Business Model and Strategy
Sainsbury has several businesses across different sectors, from grocery stores to financial services such as Sainsbury (grocery store), Argos and Tu clothing (online shopping), Sainsbury bank, Nectar and Habitat (furniture store). Sainsbury aims to provide a variety of products with the best quality and fair price for the consumer, ideally whenever and wherever they want. Their main strategies are to differentiate themselves among competitors through high quality, value and excellent service; increase sales in general merchandise and clothing sector; convenient financial service for the customer; invest in digital market; strengthen the balance sheet.
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Profitability
The gross margin for year 2019 is 6.92%, which has a slightly increase of 0.31% compared with 6.61% in year 2018. The main business is grocery store which commonly low in gross margin due to the high cost of sales, hence the company is considered doing good even under the pressure of discounter (Aldi, Lidl). The company’s focus to increase efficiencies delivered has saved 220m pounds (p. 05) but the saving has been used to offset the wage’s increment (p. 38) and cost inflation, hence did not affect the statement. The company determined to become the industry leader in terms of salary, therefore Argos’ employee’s pay has been increased for a total of 18% since September 2016 and Sainsbury’s store employees increased total 30% over the last 4 years (p. 70). The company also adopted IFRS 9 (International Financial Reports Standard) which lead to higher bad debt charges and there is an increase in the saving cost (Sainsbury bank) as the interest rate increased (p.14). Due to the cost increase as above, the operation profit margin is lower in year 2019 is 1.08% compared with 1.82% in year 2018, a decrease of 0.76%. Albeit the company has deferred the tax credit of 50m pounds (note 8) which lead to 80m pounds different shown in the income tax expense (see income statement), the post-tax profit margin in year 2019 remains lower than year 2018, which is 0.75% compared to 1.09%. Both ROCE and ROE has declined as the operation profit is affected by the higher admin cost and the company has increased the retained earnings (note 23). Although the company keens on long term debt reduction policy, this has not shown effect for now but perhaps in the future as the company will benefit from the lower interest rate.
Investment
The EPS has significantly decreased from 13.3 pence in year 2018 to 9.1 in year 2019. This is because of the lower pre-tax profit and debt reduction policy where cash was used for repayment (p. 99). Although EPS is decreased, the company has increased the DPS from 10.2 pence to 11 pence which can be deemed as the action to keep the shareholder’s confidence. Dividend cover is reduced to 0.83 times as most of the cash flow used for debt repayment, and this commonly indicated as a danger of dividend cut. Another factor is Brexit which caused pound weaker, as dividend cover normally perceived as an economy’s effect (strong or weak economy). However, the company managed to turn it around and increased the DPS. The main reason behind this could be the company able to generate a higher retail free cash flow of 461m pounds (p. 42) to cover.
The P/E ratio has drastically increased from 18.27 times in year 2018 to 24.59 times in year 2019 as Sainsbury’s and Asda confirmed to merge in year 2018. Merge of the second and third largest retailers in the UK would take over more than 30% market share (Statista.com, 2019) and this certainly increases the competitiveness and better economic scale. Hence, the market expects a better return in investing Sainsbury’s and leads to a higher P/E ratio. However, the merge has been blocked by CMA in year 2019 and the P/E ratio is likely to decrease in year 2020. Investors might want to buy shares when the P/E ratio decreased, though the great factor to increase the P/E ratio such as merger is less likely to happen within few years as CMA has applied merger blocked to major retailers. For investor who would like to earn the dividend or expect big bounce in the future market price after Brexit, it could be a great timing to invest now as the company is consistent with dividend yield (average 4.65% in 5 years according to the rate on LSE) and the current market price is lower than the peak in year 2018 (341.50 pence in August 2018 according to LSE). Brexit certainly will impact the market price as majority investors are sitting on the fence until the change has been confirmed, therefore the market price is expected to decline. Investor could speculate this opportunity for a greater return in the future.
Liquidity
Sainsbury’s has a weak liquidity position and the situation is weaker in year 2019. Though the company aim to generate strong, consistent cash flow (p. 09) but it has been utilized for long term debt reduction. Therefore, according to the ratio, the company seems less capable to cover short-term liabilities. Retail business mode commonly has low ACT (acid test ratio) as the business heavily depends on the inventory, hence it is considered doing great in the retail industry. Compared to Tesco UK (Investing.com, 2019), Sainsbury has a better ACT. Additionally, the company has more customer saving (note 18b) which might benefit the capital turnover but also lead to higher interest paid. Albeit the liquidity position seems weak, Sainsbury is capable to pay off the short-term liabilities as the company has a lump sum of retained earnings (p. 98) to utilize when deemed necessary.
