1. You work as a financial analyst for the CFO of Carrefour SA, a French multinational retailing group, which is one of the largest retailers in the world.
Carrefour are considering the possible acquisition of a large UK or European-based wholesale “cash and carry”/retailing group. The initial research has identified two potential acquisition targets. One is Metro AG a very large wholesale/retail group based in Düsseldorf, Germany which is listed on the Xetra stock exchange in Frankfurt. The other is Booker Group PLC, the UK’s largest food wholesaler and which is listed on the London stock exchange.
The CFO has asked you to write a brief internal management memo that summarises the current businesses of each of these two companies, together with a short assessment of the impact of recent economic conditions on them.
2. Undertake the necessary research and write a report to your CFO which critically evaluates and compares the financial performance and risk exposures of these two companies, together with a reasoned argument as to your advice as to which company – if either – might be the preferred acquisition target.
NOTE: Your analysis should be based on the 2013/14 financial statements of Metro and 2014 financial statements of Booker.
3. Your CFO has got an additional concern. She has been asked to give a presentation to the European Food Distributors Association conference on the topic of: “Capital Investment Decision Making”.
Write a short report for your CFO, which outlines the main investment appraisal techniques and critically evaluates their individual strengths and weaknesses. Included a reasoned recommendation as which approach might be best for a company such as Carrefour to use to evaluate investments in new distribution warehouses and “cash and carry” stores.
The paper analyses the investment decision of Carrefour. The company is considering the possible acquisition of a large UK or European based whole sale company. There are two potential targets for the acquisition. One in the Metro group and the other is the Booker Group PLC (ABEDIN and DAVIES, 2007). The financial performance of the two large retail stores has been analyzed. An internal management memo of the business of the two companies has been prepared. The paper also presents a report on capital investment decision making which outlines the main techniques for investment appraisal. The strength and weakness of the techniques has been identified (Adler, 2000).
An internal management memo comprising of the summary of the current business of Metro group and Booker group has been provided.
To CFO (Carrefour)
From Margaret Brown – Financial analyst for CFO at Carrefour
Subject – Brief summary of the internal management of Metro group and Booker group
Metro Group is one of the biggest international players in retail whole sale trade. It is amongst the largest hypermarkets in Europe. The retail brand has the largest market share in the home market. It is one of the most globalised retail and whole sale brands. The internal management of Metro AG focuses on streamlining the portfolio of the organization. The net debt of the organization was reduced by the process of divestment at the Eastern Europe (Tiffin, 2005). The internal management at Metro Group is governed by the Board of Directors. The company is planning to expand their business to Russia and Ukraine, China and India. This will lead to further reduction of the net debt of the organization. The positive performance of the organization is a result of the focus of the company on the main customer groups and the product mix is tailored to meet the need of the customers. The geopolitical situation in the country had affected financial condition of the company (Straub, 2007). However the company has moved forward and it has gone through several processes of transformation to fill the company with the new corporate culture. The major focus at work is to add value for the customers. They are constantly improving the range of products and services to improve the sales of the organization. The company was posed with major challenge with the unexpected political development in Russia and Ukraine. The conflicts in Ukraine had affected the business of the company (Annual report, 2015).
Booker group is controlled by the Board of Directors. The Board comprises of five executive directors and six Non-executive directors. There is sufficient balance between the skills and the experience of the employees in the organization. No one in the organization is provided with unfettered power to take decisions in the organization. Booker group has been delivering good performance over the years. The sales of the company rose by 17% and there has been rise of the operating profit of the organization by 23%. The customer satisfaction in the organization continued to improve. The financial performance of the organization has improved as a result of the improvement of the customer scores. The company is planning to expand the business. The internet sales of the company have risen over the previous years. The earnings per share of the investors in the organization have increased from the previous year by 4.51 pence. It has become 6.06 pence. The performance of the company has been strong in the financial years. The Board took the decision to pay dividend to the share holders of 2.75 pence per share. The food market of UK has remained competitive. The market will remain challenging but the company has been able to survive in the competitive market. Booker Group has been constantly reinventing them by offering better choice of products to the customers. They have undergone through synergy plans and efficiency programs for the innovation of their products. The business efficiency has been improved by tight cash management. They have doubled the net cash in the company. Booker group has improved the system, processes and the buying across the entire Group. Booker group operates in a competitive market. They monitor the prices with the price of the competitors and the price index for the Group has remained competitive. The customers are satisfied with the organization. In UK, Booker has worked to offer best price and service to the customers. They managed the supply chain efficiently.
Impact of economic condition on Metro group and Booker group (BOOKER GROUP PLC, 2013).
