The Business and Financial Performance of Tesco Plc

Introduction and Justification of Research Subject

1.1. Topic Selection

Oxford Brookes University allows me to choose a topic for my research project from 20 research subjects relating to different academic disciplines i.e. accounting, marketing, management and I have chosen topic number 8 “The business and financial performance of an organization over the three years of period”; and select the TESCO Plc as a case study . The business and financial analysis will be based on the data from year ending 2006 to 2008. I will benchmark the financial performance indicators of Sainsbury Plc to make comparative analysis. Comparison of both organizations will be a like-for-like analysis as they both operate in same industry i.e. retail market. The focus of my research will be critically evaluation of financial performance of TESCO Plc and its contextualization into business strategy of TESCO.

The subject matter intends to conduct research that will provide external points of view on the financial performance of TESCO from all its stakeholders, i.e. shareholder, Investors, Financial Institutions, Government Agencies, Customers and employees etc..

 

1.2. Motivation to Choose This Topic

The motivation for me to select the topic of business and financial performance of organization is my prior understanding and academic knowledge on accounting and finance that build during my study of ACCA. I have studied the subject on preparing financial statements, financial reporting, financial information management and performance management & control. These all subjects primarily relate to analyse the financial performance of the organization and build my skills in accounting ratio. I find this research project is an opportunity to apply these knowledge and skills in accounting in applied manners on real business scenario. The topic also relates to my professional career objectives as my aim is to pursue my career in field of financial analysts. This research project will be an initial exercise toward my career targets. This research project also builds my managerial skills i.e. research skills to find out appropriate financial information for analyses, interpretation skills to write financial analytical report, integration skills to contextualize the financial data within overall business strategy to conclude the results.

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1.3. Reason to Choose This Organization

I select the TESCO Plc for my analysis because it is one the biggest retail giant of United Kingdom since 1995 and have become third biggest retailer over the world in 2008. It is operated in diverse territories of the world includes republic of Ireland, Japan, Malaysia, Poland, Slovakia, South Korea, Thailand, and United State. The TESCO Plc also operates in diverse range of business and products that includes food and drink, clothing, consumer electronics, financial services, telecoms, health insurance, dental plans, retailing and renting DVDs, CDs, music downloads, Internet services, software and petrol filling stations. The profits have been exceeded over £2 billion over the year 2009. In July 2008, TESCO Plc held 31.6% market share of UK grocery marketing that was 3% higher than the previous year while the major competitor Sainsbury held only 15.9% with increment of 1% over last year. The basic earning per share of TESCO is continuously increasing since 2006 from 19.70%, 22.36% 26.95% consecutively.

The unique competitive characterizes of TESCO Plc motivate me to pursue research project on this organization. It will provide me the opportunity to analyze its business strategy and financial performance in international context.

 

1.4. Research Aims and Objectives

The objective of research is to critically evaluate the financial performance in relationship with overall business performance of TESCO Plc for the year starting from 2006 to 2008.

The study objective is to synthesize business and financial performance to pinpoint the implications of business strategy of TESCO, its effects on financial performance to sustain long term competitive position.

The researcher aims to provide transparent opinion around business and financial position of TESCO to its all stakeholders.

In order to meet this research objective, I set following research questions to be answered in my analysis.

1.4.1. Research Questions

On what critical underpinning TESCO business strategy stands?

What is the existing financial position of Tesco Plc?

Does the business strategy and financial position support each others?

What are the critical factors that impact on business and financial performance?

What are the implications for TESCO future growth?

1.5. Overall Research Framework to Meet Research Objectives and to Answer Research Questions

1.5.1. Evaluation of Business Strategy

The research project will evaluate the prospects and growth strategy of TESCO where I will analyse retail marketing strategy, its business operations, online retailing, and impact of technology. In order to conduct these analysis:-

I will apply the Generic Competitive Strategy model developed by Porter (1980) in my report to analyse the competitive strategy of TESCO Plc.

I will apply Ansoff Growth Matrix to analyse the growth strategy of TESCO Plc.

