Research and Analysis Project: Section 3

Research and Analysis Project
SECTION 3
3.0 ANALYSIS
We use different ratios such as liquidity ratios, profitability ratios, gearing ratios for financial analysis. Ratio analysis is the process of comparing and quantifying relationships between financial variables which can be found in the statement of financial position and income statement of the company. As discussed earlier, the analysis will be done considering key performance areas of the company Tesco Plc that should be taken into account when making future decisions. 3.1 Profitability Profitability ratios are the most widely used ratios. These are the key to the financial manager. It gives us an indication as whether the company is making a profit. i) Gross Profit Margin This ratio gives us the indication of the companys ability to control its production costs and to manage the margins it makes on buying and selling of its products. It assesses the financial health of the business by taking into account cost of goods sold and deducting it from the revenue. Company Tesco Sainsbury 2007 8.12% 6.83% 2008 7.67% 5.62% 2009 7.76% 5.48%
Business and Financial Analysis of Tesco Plc 1

The gross profit margin of Tesco has decreased to 7.67% in year 2008 as compare to 8.12% in year 2007. This was due to other income generated only in year 2007 which boosted up the gross profit; this income relates to an impairment of the site of (35m) and an adjustment to pension account of 258m as per companys financial statements, without adjusting these figures, gross profit margin would have been 7.60% if we base our calculation on this figure; we can see that Tescos GP margin is going up. This shows that Tesco plc managed to increase their sales and this was due to its expansion in international markets like USA (Fresh and Easy), Acquisition of 36 Hyper markets in South Korea and also the relaunching of the club cards in UK gave the opportunity to customers to double up their vouchers and as a result has increased sales. The GP margin of J.Sainsbury`s went down from 6.83% in year 2007 to 5.62% in year 2008 and 5.84% in year 2009 although their sales have gone up in year 2009 there is a possibility that J.Sainsburys is facing difficulties to control its cost of sales which is the main reason for this downturn.

Chart A: Gross Profit Margin
10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 2007 2008 2009 Tesco Sainsbury
ii) Net Profit Margin This is also known as the bottom line, net profit gives us the indication of how much profit is made by a company for every 1 it generates in revenue. Net profit takes into account all of the companys administration and distribution expenses.
Company Tesco Sainsbury
2007 4.4% 1.9%
2008 4.5% 1.8%
2009 4% 1.5%

The net profit margin for Tesco plc was lower in the year 2007. It improved slightly in 2008 but it went down again in year 2009 to 4%. This was mainly due to high finance cost which occurred in year 2009 because of the high borrowings made by the company, there is a possibility that Tesco Plc has used these borrowings for its expansion in South Korea and also on the entry to India in order to establish a cash and carry business this could also be due to the fact that company has acquired the remaining 50% of Tesco personal finance from Royal Bank of Scotland. (Chairmans Statement annual reports 2009). The NP margin for J.Sainsburys has shown a decrease of 0.36% from year 2008 to 2009 and is far behind from Tesco. The fall in the ratio is due to Share of posttax loss from joint ventures of (111m) and also the investment property fair value movement of (124m) as per financial statements 2009.
Chart B: Net Profit Margin

5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 2007 2008 2009 Tesco Sainsbury

This analysis has shown that Tesco has maintained its profitability over the last three years, although net profit margin shows a decrease because of the high finance costs but it is hoping to increase this level in the near future as gross profit margin has already started to improve. 3.2 Efficiency Ratios These ratios give us the insight of how efficiently is the business utilizing the resources invested in it. i) Fixed Asset Turnover (times) This ratio is about fixed asset capacity, it gives an indication of how well the company is utilizing its assets to increase sales.
2007 2.11 2.24
2008 1.98 2.12
2009 1.70 2.24
Asset turnover ratio for Tesco is going down every year this could be due to the fact that Tesco has expanded internationally and its assets are growing but profits are not increasing with the same pace as assets, because Tesco has entered new markets e.g. USA (Fresh and Easy), South Korea (Hyper markets) and made new investments e.g. in India, but we should consider that it takes time for the new investments to give acceptable returns and the situation might improve over time. Asset turnover ratio for J.Sainsburys faced a slight fall from 2.24 in 2007 to 2.12 in 2008 but it went back up to 2.24 in 2009 which is the same figure as in 2007, this shows that J.Sainsbury`s seems to be managing their assets a lot better than Tesco.
Chart C: Asset Turnover
2009 Sainsbury Tesco
2008
2007
0.5
1.5
2.5
ii) Return on Capital Employed (ROCE) ROCE also known as ROI (Return on Investment), it gives us a measure of how efficiently a business is using the funds available. It measures how much is earned per 1 invested.

