Financial Analysis of TESCO & J SAINSBURY

In this report we are comparing and contrasting the financial performance and position of J Sainsbury plc and Tesco plc, the two retail sector companies listed on the London Stock Exchange for three financial years 2007-2009. Our main aim is to carryout vertical analysis, trend analysis and ratio analysis to find out which company among the two is better for investment.

In the beginning sections we are analyzing the companies individually and then drawing up a conclusion on the basis of the analysis in the end. Since our main aim is to find out which company is better for investment, we are stressing on performance and profitability indicators, however we have paid due attention to indicators of sound financial position such as liquidity, working capital management and solvency.

J SAINSBURY plc

The horizontal analysis and vertical analysis of J Sainsbury plc are shown in the following exhibits.

J Sainsbury
Vertical Analysis of Income Statement
Year / 2009 / 2008 / 2007
Revenue / 100.00% / 100.00% / 100.00%
Cost of sales / -94.52% / -94.38% / -93.17%
Gross Proﬁt / 5.48% / 5.62% / 6.83%
Administrative expenses / -2.22% / -2.81% / -3.90%
Other income / 0.30% / 0.17% / 0.10%
Operating Proﬁt / 3.56% / 2.97% / 3.03%
Finance income / 0.27% / 0.47% / 0.37%
Finance costs / -0.78% / -0.74% / -0.62%
Share of post-tax loss from joint ventures / -0.59% / -0.01% / 0.00%
Proﬁt before taxation / 2.46% / 2.69% / 2.78%
Income tax expense / -0.94% / -0.84% / -0.89%
Proﬁt for the ﬁnancial year / 1.53% / 1.84% / 1.89%

Profitability and Performance:

From the above analysis, it is evident that the company is operating in a saturated market. More than 90% of the sales revenue is consumed by the cost of goods sold generating a gross profit of only 5%-7%. Although other expenses are insignificant the company is generating a net profit of 1.5% to 1.9% of sales in the three years which is negligible.

Incorporating the horizontal analysis of the income statement shown below, we see that the market is not growing, there seems to be no real growth in sales because sales growth equals average rate of inflation. The profit figures have actually declined in the financial year 2008-2009

J Sainsbury
Horizontal Analysis of Income Statement
2009-2008 / 2008-2007
Revenue / 6.02% / 4.00%
Cost of sales / 6.18% / 5.36%
Gross proﬁt / 3.39% / -14.51%
Administrative expenses / -16.33% / -24.96%
Other income / 90.00% / 76.47%
Operating proﬁt / 26.98% / 1.92%
Finance income / -37.35% / 29.69%
Finance costs / 12.12% / 23.36%
Share of post-tax loss from joint ventures / 5450.00% / -2.00%
Proﬁt before taxation / -2.71% / 0.42%
Analysed as:
Underlying proﬁt before tax / 11.27% / 28.42%
Proﬁt on sale of properties / 714.29% / 0.00%
Investment property fair value movements / -124.00% / 0.00%
Financing fair value movements / 150.00% / -150.00%
One-off items / -100.00% / -114.63%
-2.71% / 0.42%
Income tax expense / 18.00% / -1.96%
Proﬁ t for the ﬁnancial year / -12.16% / 1.54%

Although the sales seems to grow, at least nominally, the gross profit percentage has decreased from 6.83% to 5.62% in the financial year 2007-2008 and 5.62% to 5.48% during the year 2008-2009. Similarly the operating profit percentage has decreased from 3.03% to 2.97% and then increased from 2.97% to 3.56% during the year 2007-2008 and 2008-2009 respectively. This indicates a decline in the profitability of the company over the three years period. The company is already in a saturated market and needs to control costs to remain profitable because any further growth is not very probable.

Return on capital employed shows a decrease in 2007 to 2008 from 10.97% to 9.71% respectively and with an increase in 2008 to 2009 from 9.71% to 10.65% respectively following the operating profit trend.

