M&S financial analyze with a comperison company

Introduction

Marks and Spencer PLC, M&S, is a major British retailer that has its headquarters in the City of Westminster, London. M$M specializes in the sale of clothing, luxury foods products and home products. Thomas Spencer and Michael Marks established it in 1884 in Leeds, United Kingdom. Currently, it has 852 stores throughout the United Kingdom and a substantial number of international stores. In the recent years, the clothing sales of M&S have fallen; however, its food sales have increased after it axed “St Michael’s naming for its own brand.   Although there is huge competition in the retail industry, M&S lies within top 10 as it is the premier food, clothing and financial services retailer in the UK. Recently, it has been faced with stiff competition from its rivals which has resulted in the decline in its market share.

This report aims at analysing the financial performance and position of the clothing retail sector of M&S so as to decide on whether it would be prudent and viable to purchase its shares at a specific point in time. This will be achieved by discussing key financial indicators such as profitability ratios, liquidity ratios, efficiency ratios, gearing ratios, and investment ratios. It will entail analysing its financial data for the past five years to see if it is in an investable firm by benchmarking it against Next PLC.

The report will then explain the limitations of the financial ratios in analysing the financial performance of a company. Finally, recommendations and conclusion will be provided regarding whether to invest in M&S or not at its current share prices.

 

 

 

 

 

Financial Analysis

Revenue, growth and operating profit of the clothing retail sector of M&S and Next (2012-2016) values is GBP (Million)

  2012 2013 2014 2015 2016
M&S          
Turnover 9934 10026 10310 10311 10555
Growth 1.99% 0.93% 2.82% 0.02% 2.37%
Operating profit 747 753 695 701 584
NEXT          
Turnover 3441 3563 3740 4000 4176
Growth 4.35% 3.54% 4.97% 6.95% 4.43%
Operating profit 601 695 722 812 867

Table 1: Revenue, growth and operating profit of M&S and Next

Source: Morningstar.co.UK, Companies annual reports

 

The sales of the clothing retail sector of M&S have been increasing steadily across the period dues to the increase in food sales from increased food openings. In a turnaround plan, M&S expects to close down 30 UK clothing and home stores to cut back on clothing. They will open 200 new Simply Food stores with the intention of shifting away from the disappointing fashion sales. On the other hand, Next PLC has strong revenue growth across the period. After a strong performance in 2013, the operating income of M&S decreased across the period which is attributed to increasing competition in the sector; however, Next PLC experienced steady increase in its operating profits. Although M&S and Next PLC are retailers companies in the clothing retail sector, it is difficult to compare their performance using revenues because they are of different sizes and operate different divisions within the industry (Hickman et al. 2013).

  1. Profitability Ratios

Profitability ratios show an organization’s bottom line and the returns it offers the investors because they show the overall performance and efficiency of a n entity (Kieso et al., 2011).

  2012 2013 2014 2015 2016
M&S          
ROCE 11.86% 11.45% 12.89% 11.21% 9.04%
Operating margin 7.51% 7.51% 6.74% 6.80% 5.53%
Net profit 5.16% 4.65% 5.09% 4.72% 3.85%
NEXT          
ROCE 57.13% 57.65% 56.27% 58.47% 56.89%
Operating margin 17.49% 19.51% 19.33% 20.30% 20.76%
Net margin 13.80% 14.28% 14.79% 15.87% 15.96%

Table 2: Profitability ratios of M&S and Next          Source: Morningstar.co.UK

ROCE

Return on capital employed helps in evaluating the efficiency of the capital used in the business; the amount of profit the invested capital delivers (Investopedia, 2016). A higher ROCE is preferred because it indicates higher efficiency in the use of invested capital. The return on capital employed for the clothing retail sector of M&S has been fluctuating; it decreased in 2013 to11.45% but increased in 2014 to 12.89% before decreasing to 9.04% in 2016, the decrease is due to closing down of 30 UK clothing and home stores to cut back on clothing.. Next’s ROCE fluctuated across the period, between 57.13% in 2012 to 56.89% in 2016 (Financials.morningstar.com, 2016). The figures indicate that Next PLC is more efficient that the clothing retail sector of M&S in generating return using the capital employed. ROCE ratio would be considered but it is prone to manipulation by the company’s management to improve it by selling underperforming assets.

