1. Analyse the firm’s financial performance during the last three years. Identify the financial actions taken and policies adopted during these years, as far as you can tell from the available information. Investigate and discuss to what extent you think the company has been able to increase shareholders’ wealth through the financial actions you have identified.
2. Critically evaluate important qualitative factors analysts should consider when evaluating a firm’s likely future financial performance.
3. Critically evaluate the extent to which you agree with the statement that corporate governance helps ensure achievement and retention of shareholders’ wealth using your selected company.
For meeting the purpose of this assignment, Sainsbury Plc has been chosen as the organisation, which is one of the leading retailers in the province of UK. The organisation operates through four divisions, which include food retailing, general merchandise retailing, clothing retailing along with property investment and financial services (Sainsburys.co.uk 2018). In order to carry out the financial analysis of the organisation for the past three years along with the financial actions and policies undertaken, the following KPI analysis and ratios are taken into consideration:
|
KPIs |
Analysis |
|
Underlying profit before tax |
The trend of the past five years clearly indicate the decline in profit due to the rise in cost of revenue and operating cost despite the fall in finance costs. |
|
Retail underlying EBITDAR margin |
The fall in this indicator is inherent over the years as well particularly due to the rise in selling, general and administrative expenses. |
|
Core retail capital expenditure |
The organisation has reduced its spending on capital assets due to the sale of some of its fixed assets for increasing its working capital base. |
|
Underlying basic earnings per share |
The earnings per share have degraded over the years due to the lower return on investments made, which is again because of the falling popularity in the market. |
|
Retail underlying operating margin |
The operating margin has experienced downfall as well for rise in cost of sales and operating cost. |
|
Retail operating cash flow |
The trend is fluctuating due to the lower proceeds generated from the asset base of the organisation. |
|
Dividend per share |
The dividend per share could not be increased due to the falling net profit. |
The three ratios that have been considered for conducting the profitability analysis of Sainsbury Plc include gross margin, net margin and return on capital employed (ROCE) and their detailed calculations are depicted in the form of a table (Refer to Appendices, Appendix 4).
(Source: Sainsburys.co.uk 2018)
The above figure clearly illustrates that the gross margin of Sainsbury Plc has increased from 5.08% in 2015 to 6.19% in 2016 and 6.23% in 2017. In this regard, Adewuyi (2016) stated that gross margin helps in gauging the profitability of a firm in manufacturing and selling products before considering any other expenditure. On the other hand, net margin gauges the profit level after all the operating expenses, finance costs and corporate tax are taken into account. The net margin of the organisation has increased from -0.70% in 2015 to 2% in 2016; however, it has fallen again to 1.44% in 2017.
The increasing trend behind gross margin is the rising sales growth due to opening of new 92 stores in 2014 (Maynard 2017). In addition, constant growth is observed in selling price by 16% since 2009. In addition, the stable market share of the organisation denotes customer loyalty and it has managed to gain one million additional customers in 2011 due to initiation of club cards and gift vouchers. Thus, it has resulted in improved gross margin for Sainsbury Plc. However, net margin has declined in 2017 due to the rise in operating expenses, especially advertising and promotion for drawing customers as a part of its financial strategy.
ROCE gauges the ability of an organisation with which investment of new cash is made and through which profit is delivered via existing capital (Casu and Gall 2016). In case of Sainsbury Plc, the ratio has increased from 0.79% in 2015 to 5.91% in 2016; however, it has declined to 3.82% in 2017. The growth of ROCE has been lower in 2017 due to the cumulative effect of the accelerated investment of Sainsbury Plc in space growth. On the other hand, due to the lower pricing structure of the UK retail sector, an average of £0.297 is left as operating income for every £1 revenue earned (Davies 2017). Hence, based on profitability evaluation, Sainsbury Plc is enjoying moderately competitive position in the market.
The three ratios that have been considered for conducting the efficiency analysis of Sainsbury Plc include inventory turnover, payables turnover and receivables turnover and their detailed calculations are depicted in the form of a table (Refer to Appendices, Appendix 4).
