Financial Analysis of Sainsburys | Tesco Comparison

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7th Mar 2019 Finance Reference this

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The past, present and future of J Sainsbury PLC

Introduction

In this report we aim to present and evaluate the past, present and future of J Sainsbury plc. The report will hold information for potential investors, who can then use this information for their own analysis, in order to decide whether they will be investing in the company. J Sainsbury PLC was founded in 1869 and falls under the supermarket sector. Since 1869 Sainsbury’s has continued to grow and has become one of the largest supermarkets in the UK, with a current market share of 16.9%. Sainsbury’s has been affected by supermarket stores such as Lidl and Aldi, who offer products at a discounted price. Sainsbury’s has consequently lost customers to these stores and therefore seen a decrease in profits. However, Sainsbury’s leading competitor is Tesco PLC, therefore the main comparison throughout the report will be made between J Sainsbury PLC and Tesco PLC. Both Sainsbury’s and Tesco’s main business comes from grocery sector, however both companies have additional businesses such as insurance and their own brand of clothing (Sainsbury, 2016).

The Capital Structure of J Sainsbury PLC

Raising capital is an essential part of any firms’ operations and there are two main ways through which businesses raise capital, that is either from debt or equity financing. The capital structure of a firm is the term used to describe the proportions of debt and equity financing that a company currently holds. A key model within the capital structure concept is ‘Pie Theory’, which states that the total value of a firm is equal to the sum of its market value of debt and its market value of equity. These two sources of finance combine to form the total value of a firm, or the total ‘Pie’. Therefore, if an organisations aim is to make their business as valuable as possible, then they must choose a debt-equity ratio that results in the ‘Pie’ being as big as possible. There are two categories of capital structure that a business can be labelled as. It is either an ‘unlevered firm’, which means that the firm is financed by equity only, or it is a ‘levered firm’, which is a firm financed by debt only, or by both debt and equity.

Table 1: Fiscal data as of March 12th 2016 of Sainsbury PLC Balance Sheet figures

Note: Adapted from Sainsbury PLC, Financial Times, 2016

You can clearly see from Table 1 above (Sainsbury PLC, Financial Times, 2016) that Sainsbury PLC is a ‘levered firm’ in terms of its capital structure as the company uses both debt and equity financing to raise funds. From March 2014 the company has reduced its total debt by £371m in three years to a total debt figure of £2,413m in March 2016. Also you can see how the majority of Sainsbury’s total debt from all the three years is made up of long-term debt, which is debt that does not have to be paid back within 12 months. It is clear that Sainsbury PLC management have made a strategic decision to build up more long-term debt instead of short term. One likely reason is because long term loans are viewed as a safer method of accumulating debt because the firm will have a longer time frame to pay back the debt. Sainsbury PLC are also more likely to raise larger amounts of capital when taking out a long term loan as opposed to a short term loan, as well as likely to get lower interest rates. The table also illustrates how Sainsbury PLC has increased their total equity by £362m from 2014 to 2016 where total equity is £6,365m. This means that according to the ‘Pie Theory’ the firm has a ‘total value’ of £8,778m at March 12th 2016. I have illustrated this figure in the chart below compared with the previous two years.

Chart 1: ‘Pie Theory’ charts for Sainsbury PLC

Note: Calculated from data in Table 1

From the data shown above you can see how Sainsbury’s management have decided to arrange the companies’ liabilities and organise their capital structure. The key point to recognise in Chart 1 is that the firm’s capital structure is clearly more reliant upon equity than debt. It seems that management have made a strategic decision to use equity as their main source of raising finance while simultaneously reducing the company’s total debt. The reason for this could be because ever since the ‘Great Recession’ of 2007 many banks have decided not to lend to companies with already high levels of debt, as these companies are seen as riskier investments and given the current economic climate banks, as well as other lenders, have become much more cautious. As a result, companies like Sainsbury have decided to cut back on their long-term debt and become more dependent on steady sources of finance.