1.5.2. Evaluation of Financial Performance & Strategic Analysis

I will calculate the financial ratio of TESCO Plc over the three year to analyse the financial position. The ratio analysis will be based in profitability, liquidity, efficiently and investment ratios.. I will also conduct the strategic analysis of TESCO. I will apply SWOT analysis framework that will identify Strength and Weakness of TESCO and Opportunities and Threat within market. I will apply PESTEL analysis I will apply Porter (1985) five forces competitive framework includes rivalry of buyer, supplier, customer and substitute products.

Chapter # 2

Information Gathering

The chapter describes the research methodology applied for the research report and has been structured into section:-

2.1. Nature of Research Data

The nature of data required for research is highly depended upon the nature of research problem and research objective. There are two types of data that can be used in research analysis one is called primary data and second is called secondary data.

2.2.1. Primary Data

The primary data is first hand information collected by the research to investigate the research subject. The primary data is collected through personal interview, questionnaires, focus group interviews, observation, case-studies, diaries, critical incidents and portfolios. The primary data once collected become secondary data for others.

2.2.2. Secondary Data

The secondary data is information or data that has already been collected or recorded by someone else, usually for other purpose. A lot of information gathered by the government, information pertaining to financial marketing such as stock prices and trading volumes is widely available in financial newspaper or online at various financial portals, annual reports of public companies etc.

I used secondary data for my research. This study required the financial information covering the period of three years, marketing plans, future strategy, the information about the influencing factors on financial performance and marketing strategy such as economical, political, social and industry competitiveness etc. The information are only possible to collect by relying on secondary source of data. The collection of primary data on these research variables is needed long time, heavy cost and perhaps impossible to collect.

2.3. Collection of Secondary Data

2.3.1. Annual Public Report of TESCO Plc and Sainsbury

I used the annual reports over the past three years of TESCO Plc published. The annual report of TESCO provided me the information related to financial data, organization infrastructure, organization mission and objective, organization achievement and future plan. The annual report contains the message of chairman, chief executive officers and management that will provide me information to understand the business strategy and future plan of the TESCO Plc. I used the annual report of Sainsbury to conduct comparative analysis to evaluate the performance of TESCO. This resource provided information to apply in calculation of financial ratios analysis, describing competitive strategy, growth strategy, and conducting SWOT analysis. I accesses TESCO online from the internet website www.tesco.com and Sainsbury from www.sainsburys.co.uk .

2.3.2. New Papers

I used the secondary information source published in newspapers. The both organization are prominent entity of retail grocery industry and reports relates to these organization regular published in news paper. These reports provided me external views to know about the performance of TESCO and helped me to conduct the external analysis (PEST, Porter 5 forces) to identify the key threats and opportunities and internal analysis to pin point the strengths and weakness of TESCO.

The Types of newspaper that I have read include:-

Financial Time

Guardian

The Independent

The Time

Journal of retailing and distribution

2.3.3. Books

The books are the traditional source secondary data. The limitation of this resource is that books are normally not provide up to date data and are emphasis on general descriptions. But the books are very useful to understand the concepts and theories that help to follow research methodology and conclude research findings. I used the book particularly to understand research model and analysis applied to my study. This equipped me to critically understand the application of financial ratios, Ansoff matrix model, SWOT Analysis, PEST and Porter Five Forces Analysis. I studied the following book:-

Pearce, J. and Robinson, R (2005) Strategic Management

Johnson, G. and Scholes, K. (2008) Exploring Corporate Strategy

Hill, C. W. L., Jones, G. R., (2007) Strategic Management

Thompson, A. A. & Strickland, J. A. (2003), Strategic Management

Mishkin, F. S., Eakins, S. G., (2005), “Financial Markets and Institutions

Brealey, R. A. (2002), “Principles of Corporate Finance

2.3.4. E-Resources

I used the resources available at internet that provided me the counter information to evaluate the financial and business performance. One of the limitations of e-resource is that it lacks credibility than books and annual reports but provides independent external opinion in large extent. I accessed the following data in conducting my analysis.

Biz/ed: – A gateway for primary and secondary business and management information UK focus available at www.bized.ac.uk

Directgov. UK government published official statistic available at www.direct.gov.uk

RBA Information Service: – Business information gateway with links to business, statistical and government country sites.