(Source: Sainsburys.co.uk 2018)
According to the above figure, it could be observed that the inventory turnover of the organisation has remained the same at 16 days in both 2015 and 2016; however, it has increased to 20 days in 2017. This ratio helps in depicting the quickness of a firm to generate its sales (O’Hare 2016). The lower the turnover in terms of days, the greater is the efficiency of the organisation in generating sales. In this case, the aggressive marketing campaign of Sainsbury Plc has not worked effectively due to which its product demand has fallen slightly in the market (Buckland and Davis 2016).
The receivables turnover depicts the credit management of an organisation, as higher ratio in terms of days indicates scarcity of funds for the organisation (Thompson and McLarney 2017). In this case, the payables turnover the organisation has increased from 7 days in 2015 to 8 days in 2016 and it has remained the same in 2017. This denotes that the working capital cycle of Sainsbury Plc has increased due to the greater time limit extended to the debtors.
In the words of Haleem and Jehangir (2017), payables turnover is the ratio that gauges the speed with which an organisation makes payment to its suppliers. The higher the ratio in terms of days, the better it is for the concerned organisation. In case of Sainsbury Plc, the ratio has increased from 32 days in 2015 to 35 days in 2016 and it has remained constant in 2017. This is because the creditors have allowed the organisation to extend credit terms due to its market reputation and brand image.
The two ratios that have been considered for conducting the liquidity analysis of Sainsbury Plc include current ratio and quick ratio and their detailed calculations are depicted in the form of a table (Refer to Appendices, Appendix 5).
(Source: Sainsburys.co.uk 2018)
The above figure clearly indicates that both current ratio and quick ratio of Sainsbury Plc have increased over the years. With the help of these two ratios, it is possible to ascertain the ability of an organisation to pay off its existing obligations with the short-term asset base available (Rahman 2015). In this case, even though the ratios are on the increasing scale, they are well below the industrial standards. In order to deal with this issue, Sainsbury Plc has decided to reduce its inventory level by conducting market research to anticipate the prevailing market demand. Hence, a slight improvement in its liquidity position could be observed during the years.
The two ratios that have been considered for conducting the gearing analysis of Sainsbury Plc include debt-to-equity ratio and interest coverage ratio and their detailed calculations are depicted in the form of a table (Refer to Appendices, Appendix 6).
(Source: Sainsburys.co.uk 2018)
The above figure clearly illustrates that Sainsbury Plc has started to minimise its reliance on debt funding. The reason is the rise in interest payments on long-term bank loans that the organisation has obtained and such payments have reduced its overall profit margin and retained earnings. For combating with this situation, it has focused on raising additional funds through issuance of equity shares in the market. The outcome could be observed in case of interest coverage ratio, which has increased heavily in 2016; however, a slight decline could be observed in 2017. The ideal interest coverage ratio in the UK retail sector is any figure above 1 (Metzger 2014). In this case, even though the ratio has fallen in 2017, it could be stated that improvements could be observed in the gearing performance of Sainsbury Plc.
The two ratios that have been considered for conducting the investment analysis of Sainsbury Plc include price earnings ratio and dividend yield ratio and their detailed calculations are depicted in the form of a table (Refer to Appendices, Appendix 7).
(Source: Sainsburys.co.uk 2018)
According to the above figure, it could be stated that the price earnings ratio of Sainsbury Plc has increased heavily in 2016 to 10.16 and the trend is inherent in 2017 as well to 13.10. In order to increase this particular ratio, the management of Sainsbury Plc has increased its return on capital, minimised its cost of capital along with deferring the point of saturation. As a result, positive future growth is ensured in the future.
On the other hand, the dividend yield ratio has remained at 0.03 in both 2015 and 2016, while a slight fall is observed in 2017 to 0.02. This ratio defines the percentage of return, which an organisation provides to its shareholders (Van Duijn et al. 2016). Since Sainsbury Plc is one of the leading firms in the UK retail sector, the older firms tend to have a consistent dividend history. The similar could be observed in case of Sainsbury Plc and thus, it could be stated that the organisation is improving its performance and position to maximise the wealth of the shareholders.
The qualitative factors that the analysts need to consider for assessing the likely future financial performance of Sainsbury Plc comprise of the following:
This is a business analysis model, which is used to gauge intensity of competition, profitability and attractiveness of an industry or an organisation operating in the industry. This theory consists of five forces; the first force is threat to competition, which ascertains the number of competitors and their strengths in the market (Wang, Dou and Jia 2016). In case of Sainsbury Plc, the threat to competition is severe due to the presence of other big retailers like Tesco Plc, Morrison’s Plc, Marks and Spencer and others.
