Analysis of the financial performance of Sports Direct

Introduction
Sports Direct Plc is a profitable and successful with an immense potential for growth as indicated by the Price Earning ratio of 27.73 times (Appendix 1).
The purpose of this essay is to analyse the financial performance of Sports Direct Plc based on the calculation of the profitability, liquidity, efficiency, solvency and investor ratios. Thereafter, the essay will compare the financial performance and position of Sports Direct Plc with that of JD Sports Fashion Plc. Subsequently, the essay will provide a recommendation to the investors regarding the investment in Sports Direct’s shares. Finally, the essay will conclude by assessing the limitations of the financial analysis carried out based on the accounting ratios.

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Analysis of the financial performance of Sports Direct Plc and Comparison to a competitor – JD Sports Fashion Plc
Sports Direct Plc’s revenue has grown by 23.8% from GBP 2,706m in 2013 to GBP 2,185.6m in 2014 (Sports Direct Plc, 2014). This success is underpinned by Sports Direct’s core strategy of expanding their product base (Sports Direct Plc, 2014). Sports Direct has not resorted to price cutting strategies in order to achieve this growth. This is evident by the improvement in its gross margin from 40.94% in 2013 to 42.68% in 2014 (Appendix 1). The product mix of Sports Direct is improving with its premium category products gaining greater acceptance in the market (Sport Direct Plc, 2014). Operating and net margins have witnessed a modest fall because the new stores that have opened to support the growing premium lifestyle divisions are performing slightly below the capacity (Sports Direct Plc, 2014).
Sports Direct Plc has significantly outperformed JD Sports Fashion Plc in terms of the overall profitability despite of JD Sports Fashion Plc having a better gross margin (Appendix 1 and Appendix 2). The sales channel mix of the two businesses is the key driver of the overall profitability. Although online sales grew for both the businesses, the growth in online sales was higher for Sports Direct Plc compared to JD Sports Fashion Plc contributing to the improved operating profit and net profit margin for Sports Direct Plc. Online sales typically attract lower overheads compared to the retail sales and can significantly contribute to improving profitability of a company (ICAEW, 2012).
Current ratio and liquidity ratio are identified as key indicators of liquidity in a business (Robertson, 2007). The current ratio of Sports Direct Plc has fallen from 1.64 in 2013 to 1.06 in 2014 (Appendix 1). The fall in the current ratio for Sports Direct Plc is not reassuring and the absence of cash is worrying. Furthermore, weak quick ratio of 0.35 is indicative of weak liquidity position and could be indicative of inability of Sports Direct Plc to meet its short-term liabilities in the future. JD Sports Fashion Plc has a better current and quick ratio compared to that of Sports Direct Plc. One of the important factors contributing to a poor liquidity position in Sports Direct Plc is the consumption of cash to facilitate expansion through opening new stores (Sports Direct Plc, 2014). Furthermore, higher inventory turnover days of 133 days for Sports Direct Plc compared to inventory turnover days of 105 for JD Sports Fashion Plc has also contributed to lower liquidity in Sports Direct Plc compared to the liquidity in JD Sports Fashion Plc (Appendix 1 and Appendix 2).
The purpose of calculating gearing ratios is to analyse the financing structure of the business (ICAEW, 2012). Gearing ratios reflect the level of risk attached to the company and the sensitivity of earnings and dividends to changes in profitability level (Grewal, 2014). The statements of financial position of the two businesses are significantly affected by their different capital structures. JD Sports Fashion Plc is more geared compared to Sports Direct Plc. Lower gearing compared to competitors for Sports Direct Plc can enhance its ability to raise more debt to fund future expansion. Sports Direct Plc inclination towards leasing assets and reliance on overdraft facilities contributes to its relatively low level of gearing. This may allow Sports Direct plc to have flexibility in operations and reduce its risk. Furthermore, the value of non-current assets in Sports Direct plc accounts is higher than the value of non-current assets in JD Sports Fashion Plc accounts (Sports Direct Plc, 2014: JD Sports Fashion Plc, 2015). This is indicative of its ability to raise capital through debt market to fund the future expansion.
The purpose of calculating interest cover ratio is to assess the ability of a company to meet its interest obligations out of profits (Goyal and Goyal, 2012). Although the interest cover ratio for Sports Direct Plc has fallen from 22 times to 13 times and is lower than the interest cover ratio of JD Sports Fashion Plc, it is still reflective of a healthy interest cover ratio and is indicative of Sport Direct Plc’s ability to meet the interest obligations out of its profits.
The purpose of calculating efficiency ratios is to analyse the management’s effectiveness in running the business efficiently (Grewal, 2007). Efficiency ratios reflect management’s ability to reduce the working capital requirement for a given level of activity (ICAEW, 2012a). Receivables collection days of 16 days highlight low level of credit sales, which is consistent with the retail nature of the business and enables Sports Direct Plc to manage its working capital efficiently. The increase in payables payment period from 48 days in 2013 to 56 days in 2014 further contributes to efficient working capital management (Appendix 1). This reflects Sports Direct Plc’s ability to negotiate better payment terms with its suppliers. Furthermore, this is also indicative of efficient management, as the gap of twenty-seven days in the payables payment period between the two companies in the prior year has been narrowed down to a gap of two days. The inventory turnover days are 133 days and 105 days for Sports Direct Plc and JD Sports Fashion Plc respectively (Appendix 1 and Appendix 2). Furthermore, the inventory turnover days has increased by seven days from 2013 for Sports Direct Plc (Appendix 1). This is reflective of increased inventory holding cost for Sports Direct Plc. Rapid innovation of new products contributes to making previous product lines obsolete (ICAEW, 2013). This can impact the future margins because of the net realisable value for these products may drop significantly below its production cost (ICAEW, 2013). Management needs to invest more time in clearing up stock and improving the inventory turnover days because it can contribute to increasing the working capital requirement in the future.
