Business analysis of J Sainsbury and Morrisons
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This report is aimed at providing information for future investors or bank loan application by evaluating the financial performance of two companies: J Sainsbury’s and Morrisons, comparing with industry average and their main competitors. Apart from the financial ratio analysis, we also investigate these two firms’ operating model, industry background, corporate social responsibility (CSR) relating to their stakeholders and their future development.
UK supermarket industry has evolved from traditional grocery retailing and expanded to financial services, clothing and consumer electronics retailing, and property investment. Apart from physical trading in store, most supermarket businesses also operate online, given the most of chance to reach the consumers. In 2009, total industry sales volume has reached to £146.3 billion. The two companies we have chosen to examine are J Sainsbury’s and Morrisons. Sainsbury’s was established in 1869 by John James Sainsbury and his wife Mary Ann in London and today operates a total of 872 stores which comprises 537 supermarkets and 335 convenience stores. It grew to become the largest grocery retailer in 1922 and pioneered self-service retailing in the UK. It is the third largest chain of supermarkets in the UK after Tesco in first place and Asda which is the second largest supermarket since 2003. It jointly owns Sainsbury’s Bank with Lloyds Banking Group and has two property joint ventures with Land Securities Group PLC and The British Land Company PLC. In contrast, Morrisons was founded back in 1899 by William Morrisons who worked at a stall in a Bradford market. Ongoing expansion and plans for further growth lead the company to go public in 1967.
Ever since Morrisons has expanded across UK and it is the fourth largest food retailer with 425 stores, welcoming over 10 million shoppers each week. Most Morrisons stores operate as large superstores with a main focus on groceries and homewares, with fewer clothing, electronics, furnishing and banking services than its other rivals. In other word, Morrisons is less diversified about their business segments, and has less economic scope than its rivals. In addition, unlike its major competitors, Morrisons does not offer an online grocery home delivery service, neither does it offer a loyalty scheme1 – except in its petrol stations.
3. Financial performance analysis
Table 3.2 Financial ratios analysis
3.1 Liquidity ratio
Current ratio2 is a measure to examine whether firm has sufficient cash realized by the current assets to cover its current liabilities. And the quick ratio3 indicates the company’s ability to repay immediate commitments using cash or near-cash assets4. From the trend analysis5, the short-term liquidity level as measured in current ratio of Sainsbury has decreased significantly amid the financial crisis, resulting 0.66(2008) and 0.54(2009) respectively. It may be because those current liabilities are rising faster than current assets, or the firms investing substantial amount of its liquid assets (e.g. cash) into long-term investment, resulting a decrease in the above two liquidity ratios continuously from 2008 to 2009. Moreover, adverse trading conditions in recession may cause inventory becoming obsolete or introduction of new models by competitors.
Nevertheless, as the UK economy has dragged out from recession steadily from 2010, current ratio has improved, reaching at 0.66 and is closed to the industrial benchmark Tesco at 0.69. Present quick ratio of Sainsbury is 0.38, which has improved from the previous 2 year, standing at 0.32(2008) and 0.28(2009), referring the company holding more cash or equivalent liquid assets to cover corresponding current liabilities. In comparison, Morrisons did not experience significant changes in liquidity management, as current ratio in 2010 stands at 0.49, in line with 0.53(2009) and 0.49(2008) respectively, similar as quick ratios compared with previous two years. Likewise, Morrisons also has problems in its working capital management as Sainsbury. It is 0.18 less in current ratio and 0.22 less in quick ratio compared to the benchmark. While Current ratio of Sainsbury’s is 0.1 less than benchmark, indicating both of them hold more inventory against it current liability, which can also cause obsolesce or excessive storage costs, in term reducing its profitability. 3.2 Profitability ratio
Profitability ratios provide an insight to the degree of success in achieving the purpose of the business6. In profitability ratio analysis, it consists of Return on Equity (ROE), Return on Capital Employed (RoCE), Gross Profit Margin (GPM), Operating Profit Margin (OPM) and Net Margin (NM). Profitability ratio of J Sainsbury is not favorable compared to the industrial benchmark and its rival Morrisons. In light of financial crisis, ROE have decreased substantially, resulting in 7.09 (2008) and 6.21 (2009). However, ROE has improved and reached 12.52, which has increased by 6.31%, more than double than result in 2009 of 6.21. While comparing with the market benchmark at 16.96, Sainsbury would need to increase their profit margin to deliver a better return for their investors. RoCE has improved substantially at 9.49 against 6.21 (2009) and 7.09 (2008) previous years. As economy downturn has reversed steadily from recession, group’s investment on property may increase and lead to an increase in RoCE. In contrast, Morrisons was hit hard in 2009, resulting ROE at 10.34 (13.34 in 2008), but has improved since and reached 12.63 this year. RoCE of Morrisons is 10.72, which is higher than Sainsbury (9.49) and Tesco (9.58). This is due to the fact that Morrisons utilises less debts on its financing strategies, reflecting a relative low D/E and leverage ratios7.