Financial Position

Apart from performance, financial position is equally important. In the trend analysis of balance sheet on the following exhibits, we see the increase or decrease in different account balances over the period of three years.

J Sainsbury plc
Balance Sheet Trend Analysis
2009-2008 / 2008-2007
Non-current assets
Property, plant and equipment / 5.35% / 3.46%
Intangible assets / -3.03% / -5.71%
Investments in subsidiaries
Investments in joint ventures / 94.59% / 51.02%
Available-for-sale financial assets / -8.49% / -22.63%
Other receivables / -18.18% / 10.00%
Derivative financial instruments / 31.00%
Deferred income tax asset
Retirement benefit asset / -495.00% / 495.00%
0.58% / 9.91%
Current assets
Inventories / 1.17% / 15.42%
Trade and other receivables / -5.34% / 4.57%
Derivative financial instruments / 1375.00% / 4.00%
Cash and cash equivalents / -12.80% / -36.26%
-2.48% / -15.93%
Non-current assets held for sale / -81.25% / 348.00%
-7.61% / -11.24%
Total assets / -0.81% / 5.63%
Current liabilities
Trade and other payables / 9.12% / 0.57%
Borrowings / -6.67% / -55.76%
Derivative financial instruments / 833.33% / 200.00%
Taxes payable / 5.76% / 193.85%
Provisions / 90.00% / -28.57%
10.07% / -2.54%
Net current liabilities / 42.80% / 19.08%
Non-current liabilities
Other payables / 3.37% / 169.70%
Borrowings / 6.87% / -2.54%
Derivative financial instruments / -55.56% / -58.14%
Deferred income tax liability / -70.40% / 91.07%
Provisions / -9.52% / -8.70%
Retirement benefit obligations / -309.00% / 103.00%
8.31% / 0.88%
Net assets / -11.33% / 13.47%
Equity
Called up share capital / 0.40% / 0.81%
Share premium account / 1.45% / 4.55%
Capital redemption reserve / 1.49%
Other reserves / -138.66% / 245.45%
Retained earnings / 4.69% / 8.33%
Total equity / -11.33% / 13.47%

Liquidity and Solvency:

Current and quick ratios tell us about the company’s ability to satisfy its short-term obligations. The company’s credit situation is alarming. A current ratio of at least 1 should be there but the ratio is far below the threshold in all of the three year under review.

In order to obtain finance, a company should have good solvency indicators such as debt ratio, times interest earned, etc. Although the company’s debt is rising a little the situation is well under control.

Working Capital Management:

Inventory turnover ratio and receivables’ turnover ratios tells us about the company’s performance in selling its inventory and then cashing the receivable out. They are useful indicators of how well a company is managing its working capital.

The company is steadily having a good inventory turnover ratio. It has remained 14.07 days, 14.76 days, 13.48 days in 2009, 2008 and 2007 respectively. This indicates that the company is holding the optimum inventory quantity and the items are quite fast-moving.

The receivables’ turnover ratio has remained constant in the range of 3-5 which doesn’t indicate a very efficient management of receivables. The company should collect its receivables more often and improve the ratio.

TESCO plc

Now we move towards the analysis of the other company, the Tesco plc. In the following exhibits are the vertical and horizontal analyses for Tesco plc. The company’s performance and position is analyzed in the light of the analysis.