UK Data Archive: – Collection of UK focus digital data in social science available at www.data-archive.ac.uk

Netmba:- e-resource of management, strategy and finance available at www.netmba.com

FT info: – company information more than 11000 including financial performance.

London Stock Exchange available at www.londonstockexchange.com

2.3.5. Library Research

I joined the library of London school of economics that provided me the access to comprehensive list of book and published material around my research subject.

2.3.6. Credibility of Secondary Data

As it is said that the secondary data is normally deviates to the research problem as result the credibility of secondary data to use in research is always questioned. To make sure the applicability of secondary data applied the following check list.

Where and when the data is collected?

Who publish the data?

Do the data cover the information I need?

Is the information is detailed enough?

Do the data follow the definition I apply in my research problem?

Are the data accurate enough?

2.4. Research Approach

The research approach may be qualitative and quantitative. My research includes both type, it relates to quantitative when analysis and interprets the financial performance of the TESCO with the help of financial ratios and qualitative in nature when investigates business performance of the TESCO with the help of business model of SWOT, PEST, Five Forces, Ansoff Matrix. So the data should be collected in both forms quantitative and qualitative.

2.5. Research Ethics

I also considered the research ethics in my report. The research findings are interpreted in a way that provides the foundation to TESCO to know their lacks and impediments in business strategy not in the way to tarnish the image of the TESCO. Moreover only reliable information is includes in analysing the business strategy and financial performance, most of which is published by the Tesco itself. On the other the researcher did not hide or manipulate any information and provide transport fair view of Tesco performance for all stakeholders.

2.6. Business/or Accounting Techniques Applied

I have applied the following techniques in my research and analysis Project.

2.6.1. Financial Ratio Analysis

to evaluate the performance of Tesco and Benchmarked company Sainsbury I have used ratio analysis.

The limitation of accounting ratio is that it is based on accounting reality and ignores the economic realities. It can be easily manipulate by using various techniques such as valuation of stocks FIFO and LIFO method etc. I have used

Profitability Ratios

 

 

 

 

 

 

 

 

 

 

Gross Profit

Margin

Net Profit

Margin

Return on Capital Employed

Return on

Equity

Liquidity Ratios

 

 

 

 

 

 

 

 

Current / Woking Ratio

Acid Test/ Quick Ratio

Efficiency Ratios

 

 

 

 

 

 

 

 

 

 

Debtors

Turnover

Debtors

Days

Creditors

Days

Net Asset

Turnover

 

 

 

Stock

Turnover

Stock

Days

Investment Ratio

 

 

 

 

 

 

 

Earnings Per

Share

Interest

Cover

Dividend Per

Share

2.6.2 Generic Competitive Model of Porter (1980)

I have also applied The generic competitive strategy model develop by porter (1980) .

2.6.2. Ansoff’s Product/Market Matrix

I applied The Ansoff Growth Matrix to illustrate the growth strategy of TESCO.

2.6.3. SWOT Analysis

The SWOT (Strength, Weakness, Opportunities and Threat) analysis has been applied with the help of external analysis of PESTEL (political, economical, social, technological, environment and legal), 5 Forces (customer, supplier, entrance, substitute, rivalry) and internal analysis of financial ratio, organization infrastructure, porter (1985) value chain analysis is applied. The combination of these analysis eliminates the limitation of each other i.e. PESTEL analysis not captured industry competence for this 5 forces Model is applied.

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Chapter # 3

Interpretation of Results and Analysis

3. Financial Ratio Analysis

The financial ratios are illustrated in figures both statistically and graphical of both organizations TESCO and Sainsbury for the period of three year from 2006 to 2008. The short description of each financial ratio is provides with individual ratio and more focus is given to the analyse result in context strategic analysis to conclude rational research findings.

3.1. Profitability Ratio

The profitability ratio analysis includes gross profit margin, net profit margin, return of capital employed and return of equity employed.

3.1.1. Gross Profit Margin

Comparing the gross profit margins will show the efficiency of the both companies. The gross profit margin was 7.67% in 05/06 which increased to 8.12% in 06/07 the increase in profit is partly due to increased sales revenue and partly due to the fact that company made huge gain of 258m on its pension fund invested in past(I.e. Exceptional Item) which is makes up 7.5% of gross profit.