Moreover, profitability reflected in GPM, OPM and NM of Sainsbury is less than Tesco and Morrisons. In other word, proportion of cost of goods sold, operating costs and non-operating costs were greater than the other two, causing a lower margin. While the above ratio of Morrisons perform well compared to market benchmark and Sainsbury. This is possible due to its operating model as all in-house model8 without extra delegation by employing external supplier and producers, and sustaining the possible lowest costs in the industry, as GPM, OPM, and NM stand at 6.89, 4.85, and 3.88 respectively, which are higher
than the market benchmark. 3.3 Efficiency Ratio
The efficiency ratios relating to current assets are broken down into inventory turnover, trade receivable turnover, trade payable turnover and asset turnover. We will now consider each of these in more details.
Stock turnover is approximately 27 days for Sainsbury which is still slightly high compared to Tesco and industry average because of the life-span foods and vegetables have to remain fresh. This means that stock needs to be rotated very often. Nonetheless, Sainsbury also stock household and domestic items which remains a long while to be rotated. It is higher when compared it with Tesco and industry average but slightly lower than Morrisons (29 days). In what a debtor collection period concerns, Sainsbury has a debtor payment period of 97 days before, during and after the downturn. This indicates that they are not adhering to policies in place to recover their debts at a cash strapped time. However, being a supermarket, most of their sales are in cash which could not be the rationale of a high debtor payment period figure. While debtor payment period for Morrison is approximately 73 days which is lower than Sainsbury by 24 days. It means that Morrisons has stricter credit control and prompt payment by customers to receive a cash discount.
On another hand, there could be bad debts written and restriction of credit due to cash flow problems. The creditor days ratio (11) reveals that Sainsbury do not obtain payment from their debtors before paying their creditors. The cycle of both debtor collection period and creditor payment period demonstrates that the company does not receive the money quickly from their debtors before paying to their suppliers, which is not good since they need to pay off their creditors using other funds rather from its credit sales. Their payments to suppliers were not affected because they probably had sufficient cash to finance themselves without utilizing cash received from their debtors. They do not recover debts quickly but make payments to suppliers in 11 days. This ratio indicates that payment period might be due to suppliers altering credit terms. Morrisons payable is 10 days which is one day less than Sainsbury. The asset turnover ratio is 1.8 compared to industry average which is 2 but is slightly higher than Tesco (1.3).
Companies with low profit margins tend to have high asset turnover, those with high profit margins have low asset turnover which indicates pricing strategy. This ratio is useful to determine the amount of sales that are generated from each dollar of assets. Sainsbury’s asset turnover (1.8) seems to be relatively high, meaning that it makes a lower profit margin on its products. However, for companies in the retail industry you would expect high turnover ratio – mainly because of cutthroat and competitive pricing. While Morrisons’ asset turnover ratio is 1.9 which is slightly higher than Sainsbury, showing that Morrisons’ pricing strategy and control cost very well.
