FINA600 Financial Management of Woolworths Group Limited Assessment 2 Answer
The motto of Woolworths Group Limited is to create better experiences together for a better tomorrow (Woolworths Group Limited, 2019) and that it what it lives up to. With its diversified business and leadership in retailing industry, it is by far a safe investment. Over years, it has undertaken a lot of mergers and demergers for the various synergies, either tangible or intangible and it is expected to do so in the future.
Woolworths Group, with its experience accumulated over a century is guidance for the industry as a whole on sustainability as well as innovation. At present, the company is focusing on increasing the pace of innovation in its liquor business, which has expanded on account of its recent acquisition (Woolworths Group Limited, 2019). Now, if we were to look at some metrics, Woolworths Group is the second larger company in the retailing industry in terms of revenue. Secondly, the company has a positive operating cash flow and all the other ratios are also positive and well above the industry average as presented in the “Ratio Analysis” section of the report.
Overall, in the long term, Woolworths is a value investment proposition mainly due to its history but also due to its current financial conditions and future investment and development plans.
1.1 Background and Business
Woolworths Group Limited (hereinafter referred to as “the company”) is the second largest company in terms of revenue in the state of Australia (Woolworths Group Limited, 2019). It was founded around a century ago by five visionaries who believed the company to be an idea of what it is worth today. The main business of the company is centered on retailing and its allies such as liquor retailing in takeaway format and hospitality sector. Many of the innovations in the retailing industry can be traced back to the Woolworths Group. For instance, the customer centric approach of the retail industry and the need to be innovative to draw customers to the store such as rebates, loyalty points (Knox, 2015).
Retail business has since then grown in leaps and bounds since then and so has the company. The company has diversified into general merchandise, finance, hotels and gambling in the past years. Recently, it has launched a media channel to enhance communicate with its vendors and customers (Woolworths Group Limited, 2019). Today, in the age of supermarkets and e-commerce, opportunities in the retailing industry are boundless.
2 Company Analysis
2.1 Financial statements, Current Financial performance, economic outlook
Financial statements of a company are a set of four main documents, namely, the income statement or the statement of profit or loss (SPL), the statement of financial position (SOFP), the statement of changes in equity (SCE) and the cash flow statement (CFS). The SPL depicts the financial performance of a company in terms of profitability from the business activities. The company has reported profit since its internal reconstruction in 2017, which is better than the industry average. The SOFP depicts the financial position of a company. The company is in a healthy financial position as discussed in detail in the next section. The SCE explains in detail any movement within equity due to revaluations, profits, or distribution to shareholders in the form of dividend. Finally, the CFS details the actual cash inflow and outflow for the period from operating, investing and financial activities (SEC, 2007). The company has a net cash inflow from operating activities in 2019, which is offset by net cash outflow under investing and financing activities. This is mainly due to the payment of proceeds on buy back of shares and payment of dividend (Woolworths Group Limited, 2019).
Discretionary spending is the backbone of retail industry and in the current pandemic situation, the economic outlook of the retail industry is a little depressing.
3 Ratio Analysis
Ratio Analysis for the company is carried out for profitability, efficiency, liquidity and gearing for last two financial years being 2018 and 2019.
3.1 Profitability and Market ratios
|(see appendix for calculations)||2019||2018||Industry average|
|Return on assets||6.65%||7.17%||6.40%|
|Return on equity||14.49%||15.45%||11.59%|
|Net profit margin||2.60%||2.94%||-1.83%|
|Gross profit margin||29.08%||29.34%||27.19%|
|Net Interest Income||NA||NA||NA|
|Expense ratio/Cost to Income ratio||96.56%||95.92%||NA|
|Cash return on sales||4.91%||5.26%||NA|
|Earnings per share||$2.06 per share||$1.33 per share||NA|
|Price earnings ratio||14 times||21 times||NA|
|Dividends per share||$1.02 per share||$0.93 per share||$1.30 per share|
The different profitability ratios measure the profit from different perspectives. Gross profit and net profit margin are the primary considerations for accessing profitability of a company on the basis of operations carried out and the cost of operations. The company has a slight down trend in 2019 when it comes to the gross and net profit margin. The change is minor and can be contributed to the increase in operating cost due to discounted business of petrolfrom1 April. Even though it is observed that the ratios are higher than the industry average in both the years. The industry average in case of net profit margin is in negative, which is representative of the profitability of the industry as a whole due to macro-economic conditions. The company has however maintained a single digit net profit margin due to its scale of operations and good management policies.
