Tesco Plc is a leading UK retailer that operates in 13 countries across Asia, Europe and the United States. In order to evaluate Tesco’s financial positions in the market, vertical, horizontal and ratio analyses will be implemented. In addition, this report will benchmark two main competitors of the company, namely Morrisons and Sainsbury’s. Finally, in conclusion it will provide some recommendation for future investors and for those who are considering future employment in the company.
1. Review of Tesco’s financial fundamentals over the last 5 years.
In order to examine Tesco’s performance, vertical analysis of the financial fundamentals for 2006-2010 would be implemented.
1.1 Income statement trends
Table 3:
% change P&L account
2006/07
2007/08
2008/09
2009/10
Sales
8.08%
10.92%
13.95%
5.59%
Cost of sales
8.17%
10.83%
13.84%
5.21%
Gross profit
14.37%
4.82%
15.29%
10.08%
Expenses
8.27%
10.47%
14.48%
5.80%
Operating profit
16.14%
5.40%
13.54%
9.09%
Finance income
-21.05%
107.78%
-37.97%
128.45%
Finance cost
-10.4%
15.7%
91.2%
21.13%
Tax
18.95%
-12.8%
17.8%
6.6%
Retained profits
20.49%
12.16%
0.38%
9.26%
Source: Tesco PLC Annual Report and Financial Statements 2007/10
Sales are the main measures for business growth. Tesco’s revenue has increased by 7.14% per year for the last 5 years. The slowing GDP growth and the deteriorating consumer confidence, which was result of the recent economic downturn, were the main reasons for the recent slowdown in the rate of growth. The absolute level of sales has still increased. of the company’s sales levels.
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Notwithstanding the challenging economic environment, Tesco managed to maintain strong margins due to significant investments in new stores and lower prices, better pay rates and effective cost management. The lowest operating and gross profits figures were registered in 2007/2008 but this was a result of £89m investment in US and integration cost from market acquisitions in Czech Republic, Poland and Malaysia.
The most significant figure in 2009 is the increased amount of finance costs, from £250m to £478m or by 91.2% that was result of increased average net debt level slinked to acquisitions and foreign exchange movements, higher coupon rates on commercial paper and unfavourable changes in the non-cash IFRS elements of the interest charge (Tesco PLC Annual Report and Financial Statements 2009). This considerably affected retained profits and a slight increase by 0.38% was registered.
Finally, in 2010 there was a significant increase of the finance income by 128.45%, resulting growth in the retained profits by 9.26% due to the consolidation of Tesco Bank.
1.2 Balance sheet trends
Table 4:
2006/07
2007/08
2008/09
2009/10
Current assets
16.76%
37.67%
122.94%
-16.23%
Inventories
31.90%
25.84%
9.84%
2.25%
Trade receivables
20.96%
21.50%
37.15%
5.01%
Non-current assets
8.51%
17.96%
34.45%
6.77%
Current liabilities
9.69%
25.90%
75.78%
-11.23%
Non-current liabilities
8.62%
31.48%
87.75%
2.06%
Shareholder’s funds/Equity
11.93%
12.59%
9.18%
12.97%
Source: Tesco PLC Annual Report and Financial Statements 2007/10
According to the balance sheet in 2007, the increase in stock and debtors outpaced sales that was quite inconvenience, while the fixed assets were satisfactory. The problem with the stock trend was reversed in 2009 and 2010, but the debtors’ level, and the liabilities along with the fixed assets grew faster than sales in 2009 as a result of the economic downturn and the consumers’ uncertainty (see table 4).
2. Ratio Analysis of Tesco
Financial ratio analysis is one of the most common methods that provides ‘a quick and relatively simple means of assessing the financial health of a business’ ( Atrill & McLaney, 2006, pp168).
2.1 Profitability Ratios
‘Profitability ratios provide an insight to the degree of success in achieving this purpose’ (Atrill & McLaney, 2006, pp169).
