Financial Analysis of Woolworths Limited - Case Study Example

Financial Analysis: Woolworths Limited (WOW) Customer Insert His/Her Name Customer Insert Grades Course Customer Insert Tutors Name May 18, 2012. Outline 1. Introduction 2. Financial Analysis a. Liquidity b. Leverage c. Profitability d. Efficiency e. Investors’ ratio f. Cash Flow Analysis 3. Conclusion and Recommendation 4. References 5. Appendix Introduction This paper will report on the analyses of the Woolworths Limited’s financial statements using ratios. It will look at liquidity, leverage and profitability position of Woolworths Ltd. In addition, it will also determine the firm’s efficiency in utilization of the assets and conversion of stock into sales. The report will also analyse the investors’ ratios and firm’s cash flow generation. In the end the report will give recommendation to internal and external users. Financial Analysis Liquidity The liquidity ratio as measured by current ratio shows a decline in the firm’s liquidity position from 2009 to 2010 and an increase in 2011 as shown by Chart 1 below. The decline implies that firm’s current liabilities had increased in 2010 while an increase shows that the firm current assets had increased in 2011. The quick ratio shows that the liquidity position of the firm increased throughout the three years as a result of increase in current assets. The quick ratio increase in 2011 as compared to current ratio increase in the same period shows that the company held a significant amount of its current assets in stock. In the three years the level of liquidity was very low as measured by the cash ratio implying that the firm may not be able to meet its short-term obligations from the most liquid assets. Chart 1: Liquidity ratios Source: Woolworths Limited, 2012. In general, the situation implies that the firm will not be able to meet its short-term maturity obligations on time as the current liabilities are not subsequently and sufficiently covered by the current assets. Leverage The leverage ratio as measured by debt ratio and debt/equity ratio indicate that the firm’s leverage position decreased in 2010 compared with 2009 and increased in 2011 as shown by Chart 2. In 2011, 2010, 2009 the firm raised 30.07%, 25.46% and 29.73% of debt, respectively, from the total capital employed. The gearing level was satisfactory since the ratio in the three years was less than 50%. The decline in 2010 was due to repayment of long term loan while the increase in the year 2011 was as a result of increase in long term loan. In 2010 the debt/equity ratio decreased to 34.16% from 42.32% due to repayment of the bank loan. The ratio increased in 2011 to 43% implying that the firm acquired new loan from the bank. This implies that Woolworths was not highly geared because the ratio was less than 100%. Chart 2: Gearing ratios Source: Woolworths Limited, 2012. In 2011 the earnings available for interest payment covered the interest charges 13.78 times while in 2010 and 2009 the interest charges were covered 16.27 times and 15.07 times, respectively, as shown by Chart 3. This ratio was high implying that the firm was conservative in using debt and was therefore not using debt to shareholders advantage. Since the ratio is more than 7 it is thus considered safe for the firm and there is high probability that the firm may not suffer from financial distress leading to insolvency. Chart 3: Interest cover Source: Woolworths Limited, 2012. Profitability Woolworths’ profitability as measured by Net Profit Margin indicates that the firm’s profitability position increased throughout the three years. This implies that the management was able to control cost of sales, operating costs and financing costs as shown by increase in the ratio from 3.75% in 2009 to 3.94% in 2010 to 3.95% in 2011 as shown by Chart 4. Thus, the firm has been efficient in controlling it costs of doing business. Profitability as measured by Return on Equity indicates that the firm’s profitability position decreased from 2009 to 2010 and increased in 2011 as shown by Chart 4. The drop from 26.36% to 26.07% in 2010 shows a decline in the profitability of the firm and the company’s inability to generate returns to equity shareholders from owner supplied funds. While the increase in 2011 to 27.28% indicates an increase in profitability of the company and the firm’s ability to generate returns to the owners from owners’ supplied funds. In 2010 the firm was more efficient in generating returns to the providers of funds as shown by the increase in the ratio from 10.89% to 11.02%. Thus, the firm was efficient in utilization of capital employed to generate returns to the