Financial Analysis of Coles Ltd

Financial compendium of Coles Ltd1. INTRODUCTION1.1 PurposeIn this report my propose is to do a financial digest of Coles Ltd which provides a basis, on which the valuation of caller-up canister be done.1.2 ScopeThis report conducts a financial depth psychology for Coles by performing a trend compendium of financial balances using the data given for past 5 years. It to a fault includes a currency lessen analysis which along with financial proportions helps compare coles with its industry counterparts, Woolworths and Metcash and finally this analysis would help in value valuation to calculate a fair price for coles share.1.3 MethodologyThis report is base on primary data available from Coles website as well as secondary data such as seek paper, electronic database and other publications.1.4 LimitationAlthough all efforts have been made to uptake as much available information as possible still in that respect were some constricting factors such as lack of available data of past financial information which restricted this research. Reliability of data and time constraints were also hurdle in performing this analysis.The biggest mulctcoming was that authorized data was based on AIFR and data for years before 2005 was based on AGAAP, which made relative trend analysis very difficult.2. FINANCIAL ANALYSISIn this we will be evaluating the sures financial ratios and cash f slump measures of the operational, finance, and investing performance of a company in relation to key competitors historical performance. Given the firms strategy and goals, together these tools allow the analyst to investigate and examine a firms performance and its financial condition. balance analysis is the tool which involves assessing the firms income statement and balance sheet data. On the other side, the cash flow analysis relies on firms cash flow statement.2.1 Ratio analysisThe ratio analysis deals with evaluation of the performance of Coles in perspective of its ment ioned strategies and goals. In order to achieve this objective a combination of cross sectional analysis and time series analysis is performed. Workings of Ratios for 2006 are mentioned in APPENDIX 4.2.1.1 favorableness analysisIf we look at the return on equity (ROE) of Coles, for a period of 5 years, it is being observed that ROE has increased in 2006 as compared to 2002. Although ROE has fallen in 2006 (15. 30%) as compared to 2005 (18.30 %) hardly it can be seen that on an amount Coles ROE has been stalls or increased all over choke 5 years. Return on summation (ROA) has also been electrostatic around 10% during the stomach 3 years and increasing from 7.17% in 2002 to 9.54% in 2006.The main reason for stable ROE and ROA are better performance delivered by the management and as well as the mature characteristic of the industry, that produces stable return as well as stable crop sightedness population demographics in the country.Table 1 Profitability Ratio of Coles LtdS ource Coles financial statement after adjustmentGross remuneration has been quite stable and good for the last 5 years but the misgivinged part is the net profit margin. Net profit margin has been very low, it had been increasing from 2002 to 2005 but it once again fell in 2002 to 1.57% from 2.08%. Coles need to curve its run and interest expenses so as to increase its net profit margin.Table 2 Profitability Ratio Comparison within the industry in 2006On comparing the performance of Coles with its industry counterparts we can conclude that Coles Ltd is way behind its major competitor, Woolworths, in terms of ROE and ROA which might be attributable to lower net profit margin and lower financial leverage. Coles has higher financial leverage as compared to Woolworths and metcash, which doer it, has greater financial risk. But despite of high leverage it has low ROE which confirms the fact that Coles has low net profit margin asset employee turnover ratio.2.1.2 Activity Analysi sA firms operating activities require investments in both short-circuit ( origin and accounts receivable) and long term assets. Activity ratios describe the relationship amid the firms level of operations and assets needed to sustain operating activities. Asset turnover is important in determining firms ROA it also formulates reasons of how it will affect firms ROE. Evaluating the effectiveness of asset management is the purpose of asset turnover analysis.2.1.2.1 Short term activity ratiosWorking capital is our main concern while evaluating a company. It can clearly be observed that since Coles has high turnover ratios it uses cash basis in its gross revenue. It can be clearly being seen that it took only 4.48 days on an average for Coles to convert its take stock investment back in to cash. From the figures last 5 years we can clearly interpret that Coles has drastically improved its cash diversity cycle from 23 days in 2002 to 4.48 days in 2006.Table 3 Short-term Activity Ra tios for Coles LtdTable 4 Short-term activity ratio comparison, 2006Now, if we compare Coles with its competitors we can see that Woolworths has lower cash conversion cycle and metcash has higher cash conversion cycle. Woolworths has lower cash conversion cycle because it keeps inventory in stock for shorter duration and stock is converted in to good sold in less span of time. On the other hand Metcash keeps inventory in stock for lower no. of days but it provides more