However gain was one off item as the GPM decrease in 07/08 to same level as in 05/06 that is 7.67% another reason for this decrease is high rate of inflation. These results show that the Tesco is struggling in managing cost of production even though sales have increased over three years time interval but the cost of production increased in line with sales. The results are very critical because the Tesco have launched cost effective retail settings Tesco.com, Tesco online and cost control measure i.e. electronic checkout till and efficient supply chain mechanism that it claims directly linked to store shop floor shelves but the financial result are adverse to its claims to reduce cost.

Whereas Gross profit margin of Sainsbury is saturated over time period it was 6.64% in 05/06 which increased to 6.83% in 06/07 and gone down to 5.62% in 07/08. The sales revenue was in it is peak in 07/08 the sale increased 3.80% over the year as compare to the production cost which increased to 5.10% which indicates that Sainsbury is struggling to maintain its low cost of production thereby suffering.

Overall, on the grounds of reason mentioned above it is clear that Tesco is attaining high gross margin than Sainsbury overall and in all periods

3.1.2. Net Profit Margin

The net profit margin was 4.01% in 05/06, which increased to 4.41% in 06/07 the main reason for this is increase in gross profit as these two ratios are directly related to each other. Other reasons are as follow; in the same year, company discontinued one of the J.V operations and dispose its share from one of the associates, which gave rise to profit of $106m, & 25m, which makes 5.6% and 1.33% of net profit. These transactions were made partly in order to pay some of the shorterm loan, which decrease finance cost by $25m, and partly to invest in other companies in order to gain the control. As shortterm loans are expensive source of finance reduction in the fiancé cost supported by increase of 1.3% in net profit.

The net profit was increased in 07/08 by 0.09% to 4.50% the main reason for this is increased sales revenue 9.80% over a year. Other reasons being are as follow: corporation tax has reduced 99m over the year due to prior years adjustment i.e. change in tax rate, more deferred tax assets, foreign exchange movements, pension and etc. Another reason being as property related profit increased 96m that makes up 4.5% of net profit.

Despite of these all factors the net profit margin is low. It may be due the reduction of profit share with join ventures and payment of insurance claims to customers.

Sainsbury net profit over the three-year period has significantly improved. The net profit margin was .36% in 05/06 that improved to 1.89% in 06/07 the reasons in increase are as follow; increased sales revenue, reduction in admin cost, increase in other as well as finance income. However, Sainsbury did not maintain or improved over the year in 07/08, as it was slightly down to 1.84% the main reason for this even though the sales and operating profit was improved but loss in J.V of 2m and increased finance cost of 25m caused it to be lower than previous year.

3.1.3. Return on Capital Employed

This ratio is key measure of return. it measures the amount of earnings from capital provided by shareholders and lender. The ROCE was 15.15% in 05/06 that increased to 15.90% in 06/07 as operating profit increased by 13.9% and the capital employed has also increased by 9.7% the increase in the capital employed is due to issue of new share capital, increase in non- current liabilities, and massive Increase in the deferred tax liabilities. Eventhoug capital employed has increased but it did not increase inline with the operating profit that is also another reason for increase in capital employed. The ROCE in 07/08 has declined to 14.02% despite increase in operating profit of 5.1% and increase in capital employed 19.5%. The main reason for increase in the capital employed are as follow; issue of new share capital worth £3m, which also give rise to share premium of £135m, share based payment worth £199 massive foreign exchange and pension gains etc. Increase in the capital employed is not in line with the increase in operating profit however this increase in the capital employed will be beneficial in order to generate more operating profit as it has already started to show its effect i.e. increase in property related profit is classic example.

Comparatively Sainsbury ROCE has fluctuated over the three years period. ROCE in 05/06 was 2.89% well below than Tesco but well above than it previous year where it was negative it has improved to 7.59% in 06/07. The main reason as sales have improved over the year and company also saved £170m admin cost that shows they are managing cost well and capital employed over the year has decreased to £1082m that is 15.8% mainly due to payments due to Sainsbury bank and other banks. The ROCE in 07/08 has again decreased to 7.06% as the capital employed has increased due to the massive gain from the pension benefits and increase in provision of deferred tax that has to settle in future. Overall, Tesco results are far more better than Sainsbury.