Average inventory days is 26 days, which is considered long for a retailer. As per previous stated, retailer heavily depends on the inventory to generate cash and pay off expenses, hence it is less favourable. Though the inventory days is less favourable, Sainsbury’s maintained the inventory days without huge change under the pressure of consumer behaviour shifts to Aldi and Lidl. Furthermore, Sainsbury has longer payable days than inventory day hence they have more time to sell the goods and cover the payable. Due to the retailer’s characteristic, it just takes 2 days for Sainsbury’s to collect receivables. The key element to take into consideration for an investor is inventory days as it determines how fast the company can generate cash and reduce inventory loss.
Gearing
Sainsbury’s has scored a low gearing of 21.62% in year 2018 and lower to 11.23% in year 2019 as a result of business strategy to reduce net debt (p. 17). Equity mainly formed by retained earnings (p. 98) which is up to 56.33% of total equity, and next is share issue which is 21%. The remeasurement on defined benefit pension schemes is increased to 1053m in year 2019 (note 23) which affected the retained earnings. Overall, the company has a greater ability to re-invest the business in a long-term run. As we can see, Sainsbury’s aim to increase investment in the supermarket in 2019/20 (p. 10) by partnering with different sectors such as Timpson and Specsavers which will increase their profitability and market share. The net debt to equity ratio in year 2019 is -2.02%, which represents that the company could fully repay the long term borrowing whilst have cash on hands.
As the company has lesser borrowing which leads to low interest payable, therefore the ICR (interest cover ratio) is 3.15 times in year 2019. It has shown the ability to generate cash to cover interest and the financial stability of the business. Though some argued that high ICR could represent that the business is neglecting the chances to maximize earning through leverage (CFI.com, n/a). Another possible issue is the company issues more share to generate more equity, which leads to higher dividend pay-out.
Cash Flow
Sainsbury’s is capable to generate more cash from the share issued. The company has high revenue but also the high cost of sales which leads to low gross profit, but it is considered great for the retail industry. Albeit the pre-tax profit has reduced in year 2019 which affected by the debt reduction policy, the company is generating net cash and has lesser net finance cost (p. 99).
Conclusion
Overall, Sainsbury’s is performing well and financial stable. Although under the pressure of discounter and consumer behaviour shift, Sainsbury’s able to maintain the revenue whilst repaying the long term borrowing and increase retained earnings. Albeit it is a loss that the merger of Sainsbury’s and Asda is blocked, Sainsbury’s is a safe investment and is giving out dividends consistently. Additionally, Sainsbury’s aim to partner with different sectors to provide a one-stop shopping experience which will make a great profit in the future.
Appendices
Profitability measure
2018
2019
Gross Profit Margin
1882 / 28456 = 6.61%
2007 / 29007 = 6.92%
Operating Profit Margin
518 / 28456 = 1.82%
312 / 29007 = 1.08%
Pre-tax Profit Margin
409 / 28456 = 1.44%
239 / 29007 = 0.82%
Post-tax Profit Margin
309 / 28456 = 1.09%
219 / 29007 = 0.75%
ROCE
518 / (1602+7411) = 5.75%
312 / (950+8456) = 3.32%
ROE
309 / 6415 = 4.47%
219 / 7960 = 2.75%
Investment measure
2018
2019
EPS (Given)
13.3 pence
9.1 pence
DPS (Given)
10.2 pence
11.0 pence
Dividend Cover
13.3 / 10.2 = 1.3 times
9.1 / 11 = 0.83 times
Dividend Yield
10.2 / 243 = 4.2%
11 / 223.8 = 4.92%
P/E Ratio
243 / 13.3 = 18.27 times
223.8 / 9.1 = 24.59 times
*Market price based on 9th March 2018 (243 pence) and 8th March 2019 (223.8 pence)
Liquidity
2018
2019
Current Ratio
7866 / 10302 = 76.35%
7589 / 11417 = 66.47%
Acid Test Ratio (ACT)
6056 / 10302 = 58.78%
5660 / 11417 = 49.58%
Inventory days
1810 / 26574 x 365= 25 days
1929 / 27000 x 365 = 26 days
Trade Payable days
2852 / 26574 x 365 = 39 days
3044 / 27000 x 365 = 41 days
Trade Receivable days
117 / 28456 x 365 = 2 days
144 / 29007 x 365 = 2 days
Gearing
2018
2019
Debt to Equity
1602 / 7411 = 21.62%
950 / 8456 = 11.23%
Net Debt to Equity
(1602-1730) / 7411 = -1.73%
(950-1121) / 8456 = -2.02%
Interest Cover
518 / 140 = 3.7 times
312 / 99 = 3.15 times
Net Interest Cover
518 / (140-19) = 4.28 times
312 / (99-22) = 4.05 times
Reference List
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