Company Tesco Sainsbury 2007 17.22% 8.52% 2008 15.34% 8.14% 2009 12.25% 8.63%
Return on capital employed of Tesco is not very impressive as it shows a decrease to 12.25% in year 2009 as compare to the figure of 15.34% in year 2008 thus a decrease of 20%. This figure was slightly better in year 2007 but seems to be going down again, the decrease in the ratio has been because Tesco has expanded internationally and has incurred high costs but profits earned by the company were not enough in other words it has not generated a reasonable return or is due to an inefficient asset turnover as explained above. The ROCE for J.Sainsburys has done better slightly in year 2009 as it went up by 6% as compare to the last year which means it has efficient asset turnover but still Tescos ROCE is a lot higher than Sainsburys which gives a competitive edge to Tesco.
Chart D: ROCE
20.00% 15.00% 10.00% 5.00% 0.00% Tesco Sainsbury
2007
2008
2009
iii) Inventory Turnover (times) This ratio tells us how well the company is managing its stock too much stock is of no good as it ties up the money in the inventory, on the contrary too less stock is also not good as the company might not be able to meet specific demand. Holding too much of the stock also leads to high storage costs. Business and Financial Analysis of Tesco Plc 8

Company Tesco Sainsbury 2007 17.89 13.48 2008 20.31 14.76 2009 19.44 14.07
Inventory turnover or stock turnover for Tesco was 20 days in 2008 which is higher than 2007 it then shows a slight decrease to 19 days in year 2009, this figure when compare to Sainsbury is quite high, Sainsburys inventory turnover days in 2009 were 14 days, this means that Sainsbury is managing their stock very well. There could be two reasons behind the increase in Tescos figure: 1. Tesco is having difficulties in managing their stock and thus have high inventory levels or 2. It could be that Tesco is making sure that it meets its customers demands by having everything in stock as and when it is required. Retailers like Tesco and Sainsbury should have their stock turnover days to be as low as possible because this could lead to high storage costs or even stock obsolescence.

Chart E: Inventory Turnover
25 20 15 10 5 0 2007 2008 2009 Tesco Sainsbury
iv) Debtor Days This ratio tells us how long customers are taking to pay the company. If debtor days are increasing then this means that companys credit control department is not performing well. Moreover excessive credit limit makes the collection difficult and might lead to bad debts.
2007 9.24 4.19
2008 10.12 4.22
2009 12.08 3.76
The debtor days for Tesco plc are 9, 10 and 12 days for year 07, 08 and 09 respectively. This is still regarded as good ratio as other companies would normally give longer time to customers to pay off their debts normally 30 days, Business and Financial Analysis of Tesco Plc 10

this shows that Tesco has managed its credit control department very well or they have strict policies and are offering good terms like early settlement discounts in order for the customers to settle their invoices early. From J.Sainsburys perspective debtor days for the company are quite static at approximately 4 days over the three year period there is a possibility that J.Sainsburys has even more strict policies over its debtors and probably offer much better terms for its customers to settle their accounts and therefore performs better than Tesco in this respect.
Chart F: Debtor Days

14 12 10 8 6 4 2 0 2007 2008 2009 Tesco Sainsbury
v) Creditor Days This is a similar calculation to Debtor Days despite the fact that it works the opposite way and looks at how long company takes to pay off its suppliers. Businesses may use this limit for short term investment purposes. This is known to be a cheap source of finance available to the company. Business and Financial Analysis of Tesco Plc 11

Company Tesco Sainsbury 2007 30.7 38.9 2008 32.9 36.9 2009 34.5 35.3
The creditor days for Tesco plc in the year 2007 are 30 days and seems to be increasing every year, in 2009 the company in average took about 35 days to pay off its suppliers at this very moment it seems reasonable as companies do tend to take out a usual term of payment which is 30 days from the invoice date. The reason behind the increase of these days could be that Tesco is using its creditors as a short term source of finance because this is cheaper for them as they do not have to pay any interest charges on this amount. On the other hand Sainsburys creditor days are improving they were 39 days in 2007 but now they are only 35 days in year 2009, this could be due to the fact that Sainsbury is trying to avail the early settlement discounts which it can gain by setting out its invoices earlier. This will also allow Sainsbury to have better relationship with its suppliers.