The purpose of calculating investor ratios is to enable investors to assess the level of future returns and growth (ICAEW, 2012). Earning per share reflects the level of profit allocated to each outstanding share. Price earning ratio is one of the most commonly used ratios by the investors and reflect their level of confidence in a business (ICAEW, 2012). Increase in price earning ratio from 17.51 times in 2013 to 24.19 in 2014 reflects investors expectations of significant future earning growth and their willingness to pay a large multiple of historic earnings (Appendix 1). Price earning ratio of Sports Direct Plc is 24.19 times compared to price earning ratio of 14.33 times for JD Sports Fashion Plc. Lower price earning ratio is indicative of lower growth expectations by the investors (ICAEW, 2012).
Advice to the investors regarding the purchase of Sports Direct Plc shares
Investors principal concern in respect of the investment in the shares of a company is to be able to earn a good rate of return. Sports Direct Plc is fundamentally a profitable business. Furthermore, a price-earning ratio of 24.19 is reflective of the investor’s faith in the growth potential of the company (Appendix 1). However, the sales growth in the third quarter of 2015 is short of the comparable growth in the third quarter of 2014 (Ficenec, 2015). The slowdown in the growth rate and no dividend offered on the shares may make it an expensive buy in the short term. Furthermore, investment in Sports Direct may be prone to the cyclical risk as the clothing industry is directly linked with the macro economic cycles (ICAEW, 2012a). Nonetheless, slower growth in the current year is impressive given the macro economic environment in the United Kingdoms and England’s early exit from the world cup (Guardian, 2014). Furthermore, the company has invested heavily in the expansion of its product base and its margins have improved despite of competitive environment and challenging macro economic environment (Sports Direct Plc, 2014). This investment in constant innovation has the potential to translate into benefits for the investors in the long term. Favourable capital structure of Sports Direct Plc as highlighted by the gearing ratios calculated in the appendix one also makes it an attractive investment. Based on the considerations above, the essay acknowledges that there are risks associated with the investment in the shares of Sports Direct Plc, nonetheless future returns from the investment is expected to outweigh the risks. Thus, the essay recommends investors to purchase the shares of Sports Direct Plc.
Weaknesses of Ratio Analysis
Although there are a lot of advantages of ratio analysis, it is not without weaknesses (Goyal and Goyal, 2012). One of the key weaknesses of ratio analysis is that the calculation of the ratios is contingent on the figures contained within the financial statements of a company. Thus, the results of the ratio analysis would be distorted if the underlying numbers in the financial statements are inaccurate (Grewal, 2014).
Furthermore, seasonality in a business could limit the usefulness of ratio analysis (ICAEW, 2012). To illustrate this better, consider a toy retailer with a 31 December year-end. Majority of its sales is likely to be made in the last quarter of the year leading up to the Christmas. As a result, the inventory levels at the year-end might be at its lowest point throughout the year. Thus, calculating the relationship between inventory and cost of sales at the year-end to analyse management’s efficiency in managing inventory levels would be misleading (ICAEW, 2012).
Financial statements of different companies are affected by different estimates and assumptions made by the management (Whittington, 2007). Furthermore, accounting standards also may permit different companies within the same industry to apply different accounting policies (Whittington, 2007). This may impair the comparability of accounting ratios of different companies and limit its usefulness.
Ratio analysis is historic in nature, while users of the financial statements are more concerned about the future (Gracia, 2007). It is common for businesses to have both good and bad ratios, which makes it difficult for the users of the financial statements to assess if it’s a good or a bad company (Grewal, 2014).
Lastly, non-existence of ideal level of ratio makes it difficult for user of the financial statements to assess whether a particular trend is good or bad (Grewal, 2014). For example, a company with high current ratio may be interpreted as a good sign, however it could also be indicative of lack of growth potential for a company as a result of which it is holding large reserves of cash (Grewal, 2014).
Conclusion
Sports Direct Plc has witnessed a significant growth over the past two years and has been profitable. However, declining profit margins in the past two years should be a key concern for the management of Sports Direct Plc. Nonetheless, despite the fall in the profit margin of Sports Direct Plc, it still outperforms the profit margins of its competitor – JD Sports Fashion Plc. The management of Sports Direct Plc should strive to strike a balance between achieving growth and improving the profit margins of the business.
Inefficient inventory management should be another key concern for the management of Sports Direct Plc. The inventory turnover period of 133 days seems to be high for a business in the fashion industry and could be indicative of aged obsolete inventory. The management should take immediate steps to clear up old stock to improve the working capital management.
Lastly, the essay recommends the investors to purchase the shares of Sports Direct Plc because high PE ratio, sales growth and expansion into new products are likely to translate into attractive returns for the shareholders in the future.
References

