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Discuss about the Stock Evaluation for Woolworths Limited.
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The firm that has been used for this stock valuation task is Woolworths Limited which deals with organised retail business with the predominant format being that of supermarkets. The company enjoys a healthy share of around 40% and together with Coles form a virtual duopoly which in the recent years has been challenged to some extent by the entrance of German discount retailers like Aldi. The company besides being present in the grocery and liquor business also has major presence in fuel retailing (in association with Caltex), runs discount department stores, has presence in the home improvement segment besides hotels. The major market served by the company is Australia which accounts for more than 85% of the revenue generated. The company has presence in wide parts of Australia with estimated store strength of about 975 stores and is steadily increasing its presence and market share in the New Zealand market. The company also has limited presence in selective verticals in South Africa, Hong Kong, India and UK (Woolworths, 2016). The current market capitalisation of the firm is $ 30.77 billion. The given report aims to conduct a quantitative and qualitative analysis of the company taking into consideration the last five year financial statements so as to opine on whether investment should be made in the stock or not.
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The stock price movement of Woolworths during the last one year is captured in the graph shown below (Yahoo Finance, 2016).
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It is apparent from the above that in the last one year, the stock has delivered negative returns and has underperformed the ASX 200 index. Further, it is also apparent that there is a range bound movement of the stock with support coming in at lower levels and resistance at the higher value of the stock as investors book profits (Geurard, 2013). Considering the competitive nature of the industry and the current macroeconomic conditions that are not ideal for the industry, such kinds of sideways movements are not unexpected. Further, even though the fundamentals of the company remain in place, it seems that the stock is poised to underperform the broader markets primarily on account of industry dynamics, lower fuel prices and lacklustre trading environment (Petty et, al., 2015).
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The impact of various quantitative factors include the trend analysis with regards to the major items in the financial statements namely the income statement and balance sheet along with analysis of selected ratios so as to comment on the financial performance of the firm. The concerned period of interest is from FY2012 –FY2016 which constitutes a period of five years.
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The revenue growth for the company has been impressive in FY2013 as compared to FY2012 on the back of improved trading environment coupled with rising consumer confidence and increased prices of fuel. After a uptrend from FY2012 to FY2014, there has been a negative growth or de-growth witnessed in the revenue in FY2015 and FY2016. The negative growth in these years may be attributed to namely two years i.e. increased competition especially with the entry of international German discount retailers which have increased their market share coupled with sharp decrease in the fuel prices which has adversely impacted the fuel sales. Further, in FY2015, there has been decrease in the number of Caltex outlets which have been added to the revenues and hence the revenue has been lower (Woolworths, 2012; 2014; 2016).
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From FY2012 to FY2014, there is an increasing trend in the gross profit which has increased from $ 14.46 billion to $ 16.48 billion. The encouraging trend in this regard is the improvement of gross profit margins by 54 bps and 17 bps in FY2013 and FY2014 respectively. The improvement is primarily driven by expanding margins in the Australian food and liquor business coupled with Hotels. Besides, in FY2014, the gross profits were negatively impacted by the decreasing margins in the general merchandise business. However, during FY2015 and FY2016, there have been shrinking gross profit margins which are attributable to the lower prices of fuel coupled with higher competition in the food and liquor segment which is stalling price increases and thus in order to stem the falling market share, the margins have fallen (Woolworths, 2012; 2014; 2016).
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With regards to financing costs, there has been an increase trend in this regard from FY2012 to FY2016 which has been briefly interrupted in FY2014 as there has been a slight decrease in the finance costs on the back of stellar performance in FY2013 on the basis of which there has been a reduction in the outstanding debt and hence leading to the decreased expense in the form of finance costs. Additionally, some part of the total interest costs in the various years is also capitalised which influences the overall financing costs (Woolworths, 2012; 2014; 2016).
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With regards to net profit, there has been an increasing trend from FY2012 to FY2014 but the same has been reversed in the subsequent years and infact in FY2016 the company has reported a loss. While the decrease in FY2015 net profit may be explained on account of lower gross profit margins coupled with increased operational costs, but the losses made in FY2016 can be explained on the basis of loss to the extent of $ 3.1 billion on account of discontinued business (Hydrox Holdings Pty Ltd). Further, there has been a steep rise in the administrative expense by about 21% on a y-o-y basis which has led to steep fall in the operating margins of the continued business operations (Woolworths, 2012; 2014; 2016).
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From FY2012 to FY2015, there is an uptrend with relation to the cash balance which has come down only in FY2016. While during FY2012 to FY2014, there has not been much change in cash balance, however the FY2015 cash balance is significantly greater than FY2014 corresponding figure which is caused due to lower cash flow on amount of investing due to a weak trading environment persisting in Australia. However, the lower cash balance in FY2016 is primarily attributed to the lower cash flow from operations which have led to decrease in the overall cash balance (Woolworths, 2012; 2014; 2016).