Chart G: Creditor Days
40 35 30 25 20 15 10 5 0 2007 2008 2009 Tesco Sainsbury
Tesco plc is managing its working capital very well. Though the inventory days are of concern but if it satisfies the two criteria mentioned above then this proves that company is performing well. 3.3 Liquidity Ratios A liquidity ratio, also known as solvency ratios is used to identify the ability of the company to meet its short term obligations. It does that by considering two of the following: i) Current Ratio It measures how much of the total current assets are financed by the current liabilities. (Kaplan Financial F9). It estimates whether the business has the ability to meet its debts due within a year.
2007 0.56 0.71
2008 0.61 0.66
2009 0.78 0.55
The current ratio for Tesco plc in 2007 was 0.56 and is improving every year and has reached up to 0.78 in the year 2009. It is less than 1 which is relatively low but it usually depends on the type of company and the operations it is involved in, supermarkets tend to have a ratio of less than 1. The reason for the increase in ratio in the current year is increase in current assets of Tesco as compared to the last two years. This could be due to the short term investment which has increased by 873 million in year 2009, giving the total figure of 1233 million and also the positive cash balances maintained by the company.
Chart H: Current Ratio

0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 2007 2008 2009
Tesco Sainsbury
ii) Quick Ratio Business and Financial Analysis of Tesco Plc 14

This measures how well current liabilities are covered by liquid assets and is particularly useful where inventory holding periods are longer. (Kaplan Financial F9). Some assets like inventory are difficult to convert into cash quickly. The quick ratio therefore, excludes the inventory to see if the company has enough assets to pay off its current obligations; it takes a short term view.
2007 0.32 0.50
2008 0.38 0.40
2009 0.63 0.31
Quick ratio works the same way as current ratio the only difference being that it takes out the inventory from the calculation as some companies can take longer to convert their stock into cash. Short term liquidity does not seem to be a problem here because it is continuously improving Tesco has achieved this by keeping its cash flow in positive position every year which has increased by 96.3% from year 2007 to 2009. The increase in the ratio could also be due to the short term investment as explained above. The current and quick ratio for Sainsbury is falling down every year, its current liabilities are increasing every year where as the current assets more particularly the cash and cash equivalents level is dropping down every year and this is

worrying as this means that it has less chances of meeting its short term obligations.
Chart I: Quick Ratio

0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 2007 2008 2009 Tesco Sainsbury
This shows that company has enough liquidity to pay off its short term obligations. 3.4 Stability Ratios It concentrates on the ability of the company to survive in the long term and includes the following: i) Gearing Gearing is a measure of the extent to which debt is used in the capital structure. The higher the level of the gearing the higher is the risk to that business.
2007 47.52% 57.67%
2008 51.94% 45.10%
2009 70.79% 49.93%
The gearing ratio for Tesco plc in 2007 was 47.52% which then showed a significant increase to 51.94% in the year 2008. By looking at the figure in 2009 it shows a massive increase in gearing of to 70.79%. This ratio reveals that Tesco plc is highly geared which is a bad sign for Tesco plc. It is negative point to management that more of their business is financed by debts because this will increase their financial charges or interest expenses and hence decreasing the companys profits. Tesco has probably used debt finance for its expansion in international markets the acquisition of 36 hyper markets in South Korea the entry in India to establish Cash and Carry operation and also acquired the remaining 50% Tesco personal finance from RBS. This seems that Tesco prefers debt finance instead of equity finance, although equity figure has increased as well but not with the same pace as the debt. One of the most obvious reasons for Tesco to choose debt finance could be that debt is cheaper than equity as it is tax deductible. On the other hand if we see the gearing ratio from Sainsburys perspective it had a gearing of 57.67% in year 2007 which was higher than Tesco, the gearing ratio for Sainsbury was improved in 2008 which means that Sainsbury paid off some of its debt or had taken over equity, this ratio went up again in 2009 to 49.93% but it is still 20.86% less than Tesco plc

Chart J: Gearing
80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00%
Tesco Sainsbury
2007
2008
2009
ii) Interest Cover (times) The interest coverage ratio is a very important from the lender point of view. This is a measure of the companys ability to pay its interest out of the companys profits, the higher the interest cover is the better. Company Tesco Sainsbury 2007 12.26 4.86 2008 11.16 4.02 2009 6.71 4.54
This ratio shows the ability of Tesco Plc to cover its finance costs obligation out of its profits. Tescos interest cover shows a slight decrease in 2008 as compare Business and Financial Analysis of Tesco Plc 18

to 2007, but it has gone down by 66.3% in 2009 as compare to 2008 which is a huge decrease. The decrease in the interest cover is due to the high borrowings made by Tesco plc in the year 2009 thus leading to high interest payments, although this figure is still better than J.Sainsburys which means that Tesco is generating enough profits to cover its interest payments but we can see the trend from the graph that it is coming down and if this figure keeps on decreasing this could lead to a problem for Tesco plc, as its lenders might not wish to lend money in a fear that they wont be able to get the full interest payments. The interest cover for Sainsbury shows a slight decrease from 4.86 to 4.2 in year 2008 but it has improved again to 4.54 in year 2009 this shows that Sainsbury has maintained its interest cover by approximately the same figures and is able to cover the interest payments but it is significantly lower than Tesco and is making every effort to reach a reasonable position.
Chart K: Interest Cover

