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Financial Analysis: Woolworths versus Wesfarmers

HI5002: Finance for Business

INSTRUCTIONS Students are required to form a group to study, undertake research, analyse and conduct academic work within the areas of business finance covered in learning materials Topics 1 to 10 inclusive. The assignment should examine the main issues, including underlying theories, implement performance measures used and explain the corporate financial performance. Your group is strongly advised to reference professional websites, journal articles and text books in this assignment (case study).

Tasks This assessment task is a written report and analysis of the financial performance of two selected listed companies on the ASX in order to provide financial and investment advice to a wealthy investor. This assignment requires your group to undertake a comprehensive examination of corporate financial performance based on update financial statements of the chosen companies.

Group Arrangement This assignment must be completed IN Group. Each group can be from 2 to maximum 4 student members. Each group will choose two companies and once the companies has been chosen, the other group cannot choose the same two companies. First come first served rule applies here, it means you need to form your group, choose two companies from the list of ASX and register them with your lecturer as soon as possible. Indicate your group leader when registering your group with your lecturer for assignment administration and submission. Once your lecturer registers your chosen companies, they cannot be chosen by any other group. Your lecturer then will put your group on Black Board to enable you to interact and discuss on the issues of your group assignment using Black Board environment. However, face to face meeting, discussion and other methods of communication are needed to ensure quality of group work. Each group needs to have your own arrangement so that all the group members will contribute equally in the group work. If not, a Contribution Statement, which clearly indicated individual contribution (in terms of percentage) of each member, should be submitted as a separate item in your assignment. Your individual contribution then will be assessed based on contribution statement to avoid any free riders.

BACKGROUND You’re a group of investment analysts who work for a large investment consulting firm based in Australia. There’s one big institutional investor from overseas that is interested in investing in the Australian market. You’ve been asked to choose two large companies operating under the same industry in Australia (the industry you think will have the most promising future for investment) then evaluate and compare them. Finally make a recommendation through your Report to the investor which one is more superior fundamentally. Create your group’s “business name” under which your group will be providing the financial advisory services. Choose two listed companies that your group will investigate/analyse for the purposes of possible recommendation to your client. The group should obtain all information about the selected companies from this web site: www.asx.com.au.

Required: Obtain copies of Financial Statements including Income Statements, Balance Sheets, and Statement of Changes in Equity, Cash Flows Statements and Notes for three (3) financial year 2014-2015, 2015-2016 and 2016-2017. Your group can download these documents from the suggested web site using the firm’s code (example, BHP- for BHP  HI5002 Finance for Business Group Assignment T2 2018  3 Billiton Company, etc.). The assignment should cover the contents described in Part 1 to 7 bellows.

1 Description of operation and comparative advantages of the two chosen companies. 2 Calculation and comparison of performance ratios of the two companies 3 Analysis of monthly share prices movements of the two companies within 3 years 4 Identify any significant factors which may have influenced the share price of your chosen companies during the time frame. 5 Calculation of Beta values and expected Rates of Return using the CAPM of the two chosen companies 6 Identify and compare dividend policy of the two chosen companies 7 Letter Recommendation  Final Submission of Complete Assignment on Blackboard

Details of financial analysis tasks: 

1. Description of operation and comparative advantages of the two chosen companies: Prepare a brief description of the chosen companies, outlining the core activities, the market(s) in which they operate within and any factors in the companies’ history which you consider help present the pictures of your companies. Identify and compare their comparative advantages.

Calculation and comparison of performance ratios: using financial data obtained from current financial statements of your selected companies for the past 3 years. Annual reports are accessible via company websites or ASX website. Your client is strongly interested in the three groups of ratios: - Liquidity ratios; - Profitability ratios - Capital structure (leverage) ratios You need to provide charts and/or tables for analysis and justification.

3. Analysis of monthly share prices movements: Using the information from the ASX website, complete the following tasks: - Prepare graphs for movements in the monthly share price over the last three years for the companies that you are investigating. Plot them against movements in the All Ordinaries Index. 2 marks - Write a report which compares movements in the two selected companies’ share prices to each other and to the All Ords Index. For instance, how are the prices of the two selected moving? In the same trend or diverse trends? How closely are they correlated with the All Ords Index. Above or below? More or less volatile?

4. Significant factors which may have influenced the share price: Research via the internet or financial/business publications: From research via the internet (using credible sources) or financial/business publications, identify at least 2 significant announcements which may have influenced the share price of your selected companies within 3 years. These factors could include merger or acquisitions, positive or negative earnings forecasts, unusual write-offs or abnormal items, macroeconomic factors, industry wide factors, significant management changes, changes in the focus of the companies, impact of competitors or law suits etc.