Table 5:
2006
2007
2008
2009
2010
ROSF
16.69%
17.96%
17.90%
16.57%
15.91%
ROCE
12.70%
12.60%
12.70%
12.80%
12.10%
Net profit margin
5.78%
6.21%
5.90%
5.88%
6.07%
Gross profit margin
7.67%
8.12%
7.67%
7.76%
8.10%
Source: Tesco PLC Annual Report and Financial Statements 2007/10
According to table 5 Tesco’s ROSF ratios vary between 16-18% and ROCE between 12-13%. In 2007 and 2008 the ratios are tend to increase while in 2010 a considerable drop can be noticed. This reduction is result of the company’s strategy to continue investment even during the recession that has affected the returns in short term, but at the same time it promises progress in long term aspect (Tesco PLC Annual Report and Financial Statements 2010).
Net profit and gross profit margin ratios have been also remarkably consistent over the 5 years period. Despite the recent economic downturn, Tesco managed to maintain its strong positions and due to efficient cost management, price cuts and increased focus on its clubcard loyalty cart, it raised pre-tax profit by 9% in 2010 (http://www.guardian.co.uk).
2.2 Efficiency Ratios
Table 6:
2006
2007
2008
2009
2010
Stock turnover period (days)
15
18
20
19
19
Sales revenue to cap.employed (times)
2.62
2.56
2.38
1.93
1.90
UK Sales revenue per employee
170,923
177,084
179,840
196,436
196,120
Profit per employee
10,190
11,292
10,814
13,065
14,303
UK Sales per square foot
1303
1325
1322
1318
1311
Source: Tesco PLC Annual Report and Financial Statements 2007/10
Generally, the efficiency of Tesco’s performance during the last 5 years is persistent. Stock turnover ratio has been remarkably steady and has varied between 19-20 days over the last 4 years which is evidence for a good control of stock. However, from 2006 to 2010 sales revenue to capital employed ratio decreased significantly from 2.62 to 1.90 (by 27.5%) which was result of the considerable increase in the level of shareholder’s funds and non-current liabilities (by 173% and 55% respectively). Additionally, the most important ratios measuring business efficiency are sales per employee and profit per employee. Tesco’s ratios are satisfactory notwithstanding the declines in 2008 that are understandable bearing in mind the challenging economic conditions (see table 6).
2.3 Liquidity Ratios
According to McLaney & Atrill liquidity is vital to the survival of a business for there to be sufficient liquid resources available to meet maturing obligations (Atrill & McLaney, 2006, pp169).
Table 7:
2006
2007
2008
2009
2010
Current ratio
0.52
0.56
0.61
0.75
0.73
Acid test ratio
0.33
0.32
0.37
0.60
0.56
Cash generated from operations to maturing obligations
0.45
0.43
0.40
0.28
0.37
Source: Tesco PLC Annual Report and Financial Statements 2007/10
Tesco’s liquidity has considerably improved over the 5 years period due to strong cash generations and tight control of capital expenditure. Working capital also increased significantly, by 20%. However, liquidity ratios are still very low, current ratio varying from 0.5 to 0.7 and acid test ratio from 0.3 to 0.5. This seems disastrously when referencing to some textbooks that suggest that current ratio should be around 2 and the acid ratio should be around 1. But according to Atrill & McLaney (2006) the current ratio will vary from business to business and ‘a supermarket chain will have a relatively low ratio, as it will hold only fast-moving inventories of finished goods and all of its sales will be made for cash (no credit sales)’ (trill & McLaney, 2006, pp 187). (See table 7)
2.4 Financial Gearing Ratio
Gearing ratio is one of the most important indicators regarding ‘the degree of risk associated with a business…it tends to highlight the extent to which the business uses loan finance’ (Atrill & McLaney, 2006, pp169).