The Return on Assets and equity Ratio measures the earnings on the investments made and hence shows the efficient use of assets and capital (PP Drake, 2012). There is a slight year on year drop in the above-mentioned ratios, the said ratios are significantly higher the industry average. This indicates that the company is effective in utilization of its investment in assets and equity is put to good use. The increase in assets and equity is resulting in increased returns in absolute terms. Expense ratio, on the other hand, calculates the ratio of expenses to the revenue of a company. It is a somewhat opposite to the profit ratios. It shows how the operating expenses changes to revenue. Ideally the expenses should reduce in percentage to revenues to prove the efficiency in operations and building of expertise. The ratio has increased in 2019 from 2018.This shows that the company had to incur more expense to earn the revenue. Cost management needs to come into action to identify the reasons. The lesser the ratio, better the net profit margin of a company.
Accrual is one of the fundamental accounting assumptions in the maintenance of books as well as preparation of financial statements. Therefore, cash return on sales ratio provides insight into the ability of the company to convert its sales into cash. The higher the ratio the shorter the cash cycle and better the liquidity of the company. The cash return on sales ratio is lower in 2019 from2018, this shows that the revenue did not materialize into cash and the money is stuck in working capital. This is not a good sign for the company.
Earnings per share (EPS) are the net profit available to each equity shareholder after all statutory allocations from net profit are done like the tax, dividend to preference shareholders. Dividend per share (DPS), on the other hand, represents the profit actually distributed to the equity shareholders, as either interim dividend or final dividend. Both EPS and DPS have increased from the previous year. However, DPS is less than the industry average. This shows that even though the company is earning more, it is not distributing it to the shareholders at the same rate as last year. The company is retaining the earnings which shows that there are expansion/investment plans of management.
Price earnings ratio is the most favorite ratio of all financial analysts. It compares the relationship between the market price per share and the earnings per share. In other words, it equates the earning capacity of a company to its market performance. It serves as an important instrument for identifying stocks that the over or under valued. The mean price earnings ratio is around 15 times. The decline in P/E ratio from 21 times to 14 times signifies that the stock has undergone market price correction over the last one year. The ratio is near to the Industry average ratio and so it can be assumed that the price of the shares is in market equilibrium to the earnings of the company. Earnings yield ratio, on the other hand, depicts the return on the investment made by an investor on the stock of the company. As the EPS has increased, so has the earnings yield ratio. It is good sign for the investors as their total worth is increasing.
3.2 Efficiency ratios
|(see appendix for calculations)||2019||2018||Industry average|
|Asset turnover||2.6 times||2.4 times||2.1 times|
|Cash return on assets||0.13 times||0.13 times||NA|
|Fixed Asset turnover||3.5 times||3.5 times||NA|
Efficiency of a company translates to the ability of a company in converting its investment in assets to sales or revenue. Effectiveness in utilization of resources translates to higher sales. For instance, investment in superior machinery would result in reduced processing time, thereby resulting in higher production quantity and consequently higher sales. Similarly, investment in higher quality raw material results in lesser wastage, thereby resulting in higher production quantity and consequently higher sales. Therefore, it is necessary to study the impact of investment in both current and non-current assets on revenue.
Total assets turnover ratio has increased in 2019 from2018 and is higher than the industry average. This shows that the efficiency of the company in converting its assets to sales is increasing and is more than that of the industry. The decision of discontinuing some operations is good as probably those assets were not used optimally. Cash flow return on assets is same as last year and so is the fixed asset turnover ratio. The ratio is same despite discontinuance of certain operation by the company, thus it can be expected that the ratios will increase in next year.