Tesco plc
Vertical Analysis of Income Statement
53 weeks ended 28 February 2009 / 2009
£m / 2008
£m / 2007
£m
Continuing operations
Revenue (sales excluding VAT) / 54,327 / 100.00% / 47,298 / 100.00% / 42,641 / 100.00%
Cost of Sales / (50,109) / -92.24% / (43,668) / -92.33% / (39,401) / -92.40%
Pensions adjustment – Finance Act 2006 / - / 0.00% / - / 0.00% / 258 / 0.61%
Impairment of the Gerrards Cross site / - / 0.00% / - / 0.00% / (35) / -0.08%
Gross profit / 4,218 / 7.76% / 3,630 / 7.67% / 3,463 / 8.12%
Administrative expenses / (1,248) / -2.30% / (1,027) / -2.17% / (907) / -2.13%
Profit arising on property-related items / 236 / 0.43% / 188 / 0.40% / 92 / 0.22%
Operating profit / 3,206 / 5.90% / 2,791 / 5.90% / 2,648 / 6.21%
Share of post-tax profits of joint ventures and associates / 110 / 0.20% / 75 / 0.16% / 106 / 0.25%
Profit on sale of investments in associates / - / 0.00% / - / 0.00% / 25 / 0.06%
Finance income / 116 / 0.21% / 187 / 0.40% / 90 / 0.21%
Finance costs / (478) / -0.88% / (250) / -0.53% / (216) / -0.51%
Profit before tax / 2,954 / 5.44% / 2,803 / 5.93% / 2,653 / 6.22%
Taxation / (788) / -1.45% / (673) / -1.42% / (772) / -1.81%
Profit for the year from continuing operations / 2,166 / 3.99% / 2,130 / 4.50% / 1,881 / 4.41%
Discontinued operation
Profit for the year from discontinued operation / - / 0.00% / - / 0.00% / 18 / 0.04%
Profit for the year / 2,166 / 3.99% / 2,130 / 4.50% / 1,899 / 4.45%

Performance and Profitability:

The situation is quite similar to that of J Salisbury; this is because both are from the retail industry. Again, the cost of goods sold accounts for more than 90% of the revenue. Here the gross profit percentage is around 7% which is a bit better than that of J Salisbury. Other expenses are minor leading to an operating profit margin of around 5-6%. The trend analysis is shown below:

Tesco plc
Vertical Analysis of Income Statement
2009-2008 / 2008-2007
Revenue (sales excluding VAT) / 14.86% / 10.92%
Cost of Sales / 14.75% / 10.83%
Pensions adjustment – Finance Act 2006 / -100.00%
Impairment of the Gerrards Cross site / -100.00%
Gross profit / 16.20% / 4.82%
Administrative expenses / 21.52% / 13.23%
Profit arising on property-related items / 25.53% / 104.35%
Operating profit / 14.87% / 5.40%
Share of post-tax profits of joint ventures and associates / 46.67% / -29.25%
Profit on sale of investments in associates / 0.00% / -100.00%
Finance income / -37.97% / 107.78%
Finance costs / 91.20% / 15.74%
Profit before tax / 5.39% / 5.65%
Taxation / 17.09% / -12.82%
Profit for the year from continuing operations / 1.69% / 13.24%
Discontinued operation
Profit for the year from discontinued operation / -100.00%
Profit for the year / 1.69% / 12.16%

The analysis shows an increase of 12% in the profit for the year in 2007-2008 but an increase of 1.7% in 2008-2009. The reason being the higher administrative costs in 2009 coupled with a decline in income on account of properties.

Financial Position:

The company’s liquidity situation is not that great as is evident from the critically low current ratio. Although the ratio is rising up from 0.69 in 2007 to 0.91 in 2009, it still needs attention.

Debt ratio, the indicator of long-term financial stability shows a significant accumulation of debt on the balance sheet over the years. It was 57.4% in 2007 and rose up to 71.78% in 2009.

Working Capital Management:

The situation is better. The inventory is turning more rapidly coupled by higher turnover in accounts receivables. Clearly the situation is better than in J Sainsbury.

Conclusion

From the above analysis it is clear that the retail industry is saturated and that earning super profits is not possible. Both the companies spend more than 90% of their sales revenue on the cost of goods sold. The gross profits are eventually 5-8%. The key to profitability in this situation lies in effective cost control.

But Tesco is better option due to following reasons:

It is generating a little higher gross profit;
It has kept non-merchandizing costs at minimum;
It is paying higher dividends;
It is showing faster growth

However, the financial position of none of the companies is impressive. Both are having critically low quick and current ratios and high debt ratios.