5. Calculation of beta values and expected Rates of Return using the CAPM: Go online to http://www.reuters.com/finance/stocks/ and type in the code for your companies into the Search Stocks field and click on the magnifying glass button. - What is their calculated beta (β) for your companies? 2 mark - If the risk free rate is 5% and the market risk premium is 6%, use the Capital Asset Pricing Model (CAPM) to calculate the required rate of return for the companies’ shares.

6. Dividend policies: Discuss what dividend policies appear to be implemented by the companies’ management boards. Explain any reason related to that particular dividend policies. 4

7. Recommendation letter: Based on your analysis above, write a letter of recommendation to your client, providing an explanation as why you would like to include one of selected the companies in his/her investment portfolio. Please refer to the ratio results calculated earlier and any other trends or factors that you believe to be important.

8. Presentation, structure and academic writing


Answer

1. Description of operation and comparative advantages of the two chosen companies. 

Woolworths Limited 

Woolworth came into existence in 1924 and was founded by Percy Christmas in Sydney area. The company has grown enormously in the last few decades and serves more than 29 million consumers per week. It has been known to be operating no of stores in excess of 3,000 across Australian soil and also New Zealand. It sells food items, packaged foods, petrol and liquor and other merchandised items. Some o the larger stores also offers to consumers home improvement needs and gardening tools. It also has a thriving hotel business. The Woolworth Limited currently employs little more than 210,000 employees across all the operating divisions. In the last few decades it has tied up with a large no of farmers ad co-operatives for procuring farm fresh goods and other items such as dairy for selling them directly to the consumers. 

Wesfarmers limited 

Wesfarmers took shape of a co-operative in 1914 but in its more than 100years of existence has slowly and steadily evolved into a large corporate business. Like Woolworth Limited it has also a very diverse business interest in the form of hotels, leisure business, it runs many super markets and liquor to its consumers. It has also been known for its industrial division which runs a fertilizer and chemicals business. It has in its roster more than 223,000 employees across different divisions. The company is currently headquartered in Perth. Rob Scott is leading the company in his capacity as the managing director since 2017. 

2.Calculation and comparison of performance ratios of the two companies.

The selected financials and the financial Ratios of the companies selected are shown as follows:

2.1Selected financials for Woolworth and Wesfarmers Limited for 2014-2017. 

Analysis and interpretation of Financial Position and performance 

It can be seen from the above selected financial statements that the revenue generation of both the firms have taken a diverse path. While Wesfarmers Limited was able to generate sizable revenue growth in the last three years the same for the Woolworth Limited has taken a hit in 2016. However, the revenue also for Woolworth has declined further in 2017 owing mainly to the decline in oil prices worldwide. While the Wesfarmers limited has bene able to take steps to increase non-oil sector revenue to compensate for the decline in oil and petrochemical sectors revenue the same for Woolworth was not possible as more than 40% revenue came from the sector. As a result of the decline in the firm’s revenue Woolworth has lost approximately 10% of the total assets on account of losses and loss from discontinued business. However to the contrary the Wesfarmers limited was sable to retain approximately all the assets form 2015 till 2017 and there is no large scale deviation in the firms asset base (Atrill, 2013). 2.2 Financial Ratios for the companies selected are as follows:


WESFARMERS LTDWOOLWORTH LTD

201520162017 201520162017
Current Ratio 0.9350.9290.9280.8360.8260.793
Quick Ratio 0.3700.3280.3010.3040.3190.330
Debt Ratio 0.3870.4370.4030.1990.6260.569
Debt-Equity Ratio 0.6300.7770.6760.4521.6761.320
Net Margin 3.91%0.62%4.20%3.51%-4.03%2.86%







EPS (A$)2.160.362.551.71-0.981.11
P/E Ratio 17.381109.69419.85513.039-25.69125.857
ROA 6.04%1.00%7.16%8.44%-9.99%6.95%
ROE 9.85%1.77%12.00%19.20%-26.74%16.13%


Analysis and interpretation of Ratios 

Liquidity 


WESFARMERS LTDWOOLWORTH LTD

201520162017 201520162017
Current Ratio 0.9350.9290.9280.8360.8260.793
Quick Ratio 0.3700.3280.3010.3040.3190.330

The lenders and others suppliers (creditors) of a company are concerned about the paying ability of the firm in the short term. Wesfarmers limited has been able to maintain a decent current ratio of .94,.93 and .93 in 2015-2017 but the same for Woolworth is lower at .84,.83 and .80 approx. in the same time frame. This shows that Wesfarmers has been able to maintain a better cash flow to meet liabilities in all the three years. However, both companies have faltered as far as quick ratio is concerned because of high inventory they have been holding. So, Wesfarmers has been better in maintain good and satisfactory liquidity yet less than what is generally desired (Kimmel, 2012). 