3.3 Liquidity ratios
|(see appendix for calculations)||2019||2018||Industry average|
|Average collection period||NA||NA||NA|
Liquidity ratio analyzes the ability of a company to honor its liabilities in the short-term (PP Drake, 2012). Unlike solvency ratio, which analyzes the ability of a company to honor its liabilities in the long-term, it is necessary to maintain healthy liquidity ratios to maintain the trust of various stakeholders such as business partners as well as investors. Liquidity ratios are at the center of the periodic reports submitted to banks for availing short-term credit facilities such as an overdraft.
Current ratio of 2:1 is generally considered as the sign of good health. However, it varies from industry to industry. The industry average, in this case, is 0.8 and the current ratio of the company is less than that in 2018 and dipped slightly more in2019. The detailed analyses shows that some current liabilities matured in the current year and there was significant sale of current assets held for sale. Though the change is not very significant, it is important for the company to take steps to improve the current situation since current ratio of below 1 shows that the liabilities owed by the company in the next 12 months is higher than the assets realized in the next 12 months. This is a risky financial situation and might lead to dishonor of liabilities by the company. Quick ratio eliminates inventory from the current assets in the above ratio. Since inventories are a significant portion of current assets in this industry, quick ratio is as low as 0.30 for industry. In 2018 the ratio of the company was at par with the industry average but in 2019 it has declined. As discussed earlier, this is due to the decreases in Assets held for sale. This is slightly risky situation for the company and it needs to improve the short term liquidity.
3.4 Gearing ratios
|(see appendix for calculations)||2019||2018||Industry average|
|Debt to equity ratio||26.76%||20.27%||50.73%|
|Cash debt coverage||430%||419%||NA|
|Interest cover ratio||18 times||16 times||NA|
Gearing ratio measures the financial leverage of the company and helps investors to assess the risk of investing based on the level of debt obligation of a company. To put it in nonprofessional terms, higher the debt obligation, risker the investment since the equity shareholders’ claim on the assets of a company is secondary to the claim of debt holders. Debt-equity ratio depicts the amount of debt as a percentage of equity. A debt-equity ratio of 2 or 200% is considered ideal (PP Drake, 2012). In the industry under consideration, the average is 0.5 or 50%. The debt to equity ratio of the company is less which is it is highly financed by equity. The ratio has increased in 2019 from2018 but still the company, however, depicts a better situation and can easily obtain loans for expansion projects.
Debt, as a percentage of total assets stands at 12% and equity constitutes 45%. Therefore, the remaining 43% is made up of other non-current liabilities and current liabilities. Cash debt coverage measures the relationship between cash generated from operations and the debt obligation of a company. In case of the company, debt is 4 times or 400% the cash generated from operations. Interest cover ratio is used by banks to assess the interest payment capacity of a company. An ideal scenario is if earnings before interest and tax (EBIT) at least 2 time the interest obligation. The cash to debt ratio and interest coverage ratios of the company are very high as compared to standard acceptable levels, the company is in a good financial health as far as solvency is concerned.
The cost of capital of the company is less when the company is geared. This results in higher profits to the equity holders. Since that company has gearing ratios very small and high coverage ratios, it can easily increase the loans and reduce the weighted average cost of capital.
4 Recommendations and overall assessment
Has Year 1 been better than Year 2 for the company?
In absolute terms, financial performance of the company is marginally better than previous year. There is increase in revenue and hence the increase in monetary terms in profits. However, in percentage terms the performance in year 1, that is, 2019 has been less than 2018 because of slightly lower profitability ratios. The liquidity ratios have gone down. The efficiency ratios are almost the same. The gearing ratios have increased but are still very low as compared to acceptable standards. From financial position perspective, there is a decrease in equity owing mainly due to buy back of shares during the year (Woolworths Group Limited, 2019).
