Like any cash rich company Tesco is also looking to drive down the gearing and as we analyse past three years the company’s debt ratio has decreased from 49% to 44% (See Appendix A),this shows that the company has been successful in driving down the reliance of its assets financing from the debt. Although value of debt increased slightly but the company managed to increase its equity and reserves from the healthy profits which the company has earned during these years. So it looks quite obvious that the company is going towards success in its objective of the continuity of continuous funding and to maintain its policy of smoothing the debt maturity profile so that it can arrange sufficient funding for the needs ahead and it can do so by maintaining the sufficient undrawn committed facilities from the banks.This compares favourably with Sainsbury’s, whose results were 55% in FY 02/03 and rose up to 59 % in FY 04/05. Despite of the fact that the company had a massive cash inflow of Pound Sterling 1,170 million from its sale of its American based Shaw stores, which also resulted in a net profit Pound Sterling 275 million on the sale.(Source Sainsbury’s 2005 annual report).
But on the other hand Tesco has been successful by driving down its Debt/Equity ratio from 62% to 50% while Sainsbury’s is staying at around 40% since FY02/03. Here it is worth mentioning that the excessive reliance on debt makes the company very risky as it has to bear huge interest and principal repayments, but when deciding the optimal ratio it should also be noted that the respective tax benefits arising from the interest payments may be forgone.(See Appendix A and B ) Liquidity Companies live or die by how quickly they get in their payments relative paying their bills and by how much liquid resource they possess (Peter Temple ,First Steps in Shares), Normally 1.
5:1 ratio is considered very healthy. Tesco’s Credit rating in the year 04/05 has been confirmed stable by Moody’s and standards and Poor’s at A1 and A+ respectively.Tesco’s current ratio has also been increased from the last year by 33% in absolute terms .The nature of the Fast moving consumer goods retailing is that with the effective stock management , most of the times it will have a positive cash flow while analysing tesco’s current liabilities we can see from its published accounts that the 66% of the current liabilities consist of trade and other creditors and the bank loans ,corporation tax and payment of finance lease ,which are more risky in terms of non-payment add up to only 12% of the current liabilities.
Remaining components of the creditors balance consists of deferred revenue and accruals.All the liquidity analysis suggests that Tesco is “cash comfortable”company. Its debt ratio is in the comfortable zone of 44% (See Appendix A) Comparison with Sainsbury’s show that its debt ratio is in slightly weaker position than Tesco, being on 59%. Interest Cover: Tesco’ initial interest cover was 8x in 02/03 but this increased dramatically to 13 x in 04/05. A few factors have contributed to the equity build-up: The policy of the group is to finance its operations by a combination of borrowings,equity and leases to ensure to continuty of the funding.Lesser amount of interest to be paid due to less borrowing , reflecting healty cash flows Continuous revenue growth (Appendix A) means that the day-to-day cash balance is increasing, in positive correlation. Sainsbury’s comparison shows that Interest cover ratio was maintained at 11-12 times but it drastically fell 1x in 2005, main reason for which was the poor financial results in the year 2005.
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Share Price, PE Ratio and EPS Share prices are normally evaluated on the basis of price earning ratio (PER) A high PE ratio tends to indicate strong shareholder support for the company. So by comparing Tesco and its competitors of the respective PE ratios and comparing it with the industry average we can have an Idea about the future prospects of the company. The EPS of the Tesco increased from 13.
42pence per share to 14.93 in 03/04 and 17.52 pence per share in FY 04/05 showing that it is in line with the steady increase of groups profits during these years. (See Appendix A)When we have a look at the EPS of the competitor , we see that it was healthier in FY02/03 with an EPS of 23.7, then it dropped down to 20.
7Pin FY03/04 and then took a fall down in FY 04/05 to 3.5P. This decrease in EPS seems to be very much in line with the decreasing profits of the troubled Sainsbury. ( See Appendix B) However when we have look at the PE ratio of Tesco , it is almost the lowest in the UK supermarket industry , Tesco stands at about 14.7 (march 2005), while morisson is at 17.6(march 2005) and Sainsbury is at 28.
4.(Merrill Lynch Report march 1, 2005).This shows that the share price of Tesco being on the 308.5P (March 2005) seems cheap than what it should has been when we compare it to the industry average (excluding the Sainsbury, due to its troubled scenario).
As Andrew fowler says that the ” placing the UK/Eire EPS stream on 17x 2005/2006E EPS ,only a modest market premium, would justify a Pound 3 share price on its own and give international for free”. The time has proven that the share price of the company has fetched greater interest of investors through time and as at 27march2006 the price of the share is 342p which is at about 19.52x.
CONCLUSIONGeneral The grocery industry is a very simple one: both produce and perishable goods are distributed and sold to customers through the normal and traditional retail channels. But in this changing environment of business through out the world face of the grocery industry has also changed, and here in UK Tesco is leading this change by creating the greater value in comparison with its competitorsThere is no doubt that the Tesco is delivering outstanding results. The above analysi that it has shown the strong performance along the board in all the geographical locations and segments and has become a leader and very strong market player among its UK rivals. PE Ratio and Share price The PE Ratio at the point of final results is directly dependent on share price which moves in relation to company performance, but is also affected by events not directly controllable by the company, such as international oil prices and international terrorism and in tesco’s case they even matter more because a business segment of Tesco consist of fuel retailing also. Hence this metric is not a sound guide to the financial health of the company.However, the upward movements in the share price have increased the PE ratio, which currently stands at 19.
93 at the price of 342P showing greater investor confidence in the company. This is mainly due to the company’s outstanding performance and the positive news circulating the market. “Supermarket giant”. The positive movements are not always but most the times is a result of any positive news about the company like “Tesco is considering placing its 12 Billion free hold property into a real estate investment trust in a bid to enhance share holders returns” (Daily telegraph March 24, 2006)Liquidity The liquidity ratio shows that the Tesco is at comfortable level as far as the cash needs are concerned, one reason is the nature of the retailing industry where no credit sales are involved and the other can be the efficient use of its resources (as evident from the Analysis above). Although the company is making huge expansions in its national and international store portfolio and still planning ahead to expand across continents as it has been announced in the news “After months of speculation the UK’s largest retailer has announced its plans to enter the united states retail market through the convenience sector” ( Source Food and Drink Europe .com, report published on Feb 09,2006) The company is paying good dividends and covering interest payment at very good levels and is still able to maintain very good liquidity ratios.