3.4 Investment Ratio
Investment ratios such as earnings per share (EPS), price/earnings ratio (PE) and dividend yield are of great interest to investors. The P/E ratio is a vital ratio for investors. It gives an indication of the confidence that investors have in the future prosperity of the business. A ratio of one shows very little confidence in the business. The P/E ratio of Sainsbury is 10.4 which is slightly lower than Morrisons (12.7), Tesco (13.7) and industry average (14.5). This ratio suggests that the market has significantly more confidence in the ability of Morrisons to continue increasing their earnings compared to Sainsbury. This is good news for Morrisons since it reflects that the market confidence grew after the credit crunch, from increasing liquidity and profitability ratios. The earnings per share of Sainsbury’s is 0.58 which is higher than Morrisons (0.34). Shareholders use the reported increasing EPS to estimate future growth, reflecting an upward share price movement in the future. The dividend yield ratio allows investors to compare the latest dividend they received with the current market value of the share as an indicator of the return they are earning on their shares. Dividend yield for Sainsbury is 4.27%, slightly higher than Morrisons and Tesco which are 3.04% and 3.11% respectively. This suggests that Sainsbury pays more than other companies in the form of dividend. It is a vital cash flow for investors, as it is part of return on their investment. 3.5 Financial Gearing Ratio
The gearing ratio for Sainsbury is 2.2 which is quite high compared to
Morrisons (1.7). It is due to the long-term debts rising faster than the capital employed during the period from 2009 to 2010. The company resort to operations in the capital market and by operating subsidiaries to deal with the interest rate and current risk these finance involves. On another hand, the Debt/Equity ratio is 0.49 for Sainsbury but it is only 0.21 for Morrison which is very low. If this ratio is greater than one then it means that assets are mainly financed with debt, less than one means equity provides a majority of the financing. A ratio of 0.49 means that Sainsbury is exposing itself to an amount of both equity and debt. While Morrisons more relies on equity for asset formation due to a lower D/E. Interest cover ratio for Sainsbury is 2.1 when compare with Morrisons (23.19), Tesco (14.5) and industry average (9.7). A ratio under 1 means that the company is having problems generating enough cash flow to pay its interest expenses and ideally you want the ratio to be over 1.5. The ability to stay current with interest payment obligations is absolutely critical for a company as a going concern. This ratio means that Morrisons is easily able to meet its interest obligations from profits compared to Sainsbury and Tesco. 4. Operating model analysis
Food remains at the heart of Sainsbury’s proposition but non-food ranges are also a significant business. Sainsbury offers home, lifestyle product range and TU clothing brand which was launched in 2004. Sainsbury’s operates an internet shopping service branded as “Sainsbury’s Online”. This is available to about 75% of the UK population. The service is run from larger stores which carry the full product range – over 100 stores operate an Online service. In 1997 Sainsbury’s Bank was established – a joint venture between J Sainsbury plc and the Bank of Scotland, now part of the Lloyds Banking Group. Services offered include car, life, home, pet and travel insurance as well as health cover, loans, credit cards, savings accounts and ISAs. As well as this, Sainsbury’s Bank also offers a Travel Money service in stores. A large store typically stocks around 30,000 lines of which around 20% are “own-label” goods. Morrisons
In comparison, Morrisons handles its commercial operations through its wholly
owned subsidiaries which include Farmers Boy, Wm Morrisons Produce, Farock Insurance Company, Bos Brothers Fruit and Vegetables BV, Neerock, Rathbone Kear, Safeway, Safeway Overseas and Safeway Stores. All from above, they are mainly farming and produce companies, produce processing and packaging businesses, and livestock slaughter houses. The company currently employs more than 134,000 members of staff in stores, factories, distribution centres and head office administration. In this case, Morrisons focuses on managing every aspect of their commercial operation in-house. They source locally and manufacture in their own sites. Also, they distribute through their own network. Morrisons control the provenance and the quality of their food by being closer to source as well as working with the producers. In short, they operate a non-stop business without extra delegation to other producers and suppliers, as they run their business as producer-wholesaler-retailer as whole. 5. Industry Analysis
Supermarket is a matured market in the UK. In the past 10 years, UK supermarket industry has sustained steady growth at about 4.35% (see table 5.1). Table 5.1 UK supermarket industry sales turnover:
As mentioned in the Introduction, UK supermarkets have expanded across different sectors, and with market leader Tesco accounting to 30.8% of market share, following Asda(16.8%), Sainsbury(16.2%) and Morrisons(11.4%), and these ‘Big Four’ have combined market share of 75.2% in 2010. In addition, competition in the UK supermarket is intensive and its industry growth has stabilised for the previous ten years, which can be referred to a low growth but high cash flow industry, with low Beta overall as it is not a significant cyclical business. Figure5.1. Industrial market share
From above statistics, the major competitors for J Sainsbury are Tesco and Asda, and with closely identical market share with Asda, while the top three players are the main rivals for Morrisons. In addition, the performance of the industry is forecasted to slowdown, with an expected average yearly growth rate of 3.4% for the next period 2011-2015, which is anticipated to drive the industry to a value of $219.4 billion by the end of 2014. 9
Executives for business insights believe that Tesco will be the leading trendsetter in the food and drinks market over the next 5 years. It is expected that the company will form the future of the food and drinks retail market leading in innovation in private brand labelling and format diversification. 10
6. Potential future developments:
6.1 Corporate Socially Responsibility
The interpretation of Sainsbury and Morrisons’ corporate socially responsibility (CSR) can be reflected on its products, sourcing, environment, community and employees’ welfare: Sourcing strategies in Sainsbury is to support local UK farms and source the greatest-tasting British foods when in season. Moreover, it focus on socially and ethically responsibility by introducing Fairtrade products and has achieved the largest UK retailer of Fairtrade products (by sales value). It is also the leading retailer on animal welfare products, such as free range eggs. On the environmental issues, Sainsbury focus on reducing energy, packaging, and food waste. For instance, Sainsbury aimed to reduce CO2 emission by 25% per m2 by 2012 against 2005/06 baseline, reducing their brand packaging weight relative to sales by 33% by 2015 against 2009’s level.