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With regards to intangible assets, there has been an increasing trend from FY2012 to FY2014 which has then reversed into a declining trend over the period FY2015 –FY2016. While, the decline in FY2015 is only marginal and caused due to discontinued business, the decline in FY2016 is comparatively more significant and prompted by the decline in goodwill to the tune of $350.9 million and this decrease has been witnessed in relation to the continued operations only(Woolworths, 2012; 2014; 2016).
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There is an increasing trend in the trade and other payables which is witnessed during the given period i.e. FY2012 –FY2016. This is apparent from the fact that trade and other payables have increased from $ 5.24 billion as on June 30, 2012 to $ 6.26 billion as on June 30, 2016. It is apparent that the increase of trade payables reflects towards a greater credit period for the company which to an extent may be driven by the difficult conditions in the retail industry and hence the company would want to minimise the working capital requirements (Woolworths, 2012; 2014; 2016).
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In relation to the non-current borrowings, there is a declining trend from FY2012 to FY2015 but has increased only in FY2016. The increase in FY2016 is primarily on account of increase in long term bank loan to the tune of $ 853.2 million. The decrease in the long term borrowings augers well for the company and ensure that the company has less leverage and therefore could raise more debt to withstand the competitive environment using deep financial pockets (Woolworths, 2012; 2014; 2016).
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There is an increased equity trend from FY2012 to FY2015 primarily due to increase in issued capital and higher retained earnings on the basis of the profitable operations of the company. The issued capital has seen an incline in every year of the given period including FY2016. As a result of this, the issued share capital has increased from $ 4.37 billion at the end of FY2012 to $ 5.35 billion at the end of FY2016. This highlights that during the period under assessment incremental shares to the tune of $ 0.98 billion have been issued by the company. However, the major increase in equity is on account of increased retained earnings. The decline in equity as on June 30, 2016 could be explained on the basis of sizable reduction in the retained earnings due to loss of $ 3.1 billion incurred due to discontinued business as explained above (Woolworths, 2012; 2014; 2016).
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The selective ratios for the company for the given time period are computed as follows (Woolworths, 2012; 2014; 2016).
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Particulars rn |
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2012 rn |
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2013 rn |
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2014 rn |
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2015 rn |
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2016 rn |
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Return on total assets rn |
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8.42% rn |
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10.15% rn |
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10.13% rn |
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8.47% rn |
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-5.25% rn |
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Net profit margin rn |
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3.29% rn |
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3.85% rn |
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4.02% rn |
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3.64% rn |
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-2.12% rn |
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Inventory Turnover rn |
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11.0 rn |
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10.2 rn |
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9.5 rn |
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8.8 rn |
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9.4 rn |
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Current ratio rn |
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0.9 rn |
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0.9 rn |
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0.9 rn |
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0.8 rn |
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0.8 rn |
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Price earnings ratio rn |
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17.93 rn |
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18.05 rn |
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18.01 rn |
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15.83 rn |
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-21.38 rn |
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Debt ratio rn |
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0.61 rn |
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0.58 rn |
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0.57 rn |
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0.56 rn |
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0.63 rn |
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The explanation with regards to the above ratios is offered below.
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ROA or Return on Total Assets – The ROA has jumped from 8.42% in FY2012 to 10.15% in FY2013 primarily on account of higher percentage increase in net profits as compared to the total asset increase. However, there was a marginal decline in ROA in FY2014 over the previous year as the profit increase was marginal and not able to match the percentage increase in total assets. But the real worry is the decline in FY2015 and FY2016. There is a drop in ROA in FY2015 due to the drop in profitability of business operations caused to falling margins of fuel retailing besides higher competition experienced in the food and liquor segment leading to negative growth in revenues. Besides, in FY2016, the company incurs a loss due to discontinued operations which leads to a negative ROA (Woolworths, 2012; 2014; 2016).
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Net Profit Margin – There has been a positive trend in the net profit margin during the period FY2012-FY2014 on the back of growing margins in the food and liquor segment coupled with hotels business. This is the result of various initiatives undertaken by the company to streamline the operations and cut down on the overheads costs so as to ensure that the company stays competitive in a market highly sensitive to prices. However, the net profit margins have taken a dip in FY2015 primarily on the back of lower gross profit margins as the competition level increased coupled with higher operational expenses. The decline in margins in FY2016 from continued businesses is on account almost 21% increase in the administrative costs over the corresponding values in FY2014. Further, the discontinued business loss to the tune of $ 3.1 billion has resulted in the PAT turning negative (Woolworths, 2012; 2014; 2016).
