Financial Analysis of UK Retail Companies: Sainsbury's and Morrisons (Essay Sample)

Financial Analysis of UK Retail Companies:
Sainsbury’s and Morrisons
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Introduction
In order to carry out this research, two retail companies have been used in order to test their viability as a good investment for the future. The companies chosen for this research are Sainsbury’s and Morrisons which are both listed as equity instruments on the London Stock Exchange. Sainsbury’s is the second largest chain of supermarkets which is operating within the UK currently. It is responsible for around 17% of UK’s supermarket industry. Morrisons on the other hand is the fourth largest chain of supermarket which is operating within the UK area. The reason for choosing this sector is due to the fact that there is an endless possibility of growth in this sector as companies can expand within UK and are even venturing to carry out operations outside UK itself in search for more business.
They are applying an efficient model they have developed in the UK and are now expanding outside its borders in order to maximize their own potential further. In the current economic climate, these businesses are seeing greater demand and an expanding market base as they provide products and services which range from needs to luxury goods. In addition to that, due to their efficient logistics system and margins, these companies are able to use volume based marketing in order to increase profitability and minimize waste and cost. Due to unlimited expansion and profit potential, these investments will prove to be profitable for the investor in the near future as well as in the long run.
Analysis
Price Performance
The analysis of the last month’s performance of Sainsbury’s shows that the price of the share has fallen from £250 reaching a low of £215 before settling at £224 on the 8th of July (Figure 1). The biggest fall takes place after the 23rd of June which corresponded with the Brexit referendum taking place. There was a feeling in the market that UK based companies will suffer in line with the British economy which was why the fall was seen in the price of Sainsbury’s as well. A similar performance was also seen for Morrisons as the stock saw as the price went from £190 dropping to a low of £172.5 after recovering to around £180 by the end of the period (Figure 2). Just like the price of Sainsbury’s stock saw a fall after the Brexit referendum, a similar trend was seen after the 23rd of June as here was skepticism about the future of the British economy.
Figure 1 Price Performance of Sainsbury’s from 8th June till 8th July 2016 (Source: Yahoo Finance)
Figure 2 Price Performance of Morrisons from 8th June till 8th July 2016 (Source: Yahoo Finance)
Dividend Performance
The dividend history for Sainsbury’s shows that the company had paid a higher dividend of 13.2p in the financial year of 2014-2015 as compared to the latest year in which 12.10p was paid out (Table 1). The interim dividend and the final dividend paid by the company fell in the recent year compared to the past as the company saw a dividend growth of -8.33% and saw a fall in dividend yield from 5.1% to 4.4%. Morrisons saw an even worse performance history based on its dividend payout. The company was able to handout a dividend of 13.65p in the financial year of 2014-2015 which dropped to 5.00p in the recent year (Table 2). Due to the fall in dividend, the company saw a dividend growth of -63.37% while the dividend yield fell from 7.6% to 2.9%.
Table 1 Dividend History for Sainsbury’s for the last two years (Source: Hargreaves Lansdown)
Table 2 Dividend History for Morrisons for the last two years (Source: Hargreaves Lansdown)
Ratio Analysis
In order to evaluate the performance of the companies, a ratio analysis has been carried out. The ratio analysis allows the investor to be able to track the performance of the company relative to its past performance and also allows the company to be compared to other companies operating in the industry (Table 3 and 4). The gross profit margin of Sainsbury’s has increased from 2012 to 2016 while it has dramatically fallen for Morrisons. This means that Sainsbury’s has been able to cut its direct costs where Morrisons has seen an increase in its cost structure. The net profit margin for Sainsbury’s has also stabilized after being negative for 2015 while for Morrisons it has slowly gotten into the negative region. This shows that Morrisons has also been unable to cut down its indirect costs as compared to Sainsbury’s. The return on capital employed has seen a similar trend for Sainsbury’s while for Morrisons it has been negative meaning for every pound of capital used, the return is negative for the company.
The current and liquid ratio for Sainsbury’s has improved over the same period while for Morrisons both these ratios have deteriorated. In terms of the industry it can be seen that 0.5 for current ratio and around 0.25 for liquid ratio are the norm in the industry. Sainsbury’s has still been able to perform better in terms of its liquidity as compared to Morrisons. In terms of debt, Sainsbury’s has been able to minimize its dependence on debt by decreasing its gearing ratio while Morrisons has started to take on more debt in order to maximize profit and return. The PE ratio shows that Sainsbury’s is an undervalued stock as investors can purchase the stock at a multiple of around 11 while Morrisons is overvalued as its multiple is nearly double. Dividend yield shows that Morrisons has been able to give a better return to the investor of around 6% while the return of Sainsbury’s has fallen over time. Lastly, Earnings per share mirrors the fact that is seen in the profits of the companies where the EPS for Sainsbury’s went to negative in 2015 before profits improved and the EPS increased. On the other hand, Morrisons has seen a persistent deterioration in its EPS which has been negative for the most recent year.
Sainsbury’s

2012

2013

2014

2015

2016

Gross Margin %

5.4

5.5

5.8

5.1

6.2

Net Profit Margin %

3.58

3.38

3.75

-0.3

2.33

Return on Capital Employed

10.19%

9.60%

10.82%

0.57%

7.24%

Current Ratio

0.65

0.61

0.64

0.64

0.66

Liquid Ratio

0.33

0.28

0.49

0.48

0.5

Gearing  Ratio

36.03%

38.80%

19.86%

26.74%

19.95%

PE Ratio

10.78

11.78

9.56

9.81

11.29

Dividend Yield

5.05%

4.52%

5.39%

6.68%

1.46%

Earnings Per Share

0.32

0.32

0.36

-0.08

0.23

Table 3 Ratio Analysis for Sainsbury’s for the last 5 financial years (Source: Financial Statements of Sainsbury’s)
Morrisons

2012

2013

2014

2015

2016

Gross Margin %

7

6.9

6.7

6.1

4.5

Net Profit Margin %

5.3

5.36

4.85

-1

-4.71

Return on Capital Employed

13.41%

12.08%

-1.20%

-11.00%

-5.07%

Current Ratio

0.55

0.57

0.57

0.5

0.5

Liquid Ratio

0.21

0.21

0.2

0.16

0.18

Net Gearing

26.98%

41.43%

59.08%

63.38%

45.69%

PE Ratio

10.97

9.23

10.39

16.46

22.46

Dividend Yield

3.94%

4.38%

5.06%

7.33%

6.37%

Earnings Per Share GBP

0.23

0.26

0.27

-0.1

-0.33

Table 4 Ratio Analysis for Morrisons for the last 5 financial years (Source: Financial Statements of Morrisons)
Economic Conditions
Going forward, it can be seen that the recent Brexit referendum will have an impact on the retail sector of UK. As the price performance already shows, with UK choosing to leave the European Union there is a decreased incentive for retail companies to expand into Europe and open further stores in the European region. With increased costs and red tape, it would be difficult to sustain a healthy profit margin for such companies. The next strategy would be to expand into new regions like Asia where there is a potential to increase profitability, however, the cost structure of any such move would be substantially greater and would increase the turnover of the companies without providing an equal increase in profitability. This would mean that going forward, these two companies would need to focus on cost minimization rather than revenue maximization in order to increase their profitability to be considered a viable investment.
Risks Associated
There are different types of risks which can be related to buying the shares of Sainsbury’s and Morrisons. One of the biggest risk is operational risk which is related to the operations of the company. Any breakdown or failure of the supply chain of the company can lead to loss for the company which will have to be borne by the shareholder. The company will have to make sure that it is operatin...