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Case report of Mothercare plc
- Introduction to the company- very brief
Mothercare plc is a retailer, specialized in clothing industry. They predominantly sell products, such as clothing, furniture for children, bedding and toys, for mothers-to-be, babies and young children.
In recent years, there is a significant change in the ways to purchase goods. Customers prefer online shopping to walking into the stores. According to the statistics of the past 8 years, the flux years were from 2012 to 2015, where performance drastically went down. It is obvious that the company suffered from a huge loss during this period.
- Performance in the early years and problem years including causes of problems
Overall speaking, the performance in these 8 years has rooms for improvement. With reference to the graphs of return of equity (ROE) and operating margin of Mothercare and its competitors— Debenhams plc and M&S, the company’s ratios was below the industry average. The ROE of Mothercare reached its minimum points at -69.14% and -101.8% at 2012 and 2014 respectively, while other companies remained steady at approximately 20%. Moreover, the operating profit of the company plummeted since 2009 and attained its minimum at -12.61% in 2012, with a gradual growth to 1.55% in 2017. One point worths noting is that both ratios of its competitors have a declining trend, so Mothercare had similar figures as them in 2017, meaning that the performance is getting better.
Performance in the early years— 2010 and 2011— was impressive in terms of profitability and return on investment. The gross margin (12.01%) and operating margin (5.95%), dividend payout ratio (2.73%) and earnings per share (GBP 0.282) reached the peak in 2009. It reveals that stock was being sold at a lower prices and investors had more confidence in the company. It is because the potential return was higher and the investment looked attractive. A high dividend payout shows that a larger proportion of profits is distributed to shareholders in the form of dividends. The whole business was profitable and shareholders could benefit from it.
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Nevertheless, the company experienced a recession from 2012 to 2015. In terms of profitability, the percentage of operating margin and return on capital employed in this period was negative. The financial statement also reveals that the net loss was at a lowest point of GBP 91.8 million in 2012, meaning that the revenue could not cover the expenses. It was not effective in using the long term financing to generate revenue. The difference between the percentage in gross margin and operating margin should be highlighted. Particularly from 2012 to 2015, the gross margin was positive, but the operating margin was negative. The huge difference symbolized a large amount of operating expenses.
Regarding the liquidity, the firm was not capable to meet its short term obligations because the current and acid test ratios were lower than the norm. When the ratios are low, the company would have a high risk of facing liquidations. The gap between the 2 ratios illustrates that inventory was tied up in the capital, leading to insufficient liquid funds to meet its short term debts. The figures of inventory in the financial statements was around GBP 100 million over the past years, proving a high level of inventory at the same time. The cash conversion cycle had an increasing trend from 32.21 days in 2009 to 45.03 days in 2017. This 39.8% change matched with the cash figure in financial statements, which was GBP 0 in 2017. It features that it takes a long time to obtain cash from the company.
The factors behind all these alterations can be classified in to economy wide and industry wide factors. For economy wide changes, first, the labour income, i.e. wages, of households escalated in recent years. (UK pay growth rises to 3.1%, the highest in almost a decade, October 16, 2018) Hence, they can consume more goods for each hour of work. With a high consumption bundle, customers will ask for a wider variety of products and better fashion choices. They may purchase products with higher quality and price and spend money on other goods. As a result, the fall in sales revenues leads to a reduce in profits.
For industry wide changes, with the advancement of technology, online shopping has become popular, especially in the retail industry. Consumers prefer purchase online as it is much more convenient. The number of customers walking into the stores receded. Yet, the number of physical stores is fixed in short run, meaning that the fixed cost, for example rent, has to be paid. A large amount of sunk cost will make the firm difficult to breakeven and may have decreasing returns of scale. Since people would not buy the physical goods in stores, inventory piles up in the warehouse. It negatively affects the liquidity of the firm.
In addition, retail industry emphasizes a good customer experience. The attitude of staff, payment methods and layout inside the store may affect one’s impression to the company. If a person is unsatisfied with his/her shopping experience, he/she may not visit the shop again. The firm was less profitable.
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Apparently, investors were pessimistic about the prospect of Mothercare. The share price dropped gradually from 635.50 in 2010 to 14.76 in 2018. (Share price information, accessed January 20, 2019) More and more shareholders sell their shares, leading to a decrease in share price. On top of that, the dividend payout percentage have been 0 since 2013, because the firm did not distribute any dividend throughout these years. The earnings per share was below 0 from 2012 to 2015. Every share an investor bought, it could not generate profits but loss. This investment is no longer attractive to people. They do not have strong confidence in the company.
- Road to recovery
In light of this, the company obtained funds to overcome the problems. The gearing ratio was particularly high in 2014 with 19.74%. It reveals that nearly 20% of long term capital was obtained through debts financing. The company might borrow from banks and fund its long term assets.
A few strategies were adopted to improve the situation. First, the company plans to reduced its stores to fewer than 80 by April 2019 and the leases of 32 stores will expire within 3 years. (2018 Annual report, 2018) The closures will significantly dwindle the fixed cost, including the rent, equipment in the stores and wages for salesperson. It predicts to save costs by a minimum of GBP 19 million per annum. (2018 Annual report, 2018) As a result, the the gross margin, operating margin and return on capital employed were positive figures in 2016 and 2017. Profits increased due to a drop in costs.
Second, the company carried out a Corporate Social Responsibility Plan, including the CR 2020, aiming to support the overall aims of the UN Sustainable Development Goals (CR 2020 targets, accessed January 20, 2019), employee sponsorship matching fund etc. Moreover, the Mothercare Group Foundation aims at helping parents to give the best to the children, no matter education, well-being or health. The charity funds made generous donations of GBP 40,000 to Tommy’s and researched into pregnancy problems and provide health information to mothers-to-be. (Charitable Giving, accessed January 20, 2019) They even cooperated with Bliss, a UK charity providing care and support to premature and sick babies and their families. All these actions show that Mothercare contributes back to society and does not solely focus on profit maximization. People may be impressed by this practice and invest in the company ultimately.
- Future problems
Based on the past statistics, two predictions can be made. First, Mothercare has to be aware of its inventory level. The average inventories holding periods was escalating since 2009 from 47.26 days to 61.1 days in 2017. It means that the inventory usually needs to be held for around 2 months before selling it. A lengthening inventory holding period may increase warehouse costs and build up inventory levels. It may cause loss of inventories due to decay or out of date. Obsolete and expired inventories cannot be sold.
Second, the company should keep an eye on the management of debtors and creditors. The receivables settlement period spiked from 14.95 days in 2009 to 28.61 days in 2017. It takes a longer time for customers to repay their debts. It implies there is a poor credit control and if the longer a debt is owed, the more likely it will become bad. The payables period also went up from 29.89 days in 2009 to 44.58 days in 2017. The company is less efficient in paying it creditors due to a longer collection period. It implies the firm may have liquidity problems as it needs to delay its payment. They may not have sufficient cash in hand. The payables period is shorter than the receivables period, meaning that when the firm may have a lack of capital after they pay their suppliers, as they haven’t received money from debtors.
Therefore, the company should pay attention to the inventory level and strategies for debtors and creditors.
Appendix- List of References
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