The global economic momentum has slightly increased during the previous financial year. The two years of economic crisis had severe effect on the financial performance of the organization. The recovery from the financial crisis has remained modest. The company has faced several setbacks during the financial year. The sustainable economic growth of the Metro group was affected by the problems that were related to the government debt. Metro group was posed with severe Government debt during the financial year. The global economic output for the Metro group has been 0.1% above the previous year. The global economic output for 2014 is 2.4% while it was 2.3% for the previous year. The developed countries United States and UK had started to recover from the global economic crisis but the recovery was quite slow for the emerging countries. The slower growth of the developing countries was also as a result of the slow growth of the countries. The sales of Metro group were also affected by the political crisis in Ukraine and Russia. The political crisis and the increase in the turmoil have negative impact on the performance of the organization. The sluggish economic performance of Russia has negative impact on the sales of Metro group. There was decline in the investor performance and the confidence of the investors declined. There was weakening of the currencies of the emerging economies as there was withdrawal of funds by the investors. This resulted in the increase in the current account deficit to high levels. There was more than 10% decline in the currencies of Russia, India and Turkey. The fall in currencies led to the rise of the price of the consumer products. This resulted in the drop of the sales of Metro group in these countries.
Booker group has faced the risk and the uncertainty of the economic condition. The economic crisis has posed the group with severe threats. The economy of UK is expected to be difficult in the year ahead. The customers can acquire the best value from the products. The sale of the wide range of products by the Booker group remains affected as a result of the economic turmoil in the country. In order to provide the customers with best valued products, Booker has to formulate policies that will help them survive in the competitive market. However there is a separate risk management board of the company that is involved in formulating strategies that will mitigate the risk factors faced by the organization. The company operates in an industry that is governed by strict environmental regulations. The safety and the protection of the share holders and the customers are extremely important along with meeting the need of the customers. The company has to abide by the rules of the London stock exchange and the competition law. The emerging countries are adversely affected by the economic turmoil. In order to mitigate the adverse impact of the economic crisis, Booker Group has been formulating strategies that will safeguard the position of the company (Booker Group plc Interim Results for the 24 weeks ended 13 September 2013, 2013).
Analysis of the financial performance
The financial performance of Metro Group and Booker group has been compared using ratio analysis. The ratio that has been used to analyze the financial performance of the two companies includes the profitability ratios, investor’s ratios, liquidity ratios and the efficiency ratios.
1. Profitability ratios
The efficiency of the organization to turn the activity of the business into profits is determined by the profitability ratios. The margin of profit determines the ability of the organization to convert the revenue to profits.
|
Profitability Ratios (2014) |
Metro group |
Booker group |
|
Return on capital employed |
12% |
18.95% |
|
Return on equity |
4% |
17.63% |
|
Net profit percentage |
0% |
2.25% |
|
Gross profit percentage |
21% |
4.40% |
|
Operating profit percentage |
2% |
3% |
The return on capital employed indicates the return of the organization on the capital employed by the organization. The higher the return on capital employed it shows that the company is in a better position.
The return on capital employed for Metro group for the year 2014 is 12%. On the other hand the return on capital employed for Booker group is 18.95%. This shows that the return on capital employed for the Booker group is higher than the Metro group. The financial position of Booker group is better than Metro group. Metro group saw the closure of three stores in Denmark in the year 2013/14. On the other hand the Booker group saw an increase in the operating profit by 23% in the year 2014 (CENGÄ°Z, 2014).
The return on equity measures the ability of the company to make for the money that is invested by the investors.
The return on equity for the Metro group is 4% while the return on equity for Booker group is 17.63%. The financial position of Metro group is not as strong as the financial performance of the Booker group (Saeidi, 2012). The financial position of Metro group has been affected by the economic crisis of the two years. Thus the growth of Metro group in the subsequent years has been modest. The financial growth of Metro is also affected by the huge debt of the government. On the other hand the financial position of Booker group has shown improvements in the year 2014 with 23% increase in the operating profits (Chaudhuri, n.d.).
The net profit margin for Metro group is negligible while the net profit margin for the Booker group is 2.25%. There has been significant decline in the sales of the metro group for the financial year 2014. The decline of the sales is mostly a result of the influence of recession on some stores. There has been closure of 3 stores in Denmark. The net profit for Metro group has declined considerably.
On the other hand Booker group has show significant increase in the performance. There is significant increase in the revenue of the group for the financial year of 2014 than 2013. The profit before tax has also improved. The new strategies of the company have been the driving force behind the increase in sales (Dharmapala and Edirisuriya, 2011).
The gross profit margin for Metro group is 21%. On the other hand the gross profit margin for the Booker group is 4.40%. There is has been significant decline in the sales of the company for the year 2014 than the year 2013 for Metro group. On the other hand, Booker group saw the increase in the sales for the year 2014.