Operating margin

Operating margin measure the amount of revenue remaining after meeting the operating costs of the company, and it has to be high and consistent to attract investors (Investopedia, 2016). The clothing retail sector of M&S has a decreasing operating margin over the past five years because M&S expects to close down 30 UK clothing while Next PLC had an increasing operating profit margin. The decrease in M&S operating margin is due to price reductions to match competitors in the highly competitive market.

Net margin

Net margin gives a more accurate measure of the company’s profitability as it is the return that remains after paying for the total expenses of a company (Investopedia, 2016). The net margin of the clothing retail sector of M&S fluctuated but in overall decreased from 5.16% in 2012 to 3.85% in 2016 because M&S expects to close down 30 UK clothing. However, that of Next PLC increased from 13.80% in 2012 to 15.96% in 2016 (Financials.morningstar.com, 2016). Therefore, Next PLC is more profitable than the clothing retail sector of M&S.

  1. Liquidity Ratios

They indicate the ability of an entity to meet its short-term debts using current assets (Weygandt et al. 2015).

  2012 2013 2014 2015 2016
M&S          
Current ratio 0.73 0.57 0.58 0.69 0.69
Quick ratio 0.33 0.17 0.17 0.24 0.24
NEXT          
Current ratio 1.54 1.48 1.76 1.82 1.40
Quick ratio 0.91 0.97 1.18 1.24 0.91

Table 3: Liquidity ratios of M&S and Next          Source: Morningstar.co.UK

Current ratio

It measures the ability of an organization to meet its short term debts using current assets without experiencing liquidity problems. A ratio of more than one is favoured because its shows that the current assets are greater than the current liabilities and hence meeting them will not disrupt normal operations of the company. The current ratio of the clothing retail sector of M&S indicates an inconsistent trend, is appears to be decreasing or increasing year on year (Hickman et al. 2013). However, the current ratio is less than one; the clothing retail sector of M&S has an unhealthy current ratio and cannot meet its short term debts in the given five years. M&S in unable to maintain stable level of liquidity and the decrease in current ratio is due to decrease in its current assets. It has more current obligations than current assets. On the other hand, Next’s current ratio increased across the period to 1.82 in 2015 but decreased to 1.40 in 2016 (Financials.morningstar.com, 2016); its quick ratio also an inconsistent trend across the period. It appears Next has more liquid assets that M&S; it is more able to meet its short-term obligations (Khan & Jain, 2007). Next has a current ratio of more than one hence can easily meet its short term obligations because it has more current assets than current liabilities.

Quick ratio

Quick ratio measures the ability of an entity to meet its short-term financial obligations using liquid assets (Brigham &Ehrhardt, 2007). The clothing retail sector of M&S has an average quick ratio of 0.19, which has averaged below one. Therefore, it is unable to meet its short-term obligations using liquid assets. On the other hand, Next’s quick ratio is relatively high; with the lowest value being 0.91 in 2016. Next cannot meet short-term obligations in 2016; however, it has an average of 1.18 which is better than that of the clothing retail sector of M&S.

 

  1. Efficiency ratios

Efficiency ratios outline how well a firm is managing its liabilities or how effective it is in utilizing its assets in generating revenues (Kieso et al., 2011).

  2012 2013 2014 2015 2016
M&S          
Inventory  turnover 9.04 8.60 7.98 7.69 8.05
Asset turnover 1.36 1.35 1.33 1.28 1.27
NEXT          
Inventory turnover 6.47 6.93 6.97 6.62 6.03
Asset turnover 1.89 1.90 1.85 1.80 1.81

Table 4: M&S’s and Next Efficiency ratios               Source: Morningstar.com

 

Asset turnover

It shows how effective a company uses assets in generating revenue (Hickman et al. 2013). The asset turnover of the clothing retail sector of M&S decreased steadily from 1.36 in 2012 to 1.27 in 2016 due to the decrease in its property value. It has to dispose of its less efficient clothing stores. Next’s trend shows higher and consistent figures across the period.