Table 2: Ratios for Sainsbury PLC

Note: Ratios calculated from data in Table 1

Table 2 above shows a number of ratios that allow for greater analysis of Sainsbury’s capital structure. The figures show that Sainsbury’s has a debt to equity ratio of 0.3791 in 2016. This is a fairly low value and so it seems the company is not being funded largely through debt. This is a positive for the firm as a low debt to equity ratio safeguards the company from bankruptcy in case Sainsbury’s suddenly begins to experience cash flow or income issues. A low debt to equity ratio also allows Sainsbury’s to have more leverage when negotiating for loans in the future and is a sign that the firm is healthy and expanding. Table 2 also shows low debt to capital and long term debt to capital ratios. This again is an indication that Sainsbury’s seems a healthy business that does not depend upon debt as its main tool of raising finance. These ratios are strong indicators that the firm is a safe and reliable choice for potential investors however the figures must be compared with those of rival companies for a more reliable analysis of Sainsbury’s financial structure. Below I have replicated the same data for Tesco PLC as I did for Sainsbury’s so that a fair comparison could be made of Sainsbury’s capital structure with one of its closest rivals.    

Table 3: Fiscal data as of February 27th 2016 of Tesco PLC Balance Sheet figures

Note: Adapted from Tesco PLC, Financial Times, 2016

Chart 2: ‘Pie Theory’ charts for Tesco PLC

Note: Calculated from data in Table 1

Table 4: Ratios for Tesco PLC

Note: Ratios calculated from data in Table 3

The data above allows us to take the information we already have on Sainsbury PLC and put it into some context. Firstly, if you look at Chart 2 you will see a stark contrast of Tesco’s capital structure when compared to Sainsbury’s. Although Tesco PLC is also a ‘levered firm’ just like Sainsbury’s, it is clear that Tesco is much more reliant upon debt financing. Chart 2 shows that in 2016, debt financing made up 61.08% of Tesco’s capital structure whereas in the same year, debt financing made up only 27.5% of Sainsbury’s total capital structure. This figure is less than half of Tesco’s and similarly Sainsbury has amassed £10bn less in total debts in the year ending 2016 than Tesco PLC, this is apparent if you look at the 2016 figures in Table 3 compared to Table 1. Another key point to notice is that Tesco has much higher debt to equity ratio, long term debt to capital ratio, and debt to capital ratio than Sainsbury PLC. This further supports the conclusions made previously that Sainsbury’s has a very low ‘leverage’ ratios, and compared to Tesco PLC is in a far more secure and risk friendly financial situation than its competitor.

Dividend Policy

According to Sainsbury’s 2016 annual report, their board of directors aim to provide a dividend policy that is affordable to the business, and their current policy has a dividend cover that is “fixed at two times the underlying earnings for 2015/16” (Sainsbury, 2016). The organisation pays dividends to its shareholders in order to “remain focused on building shareholder value” (Sainsbury, 2016).

Sainsbury’s pay out cash dividends to shareholders, which are paid out in two separate payments. The first payment is the interim dividends, which is paid in December/January, (Sainsbury, 2016) and the final dividend for the year is paid in July (Sainsbury, 2016). For the year 2015/16, the suggested final dividend is 8.1 pence per share, which along with an interim payment of 4 pence per share, will make the full year dividend 12.1 pence (Sainsbury, 2016). When comparing this proposed dividend to previous years, there has been a decrease of 8.3% since 2014/15 and a substantial decrease of 30% since 2014/15. This decrease is likely to be a result of their change in policy, which is aimed at trying to “boost their balance sheet” (Jefford, 2015) and to help fund their price cuts, as they are faced with competition from discount stores (Jefford, 2015). Sainsbury’s also offers shareholders a ‘Dividend Reinvestment Plan’. This is a “specially arranged share dealing service” (Sainsbury, 2016) which allows shareholders to “reinvest their cash dividends in the company’s shares” (Sainsbury, 2016).

The date in which dividends are recorded and paid will have an effect on the share price of the organisation. The share price will decrease on or around the date of the ‘Ex-dividend date’. This is because any shares purchased after the ‘ex-dividend rate’ is not eligible to receive the next dividend that is being paid out. Sainsbury’s ex-dividend date was on the 12th of May in 2016. The share price for Sainsbury’s was 263GBX on the 11th of May, and this decreased to 252.50 GBX. This price decrease is roughly the same amount of the next dividend.

