Contemporary Accounting: Woolworths Company Limited - Case Study Example

Recommendation Report on Woolworths Company limited Investment Choice Institution Course Professor Date Industry profile Woolworths Company (WOW) is listed under the Global Industry Classification Standard (GICS) as food and staples retailing outlet (ASX, 2014). It was founded in 1924 in Bella Vista, Australia. The company operates in five segments namely; Australian food and liquor, New Zealand supermarkets, Petrol, BIG W and Hotels. Furthermore, the company through online platform catalogues and contact centres in Australia and New Zealand retails apparel and home wares (Dagwell, & Lambert, 2007 p.4). Economic outlooks Australian economic prediction indicates a marginal growth in financial year 2014 trending at 2.5% as consumer spending growth rate expected to increase by 2.03% in the forthcoming fiscal year 2015 according to Reserve Bank of Australia (ABS 2014). Possibility of heighten inflation and high unemployment are some of the factors suggested by economic analyst as preventing consumers from borrowing and spending. Competitive positioning Woolworths Company is at a brink of expanding internationally in an effort to raise profit growth. With its competitor (Wesfarmers) both almost reaching saturation level in Australia and New Zealand they are searching for new avenue to advance their growth. Both companies are diversifying their products with WOW venturing to financial products whereas Wesfarmers acquiring banking licence. Though this is a good idea, woollies stakeholders are fearful that the company pays huge amount to acquire and investment offshore, in process takes too much debts or forced to raise more equity to fund the deal which to their view is foolish takeaway. WOW is also seeking for new acquisitions which will boost its competitiveness. Company strategy Delivering strong, sustainable growth in the established parts of the business (segments) are the main strategic priorities of WOW Company. The company's core objective is serving its customers with the best possible value, convenience and quality product. As manifested on 2014 financial year report, investment in progress included the ongoing momentum in Food and Liquor witness by improved comparable sales, EBIT growth and market share. WOW has engaged key supermarkets promotional campaigns providing more than $750 million as saving to customers in a bid out do their competitors. Average price deflation was 3.1% for the financial year 2014 was evident. Fresh market share is growing faster than grocery in line with company's strategy thus providing more convenient access both in stores and on line where the company managed to sell to a total of 21.1 million customers in FY14. More than 3,100 stores across the country have enabled Woolworths to serve an average of 26 million customers per week. Through this Australian economy has significantly grew with an annual sales of more than $51 billion and an employment of more than 170,000 team members workforce working across metropolitan and regional Australia. Precisely, the firm contributes 4.6% of Gross Domestic Product (GDP) each year. Strategy Analysis: Strategic analysis is discussed through four levels (Banhegyi 2008, p.469). Corporate level strategy guides and streamlines the business in achieving its competitive advantage. Woolworths had employed this strategy in achieving long-term profitability through diversification and vertical integration. Other strategies employed are business-functional-global strategies all aim at customer responsiveness, greater brand loyalty and more sells than their competitors. The ever changing dynamic business environment which causes positive and negative head swigs in prices can be solved by global strategy (Banhegyi 2008, p.472). Woolworths reported Earnings per Share (EPS) of 148 cents in the year 2012, 182 cents in year 2013 and 196 cents in 2014. The trends are expected to increase as it is predicted 206 cents in financial year 2015 (appendix 1.1). Valuation/ratio analysis All ratios used in the analysis of WOW are found in appendix in order of their presentation in this report. The company's operating and financial performance is analyzed using such ratio to determine its liquidity, efficiency, profitability and solvency. The trend manifested by this ratio over successive period is studied to know whether they are deteriorating or improving. Dividend Growth Model Valuation using dividend growth model is computed as follows with assumption that growth rate kept constant, required rate of return is greater than growth rate and in case growth rate is bigger than the rate of return thus absurd answer is obtain showing negative valuation of shares (Correia 2007, p. 15). Po = D1/k-g In 2014 financial year, Woolworths ltd reported a dividend of 1.37 AUD, which depicts a 3.01% increase over last year. Financial analyst predicts dividend of 1.45 AUD for the forthcoming fiscal year 2015, indicating an impressive increase of 4.13% (appendix 1.4). Relative valuation (price multiples) In order for an investor to determine whether shares are over or undervalued; price earning (P/E) ratio and price to book value ratio is used. P/E ratio measures the relationship between the company's earnings per share and the share price. a) Price to earnings (P/E): P/E indicates the price that investors are willing to pay for each $1 of earnings (Bazley & Hancock 2013, p.362). WOW’s P/E was .17 in FY12, but it increased by 3.6 % to .18 in FY09. This result is explained by a 1.73% increase in earnings per share (EPS), whereas the average market price increased by only 24.37% (from $26.38 to $32.81). The half-year report FY14 shows a decrease in EPS of 41.6 percent and a 5.15 percent increase in markets share indicating a P/E of 33.5. Yearly performance analysis of FY2012: In FY12, WOW’s financial profit increased by 3.6 percent, these results was affected by provisioning for the disposal of the Consumer Electronics business, impacted by significant price deflation. This reduced the after-tax profit by 14.5 % and earnings per share (EPS) by 14.9 %. Besides it is predicted that increment for FY15; FY16 as 17.1 and 16.3 respectively (appendix.1.4). Liquidity analysis This ratio stipulates that a company maintain sufficient assets to meet its obligation as they fall due (Bazley & Hancock 2013, p. 348). Two ratios are employed to assess this scenario; Current ratio; shows short period debt paying ability (Bazley & Hancock 2013, p. 361). WOW had .85 times as many assets as obligation in fiscal year 2012 and .90 times as many asset as commitments in FY2013. This revelation is attributed to 7.3% increase in current asset and current liabilities shooting up by 1.7%. Quick ratio; the ratio assesses highly liquid assets to meet short term obligation and thus more conservative approach (Bazley & Hancock 2013, p. 361). WOW's quick ratio for financial year 2013 of .29 lower than previous year ratio of FY2012 of .31. Trade and other receivables show impairment allowance as per consolidated statement of FY13 of $14.8 million as compared to FY12 of 413.3 million (Woolworths 2013). From the analysis of the two ratios it is advisable for investors to invest on shares as the company is able to meet its short-term obligation. Cash flow from current operation to current liabilities; it determines the short-term debt-paying ability based on operating cash flow (Bazley & Hancock 2013, p. 360). WOW's ratio was .39 and .42 for FY13 and FY12 respectively, confirming that there was a 24.2% higher cash flow in FY12 as compared to FY13. an increase of 73.6% in movement in net investment in inventory and a decrease of 88.60% of non-cash operating cash flow and a 23.07% increase in net interest paid. Furthermore, FY15 project financial leverage of 0.68x and cash flow per share of 219 cents (appendix 1.2). Long term solvency analysis This analysis shows the ability of a company to remain solvent and meet its commitment. Debt to equity (D/E) ratio is used