Operating profit percentage
The operating profit margin for the Metro group is 2% while the operating profit margin for the Booker group for the year is 3%. The operating income of the Metro group has also declined for the year 2014. On the other hand it is seen that there is significant increase in the operating profit for Booker group. Thus it is seen that Booker group is in a profitable position that the Metro group (Enever, Isaac and Daley, 2014).
The liquidity ratios determine the ability of the organization to repay its short term obligations. The current ratio and the quick ratio are the two liquidity ratio. The ideal current ratio and the quick ratio are considered to be 1:1.
|
Liquidity ratios (2014) |
Metro group |
Booker group |
|
Current ratio |
0.77:1 |
0.98:1 |
|
Quick ratio |
0.4:1 |
0.43:1 |
The current ratio for the Metro group is 0.77:1. The current ratio for the Booker group is 0.98:1. The current assets of the Metro group have increased for the year 2014 than the previous year with the significant increase in the current liabilities. The company hast to manage the short term obligations in an efficient manner in future.
On the other hand the current ratio for the Booker group shows a significant increase in the current liabilities than the previous year. However the company has been able to manage the ratio to 1:1 proportion (Epstein and Lee, 2011).
The quick ratio shows the ability of the organization to manage the short term obligations without using the inventory. The quick ratio for Metro group is 0.4:1 and the ratio for the Booker group is 0.43:1. Both the companies are not being able to manage the short term obligations efficiently. The inventory for the Metro group has increased subsequently than the previous year. On the other hand the inventory for the Booker group has also increased in 2014 than 2013. The increase in inventory each year shows that the company is not being able to manage the inventory efficiently. The over piling of inventory has also resulted in the increase in the cost for both the organizations (Garrett and James III, 2013).
The efficiency ratios show the ability of the company to use the assets and the liabilities. The turnover of the receivables and the payment of the liabilities are determined by the efficiency ratios.
|
Efficiency ratios (2014) |
Metro group |
Booker group |
|
Inventory turnover ratio ( days ) |
8.37 |
13.66 |
|
Debtor’s payment period (days) |
3.24 |
8.85 |
The inventory turnover ratio measures the ability of the organization to manage the inventory in an efficient manner. The first component of the inventory turnover ratio is the purchase of stock. The company should sell and utilize the inventory that has been brought. The storage costs and holding costs of the inventory will increase (Pfeiffer, n.d.).
A low inventory turnover period is expected for the company. This will show that the company is managing the inventory in an efficient manner. The inventory turnover period for Metro group is 8.37 for the year 2014 and that of Booker group is 13.66 days. The amount that has been invested by Metro group in the inventory is more than the previous year. In case of Booker group the inventory turnover ratio is 13.66 days. Booker group has not been able to manage the inventory in an efficient manner. The inventory has risen than the previous years (Gazely and Lambert, 2006).
The debtor’s payment period measures the ability of the organization to turn the receivables from the debtor’s into cash during the period. The ratio indicates how many times the business is able to collect the accounts receivable during the year. The debtor’s turnover period must be less. This will indicate that the company is able to collect the amount regularly from the debtors. The debtor’s payment period for the metro group for the year 2014 is 3.24 while the debtor’s payment period for Booker group for the year 2014 is 8.85. It shows that Metro group is being able to manage the receivables in an efficient manner (Glambosky, 2009).
The investor’s ratio serves as a useful tool for the investors to assess the performance of the company. The return of the investment for the investor’s can be judged by the investor’s ratios. The investor’s ratios serve as barometers for the financial health of the organization. The investor can make the comparison with the previous years to determine the company’s stock that will be a better investment (Peterson Drake and Fabozzi, 2012).
|
Investor’s ratios |
Metro group |
Booker group |
|
Interest coverage ratio |
2.77 |
72.82 |
|
Price-Earnings ratio |
75.95 |
28.46 |
The interest coverage ratio indicates the ability of the organization to pay its interest expenses. The company uses the profit to pay the interest expenses. The interest coverage ratio for Metro group is 2.77 while the ratio for Booker group is 72.82. The interest expenses for Metro group have declined but there has been considerable decline in the revenue of the organization for the year 2014 than the previous year (Peng, 2009).
On the other hand it is seen that the interest expense of Booker group has declined significantly. The company is in the better position than the Metro group in the management of the expenses by using the profit (Griffith, 2003).
The prices earnings ratio indicates the earning of the company on the investment in each share. The higher the earning, the investment decision of the company will be fruitful.
Price earnings ratio for Metro group for the year 2014 is 77.95 while the price earnings ratio for the Booker group for the year 2014 is 28.46. The earnings per share of the Booker group have increased in the year 2014 than the previous year. The earnings per share for the Metro group have been negligible (Oehmke, 2000).