Ficenec, J., 2015, Questor share tip: Sell Sport Direct as growth slows, Telegraph. http://www.telegraph.co.uk/finance/markets/questor/11424054/Questor-share-tip-Sell-Sport-Direct-as-growth-slows.html
Gracia, L., 2007, Introduction to Financial Accounting, Harlow: Pearson.
Grewal, T., 2014, Analysis of Financial Statements, New Delhi: Sultan Chand.
Goyal, V., and Goyal, R., 2012, Corporate Accounting, 3rd edn. New Delhi: PHI Learning Pvt. Ltd.
Guardian, 2014, Who should take the blame for England’s early World Cup exit? http://www.theguardian.com/football/2014/jun/24/blame-england-world-cup-exit
ICAEW, 2013, Financial Accounting and Reporting Study Manual, Exeter: Polestar Wheatons.
ICAEW, 2012, Financial Reporting Study Manual, 6th edn. Exeter: Polestar Wheatons.
ICAEW, 2012a, Financial Accounting Study Manual, 6th edn. Exeter: Polestar Wheatons.
JD Sports Fashion Plc, 2015, Share Price. http://www.jdplc.com/investor-relations/share-price.aspx
JD Sports Fashion Plc, 2015, 2015 – Annual Report. http://www.jdplc.com/investor-relations/reports.aspx
Robertson, J., 2007, Financial Ratio Analysis, 3rd edn. Lancaster: John Robertson.
Sports Direct, 2015, Share Price Chart. http://www.sportsdirectplc.com/investor-relations/share-information/share-price-chart.aspx
Sports Direct Plc, 2014, Annual Report 2014. http://www.sportsdirectplc.com/~/media/Files/S/Sports-Direct/annual-report/Annual%20Report%202014.pdf
Whittington, G., 2007, Profitability, Accounting Theory and Methodology, New York: Routledge

