Financial performnace of Wesfarmers limited Supermarket Segments

Question: Discuss about the Financial Performnace of Wesfarmers limited for Supermarket Segments. Answer: Introduction Wesfarmers is a diversified conglomerate based in Perth whose majority revenue are derived from the supermarket segment where Coles is the major player. However, the business interests of the group span into home improvement, fuel retailing, hotels, energy, industrial safety, coal mining along with fertilisers and chemicals. The company structure was assumed by the business when it listed in 1980s and since then grown through the acquisition route (Wesfarmers, 2015).. Woolworth is the primary competitor of Wesfarmers and the two virtually have a duopoly in the grocery and supermarket segment. Woolworths unlike Wesfarmers has limited diversification and is present only in related businesses such as home improvement, fuel retailing, liquor, general merchandise and hotels. The two companies together account for more than 75% of the supermarket sales (Woolworths, 2015). Analysis of Trends in Balance Sheet Assets Liabilities It is apparent that there has been a slight decline in current assets in FY2015, but the total assets has enhanced by $ 675 million during the year. This may be attributed to the increase in the fixed assets such as PPE along with intangible assets. This is a healthy trend and augers well for the future growth as the company is making investment in the business. There has been also been an increase in both short term and long term borrowings on account of issue of corporate bonds ($ 1,168 million) and issue of long term debt ($ 295 million) respectively (Wesfarmers, 2015). The relevant ratios for short term liquidity of the company are presented below and corresponding figures for Woolworths are also given (Wesfarmers, 2015; Woolworths, 2015) The current ratio of Wesfarmers has declined from 1.13 at the end of FY2014 to 0.93 at the end of FY2015. This is on account of the sharp surge in current liabilities on account of short term corporate bonds issued to the tune of $ 1.17 billion. However, the ratio is still healthier than Woolworths in 2015 which is languishing at 0.83. The low current ratio and negative working capital are common in the industry as the sales are typically derived in cash thus amounting to lower receivables. However, the purchases are mostly done on credit due to which payables are significant. Thus, inventory is the main current asset which is reflected from the abysmally quick ratio for the two players. However, the above ratios are healthy and in line with the industry trends. The relevant ratio that indicate the capital structure and also the ability to pay interest are captured below (Wesfarmers, 2015; Woolworths, 2015) From the above table, is it apparent that even though the company has increased its borrowings in FY2015 as discussed, but still debt comprises only 26% of the shareholders equity. The corresponding ratio for Woolworths stands at 42% which is also comfortable. It is apparent that long term liquidity is not an issue with Wesfarmers as the debt equity ratio is exceptionally comfortable and leaves ample room to raise further debt (Damodaran, 2008). The interest coverage ratio for Wesfarmers has enhanced in FY2015 despite the increase in interest charges. This is attributed to the increase in EBIT. The interest coverage ratio is maintained at an exceptionally healthy multiple of about 12. Even though, it is slightly lower than Woolworths but does not indicate much as Wesfarmers is more diversified than Woolworths. Hence, it is likely that some of the businesses of Wesfarmers tend to reduce the overall profitability of the operations. (Brealey, Myers Allen, 2008). Analysis of Trends in Income Statement Revenue and Profitability There has been increase in the revenue but the same is accompanied with corresponding increase in the cost of goods sold and hence the margins at the gross level have remained stable. In the year FY2014, there was a goodwill impairment charge amounting to $ 677 million on account of Target brand and therefore the profit slumped (Wesfarmers, 2015). The relevant profitability ratios are presented below (Wesfarmers, 2015; Woolworths, 2015) From the above, it is apparent that the profitability margins of Wesfarmers at the net level seemingly have improved considerably which is also driving the return on assets. However, this is primarily because the FY2014 net profit was adversely impacted by a goodwill impairment charge of $ 677 million. Hence, accounting for the impairment charge, there is not much difference in the profitability margins. However, the corresponding margins (both at the gross and net levels) are significantly higher that of Woolworths. However, one factor that could attribute to this difference is the operations of Wesfarmers in energy, industrial safety, chemical and fertilisers which might boost of higher gross margins thereby accounting for the above figure (Wesfarmers, 2015).. With regards to supermarket business, both are rivals in a price sensitive market and hence the profitability margins would not differ significantly considering the leadership position both enjoy (Petty et. al., 2015). With regards to the ROA or return on asset, seemingly Woolworths has an advantage. But again businesses such as mining, chemicals and fertilisers are highly capital intensive business which would not generate handsome returns on assets primarily