Metro group and Booker group are exposed to various compliance risks. The risks are regularly monitored. The group is also exposed to the exchange rate risks. The fluctuations of euro will affect the revenue of the organization. The company has been exposed to the recessionary pressure (Nugus, 2006). The increasing competition as a result of the growth of the supermarket has been a major reason for decline of the revenue. There has been closure of three stores in Denmark.
On the other hand the various risks affecting Booker group is the increase in the price competition in the grocery market of UK. In order to compete with the prices set by the other competitors Booker group has to reduce their margin of profitability. The change in the legislation of the Government can have adverse impact on the sales and the operating profit of the organization. The reputation of the group can be affected if it serves poor quality of product to the customers. This will have adverse impact on the sales and the operating profit of the organization. The success of the organization will depend on the engagement of the employees and the retention. The contribution of the employees plays a major role in the success or failure of the organization. The risk can be avoided by training the employees on the various developmental measures proposed by the organization (Hansen and Mowen, 2000).
1. Net present value
Net present value is one of the most efficient ways for the calculation of the investment appraisal techniques. The net present value is the calculation involving the net flow of cash at the present time at a discount rate at the same time. The net present value has inverse relationship with the discount rate. The net present value will be reduced with high discount rate (Nissim and Penman, n.d.).
The major benefit of net present value is that it considers time value of money.
A high rate of discount rate will reduce the net present value and vice versa.
The project will be accepted when the net present value is positive.
The calculation of the net present value is a time consuming process.
The process becomes difficult to understand.
The calculation of net present value is often based on the arbitrary calculation of the rate of interest.
The accounting rate of return technique calculates and compares the profit that can be earned from a project to the amount of capital that has been invested initially. The company will generally prefer projects that give higher return (McSweeney, 2006). The accounting rate of return is a non discounted process of capital investment. The process does not take into consideration the time value of money (Jagels, Coltman and Coltman, 2004).
The accounting rate of return is based on the accounting profit and the profitability of the investment decision is calculated on the basis of the accounting profit.
Accounting rate of return is a simple process and it is easy process to understand.
Accounting rate of return does not consider the time value of money.
The cash flow from the investment is ignored by the accounting rate of return.
The terminal value of the project is not considered by the accounting rate of return method.
The internal rate of return is defined as the technique where the net present value is considered as zero. It is the discount rate at which the net present value is zero. The efficiency of the capital investment is determined by the internal rate of return method. The project is rejected when the cost of capital invested in the project is more than the internal rate of return. The time value of money is considered by the internal rate of return (Langdon, 2002).
Internal rate of return considers the time value of money. The calculation of the internal rate of return is accurate.
It is easy to interpret the method as it is simple method.
The calculation of the hurdle rate is not required in case of the calculation of the internal rate of return. The risk of wrong assumption of the hurdle rate can be mitigated as the calculation of the IRR is not dependent on the hurdle rate.
While analyzing a project with IRR it is assumed that the positive future cash flows are reinvested at IRR. A project with low IRR will assume that the reinvestment at a low rate of return. On the other hand the project with high IRR will make assumption that the reinvestment rate at a very high rate of return. But this is an impractical situation.
IRR will not be able to make selection between projects that are mutually exclusive. There might be projects that are acceptable and both of them are worth investment. Thus the IRR method will not be feasible method in case of mutually exclusive projects.
The payback period calculates the time that would be taken to get back the initial investment. It is one of the most simple capital appraisal techniques (Mclean, 2009). The projects that are with shorter payback period are considered than the projects having longer payback periods (Libby, Libby and Short, 2011).
The profitability index considers the time value of money.
The profitability index analyses the cash flows over the entire life.
The exact rate of return from the project is considered by the profitability index.
The calculation of the discount rate and the interest rate is difficult.
The calculation of the profitability index of the two projects with the same economic life becomes difficult.
The discounted payback period is the total time that is taken to cover the total cost of the project. It is calculated by adding the positive discounted cash flow that is coming from the profit of the project. While calculating the discounted payback period the discount rate has to be calculated to discount the future flow of cash over the specific period of time (Marsh, 2012).
The discounted payback period takes into consideration the time value of money.
The riskiness of the cash flows of the project is considered by the discounted cash flow.
The estimation of the cost of capital is required to calculate the payback period.
The flow of cash beyond the discounted payback period is ignored by this method.
Carrefour is planning investment in one of the largest retail stores. The company that has been chosen by the organization is either Metro group or the Booker group. The investment appraisal technique that can be chosen by the organization as its investment appraisal technique is the net present value method. The net cash flow from the investment can be determined by the organization from this method. The method considers the time value of money thus the investment decision will be accurate.
The acquisition decision of Carrefour has been discussed in the paper. The financial performance of Metro group and Booker group has been analyzed. The risk exposures of the two groups have been discussed. It is seen that the Booker group is in a better position than the Metro group. Thus Carrefour should consider acquiring Booker Group. The venture will be profitable for the organization.
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