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Financial Statement Analysis For Business

Table of Contents

Introduction.

Woolworths Success or Failure.

Company’s business structure.

Woolworths: SWOT Analysis.

Valuation.

Conclusion and Recommendation.

Reference.

Introduction to Financial Analysis

Woolworths Group is a major Australian company that is operating the business of retailing in countries majorly including New Zealand and Australia. It is the 2nd largest Australian company by revenue after Wesfarmers. Also, it is the largest retailer of liquor goods in Australia. Woolworths operates and manages supermarkets, procurement of food and liquor products, and general merchandise consumer stores. The group is also operational in the hotel and hospitality industry, the services include accommodation, pubs and gaming operations. Woolworths Group is a recognizable Australian brand, and the company owns various other well-established and well-known brands including Dan Murphy's, BIG W, and BWS (Woolworth, 2020).

Woolworths Group was founded in 1924 and its shares were first listed during 1993. The group since then has shown great progress and has become one of the largest ASX’s listed companies. The shares of Woolworths Group are generally considered to be defensive investments, as its share price has shown substantial buffer against the economic depressions. The main reason remains the nature of its primary business activities which primarily includes the items and products that are essential. And that is the reason that even in economically tougher situations for the country and the world which includes Corona Pandemic, the company will possibly grow, because there will always be a demand for essentials including food products, toiletries, etc.

The report will conduct a financial analysis of Woolworths to determine the financial health of the company. Detailed ratio analysis will be performed which measures the liquidity, profitability and efficiency of the company. In the later sections, the report will determine the reasons behind the success or failure of Woolworths, its global and countrywide positioning and make justifications using a SWOT analysis.

Financial Analysis

Every investment decision whether made in any security requires preplanning and a little research, it will help in evaluating the returns that are going to be generated from the particular investments. It also determines the level of risks the investor is exposed to. In simpler words, acknowledgment about the risk-return measures will result in the most beneficial investment decisions (Schroeder, Clark & Cathey, 2019).

A ratio analysis compares various items of financial statements of a company including income, position, and cash flow statements. It can be used to evaluate various measures like profitability, liquidity, efficiency, and capital structure ratios. The ratio analysis is not able to provide relevant and material information if conducted in isolation, therefore it is required to conduct a comparative ratio analysis which can be done internally with the periodical figures of the company, it can be compared with the peer competitor companies and the comparison can be done with the industry average.

Table 1: Woolworths: Ratio Analysis

Ratio Name

Formula

2019

2018

Industry Average

Liquidity Ratios

Current Ratio

Current Assets / Current Liabilities

0.71

0.78

0.81

Quick Ratio

Cash Equivalents + ST Invest + Accounts Receivables / Current Liabilities

0.20

0.19

0.30

Operating Cash Flow Ratio

Operating Cash Flow / Current Liabilities

0.33

0.33

NA

Source: (Woolworth, 2020)

Woolworths Success or Failure

Company’s Business Structure

The business structure of Woolworths is the key reason behind the achieved success and the reason that it will continue the success graph. Woolworths Group is primarily engaged in the business of retailing throughout New Zealand and Australia. The typical business of the company is operating supermarkets, general merchandise consumer stores, and procurement of liquor and food products, thereby, comprising largely essential items and precuts. The shares of Woolworths Group are generally considered to be defensive investments as its share price has shown substantial buffer against the economic depressions due to the nature of its primary business activities which mainly includes essential items and products, and even in an economic downturn like the country and world is going through, there will be a huge demand for essentials like food products, toiletries, etc (Gabric, 2018).

Woolworths: SWOT Analysis

Strength

· Strong Brand Portfolio: Woolworths has built a strong brand image and portfolio over the years. It helps the organization in expanding into new categories of products.

· Automation of activities: It brings consistency in the quality of services and products and enables the company to adjust based on the demand in the market (Gürel & Tat, 2017).

· High returns on capital: Woolworths has remained relatively successful in executing various new projects which helped it in generating higher returns on capital by creating new revenue streams.

Reliable suppliers: Woolworths has created a strong base of suppliers for raw and finished material. The company, therefore, can overcome the bottlenecks in the supply chain.