Table 8:
2006
2007
2008
2009
2010
Gearing ratio
37.23%
36.53%
40.03%
53.86%
51.08%
Interest cover ratio
6.26
7.04
6.81
5.64
5.01
Source: Tesco PLC Annual Report and Financial Statements 2007/10
There are no significant changes of Tesco’s gearing ratio during the last 5 years; it peaked at 53.9% in 2009 due to the significant increase of the long-term liabilities and the shareholder’s fund resulted of Homever acquisition in South Africa. On the other hand, interest cover ratio decreased significantly from 7 in 2007 to 5 in 2010, but the company still will not have problem to meet its interest (see table 8).
2.5 Investment ratios
Investment ratios give an answer to the key question whether shares should be bought, sold or hold.
Table 9:
2006
2007
2008
2009
2010
Earnings per share
20.04
22.36
26.95
27.14
29.33
P/E ratio
16.5
19.9
14.6
11.5
13.2
Dividend per share
8.63
9.64
10.9
11.96
13.05
Dividend cover
3.57
4.07
2.69
2.42
2.41
Dividend payout
27.98%
24.59%
37.18%
41.30%
41.44%
Dividend yield
2.6%
2.2%
2.7%
3.6%
3.1%
cash from operations /number of shares
0.44
0.45
0.52
0.63
0.75
Source: Tesco PLC Annual Report and Financial Statements 2007/10
Tesco’s earnings per share ratio has increased by around 46% over the last five years, which is a good trend. Dividend per share also registered an excellent growth by 51% for the 5 year period. Dividend cover ratio is another important ratio that determines whether company is attractive for investors. Tesco’s dividend cover ratio is decreasing significantly over the last 3 years, which is good for investors looking for capital appreciation. However, low dividend cover is unattractive for those seeking income (Fitzgerald, (2002, pp160). Dividend yield is another important investment indicator showing the actual return provided by the company. For 2006-2010 Tesco’s dividend yield ratio has been quite variable, the lowest rate was 2.2% in 2007 and the highest was 3.6% in 2009. In 2009 the high yield was affected by economic situation and the company was expected to have low profits growth. In contrast, low dividend yields mean that the company is expected to grow its profits quickly (Arnold, 2004, pp 191) (See table 9). In addition, in 2009 the lowest P/E ratio was registered again because of the expectation for slowdown in profits (Arnold, 2004, pp 187).
3. Benchmark the performance of Tesco
Nowadays, retail industry is characterised by very intense competition and in order to obtain clearer picture of Tesco’s growth, it would be useful to benchmark the company to some of its main competitors, namely Morrisons and Sainsbury’s, evaluating some fundamental financial indicators.
Firstly, it should be taken into consideration the fact Morrisons and Sainsbury’s operates only at national level and Tesco is operating internationally. Therefore, there would be some significant differences in their indices in comparison to Tesco.
Figure 1: Figure 2:
Source: Tesco PLC Annual Report and Financial Statements 2010, Morrisons annual report and financial statements 2010 & J Sainsbury plc Annual Report and Financial Statements 2010
Figure 1 clearly shows that for 2010, Tesco is the market leader with 63% sales levels compared to the whole three companies’ revenue. Sainsbury’s is the second with 22% and Morrisons is the third, registering 16% sales.
In terms of profitability good sign is that all the three companies have managed to maintain its position even during the economic recession and continue to increase their profit numbers. However, comparing Morrisons and Sainsbury’s uncertain fact is that they obtained almost the same levels of profit in 2010, bearing in mind that Sainsbury’s is much bigger than Morrisons. Thus, Morrisons is found to be more efficient with margin of 5.9%, comparing to Sainsbury’s ratio of 3.6% (see figure 2).
Additionally, while Morrisons and Sainsbury’s increased their return on capital employed ratio, even slightly, Tesco registered a significant drop in 2010, by 0.7%, result of the consolidation of Tesco Bank. However, from investor’s point of view, in long term, this is not an inconvenience trend because it will take some time until Tesco Bank start making any profits (see figure 2).
