About the paper
The paper is commissioned to conduct financial analysis of UK based retailer, Morrisons PLC. As part of this analysis, we will be using the raw financial figures for the year 2014 and 2015, and will take the assistance of ratio analysis to unearth the financial trend in the company. In addition, we will also calculate the intrinsic value of the stock using the dividend discount model, and will then culminate the paper with a final conclusion on the financial standing and stock valuation of the company.
About the company
Founded in the year 1899, Morrisons Supermarket is a UK based food retailer. The company is involved in manufacturing and distribution of fresh food products,meat processing and other grocery related activities.The company operates through 500 stores,130 local convenience stores and offer the home delivery option through its online platform. By the end of 2015,the company had employed 119,778 full time employees.
Ratio Analysis
This is the core section of this paper as we now analyze the financial performance of the company using the tool of multiple ratio. In order to achieve a comprehensive analysis, we will be using multiple financial ratios, both from the perspective of the shareholders and the management. Additionally, each ratio multiple will be compared with the industry average sourced from Mergent database.
-Profitability ratios
These ratios are the most sought after financial metrics by the management and the shareholders. It is through the analysis of the profitability ratios, management is able to evaluate their performance during the year, while the shareholders are able to judge how efficient is the capital being employed by the management. Highlighted below are the profitability ratios of the company, analyzed from the perspective of the management and the shareholders:
i) Operating Margin: Operating Profit/ Revenue
2014: -176/17680= -1%
2015: -909/16816= -5.40%
Industry Average: 5.11%
ii) Net Profit Margin: Net Profit/ Revenue
2014: -238/17680= -1.34%
2015: -761/16816= -4.53%
Industry Average: 4.58%
Referring to the above figures, we can see that the financial performance of the company got worse with profit margins plummeting sharply. The results will surely put the management to a deep thought and an urgent need to restructure the company’s operations. Beginning with the operating profit margin, the multiple decreased from -1% to -5.40% on account of 33.60% increase in the operating expenses while the company failed to source additional revenue,which rather plummeted by -4.89%. This indicates that all efforts put into the operations in the form of sales and advertisement expenses went in vain as despite of spending additional amount to fuel revenue growth, the management turned unsuccessful in generating additional sales revenue. An additional source of worry for the management will the comparison to the industry average as while the average industry operating profit is 5.11%, the company is unable to generate profitability from its operations.
A similar trend was witnessed in the net income margin, which just like operating margin, also decreased from -1.34% in 2014 to -4.53% in 2015 on account of uncontrolled operating costs and increasing interest expenses at times of decreasing revenue figures. Additionally, the net margin of the company recorded at -4.53% lags significantly behind the industry average of 4.58%.
In the nutshell, the management of Morrisons Supermarket PLC will need to consider an urgent thought-process to re-design the organizational architecture as for now, all the efforts are turning futile.
i) Return on Equity: Net Income/ Total Equity
2014: -238/1615= -14.73%
2015: -761/1380= -55.14%
Industry Average: 14.5%
ii) Earnings per Share: (Net Income- Preferred Dividend)/ Weighted average common shareholders
2014: -238/2327= -0.10
2015: -761/2332= -0.33
Industry Average: N/A
Shareholders of the company will largely be concerned about their wealth and how efficiently the company is utilizing it and generating returns for them. However, the above calculations reveal that shareholders of Morrisons Supermarket will feel disgruntled and will possibly lose confidence in the company’s operation post learning about the profitability ratios concerned with them. Beginning the ROE metric, the multiple decreased massively from -14.73% to -55.14% on account of magnified losses in 2015. Additionally, a comparison of the ROE metric of the company to the industry average of 14.5%, also confirms the dismal situation in the company. This indicates that the company is eroding shareholder wealth and if the trend continues, this may prove detrimental for the entity.
Another financial metric which will send a wave of concern amongst the shareholders is Earnings per Share, which reduced from -0.10 to -0.33. This indicates that per share earnings attributed to common shareholders has plummeted over the year.