For the community, Sainsbury committed to generate positive economic value by creating more jobs for the locals. Over 6,500 new jobs have created so far, and future development will provide another 6,500 new job in 2010/2011 through their planning on opening more new shops. In addition to job creation to the community, Sainsbury also make a contribution to the local philanthropic services by generous donation and sponsorship on community events amounting to £1.9 million in 2010. Current achievement on employees’ welfare have exceed their commitment by providing 10,000 colleagues with job opportunities, skills and qualification through their “You can” scheme. New commitment on the workforce will be investing in new development program that will touch every manager across the business by the end of 2010/11 financial year.
In comparison, Morrisons focus on being ‘closer to source’ through having their own supply chain. Regarding environment, Morrisons also focus on reducing carbon and preventing waste, and closely linked issues are integral
to tackling the effects of climate change, business and resource efficiency and cost reduction. Morrisons take good care of their staff, shoppers and communities by focusing on their vision to be the ‘Food Specialist for Everyone’. At Morrisons, the management of CSR is led by senior directors and integrated into the business by a Project Team of senior executives. In Morrisons, processes are in position to capture and address matters that are important to their stakeholders and material to the business. The risks and opportunities of each issue to the business are considered and assessed in terms of strategic and business impact. Those issues considered most important are addressed through Morrisons CSR programme.
Apart from the achievement in the field of CSR of Sainsbury’s, new commitment on community involves in supporting community based fundraising and colleague volunteering. Furthermore, Sainsbury’s will offer local groups and charities spaces in stores to support community activities and events, helping bring the community together. In the environmental prospect, it will install five new biomass boilers in order to decrease its carbon emission. In addition, Morrions includes reducing their carbon footprint whilst nurturing the business, take-up of the ‘Let’s Grow’ campaign in schools across the country, introducing our Fresh Food Academy to train over 100,000 colleagues and a commitment to responsible and sustainable sourcing including 100% British fresh beef, pork, lamb and poultry. Morrisons continue to look ahead and plan new goals and take initiatives for the next 3 years to continue developing their CSR programme. They aim to maximise the impact of their actions have on their material issues and make a real difference for tomorrow.
6.2 Potential future development
Future growth for J Sainsbury would expand their business in China, aiming at the middle class’s niche market11. In its domestic operation, it would seek for opening more spaces in the UK in order to increase the existing market share. Moreover, it aims to accelerate the growth of complementary non-food ranges and services. In other words, Sainsbury targets to boost their non-core business such as its banking and financial services and consumer electronic goods (through its newly launched entertainment website12) businesses and its property investment. Morrisons plans to open convenience stores and is also looking at selling groceries online as it expects further pressure on shoppers’ income. In addition, Morrisons’ range of products would be simplified, private labels would be differentiated, retailer’s expansion plans and experiment with its well-regarded fresh offer would be continued.
From the above analysis it is clear that the supermarket industry is saturated and that earning super profit is not possible. Whereas, most of Sainsbury’s profitability, efficiency and effectiveness, liquidity and investor ratios demonstrate decline compared with Morrison, the gearing ratios for Sainsbury demonstrate a rise reflecting growing long-term debts financing. Understanding the ratio analysis and the relevant information gathered looks like Sainsbury’s has gone through some difficulties in their supply chain and their financial and marketing management. Although they have invested substantially in long-term projects (such as recent project by applying IT system in their supply chain management, future development oversea, and expansion in non-food business) and are positive in a potential growth in the coming years. Above all, they still need to optimize their pricing strategies and quality control management compared to other competitors (Tesco, Asda and Morrisons), to reach a lower cost structure. While Morrisons does not have an online grocery offer and a relative traditional grocer business model would lead to limited growth of the business in the long term.
Though they still can maintain the 4th position due to its highly competitive all-in-one house operating model, but a non-diversifiable business could result in a lower margin compared to other rivals. The future prospect of supermarket multiples are ideally placed to offer an even greater range of non-food goods than at present in Morrisons. This is an opportunity for Morrisons to increase their margin on sale. The growth of the major multiples as ‘one-stop’ shops would diversify and differentiate its business by offering a variety of goods and services to their customers. To conclude, Sainsbury could sustain a higher growth in the long run, and deliver a greater return to shareholders than Morrisons. In this extent, we recommend investors to invest in Sainsbury’s, and commercial bankers can underwrite a larger amount of loan to Sainsbury than Morrisons due to their sustain growth.