Robert Meldrum Level 3 Babm
Business Finance: Assignment
Comparison of two businesses investment potential
Introduction
The two companies this report will investigate are, J. Sainsbury PLC and Somerfield PLC. Both operate in the supermarket sector of the retail industry. There are many interesting issues, which could have led to the selection of these firms, which will be discussed in the first section of the report. The next section will contain financial analysis of their positions in relation to each other and in some places the industry as a whole. The Z-score model developed by Altman will be used to look at their chances of survival in future. This model will be scrutinised to ascertain its value in a comparison of this nature. A summary of the points raised and recommendation of, which company is the better investment prospect will form the final part. The report will use the financial reports for the years 1996 to 2000.
Selection of Companies
The retail and the supermarket industry in particular have had a volatile time in recent years. Everyone from government to local shops has accused them of bad practice for various reasons. The government commissioned a Monopolies and merges investigation into their treatment of suppliers, it had been suggested that they had been squeezing prices so far many farmers could not even cover their costs. Local stores such as chemists claim that low prices in supermarkets are driving them out of business, leaving local shopping parades empty. Newspapers have carried regular articles comparing the price of shopping in the UK with various other countries, no prizes for guessing who came off worst. International giants, namely Wal-Mart of the US, have entered the market aiming to cut costs and pass savings on to consumers. Many of the major players have diversified into new markets; most now offer personal finance services. They have also expanded the range of products on their shelves selling all kinds of exotic groceries as well as moving into new ranges altogether such as clothing and electrical items often at lower prices then high street stores. Then Internet shopping has been introduced though it is only just beginning to take off. GM foods have caused some stores to guarantee their products as GM free and others to take a wait and see attitude. So the industry in general has been an interesting one to watch over the last five or so years.
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Martin Manufacturing Company Historical Ratios RATIOS ACTUAL 2001 ACTUAL 2002 ACTUAL 2003 INCREASE (DECREASE) INDUSTRY AVERAGE Current ratio 1. 7 1. 8 2. 5 0. 7 1. 5 Quick Ratio 1. 0 0. 9 1. 3 0. 4 1. 2 Inventory turnover (times) 5. 2 5. 0 5. 3 0. 3 10. 2 Average collection period (days) 50. 0 55. 0 58. 0 3. 0 46. 0 Total asset turnover (times) 1. 5 1. 5 1. 6 0. 1 2. 0 Debt Ratio (%) 45. 8 54. 3 ...
The reason this report is looking at Sainsbury and Somerfield though is nothing to do with any of these. The fact that both refused to employ its author as a part timer some years ago does. Would they have been good companies to work for and what does the future hold for them? It would be nice to know that because of that small mistake on the part of a deputy store manager they where both going down the pan though this is most unlikely. The rest of the report will give some indication of how wise this was!
Comparison of Performance
The Turnover of the two companies shows that Sainsbury’s is by far the larger of the two, as shown in this graph.
Somerfield has roughly a quarter of the amount of turnover. Both stores have similar patterns of growth and decline, showing rises year on year up to 1999 and a slight drop in 2000. Because of this major difference in the size of the two companies operations it is necessary to use ratios to allow a fair comparison of their performance.
Liquidity Ratios
The current ratio measures a firm’s current assets against its current liabilities, so represents their ability to meet their immediate commitments. Textbooks will often suggest the ideal rate to be 2 (i.e. they have twice as many assets as liabilities) or more, though there is no evidence for this. A better guide is to compare the figure with the firms past results or an industry average.
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The Company has been set up with the primary objective of producing and selling ordinary portland cement. The finest quality of cement is available for all types of customers whether for dams, canals, industrial structures, highways, commercial or residential needs using latest state of the art dry process cement manufacturing process. A longtime leader in the cement manufacturing industry, Fauji ...
As the graph shows Sainsbury has a more stable pattern though they never get a result higher then 1. For supermarkets it is not unusual to have a low current ratio as they receive large amounts of cash and offer little if any credit to customers. Somerfield also has a result of less then 2 but shows a more volatile pattern, this may show that some years they had problems paying suppliers (1997, 1998 and 1999) there is nothing to suggest this in the accounts.
Efficiency Ratios
Stock Turnover Ratio
This Ratio looks at the number of times a company sells its stock in a year; here it is expressed as times per year though it can also be shown as the average number of days it takes to sell all stock.
Sainsbury again appears a more stable, though it is a downward trend being displayed. Somerfield shows a major trough in 1998 this is probably related to their takeover of Kwick Save during this year. This led to a dramatic increase in stock levels that does not correspond with a similar rise in turnover; the take over took place in the February. If an average figure were used for the stock level rather then just the end of year levels this would not be so apparent. Using an average results in a figure of 13.52 compared with 9.8 shown on the graph. Annalists suggest a figure between 15 and 20 for the retail industry so both are performing reasonably well in this area.
Creditor Payment Period
By measuring how long it is taking to repay suppliers for any credit they give we can see how good a company is at settling its debts on time. In the UK the median is around 50 days, though this will vary greatly depending on the industry.
Articles in the press have been critical of the retail industry for delaying payments to small suppliers in order to hold on to cash for as long as possible, neither firm shows any sign of doing this from these figures so perhaps they are setting a moral example to the rest of the industry. The articles focused particularly on clothing manufacturers (not really relevant) but also on supermarkets payment of farmers so perhaps bonus points are deserved.
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The peak for Somerfield in 1998 can probably be explained by the distortion caused by their take over of Kwick Save. 1999 shows that they have got the problem under control as they have bought the payment period down to around the same level as it was previously. The graph appears to show a slight downward trend in Somerfield’s results suggesting they are paying creditors more quickly. Though this may be a good thing it should be noted that most firms would try to hold on to cash until the bills become payable.