at a time when demand from China is languishing. Hence, it would be imprudent to read these numbers in great detail and draw pivotal inferences as the two businesses are not exactly comparable and the difference in business models are driving the difference between the ratios to some extent. However, the noteworthy trend is that for Woolworths there is a market decrease in the net profit margins and also ROA which is indicative of higher competition existing in the supermarket space (Smyth, 2015). Trends in Cash Flow Statement With regards to cash flows of Wesfarmers, there has been not much movement or change in the cash flow generated from investing and financing activities. But the same cannot be said about cash flow on account of investing activities which has seen a significant change. In FY2014, the company exited the insurance business and hence a cash outflow to the tune of $ 337 million was incurred for the insurance deposit acquisition. In the same year there was a cash inflow to the tune of $ 2,641 million on account of interest sale in a subsidiary (Air Liquide WA). In FY2015, there has been acquisition of some new subsidiaries that has resulted in a cash outflow to the tune of $ 339 million (Wesfarmers, 2015). Trends in Market Performance Wesfarmers market performance is compared with that of Woolworths during the given period and tabled below (Wesfarmers, 2015; Woolworths, 2015) From the above data, it is apparent that the EPS for Wesfarmers is 216 cents in FY2015. In comparison to Woolworths, Wesfarmers has reported a much higher EPS. This is despite the fact that PAT for Wesfarmers is only marginally higher than Woolworths. Further, the dividend yield for Wesfarmers has declined owing to the decrease in the dividend paid per share. The dividend per share is however at same level for the year 2015. The dividend yield has actually deteriorated for the year 2015 from 9.1% of 2014 in the case of Wesfarmers. Woolworths on the other hand has improved from 3.7% in 2014 to 5% in 2015 as the per share dividend has marginally increased and the price has corrected in FY2015. Conclusion Recommendation Based on the analysis above, it may be concluded that with regards to profitability both at the gross level and also the net level, Wesfarmers has an edge on Woolworths which to an extent may be related to the highly diverse businesses that Wesfarmers has. Due to the ongoing price wars in the supermarket segment, there is intense pressure on margins and going forward the company can increase margins only by enhancing operational efficiency and cutting down on the costs (Parrino Kidwell, 2011). The short term liquidity for both Wesfarmers and Woolworths is comparable. The ratios obtained in this regard are characteristic of the industry where receivables are typically low. With regards to capital structure also, both companies are well placed as the debt seems to be a fraction of the overall equity. This ensures that the companies are well placed for availing more debt funding in case it is required. Payment of interest would not be an issue as the current operating profits are more than 10 times the interest expenses (Brigham Ehrhardt, 2013). With regards to market performance, Wesfarmers tends to have a higher EPS and the same is reflected in the higher stock price also. However, in order to create value for the shareholders, it would make sense for the company to spin off certain businesses especially which are capital intensive and list the same on the bourses. Even though Wesfarmers at the present seems to be a better bet than Woolworths, but still the investor must not invest in Wesfarmers. This is because majority of the revenue for the company is generated from Coles or the supermarket business and owing to weak trading environment coupled with high competition caused due to entry to German discount retailers such as Aldi, it is likely that the volume growth on the top line would be muted and also the margins would not expand significantly while they may shrink (Chung, 2016). References Brealey, R, Myers, S Allen, F 2008, Principles of Corporate Finance (Global edition), 10th edn, McGraw Hill Publications, New York Brigham, EF Ehrhardt, MC 2013, Financial Management: Theory Practice, 3rd ed., South-Western College Publications, New York Chung, F 2016, Moodys rings Aldi alarm bell for Coles, Woolies, news.com, Available online from https://www.news.com.au/finance/business/retail/moodys-rings-aldi-alarm-bell-for-coles-woolies/news-story/5fa28b85abb45c9e06b89b1c9f502fea (Accessed on August 30, 2016) Damodaran, A 2008, Corporate Finance, 2nd edn, Wiley Publications, London Parrino, R Kidwell, D 2011, Fundamentals of Corporate Finance, 3rd edn, Wiley Publications, London Petty, JW, Titman, S, Keown, AJ, Martin, P, Martin JD Burrow, M 2015, Financial Management: Principles and Applications,6th edn, Pearson Australia, Sydney Smyth, J 2015, Foreign competitors sour Australian grocery sector, The Financial Times, Available online from https://www.ft.com/cms/s/0/351943ae-14b0-11e5-a51f-00144feabdc0.html#axzz4IoHlrdI0 (Accessed on August 30, 2016) Wesfarmers 2015, Annual Report 2015, Wesfarmers Website, Available online from https://www.wesfarmers.com.au/investors/reports-results-presentations.html (Accessed on August 30, 2016) Woolworths 2015, Annual Report 2015, Woolworths Website, Available online from https://www.woolworthslimited.com.au/page/Invest_In_Us/Reports/Reports/(Accessed on August 30, 2016)