FFMA Morrisons 2 - Detailed Analysis of Financial statements of last 3 years PDF

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Detailed Analysis of Financial statements of last 3 years...

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Masters Programmes Assignment Cover Sheet Submitted by: 2083107 Date Sent: 15th December 2020 Module Title: Foundations of Financial and Management Accounting Module Code: IB9AXM Date/Year of Module: 2020-21 Submission Deadline: 15th December 2020 Word Count: 12 Number of Pages: 1729 words Question: So far, you have had some ideas of Morrions' recent performance from your first reflection note. You should be aware that Morrisons officially publishes its full annual results between March and May each year, a few months after its fiscal year end. It also publishes Q1 and interim results. This follow-up reflection note requires you to critically examine Morrisons available financial information and discuss its potential full year results 2020/21 ahead of its release.

“I declare that this work is entirely my own in accordance with the University's Regulation 11 and the WBS guidelines on plagiarism and collusion. All external references and sources are clearly acknowledged and identified within the contents. No substantial part(s) of the work submitted here has also been submitted by me in other assessments for accredited courses of study, and I acknowledge that if this has been done it may result in me being reported for self-plagiarism and an appropriate reduction in marks may be made when marking this piece of work.”

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2083107 The global disruption caused by Covid-19 has brought about a variety of changes in consumer behaviour, accelerated new market trends and pushed businesses harder than usual. In consumption, frugality became the norm and, while one would consider grocery shopping to be a necessity, the results show otherwise. Consumer confidence levels also reached rock bottom at the onset of the pandemic (Figure 1). What is more, as soon as economic conditions started to improve, a second wave combined with Brexit’s uncertainty, pushed the business environment back to where it was before the recovery. WM Morrison Supermarkets plc (hereinafter Morrisons), the fourth largest supermarket in UK, has seen similar effects on its financial performance. The three years leading up to 2020 were showing an upward trend, thanks to the success of its restructuring program – “Fix, Rebuild, Grow and Sustain” strategy, – when the pandemic aberrated the growth trajectory. Time will be needed for an overall recovery, especially in terms of financial numbers.

Figure 1: GfK UK Consumer Confidence from December'19 to November'20

DuPont Analysis Morrisons’ upward graph is showcased by a 30 bps (0.3%) bump in Return on Equity (ROE) from 2017/18 to 2018/19 and maintenance of, approximately, the same level in 2019/20 (Table 1), which evidenced a slowdown in growth and sales for the industry. This is due to a combination of factors: larger base, Brexit, and elections. Both Net Income (NI) and Shareholder’s Equity (CSE) have gone up during 2017-20, which suggests that the growth in NI is higher and reflective of its restructuring program.

ROE can be analysed and broken down into Return on Capital Employed {ROCE – Earnings before Interest & Tax (EBIT)/Capital employed (CE), Interest burden (EBT/EBIT),

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2083107 Tax burden (NI/EBT) and Leverage (CE/CSE)}. ROCE can be further broken down into EBIT Margin (EBIT/Revenue) and Operating Asset turnover (Revenue/CE).

A deep dive into Morrisons’ ROE shows that ROCE, and in particular EBIT, has been the primary driver responsible for the increase in ROE. ROCE has increased by 10.2% (6.69% to 7.37%) in the two-year period from 2017/18 to 2019/20, which has been driven by a 13.5% increase in EBIT (from 2.58% to 2.93%). This increase in EBIT is reflective of the cost efficiencies that the firm has achieved in its restructuring program, particularly Cost of Sales [COS] – which is down 20 bps in these two years (Common Size – Appendix Table 7). Operating Asset turnover, that is, amount of revenue generated per pound of CE, has dipped marginally because of the dual effects of drop in revenue in 2019/20 and increase in CE over the years.

The firm has maintained similar Net Debt levels across these two years while continuing to increase the CE with fresh equity infusion. Although this has increased the cost of capital, it has resulted in lower leverage (CE/CSE) and Interest Burden (EBT/EBIT) for the firm, thus also helping in improving its bottom line (9% increase in NI from £374 million in 2017/18 to £408 million in 2019/20). Hence, the firm has also been able to pay higher progressive dividends in line with its capital allocation framework. The tax burden for the firm has remained consistent over this period (23% to 24%). Industry wide, Morrisons has outperformed Sainsbury but still lags substantially behind Tesco, the market leader, in terms of ROE and real returns. DuPont Analysis Particulars 19/20 18/19 (restated) ROE = Underlying Net income/Closing CSE 6.91% 7.01% Net Debt # 2416 2421 # Borrowings + Lease liabilities - Cash & Cash Equivalents Closing Shareholder's equity (CSE) 4541 4325 Capital Employed (CE) 6957 6746 ROCE = EBIT/CE EBIT EBIT Margin Operating asset Turnover ROCE Check