Liquidity Ratios

Liquidity ratios measure the competence of a company and the company’s ability to settle debt. The short-term liquidity ratios are concerned with current assets and current liabilities in view of Sainsbury’s financial position over a short term period (twelve months). The current ratio measures the number of times that current assets cover current liabilities. The greater the current ratio the more beneficial it is for Sainsbury’s, as this signifies how Sainsbury’s can allow more current debt in the short term period. However, for the past five years Sainsbury’s current liabilities have exceeded their current assets, as shown in the table below. This means Sainsbury’s are not meeting their short term debts. This can cause problems for Sainsbury’s as creditors look for high current ratio’s as this shows high liquidity (Hiller, Ross, & Randolph, 2013). In comparison, Sainsbury’s competitor Tesco shows how over the past 3 years they have maintained having greater current assets than current liabilities. In the eye of creditors, it is much more likely that Tesco would gain credit over Sainsbury’s. It is very unusual for a company as large as Sainsbury’s to have a negative net working capital however, it is critical to state that a low current ratio doesn’t necessarily mean Sainsbury’s is going to become bankrupt (Hiller, Ross, & Randolph, 2013). Sainsbury’s have claimed how they believe that their current liabilities will lessen a great amount in their 2016 yearend (Morgan, 2016).

The Quick ratio is very similar to the to the current ratio however, inventory is not classed as a current asset as inventory is often the least liquid. Therefore, inventory is taken out of the quick ratio calculation. Looking at both Sainsbury’s and Tesco’s quick ratio values for the past five years it is clear how Tesco have a much greater closing inventory at the year end when comparing to Sainsbury’s. In Addition, it is more likely for companies that fall under the ‘Supermarket’ sector that their inventories become obsolete as some of their produce can become waist if their ‘sell by date’ passes. For Sainsbury’s, the fact that they have little closing inventory is beneficial as they haven’t overestimated much on sales and products, meaning they have less inventory waste comparing to Tesco.

Long-term liquidity ratios look at how Sainsbury’s are meeting long-term debt obligations. Total debt ratio illustrates the company’s financial position and how the company pay back long term debts. Sainsbury’s debt ratio has been increasing for some years, in 2015 it is at its highest where for every £1 asset they are in debt £0.64 therefore, their £0.36 in equity (Hiller, Ross, & Randolph, 2013). In comparison, Tesco have a much lower debt ratio for all years meaning they hold a lot more equity in their assets than debt.

Efficiency Ratios

Efficiency ratios show how much a company is making use of their assets and liabilities to create income for the company. The Inventory days is calculated by taking the inventory turnover ratio dividing the number of days in the year by that figure. When looking at Sainsbury’s inventory days they have maintained a steady number of days which they take to turn over the inventory in the past three years. Whereas Tesco have seen a decrease over the past three years in which the number of days it takes for them to sell all goods. This is a good factor for Tesco as this shows sales have been increasing over the past three years. Regarding Sainsbury’s results as at 2015 this is neither a good or bad thing, as it doesn’t show a decrease in sales yet no increase either. The ratios show how Sainsbury’s have a better control and understanding over their inventory levels on average over the past three years compared to Tesco. However, it has recently been reported that Sainsbury’s inventories days have increased to 22 days, meaning sales are slowing down for Sainsbury’s for the first two quarters of 2016 (Guru, 2016).

The receivable days illustrate how long it can take on average to gain outstanding credit from sales. The ratios show how Sainsbury’s find it less time-consuming to collect credit from trade receivables for each year in the past three years compared to Tesco. These ratios show how Sainsbury’s on average in the past three years have received all money from trade receivables in 6.2 days and not had to pay trade payables for 45.7 days. This meaning that Sainsbury’s could continue being deprived of money.