Profitability 


WESFARMERS LTDWOOLWORTH LTD

201520162017 201520162017
Net Margin 3.91%0.62%4.20%3.51%-4.03%2.86%
ROA 6.04%1.00%7.16%8.44%-9.99%6.95%
ROE 9.85%1.77%12.00%19.20%-26.74%16.13%

Net margin is the percentage of revenue which is finally retained by a company like Woolworth or Wesfarmers after meeting all the costs and expenses and paying taxes. Here also Wesfarmers has maintained a better ratio and track record. While in 2015 the net margins were little bit similar the same started to go wrong in 2016 as revenue decline sharply for Woolworth. While Woolworth maintained a net margin of -4.03% in 2016 the same for the Wesfarmers were positive at .62%. in 2017 both the companies made strong comebacks but Wesfarmers (4.2%) has generated a much higher profit margin than that of Woolworth at 2.86%. so, as far as pure profits are concerned wesfarmers has done well (Charles, 2011). 

The return on Equity is an indicator of returns generated for the capital supplied by the shareholders and here the Woolworth limited has generated higher returns over the Wesfarmers limited barring 2016. While the ROE for Woolworth was 1.9.2% and 16.13% in 2015 and 2017, the same for wesfarmers was much lower at 9.85% and 12%. Because of this the Price earning ratio of the Woolworth limited was estimated to be Higher as well (Dyson, 2007). 

Capital structure Ratios 


WESFARMERS LTDWOOLWORTH LTD

201520162017 201520162017
Debt Ratio 0.3870.4370.4030.1990.6260.569
Debt-Equity Ratio 0.6300.7770.6760.4521.6761.320

Debt Ratio shows the level of use of the external funds for financing of the assets being used by a registered frim. A higher ratio is indicative of higher financial risk and leverage. Woolworth Limited has used 16% debts for financing assets in 2015 and the same ahs gone up to 63% in 2016 and 57% in 2017. So, there is a sudden increase in debts as a result of declining revenue and increasing costs and expenses. However, the company is able to reduce it by over 5-6% in 2017. At the same time the Wesfarmers Limited has used 38% of the assets being financed through debts and 44% in 2016. The same has decreased to 40.3% in 2017. This indicates that Wesfarmers capital structure is far more balanced than that of Woolworth Limited and less risky (Mathew, 2006).

The Debt Equity ratio of both the companies also indicate that Wesfarmers has bene maintaining a well-balanced capital structure and debts are 68% approx. of equity in 2017. However, the same for Woolworth Limited is much higher at 132% in 2017 even as the same has declined from 167% in 2017. This means as of today Woolworth is feeling more stress as to grow its revenue and profits and pay off some portions to keep it under 100% and preferably within 75%. Overall Wesfarmers capital structure is more balanced and poised for higher returns for the shareholders of the company (Kimmel, 2012). 

Market Ratios 


WESFARMERS LTDWOOLWORTH LTD

201520162017 201520162017
EPS (A$)2.160.362.551.71-0.981.11
P/E Ratio 17.381109.69419.85513.039-25.69125.857


EPS acts as indicator of how much return is generated or how much profit (distributable) is generated on a pers share basis. The higher the EPS, the larger the likelihood of a growing dividend payment. If EPS continues to grow at a sizable rate than it would be highly likely that demand for the share increase in the ASX market and value of the shares also go up. However as can be seen from the above calculation the EPS of Woolworth Limited has actually declined in between 2015 to 2017. It was the highest in 2015 and became negative in 2016 to stabilize in 2017. Overall its sign that the company has done well from the negative performance in 2016 to recover well in time of 2017. Overall a good sign. On the other hand, Wesfarmers has no such issue as the EPS has actually grown in 2017 as opposed to 2015 despite a steep decline  in 2016. Overall Wesfarmers limited EPS has outperformed that of Woolworth (Cottrell, 2012).