7.37% 513 2.93% 2.52 7.37%

7.56% 510 2.88% 2.63 7.56%

Interest Coverage 4.62 4.25 EBT/EBIT 0.80 0.78 Net income/EBT 0.77 0.77 Leverage 1.53 1.56 ROE Check 6.91% 7.01% Table 1: DuPont Analysis for Morrisons from 2017/18 to 2019/20 3

17/18 6.71% 2403 4250 6653 6.69% 445 2.58% 2.59 6.69% 5.71 0.84 0.76 1.57 6.71%

2083107 Ratio Analysis Investment management ratios – Operating Asset turnover and Capex turnover – have both followed a similar trend, with an improvement in 2018/19 and a minor dip in 2019/20. Operating Asset turnover has dipped in 2019/20 due to a significant bump in capital employed – depicting a larger base (mostly due to higher retained earnings) – and due to reduction in sales, which were affected by the plethora of factors mentioned above. Although Capex turnover has decreased (Appendix Table 5), it shows us that management has continued to invest in capital expenditure (Plant, Property and Equipment and Goodwill) despite flagging sales. This Capex strategy provides an insight into the management’s confidence in the business and bodes well for the future. The company has continued to invest in Capex at a consistent rate of 3% of turnover.

CAPEX - as % of revenue H1 20/21 19/20 18/19* 17/18 Purchase of P,P,E 162 429 381 429 Purchase of Intangibles 38 81 77 71 Total 200 510 458 500 As % of Revenue 2% 3% 3% 3% Table 2: Morrisons Capex from 2017/18 to H1 2020, as a % of revenue

Working Capital Management ratios and Cash conversion cycle tells us that Morrisons has improved in this aspect. Better management of Inventory has reduced the number of days it is held up from 15.27 in 18/19 to 14.29 days in 19/20. The company has also negotiated better arrangements with its creditors and used them to finance its short-term needs, as is evidenced with a payable’s payment period of 66.28 days. However, the collection period from debtors has worsened significantly (by 41% from 5.22 to 7.35 days) and the firm will have to take steps to address this issue.

In liquidity terms, the company has maintained the status quo. Current ratio has remained around 0.4 and quick ratio has remained constant at 0.19. It is usual for the supermarket industry to have lower current assets compared to liabilities, as they collect quicker than they pay. However, these ratios seem to be well under par compared to the industry leaders – Tesco and Sainsbury – who have considerably better short-term solvency ratios. Even in terms of long-term solvency (Debt Equity ratio), although Morrisons’ ratio seems to be better at 0.6, Tesco and Sainsbury take that additional risk with extra debt and generate higher returns (Table 3).

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Ratios in 19/20 Current Ratio [CA/CL] Acid Test Ratio [(CA-Inventory)/CL] Debt to Equity [(Borrowings + Lease liabilities)/CSE]

Tesco 0.72 0.58 1.29

Sainsbury 0.63 0.49 0.91

Morrisons 0.39 0.19 0.60

Gross Profit Ratio Operating Profit/EBIT Ratio

7.55% 4.64%

7.91% 3.40%

3.88% 2.93%

Net Profit Ratio 2.36% 1.51% Table 3: Solvency and Profitability Ratios for Tesco, Sainsbury and Morrisons

1.79%

H1 2020 & Impacts of Covid-19 Buoyed by panic buying and lockdown, take-home grocery sales have grown at the fastest rate since records began in 1994. However, at the same time, UK shopping habits have changed as the British have adopted their lifestyle to accommodate restrictions. According to a consumer survey by the consultancy firm McKinsey & Company, 16% of Brits have changed their primary grocer since the onset of the coronavirus crisis; among these shoppers, 41% switched to find a less crowded store, while a quarter said that they needed to find cheaper prices (The Grocer 2020). This has led to an increase in revenue for the discounters: Aldi and Lidl (Kam City 2020), for they could provide cheap prices; and the bigger supermarkets: Tesco and Sainsbury, for they could accommodate social distancing guidelines comparatively better and allowed the consumers to shop in bulk.