Overall, the trend in the above ratios confirms that citing the ratio numbers, shareholders will not show interest in the company’s funding requirement and will place large sell orders soon if they do not see any signs of improvement.
-Solvency Ratios
These ratios guide through the capital structure of the company and accordingly allow the analyst to appraise the debt handling capacity of the entity. Highlighted below are the calculations for the short-term and long-term solvency of the company followed by the discussion:
Short-term solvency(Liquidity)
i)Current Ratio: Current Assets/Current Liabilities
2014: 2100/2989= 0.70
2015: 2092/2806= 0.74
Industry Average: 1.29
ii) Acid Ratio: (Cash+ Receivables)/Current Liabilities
2014: (232+585)/2989= 0.27
2015: (253+557)/2806= 0.28
Industry Average: 0.82
Liquidity ratios reveal the working capital position of the company and if it is able to honor their short-term obligations. Referring to the calculations above, we witness that even though the liquidity ratios of the company has increased over the year, but the increase has not been sourced from sustainable means. Beginning with the current ratio, the multiple increased from 0.70 to 0.74 on account of -6.12% fall in the current liabilities that inflated the current ratio despite of -0.38% fall in the current assets. Important to note, despite of the increase, the current ratio of the company is still lower than the industry average of 1.29.
We also tested the short-term solvency using acid ratio and found that while the multiple increased from 0.27 to 0.28 on account of fall in the current liabilities, it is still lower than the industry average of 0.82.
Therefore, the above trends confirms that the company is not able to improve its current asset base and is largely lagging behind the industry averages. Henceforth, this raise concern over the short-term solvency position of the company.
Long-term solvency(Gearing)
i) Debt to Total Capitalization Ratio: ST Debt+ Long Term Debt/ (ST Debt+ Long Term Debt + Equity)
2014: (1770+2244)/( 1770+2244+1615)= 0.71
2015: (1542+2552)/ (1542+2552+1380)= 0.75
Industry Average: N/A
ii) Debt Ratio: Long-term debt/ Total Assets
2014: 2244/8113= 0.27
2015: 2552/8089= 0.31
Industry Average: N/A
Gearing ratios allow us to unearth the composition of the capital structure of the company and also the risk associated with it. Referring to the above calculation we witness that over the year, the company has increased its reliance on debt financing and has thus introduced the shareholders to additional risk level. Beginning with the debt-to-total capitalization ratio, the multiple increased from 0.71 to 0.75, which confirms that the company now operates low on equity capital and largely on debt capital. Furthermore, the debt ratio, which indicates the proportion of total assets financed with debt capital, has also increased from 0.27 to 0.31. This indicates that a large part of the asset base is funded with debt borrowings.
Overall, considering the existing financial situation of the company where it is unable to generate profitability and is even losing on revenue figures, acquiring more debt is a risky and unjustified decision that will only leave the shareholders to additional risk. Hence, the overall scenario confirms that Morrison Supermarket is having poor solvency roots and there is a legitimate concern relating to the company honoring its debt related commitments.
Evaluating overall performance and position of the company
In order to evaluate the overall performance and position of the company, we have relied on the common-size financial statements of the company. Highlighted below are the common-size financial statements of Morrisons Supermarket followed by a discussion related to their performance and position:
-Income Statement
As noted from the above table, during 2015, Morrisons struggled to even keep the revenue figures intact, and rather failed as the revenue of the company declined by -4.89%. Another notable trend that negatively affected the company’s performance was the increasing proportion of costs of materials and operating expenses to the revenue figures. Following the horizontal analysis, we found that during 2015, the proportion of costs of materials to the revenue figures increased from 93.93% to 95.47% and thus eroded the gross margin from 6.07% to 4.53%. Similarly, an increased proportion of operating expenses from 7.07% to 9.93%, also plummeted the operating margin from -1% to -5.41%. Finally, higher interest expense related payment at times of decreased profitability, also contributed towards magnifying net losses of the company that went up from -£238 million to -£761 million.
