2004). For minimising the financial risk this ratio should be around 100 percent. Gearning trend maintained by M&S indicate that from 2006 to 2007 its debt-equity ratio increased and reached the 100 percent mark, but again it started declining which indicates higher risk for the company’s profitibility as well as for the investors. It reflects how much of the company’s total assets are financed by debt or the degree of debt load used by the company. Higher ratio indicates higher riskiness of the company and can disturb company’s profitability when market conditions are unfavourable. The Gearing Ration of M&S for the past five years indicates that though it did not maintain any constant trend, but it was in a range of 25-40 percent. So it was found that the company’s Debt Ratio is not so very high. This ratio measures the company’s ability to bear its financial burden which arises in form of interest to be paid for debt. This ratio is also known as times interest covered ratio. While calculating this ratio, analysts compare the company’s ability to pay the interest with the total interest payable on its debt, so higher ratio is an indicator of more stable state and less risk of default (Peterson & Fabozzi, 1999, p. 94). The Interest Coverage Ratio of M&S indicates it always has an Interest Cover Ratio greater than 1, or it can be expressed that it’s Earnings Before Interest and Tax (EBIT) was more than the interest payable. The company’s Interest Cover Ratio was constantly increasing, but due to financial downturn and economic slowdown throughout the world, this ratio declined in 2009 as profitability of the company declined. So after undertaking all the efficiency ratios of M&S it can be said the company is maintaining higher debt structure in its capital and such financial leveraging is reducing company’s ability to retain meet long-term liabilities. But the good aspect is that the company’s Interest Coverage Ratio is at a comfortable state. Financial structure analysis of Marks and Spencer Financial structure of a company indicates the proportion of debt and equity in its capital structure. Both the elements (debt and equity) have different nature and different impact on the company’s profitability. If a company introduces higher debt instruments in the capital structure, it will be considered having a higher financial leverage. There are certain benefits related with financial leveraging; the cost of debt is always lower than the cost of equity, secondly it help to get a tax benefit and finally Earning Per Share goes higher so the equity shareholders gets benefited. On the other side, the company has to bear a fixed cost in form of interest, and risk of solvency increases as breakeven point of the revenue moves to the higher level (Finnerty, 2007, p. 48-49). On considering the last five years capital structure for M&S, it can be stated the proportion of debt and equity was very unstable. Capital structure of Marks & Spencer (£000) So it can be concluded that the company’s equity base showed a constant growth, but the volume of debt used in capital was highly unstable. Such uneven use of debt affected the expense incurred by the company and directly disturbed net profits. The interests paid by the company in the last five years are presented in the below given graph: Hence at present the company is relying highly on the debt instrument for financing the business, and its risk may result in solvency if market condition gets disturbed and the financial slowdown takes a longer than expected time to recover. Share price monitoring and analysis Share price movement indicates a company’s market position as well as shareholders’ perception regarding its performance in the near future. Before making investment, an investor undertakes company’s share price movement at least for the last four weeks (1 month) to determine whether the share prices are showing an upward trend or a downward trend. But price movement seldom follows a particular proper trend; they are very much influenced by news related to the company or other domestic as well as international economic news. In the last four weeks, share price movement of Marks and Spence in New York Stock Exchange (NSE) is as follow: (Source: Guardian.co.uk, 2009) The above given graph indicates that company’s share prices were moving at a lower levels after the financial position of the firm went low due to economical downfall in all the major developed nations of the world. After the company announced it quarterly financial data that its pre-tax profit figures went to £298.3m, investors analysed its future profitability and buying of company’s share took its prices to higher levels (Guardian.co.uk-a, 2009). In the company annual report, its CEO has stated that the company plans for undertaking diversification for capturing new markets in developing nations and unexplored markets which have higher potential. They have already started making strategic collaboration for developing fully and partly owned subsidiaries. Again the positive cues regarding economic recovery will also bust M&S share prices with an expectation of better performance in coming future. Comparison of Marks and Spencer’s performance against the industry performance Marks and Spencer is in retail business and its business primarily belongs to department stores industry (Hoovers, 2009). To analyse the financial performance of Marks and Spencer, its financial ratios have to be compared against its peers. This helps to get a better understanding, how Marks and Spencer performed as per the “department stores” industry’s performance within the given time frame. To get the financial performance of a particular industry, key financial ratios are provided by Dun & Brandstreet which can be used as industry benchmark. To get the performance of a particular industry, one has to select the appropriate SIC code for that industry and then the relevant key financial ratios are be extracted. The SIC code for department store industry is 5311 (Cole Librar, 2009). Comparison of important financial