H1 20/21 Tesco

26,266

Retail Revenue H1 19/20 24,296

Trend

H1 20/21

7.50% ↑

1192

Profit Before Tax H1 19/20 1142

Trend 4.38% ↑

Sainsbury 14,836 13,856 7.07% ↑ 301 238 26.47% ↑ Table 4: Retail Revenue and PBT for Tesco and Sainsbury for H1 20/21 v H1 19/20

Morrisons is no exception to this trend and has seen its ex-fuel like-for-like sales grow by 8.7%. However, total sales have fallen by 1.1% due to a massive decrease in demand for fuel (sales down by 37.4%), as was expected because of the lockdown. The focus during the pandemic was on healthcare and feeding the country, while taking all necessary precautions. This required emergency stocking of all essential items and making masks and sanitizers available across the board. However, such stockpiling and arrangements had to come at a cost which is visible through increases in COS and operating expenses. The firm incurred £155 million in Covid-19 related direct costs in the second half. Further, new borrowings taken for improving liquidity have marginally increased finance costs. In total, Net Income was adversely affected (fall of 25.66% to £113 million), majorly due to higher lower-margin sales and closure of high-margin market street and café businesses. 5

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Cash flow from operations was also materially affected (down by 77% to £130 million). This was due to lower fuel demand and prices, immediate payment to multiple suppliers, extra discounts and inventory pile ups. Although cashflow from operations was negative after Interest and tax payments, the firm continued to invest in Capex (£200 million with plans to incur a further £325 million in H2 2020), in line with its Capex strategy. This, however, means that, going forward, the firm will have to generate enough cashflow from operations to pay off the debt. Otherwise, they risk getting its debt money stuck in long term assets, thereby leading to sustained levels of increased finance costs.

In addition to the costs associated to Covid-19, it also created adverse business and supply chain problems for the supermarket industry. According to the House of Commons (2020) committee, due to measures to control the spread of the virus, the supermarkets, initially, ran out of essential foods at a rate faster than what the suppliers could cope up with. This was partly because consumers lacked clarity about the quantities needed to be bought. Thus, disrupting the entire supply chain ecosystem. Morrisons had to respond to this and make additional investments, as it looked to tighten its supply chain and work more collaboratively with its suppliers to make complex decisions (Essential Retail 2020).

Figure 2: Which products were most difficult to buy during the Covid-19 pandemic?

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2083107 Furthermore, the pandemic has also accelerated new trends of online shopping and food delivery as is evidenced by the increase in searches for “Food delivery” (Figure 3). This has meant additional investments to ramp up IT infrastructures, accurate stocking and distribution systems and safety measures for delivery staff. Failure to quickly set up these systems would have led to lost sales to competitors and e-commerce platforms. Morrisons, thus, scaled up its online food play by partnering up with Amazon and expects to start same day delivery ‘Morrisons on Amazon’ service by H2 2020.

Figure 3: Google Searches for 'food delivery' hit a record high in April

Outlook Morrisons’ interim report highlights the scale of damage that Covid-19 has had on its business. Moreover, with the second wave and tiered lockdowns ruling the second half of the year, the results for H2 2020 and, consequently, the full year paint a dull picture. Sales for fuel do not look like they will be nearing normal levels anytime soon and increased competition from the likes of Aldi and Lidl will challenge the firms pricing strategy, thereby affecting its already low margin figures. Increased debt levels and lack of excess cash from operations to repay debt mean that finance costs for the short to medium term will continue to remain higher than normal and put further downward pressure on margins. Furthermore, additional Covid19 costs and Morrisons’ decision to give up on business rates relief (amounting to £274 million) offered by the government, following Tesco’s suit (FT 2020), is likely to have an adverse impact on its full year income statement.

Although results for H2 2020 appear to be grim, the business has a lot of potential and is still profitable. The firm’s balance sheet is extremely robust with the lowest debt levels 7

2083107 among the top 4 supermarkets. Moreover, with continuous emphasis on modernising stores, opening new stores, and establishing partnerships, such as with Amazon – the biggest ecommerce platform in the UK as of 2020 (Disfold 2020), – Morrisons can continue to close the gap on the top 3 supermarkets: Tesco, Sainsbury, and Asda.

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Appendix

Figure 4: Morrrisons Balance sheet and DuPont Analysis, along with Industry leader's ROE Ratios

19/20

18/19*

17/18

2.52 1.83

2.63 1.91

2.59 1.88

14.29 7.35 -66.28 -44.64

15.27 7.08 -65.66 -43.31

15.06 5.22 -63.84 -43.56

0.39 0.19

0.40 0.19

0.41 0.19

0.60

0.62

0.64

3.88%

3.92%

3.67%

Operating Profit/EBIT Ratio 2.93% 2.88% Net Profit Ratio 1.79% 1.71% Table 5: Ratio Analysis for Morrisons from 2017/18 to 2019/20