to uncover WOW's long-term solvency position. It indicates the capital structure of a company by highlighting the proportion of debt and equity financing employed; the rationale is that the higher ratio, the better the financial leverage (Bazley & Hancock 2013, p. 369). D/E ratio of FY12 was 1.41 times whereas for FY13 was 1.43 times comparably. This increase is attributable to 1.4% decrease in total liabilities and 2.9% increase in equity advisable for any willing investor to invest shares (appendix 1.2). Interest coverage; shows protection of lenders from defaulters on interest payment (Bazley & Hancock 2013, p. 361). WOW's experience 4.01 interest coverage in FY12 with EBIT increasing by .92 in FY13 with a reduction of interest expense of 18.54 thus interest coverage of 4.46 for FY13. This indicates that there was greater interest on investment than on loan witness on WOW’s financial statement (Woolworths 2013, p.101). Profitability analysis Profitability ratios attempt to measure a company's ability to earn an adequate return relative to sales or resources devoted to operations. Operating profit margin, net profit margin, return on assets and return on equity is employed to assess WOW’s profitability position. Operating Profit Margin (OPM): High operating margin denotes good cost control by the company and/or sales are increasing at a faster rate compared to costs. This is the optimal company situation (Bazley & Hancock 2013, p.359). WOW’s OPM was 6.11 percent in FY12, which increased by 8.2 % to become 6.24 % in FY13. The increase is attributable to 9.17 % increase in operating profit, along with 26.83 % increase in revenue (appendix 1.4). b) Net Profit Margin (NPM): NPM indicates profit produced by each dollar of sales after payment of interest (Bazley & Hancock 2013, p.360). WOW’s NPM was 4.65 % in FY12 increased by 15.52 % to become 5.34 % in FY13. The increase is attributable to a 22.78 % increase in net profit, along with a 6.83% increase in revenue. It is projected that by this rate shall increase by 3.80% and 3.84% in 2015 and 2016 financial years respectively (appendix1.4). Net capital expenditure (CAPEX): is the difference between internal investment and depreciation. CAPEX is the function of how past the firm is growing. WOW has a high growth rate with higher net capital expenditure. Net CAPEX (NCE)=Capex- Depreciation. From the analysis CAPEX for WOW company forthcoming year 2015 shall be 3.25% (appendix 1.4 Weighted average cost of capital (WACC) is taken as stated interest rate of each liability to weighted average rate of cost debt of debt (appendix 1.7/1.8). Working Capital Investment is affected by high inventory levels that ranged between 8.1% of gross revenues. In 2013 a 9.2% average calculated was recognized. Consequently there is $1903 million working capital realized. Return on Average Funds Employed (ROFE) Group ROFE of 27.6%, up was witness in 2013 and from continuing operations before significant items of 28.0% up. This result demonstrates increased momentum across the Group that shows Woolworths will continue to generate sustainable profit growth into the future influenced by significant figures in financial statement (appendix 1.6) Free Cash Flow (FCFF) FCFF=EBIT (1-T)-WC investment-Capital exp-deprn. =$4619m (1-0.30)-$1903 m-$147.2-$17.2m =$1165.9m WOW Company forecasts a net income $4619m of in FY15 at tax rate consistent at 30%. Then free cash flow to the firm will be $ 1165.9 million as calculated above. Estimating free cash flow to equity (FCFE); Net income ($2259m) less capital spending of ($1903) less depreciation (17.2m)*(1-0.78%)-Non-cash WC (1565m)*(1-0.78%) equating to $7.916 million as estimates (2013). Terminal value The DCF model present a value of $47 837 M of the total valuation representing a 1.5% (appendix 1.8). Reinvestment rate (RR): is the rate an investor is assumed earning on immediate cash flow. WOW’s RR is at 2.5%. Estimating FCFF for FY2013 FCFF=EBIT (1-t)*(RR)=$3653(1-0.30)*2.5%=$6392.75 Millions Using