3.1.4. Return on Equity

The return on equity is continuously increasing and has increased by 6.2% over three years and is higher than Salisbury but results are still not remarkable. This is mainly because of repurchase of share equity in the market not because of profitability. The Tesco is pursing the policy to buy back the share from the income coming from the release value of properties.

3.2. Market Ratio

The market ratio I have used for my analysis are as follow: Earnings Per share, Dividend Per Share and Interest Cover.

3.2.1. Earning Per Share

This ratio determines portion of company profit allocated to the each share. EPS is one of most important variable factor in determining the share price. The EPS of Tesco has been increasing since 2006. The EPS is in year 05/06 was 20.07p it has gone up to 23.84p in 06/07 followed by 26.95p in 07/08. Better profits over the years have increased the EPS another reason for increased EPS in 07/08 as Tesco bought its own share which increase EPS by 11.5%. Sainsbury have performed very well over the three years and increase EPS 82% over 3 year as Sainsbury profit has increased significantly over the three-year period due the reason such as increase in gross profit, net profit etc. Sainsbury net profit margin has increased 80.4% over three years period. Overall, The result indicates that the EPS of Tesco share high than industry benchmark.

3.2.2. Dividend per Share

The dividend per share of Tesco increases every year since 2006. In the year 2006, the dividend was 8p in the year 2007 9p and in year 2008 10p. It indicates that the increase in Tesco profitability positively impact on dividend per share. Another reason for increase in 07/08 as Tesco buy back its on share which directly impact on ratio. Dividend per share On the other hand paid by Sainsbury are for same 05/06 and 06/07 of 8p but has increased in 07/08 to 10p which clearly indicates that it wants to pay same amount of dividend as per its competitor in order to attracts more shareholder.

3.2.3. Interest Cover

Tesco has sustainable proportion of profit to cover interest. This is mainly because of stable external borrowing and realization of growth investment in diverse products and markets. This was 10.27% in 05/06, which increased to 13.28% in 06/07 and decrease to 12.21% in 07/08. the reason for decrease in 07/08 as PBIT increase by 6% as compare to interest paid which was 13.6% The performance is quite better and stable than Sainsbury.

3.3 Liquidity Ratio

Liquidity ratio informs the ability of Tesco to meet its short term liabilities and includes current and acid test ratio.

3.3.1. Current Ratio

The current ratio of Tesco is increasing over the time and indicates improving ability of Tesco to have liquid funds to repay short term obligation but it is lower than Sainsbury. The performance is better in a way that since 2006 the Tesco have grown 0.09 form 0.52 to 0.61 but still lower than ideal ratio of which is 1:1. Whereas Sainsbury who have declined from 0.88 to 0.66 which indicates that Sainsbury ability to meet its short term obligation is decreasing. Tesco is strengthening its liquidity power.

3.3.2. Quick/Acid Ratio

The quick ratio has increase to 0.38 in 2008 from 0.32% of 2007, which was 0.01 low to 2006. The maintenance of cash and banks is almost according to benchmark competitor but need to be strengthened.

3.4 Leverage Ratios

The leverage ratio is being applied to measure risk factor of Tesco and these includes total debt equity ratio, long term debt equity ratio and interest cover.

3.4.1. Total Debt Equity

The ratios of debt to equity have increased in 2008 to 68% that was 60% in 2006 followed by 59% in 2007. The change is not critical because it is the effects of equity buy back that have decreased the equity value. It is also justifiable because Tesco is enjoying lower cost of debt than cost of equity. It will readjust when the Tesco will launch free share option for its employee.

3.4.1. Long-term Debt Equity

The results illustrate similar progress to total debt to equity but more precisely describes the impact equity buy back. The Tesco still have the opportunity to raise fund through external borrowing without critical leverage.