In the year 2018, the company has made significant investments in tangible and intangible assets resulting in huge net cash outflow under investing activities. On the other hand, the company has huge net cash outflow under financial activities owing mainly to the reason mentioned above. Thus it can be assumed that the slight dip in profit is due to the increased investment and will improve once the investment is utilized optimally. Dividend paid to equity sharesholders has declined to support the large investments. The company is in the growth and expansion phase and hence the slight decline in profits is acceptable. Overall, the performance of the company has been stable.
Will the company succeed in the future?
Woolworths Group has exhibited a history of tremendous success over the last century. The real question here is whether it will be able to sustain the success in future. The critical success factor in retailing industry is an efficient supply chain. The company has invested tremendously in the same keeping in view the emerging e-commerce business. Moreover, retailing is a people’s industry. People visit a store not just for the goods but also for the experience (Knox, 2015). Given, the company’s investment in quality staff, future success of the company is in no doubt.
The likelihood of a merger or acquisition?
Mergers and acquisitions are nothing new to the company. It has undertaken several mergers and acquisitions since 1985 when it acquired a retail store to emerge as one of the largest food retailer in the country (Knox, 2015). Further, it diversified into the petroleum and financial sector over the year through various acquisitions. Most recently, the company has proposed to spin off its liquor and gambling business subject to statutory approvals as per various communications by the company. Hence, there are plenty of possibilities of mergers and acquisitions in future mainly for the synergies offered by such deals.
Consider the relevant ethical considerations if the organisation becomes insolvent
Corporate insolvency refers to a situation wherein a company is unable to honor its debts when they are due. This is a situation strictly covered by law mainly due to the existence of corporate viel which separates a corporate from its management or owners thereby limiting their liability. Hence there have been efforts by various countries such as US, UK and Australia to have the situation covered by laws (Ziegel, 1994).
On the other hand, even in genuine insolency cases, it is essential for corporates to uphold ethical values. This can be in the form of full disclosure of all known facts and transparency in financial reporting. The financial statements should be fair in their presentation and should value substance over form.
Suggest what should the company be doing help it succeed?
Success happens through diversification or internationalization and concentration upon the core competency. All of which has been adopted by the company over the years. The strategy that seemed to work best is core competency since the company has leveraged its retailing brand name to establish all the other business units. By strengthening the supply chain and adopting penetration strategy, the company can multiply its current profits. However, there is no reason why the company should not pursue other businesses for the synergies they offer to the existing businesses. Further, in the present global era, markets can be expanded to endless capacity through international operations. However, the same comes with a huge risk of establishing supply chain in a foreign land which different culture of the workforce and customers.
The impact of the political competitive environment on the business
Australia remains among the top 15 countries in the ranking for ease of doing business over the last decade (ST Cavusgil, 2012). This is mainly due to the stable political system in the country. Transparency in government proceedings and excellent governance frameworks infuses confidence for starting a business, while corruption and red tapes are a buzz-kill for any new entrepreneur trying to set up business in a foreign country. In that sense, political environment has a very positive impact on the business of the company given that the country has very good trade relations with global trade organisations such as OECD (Organisation for Economic Co-Operation and Development), WTO(World Trade Organisation) AND G20. Australia is one of the countries which has had economic growth continuously for last 30 years (ATIC, 2020).
External factors that need to be taken into consideration
For analyzing the external or macro-economic factors affecting the business, we may undertake the PESTEL analysis. Social factors help in understanding the workforce of a country (ST Cavusgil, 2012). Australia has a small population as compared to other countries and socially divided mainly based on income. On the economic front, the country offers stable overall growth and is a preferred location for global companies due to the favorable economic climate. The final factor is technology and innovations. It is quite evident in the company’s drive for a supermarket for the future (Woolworths Group Limited, 2019) that the country appreciates innovation.
Would you invest in this company?
Performance of the company over the last years is depicted below-
There is an uptrend in the share price, which shows that the company is performing technically well. Hence, in accordance with the fundamental analysis as presented in the executive summary in the beginning, I would definitely invest in Woolworths Group Limited.