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Inventory Turnover – There is a declining trend in the inventory turnover from FY2012 to FY2015 which hints at higher cash cycle and is not in the best interest of the company or the shareholders. This may be attributed to the continuously rising inventory levels from $ 3.7 billion as on June 30, 2012 to $ 4.87 billion as on June 30, 2015. This may be reflective of the muted sales of the company which may not be in accordance with the expectations of the company. However, at the end of FY2016, there is a decline in the inventory level and hence an improvement in the inventory turnover (Woolworths, 2012; 2014; 2016).
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Current Ratio – The current ratio for the company has shown very slight variation as from FY2012 to FY2014, the current ratio remains almost constant at 0.9. This may be attributed to proportionate changes in both current assets and current liabilities. However, in FY2015, there is a decrease in the current ratio fuelled by the higher percentage increase in the current liabilities caused due to increased amount of current borrowing in FY2015 as compared to the previous year. In FY2016, even though there is a decrease in current borrowing by almost $ 1.1 billion, but to some extent this is balanced by increase in $ 0.8 billion on account of provisions, the net result of which is that the current ratio has not improved (Woolworths, 2012; 2014; 2016).
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Price earnings ratio – With regards to P/E ratio, there is a slight improvement from FY2012 to FY2013 which may be on account on better financial performance by the company. However, for FY2014, the P/E ratio remained almost static. Then, in FY2015, due to increased competition and falling margins especially on fuel retailing, the P/E ratio was adversely impacted particularly on concerns with regards to growth especially in the short term. The concern continued in FY2016 as earnings became negative on the back of loss to the tune of $ 3.1 billion arising from discontinued business (Woolworths, 2012; 2014; 2016).
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Debt Ratio – The debt ratio has shown a marginal declining trend from FY2012 to FY2015 but there has been a reversal in the trend in FY2016. The declining value of debt ratio was favourable for the company implying that the liability as a percentage of debt was on the decline. The increase of the debt ratio in FY2016 is primarily on account of the decrease in total assets brought about mainly in decrease of PPE from $ 10.06 billion as on June 30, 2015 to $ 8.26 billion as on June 30, 2016. This has been brought about due to the discontinued business (Woolworths, 2012; 2014; 2016).
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Strengths of the company
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Weakness of the company
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From the above, it is apparent that the company in the long run would deliver returns as the business fundamentals remain sound. But in the near to medium term, the stock is expected to be range bound only as the margins made witness more pressure and thus have a downward bias. Clearly, it is best to avoid the retail industry stocks and instead look at companies in other industry segments which offer much better value and growth upside. Hence, taking above factors into consideration, it may be recommended that investment should not be done in the company’s stock (Parrino & Kidwell, 2011).
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Dividend paid by Woolworths in FY2016 ($ per share) = $ 1.65717
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Perpetual dividend growth rate (given) = 4% p.a.
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Expected return on Woolworths stock = 9% p.a.
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Hence, expected dividend in FY2017($ per share) = 1.6517*1.04 = $ 1.72345
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Thus, by applying the Gordon Dividend Discount Model, we get (Northington, 2011)
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Fair price of the stock = 1.72345/(0.09-0.04) = $ 34.47
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Thus, at current price, the stocks seem to be underpriced. However, it is imperative to note that market dynamics tend to function differently from theoretical prices and it may take a long time before this aberration is corrected as the markets may not be efficient (Kane & Marcus, 2013).
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References
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Guerard, J 2013, Introduction to financial forecasting in investment analysis, 6th eds., Springer, New York
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Kane, BZ & Marcus, AJ 2013, Essentials of Investment, 9th eds., McGraw-Hill International, Singapore
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Northington, S 2011, Finance, 6th eds., Ferguson, New York
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Parrino, R & Kidwell, D 2011, Fundamentals of Corporate Finance, 3rd eds., Wiley Publications, London
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Petty, JW, Titman, S, Keown, AJ, Martin, P, Martin JD & Burrow, M 2015, Financial Management: Principles and Applications, 6th eds., Pearson Australia, Sydney
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Woolworths 2012, Financial Report 2012, Woolworths Website, Available online from https://www.woolworthslimited.com.au/annualreport/2012/pdf/WW_AR12_FinReport.pdf
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(Accessed on October 11, 2016)
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Woolworths 2014, Annual Report 2014, Woolworths Website, Available online from https://www.woolworthslimited.com.au/annualreport/2014/files/Woolworths_Annual_Report_2014.pdf (Accessed on October 11, 2016)
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Woolworths 2016, Annual Report 2016, Woolworths Website, Available online from https://www.woolworthslimited.com.au/icms_docs/185841_Annual_Report_2016.pdf (Accessed on October 11, 2016)
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Yahoo Finance 2016, Woolworths Summary, Yahoo Finance Australia, Available online from https://au.finance.yahoo.com/q?s=WOW.AX (Accessed on October 11, 2016)
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