Sainsbury payment period is increasing slightly, which could suggest that they are having trouble meeting commitments. However the trend is only gradual and so maybe just that they have negotiated better terms on their contracts. It would be worth keeping an eye on future performance in this area as it could indicate trouble.
Share Price
(In the graph, the black line represents the share price adjusted where necessary for capital changes that have occurred (eg. for scrip or rights issues).
The purple line represents the share price movement relative to the FT-SE All-Share Index and the green line represents the share price movement relative to the company’s sector.)
Sainsbury graph show that the have started 1996 at roughly the same level as they are at the present time, they have not though been constantly at this level. Throughout 1996 the company performed steadily as indicated by its stable share price as they convert their Texas stores to the Homebase format with 40 stores converted by the end of the year. During early 1997 the share price takes a sharp down turn as worries regarding their banking service emerge. Annalists suggest that the time they have predicted for breaking into profit is over optimistic. Over the summer the share price begins to climb as customers vote for new product in a survey “More choice because its your choice” and the annaversery of their store card brings an announcement of further discounts. The share price continues to rise as they launch home shopping by both phone and internet. They also show signs of regaining some of the ground lost to Tesco in terms of like for like sales figures.
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Executive summary By early 1988, Augustine Medical executives were actively engaged in finalizing and marketing the program for the patient warming system named Bair Hugger Patient Warming System. The principal question yet to be resolved was how to price this system. Several considerations are required in terms of organizational objectives, demand for the product, customer value perception, buyer ...
(In the graph, the black line represents the share price adjusted where necessary for capital changes that have occurred (eg. for scrip or rights issues).
The purple line represents the share price movement relative to the FT-SE All-Share Index and the green line represents the share price movement relative to the company’s sector.)
The share price graph for Somerfield from their floatation half way through 1996 when they were priced at £1.45 shows an interesting and varied pattern. For the first year and a half the remained relatively stable rising slowly until January 1998. In this month rumours of a take over bid from either Safeway or Asda emerged. In February Somerfield secured a merger worth around £1.4bn, joining forces with Kwick Save created a £6bn food retail business. Throughout 1998 they continued to be in the news as they announced re-fits of the Kwick Save stores and more rumours of mergers, this time with Booker the food distribution group. New products are introduce, music and videos in time for Christmas. They also launched a home shopping service online and opened stores in Elf petrol station forecourts. Just before the end of the year they announced a move into direct wine selling through a freephone number offering delivery within 2 days. A busy year clearly producing interest from investors as the share price rose rapidly and stayed at over twice its starting price.
Early 1999 shows a peak in January that turns out to be a its last, it corresponds with a further announcement regarding their forecourt retailing expansion. Throughout 1999 announcements of new distribution depots around the coutry, further details of home shopping and forecourt expansions do little to buck the downward trend in the share price. In November they begin to sell of their larger stores in order to concerntrate on convienience retailing, this does nothing to improve the markets confidence as they slip below £1 a share for the first time. Troubles with the integration of Kwick Save stores seems to be the main problem they face and they seem unable to convince investors they will do any better in the future. Rumours of a possible take over bid in early 2000 never amount to anything and the company offers its 1800 head office staff voulentary redundancy packages in February. In the summer the last major announcement is the withdrawl of their home shopping service. The shares are currently trading at 70p, around half their starting price. All in all, a pretty rough ride for anyone with shares in Somerfield.
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Altman’s Z-score model
This model was devised in the hope of providing a way of predicting business failure. Being able to do so would allow investors and any other interested party with a method that could be used to protect these parties from relying on businesses unlikely to survive much longer.
Altman’s Z-Score model aims to calculate one quick, inexpensive method of predicting failure in industrial companies. The Z-Score was developed Edward I. Altman, a professor of finance at New York University School of Business, using a discriminate analysis. Z-Score measures corporate health according to several key ratios that may indicate the potential for bankruptcy up to three years in advance. Using his method, a healthy company would receive a score of 2.99 or above, an unhealthy company would receive 1.81 or below, and companies who fall between these two points would be considered in the grey area. The original Z-Score model was confined to public companies, but in 1982 it was extended to privately held companies as well. The Z-score does not provide unqualified results, as Altman himself points out in his book “Corporate Financial Distress, A Complete Guide To Predicting, Avoiding and Dealing With Bankruptcy” (John Wiley & Sons, Inc.), you should exercise care in using the Z-Score, mainly because of the lack of data in particular business sectors. A Z-Score is only as valid as the data from which it was derived i.e. if a company has altered or falsified their financial records, a Z-Score derived from these is of less use.
Note: There is no Z-score for Somerfield in 1996, as they had not been floated so the market capitalisation could not be calculated.
The most noticeable aspect of the graph of Z-scores is that Sainsbury operate in the grey area of uncertainty. This according to Altman’s theory would suggest that they are in trouble or are likely to be if they don’t act quickly. However this may not be the case at all, no model will ever be perfect as mentioned Altman admits this. It is more likely that Sainsbury simply is the exception to the rule, they can operate fine with a low Z-score because the way they trade is not hinged on the factors it measures. They may have used some kind of unusual accounting practise, which has distorted the result. As the result seems relatively stable it suggests that this should not cause major concern in relation to the company’s future.
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Somerfield has a high Z-score if somewhat variable. Their 1998 low may have been explained by the take over of Kwick Save if they had returned to a similar level afterwards. However 1999 peaks at just under 8 only for 2000 to head towards another comparatively low score. There is no one component, which can be blamed for this pattern, although the profits in these years were poor (becoming a loss after tax and interest) so this will have affected the results. The wild swings in the results cause more worry from an investors perspective as they indicate performance instability.
