Financial Performance Analysis of Tesco Plc and J Sainsbury Plc.

A comparison of the performance of Tesco Plc and Sainsbury Plc, both listed on the London Stock Exchange

Introduction:

This report will compare Tesco Plc and Sainsbury Plc, paying close attention to selected ratios for comparison. The ratios have been chosen to show profitability, efficiency and liquidity of both companies over a three-year period. Both companies operate in the UK grocery sector, with both classed in the big-4 supermarkets. According to the latest Kantar Worldpanel (2014) report, Tesco held 29.6% of the UK grocery market in top place, while Sainsbury held 17% of the market, holding third place after ASDA.

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In addition to their main grocery business, both companies have business in other services, including clothing, non-food items, banking and insurance services, as well as international operations for Tesco. Of the two, Tesco has more of a focus on its non-food and non-UK business. According to Tesco’s latest Annual Report (2013), sales from non-UK markets represent ?20.8Billion of revenue, with revenue from Asia growing 6% over 2013; while revenue from the UK banking operation is ?1Billion. In comparison, Sainsbury’s total revenue (all-UK) only amounts to ?23.03Billion, with non-food and banking making up a much smaller proportion of sales, Sainsbury’s (2013).

Performance analysis of your chosen companies:

This section will consider a number of ratios to determine company performance, splitting the ratios up into profitability, efficiency and liquidity. This report will then use the Annual Reports as well as supporting analysis to determine the reasoning behind the results.

Liquidity Ratio

Liquidity ratios are a sign whether a company has the ability to pay off short-term obligations (debts due to be paid within one year). Generally, a higher value is desired as this indicates greater capacity to meet debt obligations, for example, shareholders may prefer a company to have current assets that are greater than current liabilities, indicating that the company can repay all debts at short-notice if required, (Koller, 2011)

The Current ratio measures a businesses ability to repay short-term liabilities such as accounts payable and short-term debt using short-term assets such as cash, inventory and receivables. This would be the value of a company’s current assets that could be converted to cash over the next twelve months compared to the value of liabilities that may mature over the same period, (Peterson, 2012).

The Current ratio is useful as it shows whether a company has adequate resources to repay short-term debt or if it will experience cash flow problems in the near term. A ratio of 2:1 is usually considered a benchmark, however, this may vary across industries depending on cash-flow. A ratio of less than one suggests that the company may not have sufficient resources to settle its short-term debt obligations.

For a more conservative alternative, Current Assets may be adjusted to remove inventory, as inventory may be viewed as not very readily convertible to cash; for example, to shift inventory fast, the business may have to discount products. With this the value of inventories will be lower than the value recorded on financial statements. This is known as the Quick ratio, (Moyer et al, 2011)

The calculations can be seen in Appendix 1. The results are shown below:

The results above show that both retailers have low ratios compared with the benchmark mentioned above; however this may be the case due to:

There are very few trade receivables on the books, while trade payables are higher suggesting that the business could effectively operate without any cash. Discussed more in Efficiency.
Both businesses have a high level of turnover and high level of cash-generation which could be used to meet short-term obligations.
Investor confidence in both businesses would allow the ratios to be lower. Investor’s may demand higher ratios from start-up or ‘riskier’ companies.

Comparing the two, Tesco plc, has the higher ratio, which may be down to the business having much higher receivables then Sainsbury’s. For example, in 2013, receivables made up 41.7% of total current assets at Tesco, compared with just 15.9% at Sainsbury’s. This may be down to Tesco having a greater focus on higher-value non-food items through its catalogue business. Higher receivables present higher risks, given some consumers may have an in-ability to pay.

Profitability Ratio

Profitability ratios measure a company’s profitability. As profits are used to fund capital expenditure and pay dividends, these measures will be important to analysts and closely watched in terms of industry comparisons.

Earnings per Share (EPS) measures the earnings available of each share, a shareholder may use this calculation to determine the level of earnings available for each share owned; this could then be compared with the actual dividend to determine the payout ratio. Again, this would be important to a shareholder as a company would use income for either dividends or capital expenditure; so, if dividends are low, investors would expect higher capital expenditure in the hope of increasing the future value of the business, increasing share-price, leading to capital gains.

Other ratios to be considered are Gross Profit Margin and Net Profit Margin. Gross profit margin considers revenue minus the cost of goods sold. A company’s gross profit margin may also be viewed as a measurement of production efficiency. A company with a gross profit margin higher than that of its competitors, or the industry average, is deemed to be more efficient and is therefore, all things being equal, preferred, (Paramasivan, 2009). Net profit margin considers the net income once all costs are removed. With this, the margin could be seen as determined by a range of factors including competition or rising costs.

Given the results above, Tesco appears to be in a better position given its margin; however this may be down to Tesco’s exposure to a greater non-food business through its catalogue, where it can achieve greater margins, (Head, 2013) [Online]. To add, a greater online presence may have also benefitted Tesco’s margin, giving the lower overheads involved. However in its latest results, Tesco took a charge of ?1.26Billion for exiting its U.S business, which impacted on net profit margin and EPS, (Tesco, 2013). The figures are surprising given Sainsbury’s perception as a more expensive grocer compared to rivals Tesco Plc. The figures also show a falling margin for both grocers in 2013, which could be down to the intense competition in the sector, and supermarket ‘price war’.

Efficiency Ratio

Efficiency ratios determine how efficient a company is using liabilities/ assets to generate revenue for the business. Ratios such Sales to Inventory could be used to determine the efficiency of the business compared with peers.