ratios for the year 2008-2009 Department Store Industry Marks & Spencer Liquidity Current Ratio 3:1 0.60:1 Quick Ratio 0.4:1 0.37:1 Efficiency Age of receivables 5 days 3 days Age of payables 57days 14 days Inventory turnover ratio 76 days 34 days profitability Return on Shareholders fund 7.6% 33.92% Solvency Debt-Equity Ratio 54.1% 82.6% After making such comparisons it can be said the short term liquidity condition of M&S is as per the industry standards, though its current ratio is far below the standards. This can be due to higher current liabilities. M&S is far better than the industry in terms of efficient utilisation of resources as its age of payable is 4 times shorter than the industry average. Also inventory turnover cycle is almost half the industry standards. So the company has performed much better than industry while managing its resources. Though the industry was in a bad phase during the phase of recession, but M&S managed higher returns on shareholders fund which was almost 4.5 times of the industry averages. As discussed before, M&S is a highly leveraged company with higher percentage of debt in their capital structure, so its debt equity ratio is quite above the industry’s standards. Conclusion & Recommendation Taking a comprehensive look at the financial fundamentals of Marks and Spencer and analysing its past performance in the last five years (2005-2009) in terms of profitability, efficiency, solvency, liquidity and investment performance, it was found that from 2007 onwards company’s performance has declined in almost all the sections. The biggest risk for the company is higher debt component in the capital structure. No doubt such financial leverage is helpful in multiplying the benefit of profitability but on the same side it increases risk of adverse affect when conditions are not favourable. After comparing the share price movement throughout the 4 weeks, it was found it is in an upward phase as the investors have identified company’s potential to perform in near future. Marks and Spencer is among the market leaders in departmental store industry and it was further proved by making a comparison with the industry. After taking all the results into consideration, it can be concluded that for any long term investor Marks and Spencer is a good option. Due to the financial slowdown, its share prices have gone quite low (almost 3 times lower), so as the market condition will improve, they will perform better. Due to this economic slowdown many developing countries has came out as potential market for consumer goods and M&S has identified this fact and has already taken steps to capture the unexplored markets. All this clearly indicates M&S is a good choice for any investor in long term basis. Reference Bridge, J. & Dodds, C. J. 1978. Planning and the growth of the firm. Routledge. Brigham Young University. No date. Understand How Stocks Are Valued. Personal Finance. [Online]. Available at: http://personalfinance.byu.edu/?q=node/754 [Accessed on March 16, 2009]. Cole Librar. 2009. Retail industry Data Finder. (Online). Available at: http://www.ewp.rpi.edu/hartford/library/industry/retail.htm [Accessed on November 19, 2009). Company Annual Report. 2009. How We Are Expanding Our International Business. . [Online]. Available at: http://annualreport.marksandspencer.com/operating-financial/ms-international/ms-international.aspx [Accessed on November 14, 2009]. Finnerty, D. J. 2007. Project financing: asset-based financial engineering. 2nd ed. John Wiley and Sons. Guardian.co.uk. November 14, 2009. Marks & Spencer. Online]. Available at: http://www.guardian.co.uk/business/marksspencer?page=2 [Accessed on November 16, 2009]. Guardian.co.uk-a. November 04, 2009. Market forces breaking news: Marks and Spencer beats profit forecasts. [Online]. Available at: http://www.guardian.co.uk/business/marketforceslive/2009/nov/04/marksspencer-next [Accessed on November 16, 2009]. Hoovers. 2009. Marks and Spencer Group p.l.c. Available at: http://www.hoovers.com/free/co/competition.xhtml?ID=crrss&FRIC=360&x=51&y=9 [Accessed on November 19, 2009). Lee, A. T. 2007. Financial Reporting and Corporate Governance. John Wiley. Marks and Spencer-a. No date. Company overview. About Us. [Online]. Available at: http://corporate.marksandspencer.com/aboutus/company_overview [Accessed on November 14, 2009]. McConnon, C. J. & French, M. F. No date. Ratio Analysis. The University of Maine. [Pdf]. Available at: http://www.umext.maine.edu/onlinepubs/PDFpubs/3002.pdf [Accessed on March 16, 2009]. Peterson, P. P. & Fabozzi, J. F. 1999. Analysis of financial statements. John Wiley and Sons. Ross, Westerfield, R. & Jaffe, J. 2004. Chapter 16- Capital Structure: Limits to the Use of Debt. Corporate Finance. Tata McGraw-Hill. Smart, B. S. & Megginson, L. W. 2008. Corporate Finance. Cengage Learning EMEA. Washington State University. No date. Liquidity Ratios. Session 2: Ratio Analysis Techniques. Financial Analysis revised. 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Available at: http://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page38.htm [Accessed on March 16, 2009]. 2005 Investment Ratios Price-earnings Ratio Market price per share / Earnings per share (Market price as on 31th March 2005) 346.00 / 29.1= 11.89 2006 Investment Ratios Price-earnings Ratio Market price per share / Earnings per share (Market price as on 31th March 2006) 556.50 / 31.4 = 17.72 2007 Investment Ratios Price-earnings Ratio Market price per share / Earnings per share (Market price as on 31th March 2007) 676.50/ 39.1 = 17.30 2008 Investment Ratios Price-earnings Ratio Market price per share / Earnings per share (Market price as on 31th March 2008) 389.25 / 49.2 =7.87 2009 Investment Ratios Price-earnings Ratio Market price per share / Earnings per share (Market price as on 31th March 2009) 296.00/ 32.3=9.16 Investment Summary Ration 2009 2008 2007 2006 2005 Earnings per share 0.23 0.07 0.04 0.02 0.02 Dividend Payment Ratio 43.96% 24.39% 23.53% 23.89% 24.40% Price-earnings Ratio 9.16 7.87 17.30 17.72 11.89 Read More