The second force of this theory is the threat of new entrants, which could weaken the position of a firm. For Sainsbury Plc, this threat is moderate, since it enjoys cost advantages, which are not available to the new entrants. The third force is the bargaining power of the suppliers, which addresses the way the suppliers increase the costs of products and services (Huarng, Rey-Martí and Miquel-Romero 2018). In the UK supermarket, the bargaining power of the suppliers is low, since it relies on four big retail stores to reach 75% of the UK supermarket and Sainsbury Plc is one of them.
The fourth force is the bargaining power of the buyers, which deals with the capability of the customers in driving the prices down of the organisations. For Sainsbury Plc, this power is high due to the fact that the purchasers have the alternative of a group of various products at the time of purchasing them. The final force is the threat of substitutes, which denotes the alternative products that the competitors use as substitutes in the market. In case of Sainsbury Plc, the threat is moderate, since the availability of substitutes is significantly low for food items and medium for non-food items.
Another factor that the analysts need to consider at the time of analysing the future financial performance of Sainsbury Plc is human capital, as it helps in gauging the economic value of the skill sets of an employee. This theory is based on the assumption that all staffs do not have the same types of skills and hence, their skills could be improved by enhancing education, existing skills and their overall capabilities (Churet and Eccles 2014). Sainsbury Plc has designed its training and development program in such a way that it raises the skill sets of its existing staffs. For new staffs, it conducts induction training that continues for two days and after induction session is over, the staffs are provided with clear descriptions of their job roles and responsibilities. Intermediate training, advanced training and career development programme are present in the organisation to enhance the motivation level of the employees.
In case of Sainsbury Plc, intangible asset could be classified as its brand image, as it remains with the organisation as long as it operates in the market (Wagner et al. 2015). It has already been evaluated that Sainsbury Plc is one of the leaders in the UK supermarket, since it provides high quality products and services. Moreover, it maintains competitive pricing structure along with promotional offers and discounts. As a result, the customer satisfaction level is increased and in turn, its brand image and popularity in the market.
The corporate governance policies of Sainsbury Plc have certain factors that help in assuring retention and accomplishment of shareholders’ wealth and they are enumerated briefly as follows:
The executive management of Sainsbury Plc has formulated internal control system for facilitating effective operations of the organisation. The aim is to help the management to make appropriate response to considerable risks for achieving global business objectives. The internal control system is formulated to change, instead of eliminating the failure risk for accomplishing the global business objectives. In addition, it could provide reasonable; however, not absolute assurance against any loss or material misstatement (Tricker and Tricker 2015). Such advanced internal control system enables in assuring the quality of external and internal reporting of the organisation. In addition, it helps in conforming to the prevailing regulations and legislations along with internal policies in relation to the business conduct (Krüger 2015).
The board of the organisation is accountable to review and monitor the reliability of accounting policies, financial statements and information within its annual report. In order to undertake this accountability, the on-going processes support the directors to identify, analyse and manage the risks encountered. The management implements all the processes and the group internal audit monitors its effectiveness independently.
The board of Sainsbury Plc is fully responsible for the overall risk management process. It is the responsibility of the executive management to detect risks and accordingly, suitable mitigation and controls would be implemented within the organisation (McCahery, Sautner and Starks 2016). In addition, there is presence of independent group risk management department, which is accountable to the board risk committee directly. This committee has no restrictions to the chairperson of the committee and thus, it is accountable to design and review the process of risk management.
Sainsbury Plc has an internal audit function, which is commensurate with the nature, size and degree of business. The internal audit is obliged to report to the board audit committee and the access is unrestricted to the chairperson of the board audit committee. The organisation is involved in following a risk-based audit approach, in which the board audit committee makes the approval of yearly audit plans (Mishra and Modi 2016). On the other hand, the internal audit department is authorised to ascertain the functioning and adequacy of the business network of governance and control processes along with risk management.