no. of days to its receivables for payment due to which it has higher cash conversion cycle. perceive the industry it can be concluded that Coles has good cash conversion cycle but it can improve on it by reducing the fairish number of days for which inventory is in stock.2.1.2.2 foresighted term activity ratiosIn the analysis of long term activity ratios, long-term asset turnover and property, plant and equipment turnover have been utilized.Table 5 Long term activity ratios for Coles LtdOn the whole both ratios m oved in the same ensample during these periods. Relatively, this pattern shows that asset utilization has improved uniformly for the period ranging from 2002 (310.12%) to 2006(372.70%). This helps to conclude that company is continuously improving its utilization of assets to increase its production.Table 6 Long term activity ratios comparison, 2006While comparing to its competitors it can be seen that Coles thorough waiver asset turnover ratio is approximately 30% higher than its competitors. It helps to analyze that Coles is more efficiently utilizing its re parentages to increase its production as compared to its competitors. Metcashs high PPE turnover ratio can be contributed to the fact that PPE forms a very small part of Metcashs total assets. If compare Coles with its major competitor Woolworth on PPE Turnover Ratio we can conclude that Coles has been utilizing its fixed asset better than Woolworths.2.1.3 Liquidity AnalysisLiquidity is referred to a firms ability to have su fficient funds when needed and convert its non-cash assets in to cash easily. Liquidity Ratios are employed to determine the firms ability to pay its short-term liabilities. Liquidity analysis enables us to determine Coles ability to cover its liquidness risk. Liquidity risk may arise due to shortfall or over liquidity within the firm and this in turn lead to firms disability of fulfilling its liquidity needs.In order to determine firm liquidity level, Current ratio, supple ratio and cash ratio are short- term liquidity ratios which have been employed.Table 7 Coles Short-term Liquidity RatiosOn doing the trend analysis for last 5 years it can be observed that Coles up-to-the-minute ratio has been consistently falling, which increases the possibility that Coles will not be able to meet up its short term liabilities. Current ratio has fallen from 1.37 in 2002 to 0.98 in 2006 which is of major concern, as a true ratio of less than 1 center that company has negative working capital and is probably facing a liquidity crisis. The more stringent measure of liquidity is quick ratio and cash ratio which have also been falling uniformly in last 5 years. It seems Coles is falling in to liquidity crunch and might need short term funds to meet its current liabilities. There has been lot of volatility in the cash ratio of the firm as they have been rising and again falling, so we can conclude that Coles is not able to maintain stable liquidity.Table 8 Short term liquidity ratios comparisons, 2006As compared to its competitors Coles has better current ratio than Woolworths but has current ratio less than Metcash. Comparing Coles with its major competitor in retail sector, Woolworth, we can clearly see Coles has better current cash ratio but is behind on quick ratio. On comparing with metcash we see that Coles is behind on all the short term liquidity ratios by a very high margin. Metcash has twice the cash ratio as compared to Coles, which makes Coles ability to meet i ts short term liabilities questionable.2.1.4 Long term Debt and solvency AnalysisThe analysis of a firms capital structure is essential to evaluate its long term risk and return prospects. The long term debt and solvency ratios which we are going to use here are debt to equity, debt to capital and interest coverage ratio.Table 9 Coles long term Debt and Solvency ratiosAs indicated by Coles debt and long term solvency ratios, it denotes that firm is not a solvent company and relies heavily on debt financing. The firms debt to equity and debt to capital ratios are consistently above 1.00 which shows that Coles employed more debt than equity as its source of financing. Debt to total capital has also been consistently been around 0.55-0.60 during the 5 year period. This shows that firm has been stable with its financing policy and has not done much flip-flop with its debt and equity mix. Since it relies so heavily on debt financing, issues can be raised regarding its ability to pay of f the interest arising due to long term debt financing but we see that company has EBIT 7 times more than the interest charges it has to pay, so that should concern much. It can be observed interest coverage ratio has declined in 2006, as compared to 2005 2004, but it is still able to meet industry benchmarks.Table 10 Debt and Solvency ratios Comparison 2006Compared to its competitors, long term solvency ratios of Coles seem to be performing optimally. Woolworths has got the highest debt to equity, debt to capital interest coverage ratio. Historically a debt to equity ratio of 21 is considered optimal so Coles can still rely on debt to finance its future undertaking rather then issuing new shares. It can be observed that Coles has interest coverage ratio greater than Metcash but less than Woolworths but that can be attributable to its low profit margin as compared to Woolworths. It seems Coles is at par with its competitors in terms