3.5. Efficiently Ratios

Efficiency ratio ratios are used to map to performance to mange stocks, debtors and assets of the Tesco. It includes the debtor turnover ratio, stock turnover ratio, debtor days, stock days, creditor days, net assets turnover and fixed asset turn over.

3.5.1. Debtor Turnover & Days

Debtor turnover and days are directly related to each other i.e. if one goes up second will go up as well vice versa. The debtor turnover was 44.23T in 05/06, which indicate that debtor days were less, 39.52T in 06/07 and in 07/08 36.08T that is reason in 07/08 on average each customer, took 10.12 days to pay debt. The ratio has moving trends over the time. On the other hand debtor turnover of Sainsbury have increase from 05/06 of 58.19T to 86.59T in 2008, which indicates Sainsbury is able to convert its debtors into cash frequently and enjoying having cash benefit as its debtors day have reduced from 6.27D to 4.22D. It is found that Tesco Debtor management need improvement and the debtor days are critical and need to be minimised.

Debtors Days

Debtors Turnover

3.5.2. Stock Turnover & Days

These two ratios also directly related to each other as Debtor turnover and days. This ratio informs how many times the Tesco convert stock in to sales revenue. The stock turnover ratio has decreased since 2006 that is reason why stock days for Tesco have increased over the period. As turnover was 24.88T in 05/06, therefore the days were less. It was 20.40T in 06/07 and 17.97T in 07/08, which increases the days to 20.44. Whereas the stock turnover & days ratio of Sainsbury is significantly better than Tesco in all years. Inefficient stock control not only increases the storage and handling costs but also waste which impact on overall profitability.

Stock Turnover

Stock Days

3.5.3. Creditor Days

The creditor ratio informs the ability of Tesco to settle its creditors. It is found that the Tesco creditor days are increasing over the year but always less than Sainsbury. In 2006 the creditor days was 28.47 days, in 2007 30.97 days and in 2008 32.90. This will improve the credibility Tesco to purchase competitively than its competitors. Keeping in view of early payment to creditor it can get competitive purchasing price that help it to over good cheaper in the marketing or attain higher margin.

3.2.4.6. Net Asset Turnover

The net asset turnover ratio informs Tesco assets ability to generate sales. It is found that net asset turnover ratio is in 2006 is 2.62, in 2007 is 2.56 and in 2008 is 2.38. The ratio has been decreased in 2008. This reflects the impact of heavy investment made by the Tesco on store refurbishment, electronic tills and infrastructure. The performance is almost equal to Sainsbury.

3.6. Evaluation of Future Prospects and Strategy Analysis

3.6.1. Competitive Strategy

The Tesco aims to deliver maximum value and choice to customer to attain their life time loyalty. According to my analysis the Tesco is pursing hybrid strategy simultaneously is struggling to achieve low price and differentiation relative to competitors i.e. Wall Mart-ASDA and Sainsbury but influence of low cost is very high than differentiation. It has launched its low cost brand Tesco value, price discount but on the other hand have premium brand i.e. Tesco Finest. The Tesco declares itself as “discounter”. The underpinning of Tesco competitive is a relentless attitude lowest cost provider of goods and services to be successful in world’s most competitive markets.

Porter Generic Competitive Strategy Presentation of TESCO

Competitive Advantage

Efficiency

Quality

Competitve Scope

Brand Market

Low Cost

TESCO

Differentiation

Narrow Market

Focus

Cost

Focus

Differentiation

3.6.2. Growth Strategy

The Tesco is pursing consistent strategy since 1997, which strengthen its core UK business and help to drive expansion into new product line and international markets. According to the Ansoff Matrix presentation, the Tesco is operating in all three extremes. It has introduced Non food, Tesco online retailing, launched personal finance, Insurance and enter in telecommunication sectors. The have entered into 12 international markets.

Ansoff Matrix Presentation of Tesco Growth Strategy

Existing Products

New Product

Existing

Market

Market Penetration

UK Core (Grocery)

Product development

Non-Food

Tesco Online

Personal Finance

Insurance

Telecom

New

Market

Market Development

12 International

Markets

Diversification

The grocery business of Tesco is the largest contributor of its revue to £51.8bn which is 40% of total sales, Asia 29% and Europe 25%. Intern