Figure 3:
Source: Tesco PLC Annual Report and Financial Statements 2010, Morrisons annual report and financial statements 2010 & J Sainsbury plc Annual Report and Financial Statements 2010
When it comes to productivity, for 2010, again Tesco is on the top with the highest level of sales per square ft in UK, followed by Sainsbury’s and Morrisons. In terms of sales per employee, there is not a significant difference between the three retails, although Morrisons is presenting more convenience levels in contrast to Sainsbury’s (see figure 3).
Figure4: Figure 5:
Source: Tesco PLC Annual Report and Financial Statements 2010, Morrisons annual report and financial statements 2010 & J Sainsbury plc Annual Report and Financial Statements 2010
From all the three companies, in 2010 Tesco registered the highest level of gearing, 51.08%, Sainsbury’s 38.4% and Morrisons 25.1%, which means Tesco I highly geared. This is not necessary uncertain fact because Tesco is a mature business with strong and reliable cash flows that can allow higher level. In terms of interest cover, Morrisons presents the most convinience positions with ratio of 15.11. Sainsbury’s and Tesco’s rates are low (see figure 4 & 5).
Figure 6:
Source: Tesco PLC Annual Report and Financial Statements 2010, Morrisons annual report and financial statements 2010 & J Sainsbury plc Annual Report and Financial Statements 2010
Finally, Morrisons has the highest earnings per share ratio, 30.36p, but at the same time and the highest dividend cover, which is not very attractive for investors seeking income. Those investors would be more attracted by Sainsbury’s and Tesco’s ratio that are quite low, 2.43 and 2.41, respectively (see figure 6).
Evaluation & Conclusion
Based on the analysis above, it could be concluded that Tesco is a growing company that demonstrates very convenience performance over the last 5 Years, increasing revenues and profits. However, in order to take objective investment decision, share prices and dividend trends should be taken into consideration.
Over the last 5 years Tesco has increased its market shares. ‘In October 2010, Tesco PLC reported semi annual 2011 earnings of 16.43 per share… that is better than the last year’s result for the same period by 18.20%’ (markets.ft.com). In comparison to the FTSE 100 Index, for example, it also demonstrates good trends; ‘over the last week Tesco outperformed the FTSE 100 Index’ (markets.ft.com) (see Table 10). On the other hand, Tesco’s current share prices (432.00p) do not seem so attractive, comparing to its rivals with lowest prices, Morissons- 269.20p and Sainsbury’s-376.00p. Additionally, in terms of the dividend yield rates, there is a significant drop from 3.6% in 2009 to 3.1% in 2010. This could be caused by several factors, but at the same time, it could be a warning sign that the prices are raised excessively and they might be overpriced (moneyweek.com).
Table 10:
Name
1 Week
1 Month
6 Month
1 Year
5 Year
Tesco PLC
-0.24%
+2.48%
+8.74%
+2.57%
+30.59%
FTSE 100 Index
+1.42%
+1.63%
+12.91%
+10.83%
+6.70%
Source: Tesco PLC, markets.ft.com
Finally, according to the Tesco’s ratio analysis and the benchmark there are some other uncertainties regarding liquidity and gearing in comparison to Morrisons and Sainsbury’s, for example. Thus, notwithstanding the satisfying dividend and earnings per share and the strong performance of Tesco, the current share prices do not look very attractive for buying. In this case, Morrisons might be more attractive for future investment noting its successful nationwide expansion, fast growing trend and low share prices.
At first glance Tesco seems an attractive place to work as it has significant growth potential and has very strong positions in the market. The company’s employment policy is very
Overall you have made a good start here. You need to analyse the current share price, dividend yield and P/E ratio for Tesco to see whether it is worth investing. Even if Tesco is a strong performer in a business sense that doesn’t mean we should buy its shares. The strength may already be reflected in the share price or, indeed, the shares may be overpriced. You need to look at share price trends and compare with the FTSE 100 or with an index for the food and drug retail sector. Or you could examine TSR and compare that with the competittion. You need to try to get a feel for whether the shares should be bought at the current price.
You also haven’t answered the employment question – you need to find some employee related data.
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