The Asset Turnover expresses how the company is

Profitability Ratios

Return on capital employed determines how efficiently the capital is used, the greater the ROCE of a company means the capital is being used more effectively. Sainsbury’s has used their capital to their benefit in 2013 and 2014, but in 2015, it is very low. This indicates that Sainsbury’s is not employing its capital effectively and is not generating shareholder value. That is because the profit before tax is -£72 million in 2015. This is almost a 93% decrease of the profit from 2014. A reason for this could be how Sainsbury’s have spent a lot of money regarding their administrative expenses in 2015 comparing to their previous years (£1132 million in 2015, £444 million in 2014 and 462 million in 2013) (Sainsbury, 2016). Therefore, the operating profit margin has a huge decrease in 2015. In comparison with Tesco, Tesco has excellent use of its capital, increasing to 26.13% in 2015, almost a 43% increase. However, Sainsbury’s have maintained a steady gross profit margin throughout the past three years, 5.08%, 5.79% and 5.48% respectively. On the other hand, Tesco’s gross profit margin has decreased in 2015, which is almost a 50% decrease from the previous year. The ratios show how Sainsbury’s will be having more profit from each sale. However, regarding profitability Tesco’s will have better liquidity than Sainsbury.

Gearing Ratios

Gearing ratio indicates the financial risk of a company. The higher the gearing ratio represents the high percentage of debt to equity. Sainsbury past and present gearing ratios have always stayed relatively low; the gearing ratio can be classed as low if it stays below 50%. These ratios indicate that there is lower risk to the company. On the other hand, Tesco gearing ratio has faced a massive increase in 2015, this isn’t good for Tesco as they are now at a high financial risk.          

“Interest coverage ratio is used to determine how easily a company can pay for their interest expenses. When the company has interest cover ratio lower than 1, in order to meet the difference or borrow more, the company have to reserve some cash, because if is lower in a single month, it will be meet bankrupt” (Investopedia, 2016). In 2014 and 2013, Sainsbury has good interest coverage ratio that is 6.82 and 6.17 respectively, but in 2015, it drops to 0.6. But for Tesco the interest cover rises in 2015 comparing with previous years. From the above results, it can be said that Tesco are in a better position to pay their interest expenses due to their greater profitability.

Share Price movement

Sainsbury’s is a large contender in the grocery stores market, Sainsbury’s hold a 16.9% share of the supermarket sector in the UK (Lansdown, 2016). With its main competitor being Tesco. Although due to the downturn of the British economy, and the increasing popularity of discounted grocery stores such as Lidl and Aldi, this has led to a decrease in sales, which therefore influences Sainsbury’s shares.

The sector average for the price earnings ratio is 22.6, whereas Sainsbury’s p/e ratio as of March 2016, was 11.29, this is almost half the sector average. In 2015 Sainsbury’s dividend yield was 6.68%, whereas their competitors such as Morrison’s had a dividend yield of 7.60%, compared to Tesco which was 0.50%. This shows that Sainsbury’s were doing well in 2015.  Sainsbury’s dividend yield has fluctuated in the last 5 years, and peaked in 2015, although in the same year net asset value per share fell to its lowest of 271.64p (Stock, 2016). Profits in 2015 were down compared to previous years, and the earnings per share had dropped to -8.70p in the same year.

This table shows the share price for both Sainsbury’s and its two-main competitor Tesco and Morrison’s (Sainsbury, 2016). This shows that there has been fluctuation throughout the last 5 years, but shows that there has been a slight and steady drop of share prices in these years, and that the percentage change for all three companies is a minus figure. Sainsbury’s -20.64%, Tesco -46.95%, Morrison’s -30.94%. This shows that Sainsbury’s has the least movement in percentage change, whereas Tesco are almost double of what Sainsbury’s, this shows that things aren’t looking too good for Tesco throughout the past couple of years, Tesco are now seen as ‘old’, whereas Morrison’s haven’t been as big as they are now (Aldi, 2014). States that in 2014 Aldi had a 4.8% market share, and the increasing popularity of this company, and others like it, this market share is likely to see an increase and in 2015 Aldi and Lidl’s market share had increased to 10% (Guardian, 2015). That’s an 5.2% increase in just 1 year.

Other factors relating to J Sainsbury plc for a potential investor

Sainsbury’s have many things planned for the future, that may be of interest to potential investors. One very recent thing is the “Parent company of big 4 retailer Sainsbury’s has confirmed its acquisition of Home Retail Group is now complete. This means that as of today, J Sainsbury is one of the UK’s biggest retail companies.” Home Retail group owned retailers such as Argos and Habitat. This would be extremely enticing for investors as Sainsbury’s is the “UK’s Second biggest supermarket” (Armstrong, 2016).The company is working to integrate the two companies into their stores as part of a strategy over the next few years.