14 12 10 8 6 4 2 0 2007 2008 2009 Tesco Sainsbury

Gearing ratio for Tesco plc shows a high increase According to lenders point of view a lender will be more happy to lend money to Sainsbury as compare to Tesco because at the moment Tesco is highly geared and is subject to high risk. But if we look at the interest cover it shows that Tesco plc still has the ability to pay its interest through its profits. 3.5 SWOT Analysis Strengths The key strength of Tesco is that it has a very strong brand name, is recognized internationally and is the third largest in the world behind Wal-mart and France's Carrefour. It has multiple stores selling wide range of products all over the world to help everybody spend less which allows them to be the market leader. Tesco has spent a large amount of money in development and expansion. It has expanded super markets in China, Hungary, Poland, Malaysia, Japan Republic of Ireland South Korea, Turkey, Thailand, UK, and USA and also announced entry to India. There has been a massive increase in the number of Tesco retail stores in U.K from 1,988 stores in year 2007 to 2,306 stores in year 2009. It has now 4,331 stores all over the world and over 470,000 employees. (Annual Reports 2009). Tesco has the ability to buy in bulk from their suppliers and therefore, enjoys economies of scale. This means that they have access to bulk discounts which leads lower prices, in this way they can keep their prices attractive for its customers and compete with its main competitors like Sainsburys and ASDA Tesco has a diversified portfolio. Tesco not only deals with food items, but also has a variety of different non-food products including clothing, books, electronics, insurances, mobile and finance services and this seems to be increasing. It has helped Tesco to maintain profits through different diversified products. Business and Financial Analysis of Tesco Plc 20

Tesco plc has an integrated stock control system with its supplier like Kelloggs. This gives the advantage to the company as they dont always have to check the stock and go through all the process of ordering goods thereby, reducing administration costs. Weaknesses Tesco has wide range of products and may not have the flexibility to focus on many of its items as other specialised retailers. For example Tesco would never be able to provide a good service in Electronics like Comet or Currys as they specialise in this field. Tesco does not specialise in the areas like Phone and Insurance and therefore, lack experience and expertise in these markets, entering into the markets in which they are not specialise might leave a negative impact on their reputation. Tesco plc faces tough competition all over the world. In UK companies like J.Sainsburys, Morrisons and ASDA etc and internationally companies like Wall Mart and Carrefour are doing well. Tesco plc has expanded very rapidly and has a large capital expenditure on new stores using debt finance; this has lead to company emerging into gearing problems and interest payments and would make harder for Tesco plc to borrow money in future. Opportunities Setting up integrated stock systems with other suppliers would lead better management of inventory control and less holding costs for Tesco.

Forming a strategic alliance with another company who specialise in areas where Tesco is not performing well could improve their non-food services such as insurance and will help them overcome their weaknesses. Tesco should consider entering Middle East in countries like Dubai, Abu Dhabi or Oman. Although Tesco will face tough competition but there are still opportunities to grow due to its brand strength. Tesco has successfully attracted lots of its customers through club card promotions and during the period of economic downturn Tesco offered discounted brands to its customers this gave the company a competitive edge and helped it to remain the biggest retailer in UK. Threats Cost leadership companies like NETTO, Lidl and Aldi sell its goods for less and quite possibly can attract customers towards them because of their low prices. Tesco plc faces tough competition in UK from other retailers like J.Sainsburys, ASDA and Morrisons etc. Tesco is new to most of the markets and this could cause problem for the company as it might not understand its new markets properly and will see a fall in revenue and therefore its profits.
SECTION 4
4.0 Conclusion This analysis was undertaken in order to analyse the financial and business performance of Tesco plc this has been done by performing a SWOT analysis and also by assessing the Financial Statements and other related information of the group under the headings of profitability, liquidity, stability and efficiency. Tesco has maintained its profitability over the last three year period; despite of the low NP margin, tough competition and recession it does not show any losses over the last three year period of its operations. It has a very good control over its costs and has put more focus on their efficiency. ROCE is the most important ratio and it has been declining over time this is due to the new investment which will take a reasonable time to give good return but as soon as the company start making returns from its new investments this ratio should start improving. Tesco seems to have managed its working capital very well by keeping tight control over its debtors around 12 days and they are also taking full advantage of using interest free short term finance by paying its creditors late but always on time, inventory turnover should have been low as possible because this would

