Introduction
The objective of this report is to perform the financial analysis of Next PLC and its competitor firm, Debenhams PLC. While both the stocks are listed on the London Stock Exchange(LSE), however, the report is solely attributed to uncover the fundamental analysis using the tool of financial ratios. Here, the attempt will be made using necessary ratios delineating profitability, efficiency, liquidity and gearing position of both the firms over the period of the past two years. The report shall finally be culminated discussing whether there is an improvement in the overall performance of each firm along with the final recommendation suggesting long or short position on the stocks.
Liquidity Analysis
Liquidity ratios allow us to learn about short-term payment capacity of the firm. For the liquidity assessment of the subject companies, two ratios are considered:
i) Current Ratio: Current Assets/ Current Liabilities
ii) Quick Assets Ratio: (Current Assets- Inventory)/ Current Liabilities
(NEXT PLC, 2016) (Debenhams, 2016)
Referring to the above figures, we can see that Next PLC is having a comparatively better liquidity position than Debenhams PLC. However, the liquidity trend in 2016 for the former company was not encouraging with current ratio and quick ratio witnessing the downward trend. As for the current ratio, the ratio multiple decreased from 1.82 to 1.40 on account of 32.02% increase in the current liabilities while the current assets increased marginally by 1.61%. On the other hand, the current ratio of Debenhams PLC surged from 0.66 to 0.73 following 9.35% increase in the current asset base while the current liabilities decreased by -1.15%. A similar trend was noticed in the quick ratio, which is rather a stringent measure of the liquidity position of a company. While Next PLC’s quick ratio decreased from 1.35 to 0.99, on the other hand, the trend was favorable for Debenahms PLC, whose quick ratio increased from 0.18 to 0.26.
Therefore, these trends confirm that while NEXT PLC is more liquid than Debenhams, however, the trend in 2016 was more favorable for the latter company. However, despite of the ebullient trend in 2016, Debenhams still lags significantly compared to the liquidity position of Next.
Profitability Analysis
Profitability ratios reveal the ability of the management to generate profitability from business related activities. While the profitability figures on the financial statements can be misleading, turning these figures into financial ratios will provide meaningful information about the profitability trend in both the companies. Discussed below are some of the profitability ratios for Next PLC and Debenhams PLC
i) Gross Profit Margin: Gross Profit/ Revenue
(NEXT PLC, 2016) (Debenhams, 2016)
The above figures clearly indicate the profitability dominance of Next PLC over Debenhams. As we can see from the figures above, during 2016, gross profit margin of Next PLC increased from 33.58% to 34.79% on account of 4.42% increase in the revenue figures while the controlled proportion of costs of goods sold, also fueled the increase in the gross profit margin. As for Debenhams, being a comparatively small brand, the company could only generate a 0.82% increase in the sales figure while the higher proportion of costs of goods sold, which account for more than 87% of the revenue figures, eroded the gross margin this year for the company.
ii) Operating Profit Margin: Operating Profit/ Revenue
(NEXT PLC, 2016) (Debenhams, 2016)
Here also Next dominates Debenhams with a comparatively better operation structure. As we can see from the above figures, the operating margin of Next PLC surged marginally from 20.08% to 20.90% as the company successfully managed to keep its operating cost under control despite the commendable increase in the revenue figure.
ii) Return on Equity: Net Income/ Total Equity
ROE is a meticulously watched upon profitability multiple for the shareholders as it reveals how much return the company is generating on its equity capital. As we see from the above figures, Next PLC generates exorbitant returns for its comparatively small shareholder base. Moreover, the trend will turn the shareholders ecstatic as ROE of the company surpasses 200% level in 2016. On the other hand, shareholders of Debenhams might lose their confidence with ROE multiple decreasing from 11.02% to 9.73%.
Overall, the profitability trend clearly favors Next PLC, which, owing to commendable revenue growth and controlled cost structure, is able to generate higher profitability margins.
Working Capital/Efficiency Ratios
These ratios allow us to analyze the efficiency of the company’s management to handle the assets that affect working capital position of the company. Discussed below is the trend in all such ratios:
i) Inventory Turnover (Days) = Inventory / Cost of Sales x 365
Referring to the above figures, we can see that during 2016, it took more time for Next PLC to sell its inventory, while Debenhams witnessed a marginal improvement of one day only. These trends reveal that an extended inventory period must have affected the liquidity position of Next as additional days of inventory means liquid capital was tied up to inventory levels for a longer period of time.
ii) Trade Payables (Days) = Trade Payables / Credit Purchases x 365
While Next Plc took additional time to sell its inventory this year, however, it paid its payable a day earlier compared to 2015. On the other hand, Debenhams delayed their payments by one day.
Cash Flow Analysis
Comparing the cash flow statement of both the companies, we found that Next PLC generates a significantly higher operating cash flow amounting to $608 million, though this amount was 22.20% lower than the figure in 2015. On the other hand, Debenhams PLC generated operating cash flow of $214 million this year, which was 1.83% lower than the one in 2015. (Morningstar.com, 2017)
Weaknesses of Ratio Analysis
i) Projects historical trends:
Ratio analysis only projects the past historical trends and is not a good tool to use for preparing pro-forma statements or making projections.
ii) Historical v/s Current Cost:
Some of the items on the income statement are stated in current costs while items in balance sheet may be reported in historical cost. This difference may distort the results of mixed ratio.
iii) Gathering industry average data:
It is always recommended that outcome of ratio analysis must be compared with industry average data, which unfortunately is not easily available for all the industries.
(Accountingtools.com, 2017)
Recommendation:
On the basis of above discussion,we recommend that investors looking for a strong fundamental stock should invest in Next PLC, which is supported by strong liquidity, supportive sales growth and commendable margins.
Bibliography
Accountingtools.com. (2017). What are the limitations of ratio analysis? - Questions & Answers - AccountingTools. [online] Available at: http://www.accountingtools.com/questions-and-answers/what-are-the-limitations-of-ratio-analysis.html [Accessed 29 Jan. 2017].
Debenhams PLC, (2017). Annual Report 2016. Debenhams PLC.
Financials.morningstar.com. (2017). Cash Flow for Debenhams PLC ADR (DBHSY) from Morningstar.com. [online] Available at: http://financials.morningstar.com/cash-flow/cf.html?t=DBHSY®ion=usa&culture=en-US [Accessed 29 Jan. 2017].
Financials.morningstar.com. (2017). Cash Flow for Next PLC (NXT) from Morningstar.com. [online] Available at: http://financials.morningstar.com/cash-flow/cf.html?t=NXT®ion=gbr&culture=en-US [Accessed 29 Jan. 2017].
NEXT PLC, (2017). Annual Report 2016. NEXT PLC.