Inventory turnover

Shows how effective a company converts inventories into cash (Hickman et al. 2013). The inventory turnover of the clothing retail sector of M&S shows an inconsistent trend, it decrease from 2012-2014 but increased from 2015-2016 while Next’s inventory turnover increased from 2012-2014 but decreased from 2015-2016.

 

  1. Solvency or Gering Ratios

Gearing or solvency ratios measure the proportion of r assets of a company that are provided by equity and debt (Weygandt et al. 2015). A higher ratio implies more risks.

  2012 2013 2014 2015 2016
M&S          
Gearing ratio 70% 69% 61% 55% 52%
Interest cover 5.85 5.50 5.79 7.01 5.84
NEXT          
Gearing ratio 293% 198% 280% 260% 197%
Interest cover 23.99 28.32 28.48 26.97 27.21

Table 5: Gearing ratios of M&S and Next                  Source: Morningstar.co.uk

 

Gearing ratio

In the past 5 years, the clothing retail sector of M&S has been experiencing reduction in its debt to equity ratio (Hickman et al. 2013). It has a relatively low debt to equity ratio of approximately 50%. On the other hand, Next PLC has a higher debt to equity ratio implying it has much more debt finance that M&S. The figures are quite worrying from the investor’s standpoint. M&S is less riskier than Next.

Interest cover

Interest cover measures the proportion of net profits allocated to meet a company’s interest payments (Hickman et al. 2013). A higher interest cover is favoured because it improves the credit rating of a company. M&S’s interest cover indicates an inconsistent trend with a substantial decrease in 2016 from 7.01 to 5.84 because M&S expects to close down 30 UK clothing. On the other hand, Next has a fluctuating trend in interest cover; however, it is extremely healthy because it is more than four times higher that the figure of the clothing retail sector of M&S. However, both the firms have healthy interest coverage figures. Even a huge fall in their operating profit cannot prevent them from meeting their interest payments. The two companies have a good credit rating thus can easily borrow loan capital from creditors to finance their expansion (Arnold, 2013).

 

  1. Investment ratios

They gauge the financial status of an entity in the wider marketplace (Kieso et al., 2011).

 

  2012 2013 2014 2015 2016
M&S          
Share price £2987 £4366 £6945 £7515 £4922
EPS 34.90p 31.90p 32.20p 33.10p 35.00p
P/E 10.86 12.23 14.09 16.01 11.64
Dividend cover 2.05 1.88 1.89 1.92 1.90
Dividend yield 4.49% 4.36% 3.75% 3.25% 4.52%
NEXT          
EPS 255.40p 297.70p 366.10p 419.80p 442.50p
P/E 10.33 13.63 17.15 17.03 15.65
Dividend cover 3.17 3.18 3.33 2.94 2.89
Dividend yield 3.05% 2.30% 1.75% 2.00% 2.21%

Table 6: Investment ratios of M&S and Next                        Source: London stock Exchange

 

Dividend yield

Shows the percentage of the dividends shareholders receive of their investments (Halim et al. 2012). The dividend yield of the clothing retail sector of M&S shows an inconsistent trend across the period, it decreased from2012-2015 but increased in 2016. Next’s dividend yield also fluctuated, decreasing from 2012-2014 but then increasing from 2015-2016. The dividend yield of M&S outperformed that of Next.

EPS

EPS is the amount of profit distributed to each share outstanding and it indicates company’s profitability (Halim et al. 2012). The EPS of the clothing retail sector of M&S shows an upward trend in overall across the period. Next’s EPS increased steadily from 2012-2016 due to growth in its operating margin. Next’s EPS is much better than that of M&S.

Dividend cover

It is the ability of an entity to pay dividends out of profits to its shareholders. A higher dividend cover attracts more investors (Halim et al. 2012).  M&S’s dividend cover increased in overall across the period despite minimal fluctuations between 2.05 and 1.88 (London Stock Exchange, 2016). It has a healthy level of dividend cover as it is more than 1.50. Next dividend cover fluctuated between 3.33 and 2.89; however, it is higher than that of the clothing retail sector of M&S.