stable period WACC of 9.2% we determine the terminal value: TV=FCFF/WACC-g= $6392.75 /(9.2-4.3)=$31324.475m. Cost of equity-analysed using the Capital Asset Pricing Model (CAPM) as 12.56% (appendix 1.8, (b) which entails: Risk Free Rate: A 10-year Australian government bond rate-3.94%. Implied market risk premium: Calculated Australian implied risk premium of 7.12% to capture forward-looking estimate for future growth. Historical fundamental beta of 1.5 applied from a 5-year weekly regression. The EV/EBITBA relative valuation of WOW is calculated 47795/4772=$10.02. EV stands for Value of Enterprise and EBITBA as Earnings before interest, tax, depreciation and amortisation. The figure is accurate as the formula is not undermined by non-cash items. Recommendation Based on the analysis made above, it is clear that the WOW is a going concern company with sound financial status. Therefore, it is prudent for investors to invest shares. Appendices Appendix 1.1 Annual Income Statement Data Actuals in MAUD Estimates in MAUD Fiscal Period June 2012 2013 2014 2015 Sales 55 130 58 516 60 773 63 638 Operating income(EBITDA) 4 236 4 619 4 772 4 980 Operating profit(EBIT) 3 352 3 653 3 775 3 960 Pre-Tax Profit(EBT) 3 068 3 215 3 515 3 739 Net income 1 817 2 259 2 452 2 417 EPS(cts AUD) 148 182 196 206 Dividend per Share(cts AUD) 126 133 137 145 Yield 3,58% 3,78% 3,89% 4,13% Appendix 1.2 Actuals in M AUD Estimates in M AUD Fiscal Period June 2012 2013 2014 2015 Debt 3 916 3 603 3 433 3 392 Finance - - - - Operating income(EBITDA) 4 236 4 619 4 772 4 980 Leverage (Debt/EBITDA) 0,92x 0,78x 0,72x 0,68x Capital Expenditure 1 166 1 903 1 841 2 066 Book Value Per Share (BVPS) 665ctsAUD 744 cts AUD 814 cts AUD 873 cts AUD Cash Flow per Share 234 cts AUD 219 cts AUD 277 cts AUD 287 cts AUD Appendix 1.3 Financial Ratios Size 2015e 2016e Capitalization 44 445 M AUD - Entreprise Value (EV) 47 837 M AUD 47 795 M AUD Valuation 2015e 2016e PER(Price / EPS) 17,1x 16,3x Capitalization / Revenue 0,70x 0,67x EV / Revenue 0,75x 0,72x EV / EBITDA 9,61x 9,03x Yield(DPS / Price) 4,13% 4,37% Appendix 1.4 Profitability 2015e 2016e Operating Margin(EBIT / Sales) 6,22% 6,31% operating Leverage(Delta EBIT / Delta Sales) 1,04x 1,32x Net Margin(Net Profit / Revenue) 3,80% 3,84% ROA(Net Profit / Asset) 13,6% 13,8% ROE(Net Profit / Equities) 24,6% 24,0% Rate of Dividend 70,5% 71,1% Balance Sheet Analysis 2015e 2016e CAPEX / Sales 3,25% 3,08% Cash Flow/ Sales 5,68% 5,79% Capital Intensity (Assets / Sales) 0,28x 0,28x Financial Leverage(Net Debt / EBITDA) 0,68x 0,63x Appendix 1.5 Financial Summary Year to Jun NPAT EPS EPS chg (%) PER DPS Yield (%) Franking (%) 2016 F 2,912.0 233.3 8.1 14.9 160.0 4.6 100.0 2015 F 2,693.6 215.8 9.9 16.1 150.0 4.3 100.0 2014 A 2,451.4 196.4 3.7 17.8 137.0 3.9 100.0 Source: Morningstar analyst estimates. Peer Comparison EPS Growth (%) P/E (%) Dividend Yield (%) Company Mkt Cap 2014 A 2015 F 2016 F 2014 A 2015 F 2016 F 2014 A 2015 F Wesfarmers (WES) $47,274 M -0.0067 0.1250 0.1309 21.0722 18.7316 16.5639 4.84 4.96 Woolworths (WOW) $43,719 M 0.0361 0.0595 0.0527 17.7403 16.7447 15.9058 3.95 4.18 Appendix 1.6 Weighted Average Cost of Capital (WACC) Market Capitalization 44 445 M Debts and Operating leases 3602.7M Total firm value 47 837 M Weight to Equity 22.2% Weight to Debt 26.8% Corporate tax rate 30% WACC 9.2% Appendix 1.7 Five year performance table FY09 FY10 FY11 FY12 FY13 Sales ($m) 49,595 51,694 54,143 56,700 59,158 EBIT ($m) 2,816 3,082 3,276 3,377 3,656 ROFE (%) 31.9 31.0 29.3 24.1 27.6 STIP paid ($m) 194 171 169 176 226 STIP/ EBIT (%) 6.9 5.5 5.2 5.2 6.2 Appendix1.8 a)Valuation inputs EBIT grow the (CAGR) Years 1 to 5 6.3% Years 5 to 10 4.0% ROIC FY12A 12.2% FY17F 11.7% FY22F 11.2% DCF WACC 9.2% Terminal growth 1.5% b) CAPM Cost of Equity Australia 10-year risk free rate 3.94% Woolworths fundamental Beta 1.50 Implied market risk premium 7.12% CAPM Cost of Equity 12.56% References Australian Bureau of Statistics (ABS), Accessed 22 October 2014 at: >http://www.abs.gov.au Read More