result in stock obsolesce and also high storage costs, but Tesco might have chosen to keep high levels of inventory so it can meet its customers demands. Liquidity ratio for Tesco is less than 1 but it is making every effort to improve that ratio, Tesco plc has strong cash balances which mean that the company is liquid enough to meet its short term obligations so short term liquidity is less worrying. High gearing is an issue as it put its lenders in a worrying position, this was due to high borrowings and they were mainly due to expansion overseas like hyper markets in South Korea and also the establishment of cash and carry operation and a franchise agreement with Trent to support the Star Bazaar hypermarkets in India. All of this expansion requires finance and Tesco plc has used debt as a source of finance for this purposes. SWOT suggests that Tesco plc is a number one retailer in UK and third largest in the world it has a strong brand name and a reputable image it has the ability to attract its customers by providing them reasonable prices and achieves this by using economies of scale. Tesco has some weaknesses and to address this issue company needs to adopt appropriate strategies. It has a lot of strengths which it can use to avail opportunities and will help them overcome their weaknesses. The chart below shows the comparison of Tescos share price with J.Sainsburys, where Orange line represents the share price of J.Sainsburys and Blue line represents the share price of Tesco plc.
This comparison has been done from 20/11/2007 to 21/11/2009. Share price of J.Sainsbury`s was high in the early 2007 but it went down by the end of the year and it kept on going down in year 2008 this was mainly due to the economic downturn in the environment and high competition faced by all supermarkets. Tesco plc share price was lower than Sainsburys in 2007 and it also went down in the year 2008 because of the same reason described above but this drop down was lower than Sainsburys. As we can see from the chart that Tesco plc share price is now constantly improving which means that it has successfully survived its way through the recession and high competition, whereas Sainsbury is still struggling with its share price. The share price of Tesco plc as at 20/11/2009 was 420.50p

Tesco has performed very well in the last three years, high gearing is the issue but growth has been significantly well. Tesco is expanding rapidly all over the world. Tescos UK market share dropped to 30.6% as at 19 April 2009 from 31.1% in 2008 where other supermarkets like Sainsburys ASDA and Morrisons all gained market share; Sainsbury grew from 16.1% to 16.3% of the market. Most recently Tesco plc has shown a growth again in its UK market share to 30.7% as at 11 November 2009. Tesco plc still holds high market share of UK. Tesco has maintained positive cash flows over its three year period of operation The share price seems to be improving and profits are expected to go high. This means that in spite of high competition and economic changes Tesco plc is performing very well. Tesco is now market leader in Thailand and following their acquisition of 36 hypermarkets in South Korea they are now in a very strong position to challenge for market leadership there as well. (Annual Reports 2009).
References: Annual Reports http://www.tescoplc.com/plc/ir/ar/archive/ (11/10/09) Company History http://www.telegraph.co.uk/finance/markets/2788089/A-history-of-Tesco-Therise-of-Britains-biggest-supermarket.html http://www.tescoplc.com/plc/about_us/tesco_story/# (12/10/09)
Efficiency http://www.answers.com/topic/efficiency (14/10/09)
Financial Analysis Free Encyclopaedia http://en.wikipedia.org//Financial_analysis (12/10/09) Limitations of SWOT http://www.referenceforbusiness.com/management/Pr-Sa/SWOT-Analysis.html Market Share Information http://news.bbc.co.uk/1/hi/business/8023250.stm http://business.scotsman.com/retail/Tesco-rings-up-growth-in.5812166.jp (22/11/2009) Business and Financial Analysis of Tesco Plc 27
Profitability http://www.businessdictionary.com/definition/profitability.html (14/10/09). Share Price Info http://www.tescoplc.com/plc/ir/shareinfo/sharechart/# http://uk.finance.yahoo.com/q/bc?s=TSCO.L (22/11/09) Tesco Official Website www.tescocorporate.com
Bibliography: Kaplan Financial (2009) P3 Business Analysis 2009/2010, Berkshire, Kaplan Publishing UK. Kaplan Financial (2009) P5 Advanced Performance Management 2009/2010, Berkshire, Kaplan Publishing UK. Kaplan Financial (2009) F9 Financial Management 2009/2010, Berkshire, Kaplan Publishing UK.

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Research and Analysis Project

Business and Financial Analysis of Tesco Plc 1