Weakness

· The product range offered by the company is limited and has huge gaps. It can provide a foothold to its competitors in the market.

· The business structure is compatible with just the prevailing business model and limits the expansion in other product segments.

· Limited success outside core business: Woolworths is a leading business in its industry but has faced challenges and failures in other product segments (Woolworth, 2020).

· Also, the company's business is majorly limited within the territories of Australia and New Zealand

Opportunities

· New market exposure after government agreement: Government free trade agreement and the adoption of new technology standards have provided the company with huge opportunities to enter into the emerging markets.

· The new taxation policy: It can highly impact business operations and increase profitability (Jalbert, 2017).

· Economic uptick: It will lead to an increment in customer spending. The country is going through a slow growth rate in the industry and recession. If the economy grows then Woolworths can make new customers and enhance its market share.

Threats

· Global Economic Slowdown and Corona Pandemic: The possibility of an economic recession in the global market which is going to be enhanced due to the Corona pandemic is going to highly affect the growth of the company.

· Lack of innovative products: The company continuously develops new products but in response to the counter other players. Also, the supply of such newly developed products remains irregular which results in low and high swings in the sales volume over a period of time (Pierson & Thompson, 2015).

· The rising cost of raw material can result in a bigger threat to the profitability of the Woolworths Group.

· The company has been facing various lawsuits in the markets of operations. The difference in laws and fluctuations of the product standards can cause problems.

Valuation

The valuation of the Woolworths Group will be conducted using 2 methods as follows

  1. Screening Analysis and
  2. The Discounted Cash Flow Model

 Screening Analysis: In this analysis, a valuation ratio called price to earnings (or PE) ratio that is calculated by dividing the current market price (P) of the company with the net earnings generated by the company for each individual outstanding share (E or EPS) will be calculated. We will compare the PE ratio with the industry average to determine the valuation of the company.

Ratio Name

Formula

2019

2018

Industry Average

The Price Earnings Ratio

Market Price / EPS

25.17

24.42

21.58

Dividend Yield Ratio

Dividend per share / Market Price

3.1%

3.0%

5.27%

 Dividend Yield: It determines the amount a company is paying out in dividends per year concerning its share price. The average dividend yield prevailing in the industry is 5.27 %, where Woolworths's dividend yield is just 3.1 % for FY 2019 which is less than 2 %. This means that the company is paying a very lower dividend to the shareholders of the company or the share price of the company is very high, both the factors are not in the favor of investing in the company.

As per the above calculations, the PE ratio of WOW for FY 2019 comes out to be 25.17 times, which has increased from 24.42 times in 2018. It might happen due to two reasons: 1) the price could have increased and 2) the earnings could have decreased. Upon detailed study of the income statements, balance sheet and historical price data of WOW, it has been found that both market prices and earnings have increased, but since prices increased at a higher rate than earnings, there is an increment in the PE ratio.

The PE ratio of 25.17 times of WOW indicates that an investor to claim in the company’s earnings of a single dollar, it has to pay AU$ 25. WOW has a higher PE ratio which indicates that investors have to pay higher price as compared to other companies of the industry. In other words the stock of Woolworths is overvalued as per screening analysis (Woolworth 2020).

The Discounted Cash Flow Model: Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment based on its future cash flows. The purpose of DCF analysis is to estimate the money an investor would receive from an investment, adjusted for the time value of money. Discounted Cash Flow (DCF) analysis is an intrinsic value approach where an analyst forecasts the business’ unlevered free cash flow into the future and discounts it back to today at the firm’s Weighted Average Cost of Capital (WACC).