Appendix 1 – Sports Direct Plc

S.no.
Ratio
Year End 27th April 2014
Year End 28th April 2013

1
Gross Profit Margin
42.68%
40.94%

2
Operating Profit Margin
9.21%
9.75%

3
Net Profit Margin
6.64%
6.94%

4
Current Ratio
1.06
1.64

5
Quick Ratio
0.35
0.60

6
Interest Cover Ratio
13.06 times
22.39 times

7
Financial Gearing
8.15%
41.52%

8
Equity Gearing
25.93%
23.89%

9
Earning per share
32.1p
26.9p

10
Price Earning Ratio
24.19 times
17.51 times

11
Receivables Collection
16.6 days
16.1 days

12
Payables Payment Period
56.35 days
48.06 days

13
Inventory Turnover Period
133.07 days
126.39 days

(Source: Sports Direct Plc, 2014)
Note:

The formulas used to calculate the ratios above are included in Appendix 3.
Share prices used for calculating price earning ratios are 776.50 pence and 471.1 pence for the year-end 27th April 2014 and 28th April 2013 respectively (Sports Direct, 2015).

Appendix 2 – JD Sports Fashion Plc

S.no.
Ratio
Year End 31st Jan 2015
Year End 1st Feb 2014

1
Gross Profit Margin
48.6%
48.7%

2
Operating Profit Margin
6.1%
6.4%

3
Net Profit Margin
3.5%
3.4%

4
Current Ratio
1.22
1.15

5
Quick Ratio
0.54
0.50

6
Interest Cover Ratio
33.24 times
48.46 times

7
Financial Gearing
19.9%
18.05%

8
Equity Gearing
27.2%
16.6%

9
Earning per share
35.17p
29.08p

10
Price Earning Ratio
14.33 times
13.88 times

11
Receivables Collection Period
12.9 days
20 days

12
Payables Payment Period
58.1 days
75.1 days

13
Inventory Turnover Period
104.9 days
108.8 days

(Source: JD Sports Fashion Plc, 2015)
Note:

The formulas used to calculate the ratios above are included in Appendix 3.
Share prices used for calculating price earning ratios are 503.00 pence and 403.50 pence for the year-end 31st Jan 2015 and 1st Feb 2014 respectively (JD Sports Fashion Plc, 2015).

Appendix 3 – Formulas

S.no.
Ratio
Formula

1
Gross Profit Margin
Gross Profits/Revenue * 100

2
Operating Profit Margin
Profit from Operations/Revenue*100

3
Net Profit Margin
Net Profit/Revenue * 100

4
Current Ratio
Current Assets/Current Liabilities

5
Quick Ratio
(Current Assets – Inventory)/Current Liabilities

6
Interest Cover Ratio
(Profit before interest Payable + Investment Income)/Interest Payable

7
Financial Gearing
Long term liabilities/capital employed * 100

8
Equity Gearing
Net Debt/Equity * 100

9
Earning per share
(Net Profit – Dividend on preference stock)/ No. Of shares

10
Price Earning Ratio
Market Value of Share/ Earning per share

11
Receivables Collection Period
Trade Receivables/Revenue*365

12
Payables Payment Period
Trade Payables/cost of sales*365

13
Inventory Turnover Period
Inventory/Cost of Sales * 365

(Source: ICAEW, 2012)
Note: Capital Employed = Equity + Net Debt, where net debt = interest bearing debt (non-current and current) minus cash and cash equivalents