Sainsbury’s used to have a clothing range, at the cheap end of the spectrum, however in September 2016, they decided to launch a new “Premium Fashion Range… The range will cost more than previous budget offerings, but will seek to represent the value that supermarkets depend on” (Stevens, 2016) .I believe this is important to potential investors as a premium fashion brand at prices people can still afford has great potential to make the company and investors a lot of money. Another thing Sainsbury’s are doing that is attractive to potential investors is how ethical they are as a company. For example, they recently introduced a trial period of “Slow shopping” in certain stores. This was an initiative designed to help elderly customers and customers with mental disabilities like Autism. This shows the company cares greatly about its customers, and as a business they want to be ethical. Ethical companies tend to attract more customers as customers know they are buying from a good company. The increase in customers will be attractive to investors as they can earn them more money. Sainsbury’s have also announced the “Second step in its waste less, save more campaign, investing £1m into towns and cities across the UK to cut back on food and waste” (Baldwin, 2016) .In 2016, “Sainsbury’s is to fight back against amazon with a one hour grocery delivery service in London” (Butler, 2016) . Innovation like this will attract investors as not many other retailers offer this, proving there is potential for money to be made from this.

Sainsbury’s recently “Poached Poundlands boss Kevin O’Byrne, to be its new chief financial officer, despite the discount retailer Chains New South African Owners offering him £2.7m to stay on” (Armstrong, 2016) Another recent reshuffle of management at Sainsbury occurred when “Shop Direct has poached Sainsbury’s head of technology Jon Rudoe for a newly created role as it merges its retail and IT terms” (Bowden, 2016) .This is important to potential investors, because some investors may have believed that Jon Rudoe was good in the role he was at within Sainsbury’s, and the fact that he has left, could potentially cause investors to be put off.

Prediction of J Sainsbury plc performance in the near future

I think that Sainsbury’s performance in the future will be okay, however there are some areas where the retailer will need to improve for it to perform better. It is still the “UK’s second biggest Supermarket” (Butler, 2016).The largest retailer in the UK currently is Tesco, and by quite some margin. Their market share is around “28%” (Butler, 2016). Despite them being the second largest supermarket in the UK, as we discussed earlier in the essay, over the past three years, Sainsbury’s current assets have been exceeding current liabilities, meaning they are failing to meet their short-term debts. If they want to perform well in the future, they will have to start meeting these debts. This is not the main way to perform well however it is necessary. With Sainsbury’s constantly innovating with the launch of their premium fashion brand, and one-day delivery service, the future does look bright for Sainsbury’s as these two things should drive sales, increasing profits. Also, “Sainsbury’s has revealed its first quarterly sales growth in more than two years” (Butler, 2016). This rise occurred in the first quarter of 2016, so if things continue, especially with the acquisition of Home Retail Group, they should be looking to continue this growth in future quarters into 2017.

Conclusion

From studying Sainsbury’s, it is clear that the company is in a healthy position in terms of its financing and is considerably less dependent on debt as a source of raising finance than its nearest competitor Tesco. Sainsbury’s share price has fluctuated throughout the past 5 years, along with their competitors, due to a troubled economy, and the introduction of discounted supermarkets such as Aldi and Lidl. With the expansion of discounted supermarkets, Sainsbury’s and its main competitors, Tesco and Morrison, could see their future share price and market share decrease, or remain stable and not increase. It seems clear that Sainsbury’s is and will remain a safe option for investors in the near future. Although the firm’s growth has slowed down in recent years it is still a very profitable business and I think it is a ‘safe bet’ for potential investors in part because of how little it relies on debt financing and how it has a much lower level of long-term debt than some of its main competitors.

References

J Sainsbury PLC, SBRY:LSE profile – FT.com. (2016). Markets.ft.com. Retrieved 9 December 2016, from https://markets.ft.com/data/equities/tearsheet/profile?s=SBRY:LSE

Tesco PLC, TSCO:LSE financials – FT.com. (2016). Markets.ft.com. Retrieved 9 December 2016, from https://markets.ft.com/data/equities/tearsheet/financials?s=TSCO:LSE&subView=BalanceSheet

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