For evaluating the quality of management, Sainsbury Plc has carried out an external facilitator for conducting the same. The Manchester Square Partners (MSP) has been appointed to carry out the evaluation exercise of the management. The review has considered certain points like strategy, operational capabilities, the structure, role and balance of the board along with risk management, succession and governance.
MSP has inferred that the organisation has been functioning effectively to meet the needs of all its stakeholders along with maximising the business profit. This is because it has increased the return on capital along with raising additional equity shares and thus, the overall price per share has increased. Moreover, dividend payment to the shareholders has increased and thus, it could be said that the management quality of Sainsbury Plc is effective in increasing the wealth of the shareholders (Larcker and Tayan 2015).
Agency problem could be defined as the conflict of interest present in any relationship, in which one party is expected to perform to meet the expectations of the other party. In case of Sainsbury Plc, the agency problem might arise due to the conflict of interest between management and the shareholders. The managers acting as the agents for the shareholders are needed to undertake decisions to increase the wealth of the shareholders (Choi, Han and Lee 2014).
The following could be the major agency problems in Sainsbury Plc:
Hence, based on the above evaluation, it could be stated that corporate governance plays a significant role in assuring the maximisation of the wealth of the shareholders.
References:
Adewuyi, A.W., 2016. Ratio Analysis of Tesco Plc Financial Performance between 2010 and 2014 in Comparison to Both Sainsbury and Morrisons. Open Journal of Accounting, 5(03), p.45.
Buckland, R. and Davis, E.W., 2016. FINANCIAL STRATEGY AND ACCOUNTABILITY AROUND. Finance for Growing Enterprises, p.249.
Casu, B. and Gall, A., 2016. The Performance of Building Societies: A Comparative Analysis. In Building Societies in the Financial Services Industry (pp. 79-98). Palgrave Macmillan, London.
Choi, Y.K., Han, S.H. and Lee, S., 2014. Audit committees, corporate governance, and shareholder wealth: Evidence from Korea. Journal of Accounting and Public Policy, 33(5), pp.470-489.
Churet, C. and Eccles, R.G., 2014. Integrated reporting, quality of management, and financial performance. Journal of Applied Corporate Finance, 26(1), pp.56-64.
Davies, D., 2017. Managing financial information. Kogan Page Publishers.
Haleem, F. and Jehangir, M., 2017. Strategic Management Practices by Morrison PLC, UK. Analysis, Lessons and Implications. Middle East Journal of Business, 12(3).
Huarng, K.H., Rey-Martí, A. and Miquel-Romero, M.J., 2018. Quantitative and qualitative comparative analysis in business.
Krüger, P., 2015. Corporate goodness and shareholder wealth. Journal of financial economics, 115(2), pp.304-329.
Larcker, D. and Tayan, B., 2015. Corporate governance matters: A closer look at organizational choices and their consequences. Pearson Education.
Maynard, J., 2017. Financial Accounting, Reporting, and Analysis. Oxford University Press.
McCahery, J.A., Sautner, Z. and Starks, L.T., 2016. Behind the scenes: The corporate governance preferences of institutional investors. The Journal of Finance, 71(6), pp.2905-2932.
Metzger, K., 2014. Business analysis of UK supermarket industry.
Mishra, S. and Modi, S.B., 2016. Corporate social responsibility and shareholder wealth: the role of marketing capability. Journal of Marketing, 80(1), pp.26-46.
O’Hare, J., 2016. Analysing Financial Statements for Non-specialists. Taylor & Francis.
Rahman, M.M., 2015. Critical analysis of the influence of discount retailers on Tesco plc in the UK.
Sainsburys.co.uk., 2018. [online] Available at: https://www.about.sainsburys.co.uk/investors/annual-report-2017 [Accessed 16 Mar. 2018].
Thompson, J. and McLarney, C., 2017. What effects will the strategy changes undertaken by next Plc have on themselves and their competition in the UK Clothing Retail Market?. Journal of Commerce and Management Thought, 8(2), p.234.
Tricker, R.B. and Tricker, R.I., 2015. Corporate governance: Principles, policies, and practices. Oxford University Press, USA.
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Wagner, D., Block, J.H., Miller, D., Schwens, C. and Xi, G., 2015. A meta-analysis of the financial performance of family firms: Another attempt. Journal of Family Business Strategy, 6(1), pp.3-13.
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