DCF = FCF1 / (1 + r) 1 + FCF2 / (1 + r) 2 +…………. + FCFn / (1 + r) n

Where:

  • FCF = Free Cash Flow in the Period
  • r = the discounting rate, WACC in the case of equity valuation (calculation of WACC is given below)
  • n = the period number

Calculation of WACC:

Particulars

Source & Calculation

Figures

Risk-Free Rate (Rf)

10-Year AU Govt Bond Rate

2.26%

Equity Risk Premium (Rm - Rf)

S&P Global

6.00%

Beta

S&P Global

0.8

Ke

Rf + beta * (Rm - Rf)

Ke

7.06%

   

Kd

Finance cost / Total debt

Kd

4.73%

 

Capital Structure

Total Equity

10101

Total Debt

2855

 Total Capital

12956

Capital elements

Weights

% of equity

78%

% of debt

22%

 

WACC (Kd = 7%)

Ke

7.06%

Kd

4.73%

We

78%

Wd

22%

Tax rate (t)

30%

WACC

(Ke * We) + Kd * (1-t) * Wd

WACC

6.23%

Calculation of Intrinsic Value:

WACC

6%

As per Calculations

terminal growth rate

2.3%

10-Year AU Government Bond Rate

Tax Rate

30%

Average Corporate Tax Rate

 

YEARS

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

1

2

3

4

5

6

7

8

9

10

A. FCF

1,245

1,516

1,787

1,960

2,109

2,222

2,321

2,409

2,489

2,564

B. Discount Factor

0.941

0.886

0.834

0.785

0.739

0.696

0.655

0.616

0.580

0.546

FCF (PV) (A * B)

1172

1343

1491

1539

1559

1546

1520

1485

1445

1401

 

Total PV

14,501

sum of PV

PV for terminal value

[FCF10 * (1 + g)] / (Ke - g)

PV for terminal value

36,432

perpetuity growth

Total PV

50,933

(sum of PV) + (perpetuity growth

net debt level

2,855

 

Enterprise Value

48,078

total PV - net debt level

shares outstanding

1,314

 

value of equity of shares

$ 36.60

value of equity/shares outstanding

Current Market Price = $36.370 (as on June 29)

As per the DCF valuation of the company, it can be stated that the company is fairly valued because the stock of Woolworths (WOW) is trading at $ 36.370 which is very close to the fair price of the stock of $ 36.60.

Conclusion and Recommendation on Financial Analysis

In this report, the overall analysis of the financial health of Woolworths Group Ltd has been conducted and a valuation of their share prices. The analysis has been conducted in detail using regressive ratio analysis valuation of the fair price using scenario analysis and DCF model. The company looks financial healthy and also it is growing YOY, especially due to the Corona Pandemic, it is one of the few business models that were able to successfully survived due to the nature of the business. WOW has generated optimum levels of earnings which are increasing year on year. From the analysis of the capital structure of WOW, it has been discovered that the company has very low levels of debt pools as compared to the industry average or other peer companies which further indicates that the company also has lower obligations towards fixed interest payment. The valuation of the company seems to be fairly valued and the company can be bought for a long term perspective.

Reference for Financial Analysis

Campbell, J. L., D'Adduzio, J., Downes, J., & Utke, S. (2019). Do investors adjust financial statement ratios when financial statements fail to reflect economic substance? Evidence from cash flow hedges. Evidence from Cash Flow Hedges (April 2019). 

Cucchiella, F., D’Adamo, I., & Gastaldi, M. (2015). Financial analysis for investment and policy decisions in the renewable energy sector. Clean Technologies and Environmental Policy, 17(4), 887-904.

Fortune (2020). Fortune 500. Retrieved from https://fortune.com/fortune500/

Gabric, D. (2018). Determination of accounting manipulations in the financial statements using accrual based investment ratios. Economic Review: Journal of Economics and Business, 16(1), 71-81.

Gürel, E., & Tat, M. (2017). SWOT analysis: a theoretical review. Journal of International Social Research, 10(51).

Jalbert, T. (2017). A Model for Forecasting Small Business Financial Statements and Firm Performance. Business Education & Accreditation, 9(2), 61-84.

Pierson, K., Hand, M. L., & Thompson, F. (2015). The government finance database: A common resource for quantitative research in public financial analysis. PloS ONE, 10(6).

Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial accounting theory and analysis: text and cases. New Jersey: John Wiley & Sons.

Woolworth (2020). Annual Report 2019. Retrieved from https://www.woolworthsgroup.com.au/icms_docs/195582_annual-report-2019.pdf

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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