2.58% 1.65%

Investment management (Efficiency) Operating Asset Turnover Capex Turnover Working Capital Management Inventory holding period [(inventory/cost of sales)*365] Receivable collection period [(Receivables/sales)*365] Payable Payment period [(payables/purchases#)*365] Cash Conversion Cycle Liquidity Ratios Current Ratio [CA/CL] Acid Test Ratio [(CA-Inventory)/CL] Solvency Ratio Debt to Equity [(Borrowings+Lease liabilities)/CSE] Profitability Ratios Gross Profit Ratio

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2083107 # Calculation of Purchases 19/20 COGS 16855 (+) Closing Inventories 660 (-) Opening Inventories -713 Purchases 16802 Table 6: Calculation of Purchases for Ratio Analysis

Income Statement Particulars

Year (Underlying)

18/19* 17039 713 -686 17066

Trend %

17/18 16629 686 -614 16701

Common Size Analysis

19/20

18/19*

17/18

16/17

19/20

18/19*

17/18

19/20

18/19*

17/18

Revenue

17536

17735

17262

16317

-1.12

2.74

5.79

100.00

100.00

100.00

Cost of sales Gross profit

-16855 681

-17039 696

-16629 633

-15713 604

-1.08 -2.16

2.47 9.95

5.83 4.80

-96.12 3.88

-96.08 3.92

-96.33 3.67

Other operating income P/L on disposal of properties

94

88

78

76

6.82

12.82

2.63

0.54

0.50

0.45

0

0

0

32

Administrative expenses Operating profit or EBIT

-262 513

-274 510

-266 445

-244 468

-4.38 0.59

3.01 14.61

9.02 -4.91

-1.49 2.93

-1.54 2.88

-1.54 2.58

Finance cost finance income

-111 5

-120 5

-78 5

-160 15

-7.50 0.00

53.85 0.00

-51.25 -66.67

-0.63 0.03

-0.68 0.03

-0.45 0.03

Profit from joint venture Profit before taxation

1 408

1 396

2 374

2 325

0.00 3.03

-50.00 5.88

0.00 15.08

0.01 2.33

0.01 2.23

0.01 2.17

Taxation Profit for the year/Net Income

-94

-93

-89

-20

1.08

4.49

345.00

-0.54

-0.52

-0.52

1.79

1.71

1.65

314 303 285 305 3.63 6.32 -6.56 Table 7: Morrisons’ Income statement from 2016/17 to 2019/20

Income Statement Particulars

H1 20/21 H1 19/20 Common Size Revenue 8734 8831 100% 100% Cost of sales -8437 -8490 -96.60% -96.14% Gross profit 297 341 3.40% 3.86% Other operating income 45 44 0.52% 0.50% P/L on disposal of properties 0 0 0.00% 0.00% Administrative expenses -141 -133 -1.61% -1.51% Operating profit or EBIT 201 252 2.30% 2.85% Finance cost -57 -55 -0.65% -0.62% finance income 4 1 0.05% 0.01% Profit from joint venture 0 0 0.00% 0.00% Profit before taxation 148 198 1.69% 2.24% Taxation -35 -46 -0.40% -0.52% Profit for the year/Net Income 113 152 1.29% 1.72% Table 8: Morrisons’ Income statement for H1 20/21 V H1 19/20

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Trend -1.10% -0.62% -12.90% 2.27% 6.02% -20.24% 3.64% 300.00% -25.25% -23.91% -25.66%

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References Disfold (2020) Top 10 e-commerce sites in the UK 2020. [online] Available from: https://disfold.com/top-e-commerce-sites-uk/ (Accessed 12 December 2020). Essential Retail (2020) Morrisons tightens up its supply chain by sharing data. [online] Available from: https://www.essentialretail.com/news/morrisons-tightens-up-itssupply/ (Accessed 13 December 2020).

Financial Times (2020) Tesco to repay £585m in business rates relief. [online] Available from: https://www.ft.com/content/13444e6c-4ed4-48eb-a86d-552158b2c62b (Accessed 13 December 2020).

House of Commons Committee (2020) What effect did the coronavirus pandemic have on our food supply? [online] Available from: https://houseofcommons.shorthandstories.com/EFRA-covid19-foodsupply/index.html (Accessed 13 December 2020).

KamCity (2020) Discounters and Convenience Stores Make Biggest Gains During Record Period For Grocery Sales. [online] Available from: https://www.kamcity.com/namnews/uk-and-ireland/supermarkets/discounters-andconvenience-stores-make-biggest-gains-during-record-period-for-grocery-sales/ (Accessed 12 December 2020). Morrisons (2020)...