From the results above, it appears that Sainsbury’s has a greater control over its stock levels, as the company is able to turn over its inventory at a faster pace, which will be important in the grocery industry to reduce waste. However, it must again be noted that Tesco Plc, has greater exposure to the non-food business, which will then impact on stock levels, in particular for its catalogue business, which sells higher-value items such as electrical’s.

Another efficiency to mention could be the difference seen between average receivables and average payables. For example take Tesco in 2011; receivables turnover (sales / average receivables) was 60,455/ 4,457 = 13.56, which translated into 27 Days (365 / 13.56). Payables turnover was 55,330 / 5,786 = 9.56, which translates into 38 Days (365/ 9.56). With this, Tesco receives the all the money from sales in 27 Days on average, whereas it doesn’t have to pay suppliers for the goods sold for 38 Days on average. Effectively, the business could survive without cash. Given less focus on non-food items, Sainsbury’s position is favorable to Tesco. Receivables turnover comes in at just 5 Days, while payables turnover comes in at 34 Days on average.

Conclusion:

Based on the ratios above it appears that Tesco would be the favoured choice, given higher margins stemming from operations in non-food items and a greater online presence. To add, Tesco has a greater presence on the high-street, and so an ability to take advantage of the UK economic recovery. Tesco’s exposure outside of the grocery market could also be seen as a benefit when rivals from Aldi, Lidl and Waitrose continue to take grocery market share. According to Kantar Worldpanel (2014), over the past 3 years, the 3 grocers above have taken a combined 3.5 share points from competitors, equating to around ?4.4Billion in sales. Momentum continues with Y-O-Y growth at Aldi accelerating to 33.5%, compared with Tesco, who over the six-weeks to February 2nd 2014, experienced a 2.4% drop in sales, (Webb, 2014) [Online]. Increasing competition in the industry has led to another supermarket ‘price-war’, which is expected to knock margins again as retailers vie for market share. Again, Tesco Plc will be the favoured choice due to its exposure to non-food business as well as international operations, which have potential to drive future sales. Recently, Tesco has announced it will enter the Indian market, under a 50:50 joint venture with Tata, making it the first foreign supermarket to enter India’s ?330Billion retail sector. Given this, Tesco Plc, could be seen as less risky than Sainsbury Plc, given the greater scope of income streams.

When considering an investment, other figures may be considered to do with investor returns. First is dividend pay-outs; dividend growth has been stagnant for both companies over a three-year period, while Graph 1 below shows the share price performance, showing that over a three-year period, shares in Tesco and Sainsbury are down by 32.41% and 19.48% respectively.

Tesco Plc. is favoured given its extensive offering of businesses, both UK and international, which are expected to benefit as the global recovery strengthens. The main benefit is the business scope, with potential risk in the UK grocery market mitigated by improved performance from other operations and international sales. Sainsbury’s is more exposed to the growing competition on the UK market given the UK market represents the lions-share of its revenue. Tesco is well-placed to take advantage of improving sediment through its multi-channel business. In its latest Interim Report (2013)1, Tesco mentioned sales were supported by strong growth in online retailing (+13% in UK and +54% Overseas), and strong clothing sales up 8.4%. To add, the report also mentioned that UK margins had been hit since FY2013 results, falling to 5.2% (possible downside for Sainsbury’s too), however reported a 6% margin from Asian operations and 17.7% margin from its banking operations, showing that expansion is paying off for the company, (Tesco, 2013)1.

References:

Bloomberg (2014) [Online]: Company Share Prices, Available at http://www.bloomberg.com/markets/stocks/, Accessed 25/03/2014.

Financial Times (2014) [Online]: Tesco Plc, Available at http://markets.ft.com/research/Markets/Tearsheets/Financials?s=TSCO:LSE, Accessed 25/03/2014.

Financial Times (2014)1 [Online]: J Sainsbury Plc, Available at http://markets.ft.com/research/Markets/Tearsheets/Financials?s=SBRY:LSE&subview=IncomeStatement, Accessed 25/03/2014.

Head, R (2013) [Online]: This is why I’m considering buying J Sainsbury, Available at http://www.fool.co.uk/investing/2013/10/07/this-is-why-im-considering-buying-j-sainsbury-plc-today/, Accessed 25/03/2014.

Kantar Worldpanel (2014): Unprecedented changes in grocery retailing in the UK, UK, Kantar Worldpanel.

Koller, T, Goedhart, M and Wessels, D (2011): Valuation; Measuring and managing the value of companies, US, McKinsey & Company.

Moyer, C, McGuigan, J and Rao, R (2011): Contemporary Financial Management, USA, South-Western Cengage Learning.

Paramasivan, P (2009): Financial Management, USA, New Age International.

Peterson, P and Fabozzi, F (2012): Analysis of Financial Statements, USA, Wiley Finance.

Sainsbury’s (2013): Annual Report 2013, London, J Sainsbury Plc.

Tesco (2013): Annual Report 2013, London, Tesco Plc.

Tesco (2013)1: Interim Report 2013-2014, London, Tesco Plc.

Webb, S (2014) [Online]: Supermarket price war looms, Available at http://www.dailymail.co.uk/news/article-2566542/Every-little-helps-Tesco-slash-prices-attempt-boost-sales-losing-ground-rivals.html, Accessed 25/03/2014.

Appendices:

Appendix 1

The following tables provide calculations for the chosen ratios.

Figures obtained from Financial Times (2014) [Online] and Financial Times (2014)1 [Online].

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