Despite a sharp decline of EPS, Woolworth Limited has been able to maintain a good outlook for the shareholders and investors as can be seen in the price earnings ratio. The price earnings ratio of the Woolworth company is much higher in 2017 as opposed to that of wesfarmers that shows the investors have put their faith in the management of the company and believes in what the company has bene working on overall (Charles, 2011). 

3. Analysis of monthly share prices movements of the two companies within 3 years. 

The monthly stock prices and Index is shown as follows:

DateALL Ordinaries WOWWES
7/31/2015


8/31/20155058.622.2305333.93031
9/30/20155288.622.2084934.09469
10/31/20155218.221.8031932.95272
11/30/20155344.622.5677335.99797
12/31/20155056.622.3650836.48244
1/31/20164947.921.0939233.81784
2/29/20165151.820.3570136.68736
3/31/2016531620.7706137.85569
4/30/20165447.820.7835.96158
5/31/20165310.419.6245135.49247
6/30/2016564421.9918537.99731
7/31/20165529.422.2736837.56361
8/31/20165525.221.8603339.88767
9/30/20165402.422.525537.09282
10/31/20165502.421.8016437.78928
11/30/20165719.122.954138.11489
12/31/2016567523.4303336.41446
1/31/2017576124.5351838.63948
2/28/20175903.825.2399941.76331
3/31/20175947.625.9477539.84518
4/30/20175761.325.1465439.56719
5/31/2017576424.6542337.17648
6/30/20175773.925.77437.74172
7/31/20175776.325.0982739.49305
8/31/20175744.924.3356739.40778
9/30/20175976.425.4769439.85592
10/31/20176023.526.490941.87732
11/30/20176167.326.8748342.35407
12/31/20176146.526.5302841.77244
1/31/20186117.327.1839.40778
2/28/20185868.925.8805640.6106
3/31/20186071.627.8642.77012
4/30/20186123.528.4644.51923
5/31/20186289.730.5248.23242
6/30/20186366.230.0948.33013
7/31/20186357.928.7750.56782

The price and index charts are shown as follows:

All ordinaries chart 

All ordinaries chart

Woolworths stock price Chart (36 months) 

Woolworths stock price Chart

Wesfarmers stock prices chart (36 months) 

wesfarmers stock prices chart

As can be seen the chart shows that all ordinaries and WOW and WES.AX stock prices have shown a general upward stock price trend in the last 36 months period. 

4. Identify any significant factors which may have influenced the share price of your chosen companies during the time frame. 

Woolworth Stock prices -indicators

In between 2013-14 and 2016, the stock prices of Woolworth went downhill primarily because of decline in oil retailing and loss of margins in other retail formats. Apart from the same WOW stock also lost sheen by beginning to compete with Bunnings in the highly competitive Home improvement market and which increased its operating expenses too much driving down profits and eventually resulting in losses in 2016. However, Woolworth has gained ground ever since and expected to add value and increase stock prices through higher revenue growth and better utilization of the long-term assets (Kimmel, 2012). 

Wesfarmers Stock prices -indicators

Wesfarmers paid too much cash for acquiring Coles Myers and invested millions of dollars each year to make it competitive against competitors like Woolworth. But the investment did not yield the desired results and finally the company decided to divest Coles. This has improved the fundamentals of the parent company as it is now concentrating on trading rather than maintaining and improving Coles. This has helped the company to increase its net margin to 4.2% in 2017 up from 2.8% in 2015. The decline in revenue in 2016 was caused by Coles Myers slowing approx. 20% over the years and which significantly dented the profit generating ability of the Wesfarmers core business. Now the stock prices are set to gain as a result of higher EBIDTA and Net profit. This is already showing in an all-time high stock price in July 2018 (canon, 2013). 

5. Calculation of Beta values and expected Rates of Return using the CAPM of the two chosen companies 

The beta for the stocks of Woolworth Limited was found to be .89

https://www.reuters.com/finance/stocks/overview/WOW.AX

The beta for the stocks of Wesfarmers Limited was found to be 0.91.

https://www.reuters.com/finance/stocks/overview/WES.AX

Expected return (CAPM) for Wesfarmers stock:

R= Rf + (Rm-Rf) Beta = 5% + 6%*.91 = 5% + 5.46% = 10.46%

Expected return (CAPM)  for Woolworth  stock:

R= Rf + (Rm-Rf) Beta = 5% + 6%*.89 = 5% + 5.34%= 10.34%

As can be seen from the above the return expected for Woolworth is slightly lower as its beta is marginally lower than that of the Wesfarmers limited (Mathew, 2006). 


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