P/E ratio

It is the current market share price relative to company’s EPS and is used by investors in determining the company to invest in (Halim et al. 2012).  M&S’s P/E ratio increased from 2012-2015 but decreased to 11.64 in 2016 because M&S expects to close down 30 UK clothing and the same trend is evident in the case of Next PLC (London Stock Exchange, 2016).  The increase in P/E ratio can indicate the two firms are performing relatively well.

 

Share price of M&S

 

Figure 1: M&S’s share price                                       Source: London stock Exchange

Figure 1 above shows the share price performance of the clothing retail sector of M&S from 2012-2016. The share price reached its peak in December 2015 at £7,505.00 (London Stock Exchange, 2016). It fluctuated across the period and fell in April 2016 because of poor results while in October 2016, it fell to £4397.00, the lowest fall due to the news of closing down 30 UK clothing stores.

 

Limitations of financial ratio analysis

There are several limitations of financial ratios that affect their effectiveness in providing the true financial condition of an organization. Firstly, different companies in different industries with different environmental conditions like market structure, regulation, policies among others (Kapil, 2011). The significance of such factors is so great that comparing two firms that operate in different industries might be misleading (Beaver et al. 2010). Because of this, I face a difficulty in coming up with standardized ratios for M&S and Next because they run different departments in several sectors such as banking, food and clothing.

Secondly, financial accounting data or information is arrived at on the basis of assumptions and estimates because accounting standards permit the use of different accounting policies. This impairs the comparability thereby rendering ratios analysis less useful in certain situations as the different accounting methods influence the overall results because of its subjectivity (Brigham, &. Ehrhardt, 2013). Organizations tend to manipulate financial figures to create more attractive accounts. Therefore, I was not able to gauge the level of accuracy of the figures of M&S and Next PLC as they may have been subject to manipulation by management.

Thirdly, ratio analysis is conducted using actual historical results. It explains relationships between historical or past information and not the future or the current information which users are more concerned about (Malíková & Brabec, 2012). This disparity could result in unusual results of the ratios. In addition, different companies have different accounting periods and comparing their financial performance may be misleading. I faced difficulty comparing data for M&S and Next PLC because they have different year end dates hence they are published at different times. For instance, the M&S data which is prepared by March was compared with Next data prepared by January.

On the other hand, ratio analysis is distorted by the seasonal factors in the economy. For instance, the rate of inflation usually changes in any of the periods that are being reviewed, as a result, the numbers arrived at may not be comparable across the periods. In addition, a change in the underlying operational structure of an entity may result in misleading conclusion in case ratios computed many years back before the change are compared to ratios computed after the change (McLaney & Atrill, 2014). Since I was not able to understand a number of the seasonal factors, I faced a difficulty in reducing the chance of misinterpretation. During the summer, the inventories of the retailers may be high in the preparation for the season of back-to-school thus resulting in lower ROA and higher accounts payable (Overview, 2013).

Finally, due to aggregation, the financial data in financial statements used for ratio analysis may not compare well in case they have been aggregated differently in the past (Collier, 2009). Besides, it is quite hard to ascertain the reasons for the ratio’s results as it may appear to be excellent even if the organization has only taken an ad hoc decision, for instance, selling a large amount of inventories to bolster cash position of a company (Roxas, 2011). Therefore, financial ratios cannot effectively indicate financial condition of a company.

Conclusion

From the financial analysis of the clothing retail sector of M&S, it is clear that the company is doing fairly well. Therefore, I would invest in the shares of this company at the current share price because of the following reasons. Even though there are mixed messages regarding its financial performance, the clothing retail sector of M&S has higher revenues implying higher rewards in the form of dividends. Also, the clothing retail sector of M&S is relatively profitable and hence has profits that will be distributed to the investors in the firm of dividends. Secondly, the clothing retail sector of M&S is a safe choice for investors because it has a healthy interest coverage figures. In addition, it has a good credit rating thus can easily borrow loan capital from creditors to finance its future expansion.

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