providers of funds. In 2011 the ratio decreased to 10.15% indicating that the company became inefficent in utilization of the capital employed to generate returns to providers of those funds. Chart 4: Profitability ratios Source: Woolworths Limited, 2012. In 2010 the operating profit margin increased from 5.68% in 2009 to 5.96% in 2010, the margin of 0.28% is due to improvement in company’s efficiency in controlling its operating expenses. In 2011 the ratio increased to 6.05% this indicates that the firm improved its efficiency in controlling costs of operation. Efficiency In 2011, 2010 and 2009, the firm generated AUD 3.73, AUD 3.89 and AUD 4.06 of sales from every Australian dollar invested in fixed assets. This shows that the efficiency with which the firm was using its fixed assets to generate sales had decreased as shown by the drop of the fixed asset turnover ratio from 2009 to 2011. Similarly, asset turnover ratio decreased throughout the three years as shown by Chart 5. In 2011, 2010 and 2009 the firm generated AUD 2.57, AUD 2.80 and AUD 2.90 of sales, respectively, from every Australian dollar invested in total assets. This implies that the firm’s efficiency in utilization of assets had reduced throughout the three year period. Chart 5: Efficiency ratios Source: Woolworths Limited, 2012. The company’s stock was turned into sales 11.20 times in 2011, 11.41 times in 2010 and 11.73 times in 2009 as shown by Chart 5, showing a deterioration in efficiency of converting stock into sales. It also means that the firm had more idle stock in 2011 compared with 2010 and 2009. Investors’ Ratios In 2011, 2010 and 2009 the dividends have been covered 1.47 times, 1.50 times and 1.57 times, respectively, by earnings attributable to equity shareholders. It has reduced from 2009 meaning that the company may not sustain paying dividends in future if the trend continues. Chart 6: Investors’ ratio Source: Woolworths Limited, 2012. In 2009, 2010 and 2011 the market was willing to part with AUD 17.49, AUD 16.47 and AUD 15.89 for the Woolworths’ earnings in that order. In addition it can be interpreted to mean that the investors will take 17.49, 16.47 and 15.89 years for them to recover their earnings based on firm’s 2009, 2010 and 2011’s earnings, respectively. According to Morningstar.com (2012) the industry Price/Earnings (P/E) ratio average is at 28.2 while the market as measured by S&P 500 is at 15.3. When the firm has a high P/E it means that the market will be willing to part with more for its earnings. Many investors consider a firm with high P/E to have an overvalued stock, which may be true but it could also be an indication that the market expects the stock to perform better in the future and that is why the market has priced the stock high. Alternatively, low P/E indicates that the market has “a vote of no confidence” or that stock has been overlooked by the market (Little, 2012: Luesby, 2012). Compared with market the firm has a high P/E while compared with the industry it has a low P/E. The right P/E depends on the investor’s readiness to invest in firm’s earnings. The investor’s willingness to invest in the firm implies that he/she believe the firm has good long-range potential besides its present position. Another investor might think that what you consider “right” P/E is wrong (Little, 2012). Cash Flow Analysis Operating Cash Flow Ratio decreased to 36.09% in 2011 from 38.47% in 2010 as shown by Chart 7, this implies that the firm was not making sufficient cash to meet its short-term obligations which was very serious for the company and the lender. This shows that it is likely that the company might not have the capacity to continue with operations. Chart 7: Cash Flow Analysis Source: Woolworths Limited, 2012. The ability of the firm to translate sales into cash was lowest in 2009 compared with 2010 and 2011. In 2010 the ratio had increased to 5.32% and increased in 2011 to 5.52%, this implies that the firm had more cash in 2011 compared with 2010 and 2009 to pay suppliers, service debt and acquire new assets The company’s free cash flows increased to AUD 934.30 million in 2010 by 0.9% from AUD 926 million but reduced to AUD 852.6 million in 2011. Thus, the firm’s Free Cash Flow figure is not growing. Chart 8: Free Cash Flow Source: Woolworths Limited, 2012. Conclusion and Recommendation The firm is facing high liquidity risks because the current liabilities cannot be covered subsequently and sufficiently by the current assets, which should be a major concern for the firm. However, the firm is able to repay the bank loan together with interest as a result of high earnings that sufficiently cover the