-Balance Sheet
As noted from the above table, we can see that over the year, the asset count of the company has decreased b -0.30% while the current asset position is down by -0.38%. In addition, the company also failed to increase its non-current asset base, which also decreased by -0.57%.
As for the liabilities position, during the year, the company managed to pull down the current liabilities by -6.12%. However, what was noteworthy here was the 11.3% increase in the non-current liabilities as the company opted for a 13.73% increase in long-term debt while pension related liabilities surged by 65.74%.
Finally, the equity position of the company also decreased by -14.55%, primary lead by an additional purchase of treasury stock. This indicates that the management is using the purchase of treasury stock to send signals that the management is optimistic of the future success. However, considering the existing financial position with magnifying losses and low liquidity, shareholders may not show any interest in such indications.
Stock Valuation: Dividend Discount Model
For the purpose of calculating the intrinsic value of the company’s stock, we have used the Gordon growth dividend model. As part of this model, we have forecasted dividend growth of the company using 5-year average of retention rate and return on equity. However, before we introduce the calculations, it is important that we understand the pros and cons relating with this stock valuation model:
Pros:
i)Simplicity: The model is simple and easy to understand. The reader can judge that the calculations are performed with an assumption that the dividend growth rate will be constant forever.
ii) Wide scope: The model is readily applicable for the stable business entities that had been paying regular dividends.
Cons:
i)Unrealistic assumption: The model is based on the assumption that the company will pay dividend at a constant rate, which is usually not true in the real world. Even research papers have confirmed that dividend growth is seldom linear.
ii) Precision Required: Dividend growth model is highly dependent on the inputs related to the required rate of return specific to the company and the growth rate. Since these two multiples are calculated by analysts with assumptions involved, even a small mistake in the calculations or assumptions can yield in accurate results.
Calculation:
Fair Value: Current Dividend (1+Growth Rate) /(Required Rate- Growth Rate)
= 0.13(1+0.0068)/(0.0742-0.0068)
=0.13 /0.0674
= £1.93/share
Current Price: £2/ share
Result: Overvalued
Calculative Notes:
a) Required Rate: RFR+ beta(Equity Risk Premium)
= 1.55+0.71(9.90-1.55)
= 7.42%
Here:
RFR= UK 10-year Gilt rate
Beta:Volatilty of stock returns to market index
Equity Risk Premium: Excess return of the market index over risk free rate
b) Growth Rate(5 year average)= Retention Rate* ROE
Conclusion
At the end of this paper, we can conclude that Morrisons Supermarket is going through a bearish period where failure to generate additional and control materials and operating costs is resulting into massive losses. Moreoever, the company has consistently failed to generate sufficient return for the equity shareholders, rather even in tough financial conditions, the company is borrowing additional debt and is thus transferring risk to the shareholders.
References
FROIDEVAUX, P. S. (2004). Fundamental Equity Valuation. University of Fribourg (Switzerland) .
Jeffries, T. (2015, February 15). What's done best - cash, stocks or bricks and mortar? How popular asset classes have performed over the past 30 years. Retrieved March 13, 2016, from http://www.thisismoney.co.uk/money/investing/article-2958803/Cash-stocks-property-best-returns-past-30-years.html
Morrisons Supermarket PLC. (2015). Annual Report 2015. Morrisons Supermarket PLC.
Profile: Morrisons Supermarket. (n.d.). Retrieved March 15, 2016, from Yahoo Finance: https://uk.finance.yahoo.com/q/pr?s=MRW.L
Quote: Morrisons Supermarket. (n.d.). Retrieved March 15, 2016, from Morningstar: http://www.morningstar.com/stocks/PINX/MRWSF/quote.html
United Kingdom Government Bonds. (n.d.). Retrieved March 15, 2016, from Bloomberg: http://www.bloomberg.com/markets/rates-bonds/government-bonds/uk