of debt and solvency ratios.2.2 Cash come down AnalysisCash flow analysis is essential to understand that whether the firms cash flow have the ability to sustain the business, to meet unexpected obligations and to meet its short term liabilities. This also helps to understand whether firm will be requiring additional financing and firm can take advantage of new business opportunities as they arise.In cash flow analysis we will evaluate 3 ratios Operating cash flow to current liabilities, Interest coverage (cash flow basis) operating cash flow to dividend payment. Methodology for calculation of cash flow ratios is shown in APPENDIX 5Table 11 Cash flow ratios for Coles LtdBased on the table above, we can say that Coles has the ability to service its debts which can be seen in firms interest coverage ratio from cash flow basis. Moreover, we observe that Op. cash flow to dividend payment has fallen over the time span from 2002 to 2006 which could be an area of concern. Operating cash flow to current liabilities has also fallen a b it, which ungenerouss it can be a problem for the firm if certain unexpected obligation come up due to which it might require additional financing.Table 12 Cash flow ratios Comparison, 2006If we compare Coles to its competitors in the industry which it operates we observe that Coles has got better interest coverage ratio (cash flow basis) as compared to Woolworths Metcash which involves that Coles has better ability to service its debts than its counterparts. Coles also has a shortcoming in operating cash flow to dividend payment ratio, as it can be seen it has the last operating cash flow to dividend payment ratio. It can be attributable to the fact that it pays more dividends than it should pay. So it can be concluded that Coles needs to reduce dividend payment as it might lead Coles in to financial difficulties if some unexpected obligations turn up. In terms of operating cash flow to current liabilities we see that although it has fallen substantially for Coles in last 5 yea rs but it is at par with its biggest competitor Woolworths greater than Metcash.3. potential analysisProspective analysis enables us to determine future performance of the firm based on historical performance of the company. Here will be determining the mean return for sales and earning before interest taxes (EBIT) . Using those mean returns we will be making a sales forecast and EBIT forecast.3.1 Sales and EBIT forecastIn determining the sales growth, I have considered the following assumptions-Past trend of sales is going to continue in the following years.Firm is not going to bring a major change in its pricing policy.The foundation for sales EBIT growth is historical sales EBIT growth and I have use mean reverting amaze to determine the future sales growth, in which future sales EBIT growth will be mean return of last 4 years sales growth. I have not taken the 5 year sales EBIT growth because EBIT growth rate is to high in 2002 (73%) which could adversely effect the mean return considering gratuity situation of Coles.Table 13 Sales EBIT Growth Rate for Coles LtdUsing the mean reverting model we are able to find out a growth rate of sales for 7.64% EBIT growth rate of 11.87%. Using these growth rates we will be able to make a sales forecast EBIT forecast. This forecast will help in proper valuation of Coles on the basis of its predicted future performance. determine 1 Line chart for sales EBIT growthTable 14 Sales EBIT Forecast for Coles LTDUsing the growth rates we can forecast the sales and EBIT for Coles which helps an analyst in a fair valuation of the company. The main reason we use the sales growth as a base for forecasting, is that the majority of firm income is derived from its supermarket business.This forecast suffers from one serious shortcoming that EBIT growth has fallen from 34.31% in 2004 to 11.16% in 2005 and then to -17.07% in 2006 but we are still predicting a growth in EBIT of 11.87% in 2007 and thereafter.4. ConclusionI hav e gone through the multi-step process of ratio analysis, cash flow analysis and future analysis to present a report on financial analysis of Coles ltd. During the process, I have identified that Coles is operating in a mature industry with small profit margins.I have performed ratio analysis, cash flow analysis prospective analysis which would help a great deal in valuation of Coles based on its current market situation. During the Ratio analysis I was able to conclude that Coles has got good activity liquidity ratios but the major area of concern is profitability ratios. Coles needs to improve its net profitability so as survive in this competitive environment. Cash flow analysis helped us to absorb that Coles has cash flow ratios at par with its competitor, Woolworths, but Coles need to reduce its dividend payout as it is too high as compared to industry counterparts. By doing a prospective analysis I am able to forecast the future sales EBIT for Coles for next 4 years. Growt h rate for forecast has been calculated using the mean return for past 4 years. This helps us to understand future growth of the company.I would like to conclude by saying that although Coles is competing in a low profit margin industry but it is the 2nd biggest company in the retail industry, therefore if it brings about certain petite changes in its financing and operating activities it can add a great deal to its shareholders value.