financing costs as a result of low gearing. Therefore, the firm is not exposed to high financial risks due to low leverage ratios. The firm’s management has been effective as shown by the increase in returns generated on sales and investment. This means that the firm will be able to meet short term obligations and shareholders will obtain reasonable returns on their investment in terms of dividends if the trend continues. But the management should watch out on how it uses shareholders and debt holder money because the firm was less efficient in 2011 in generation of returns to providers of those funds. Thus, management should think of how they are going to increase shareholders’ value as well as increase earnings for the safety of the creditors. The Woolworths Ltd’s management should also try to improve the efficiency of assets utilization as well as try to increase the number of times they turn stock into sales. This is by increasing sales which will increase earnings to shareholders in terms of dividends and at the same time increasing firm’s cash flow hence its value. The value investors should look forward to selling Woolworths stock because the firm’s value and dividend cover from firm’s earnings are on a declining trend. The firm is also faced with high liquidity risks and it is not using assets and long-term debt to the owners’ advantage. References Little, K. (2012). Understanding price to earnings ratio. Retrieved from http://stocks.about.com/od/evaluatingstocks/a/pe.htm> Luesby, J. (2012). Interpreting the Price/Earnings ratio. Retrieved from http://economics.about.com/cs/finance/l/aa030503a.htm Morningstar.com. (2012). Woolworths Limited (WOW): Valuation. Retrieved from http://financials.morningstar.com/valuation/price- ratio.html?t=WOW®ion=AUS&culture=en-us Woolworths Limited (2012). Investor centre: Annual Reports. Retrieved from http://www.woolworthslimited.com.au/phoenix.zhtml?c=144044&p=irol- reportsannual Appendix     2011 2010 2009 Liquidity ratios Current Ratio       =Current assets/ current liabilities 6593/8288.3 = 0.80 5199/7153.4 =0.73 4859.2/6414.6 = 0.76 Quick Ratio       =(Current assets - inventories- assets held for sale - other financial assets) / current liabilities (6593-3736.5-93.9-120.8)/8288.3 = 0.32 (5199-3438.8-37.3-92.7)/7153.4 = 0.23 (4859.2-3292.6-36.9-102.9)/6414.6 = 0.22 Cash Ratio       =(cash + short-term marketable securities)/ current liabilities 1519.6/8288.3 = 0.18 713.4/7153.4 = 0.10 762.6/6414.6 = 0.12         Gearing ratios Debt ratio       =Total long-term debt/ capital employed 3373.8/(3373.8+ 7845.8) = 30.07% 2670.4/(2670.4+ 7817.7) = 25.46% 2986.3/(7057.3+ 2986.3) = 29.73% Debt/equity ratio       =Long-term debt/ Equity 3373.8/7845.8 = 43% 2670.4/7817.7 = 34.16% 2986.3/7057.3 = 42.32% Interest Cover (times)       =(EBIT + Depreciation)/ Interest charges (3276.4+ (853+4.9))/300 = 13.78 (3082.1+(792.9+ 4.8))/238.5 = 16.27 (2815.5+(724.7+ 4.7))/235.2 = 15.07         Profitability ratios Net Profit Margin       =Net profit / Sales 2140.3/ 54142.9 = 3.95% 2038/51694.3 = 3.94% 1860/49594.8 = 3.75% Return on Equity       =Earnings attributable to equity shareholders/ equity 2140.3/7845.8 = 27.28% 2038/7817.7 = 26.07% 1860/7057.3 = 26.36% Return on Assets       =Net profit/ Total assets 2140.3/ 21094.5 = 10.15% 2038/18487.3 = 11.02% 1860/17084.9 = 10.89% Operating Profit Margin       =Operating profit/sales 3276.4/ 54142.9 = 6.05% 3082.1/51694.3 = 5.96% 2815.5/49594.8 = 5.68%         Efficiency Ratios Fixed Asset Turnover       =Sales/fixed assets 54142.9/ 14501.5 = 3.73 51694.3/13288.3 = 3.89 49594.8/12225.7 = 4.06 Asset Turnover       =Sales/Total Assets 54142.9/ 21094.5 = 2.57 51694.3/ 18487.3 = 2.80 49594.8/17084.9 = 2.90 Stock Turnover       =Cost of sales / Average stock 40186.3/ ((3736.5+ 3438.8)/2) = 11.20 38391.2/(( 3438.8+3292.6)/2) = 11.41 36974.4/((3292.6+3010)/2) = 11.73         Investors' ratio Dividends Cover       =Earnings per share/ Dividends per share 174.64/119 = 1.47 164.01/109 = 1.50 150.71/96 = 1.57 Price/Earnings ratio       =Market price per share/ Earnings per share 27.75/1.7464 = 15.89 27.02/1.6401 = 16.47 26.36/1.5071 = 17.49         Cash Flow analysis Cash Flow margin       =Operating Cash Flow/ Net Sales 2991.1/ 54142.9 = 5.52% 2752/51694.3 = 5.32% 2604.2/49594.8 = 5.25% Free Cash Flow       =Net operating cash flow - capital expenditures 2991.1-2138.5 = 852.6 2752-1817.7 = 934.3 2604.2-1678.2 = 926 Operating Cash Flow Ratio     =Cash Flows from operations/ Current liabilities 2991.1/ 8288.3 = 36.09% 2752/7153.4 = 38.47% 2604.2/6414.6 = 40.60%         Source: Woolworths Limited, 2012. 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