Executive Summary
This report presents the financial statement analysis for Country Road Limited (CTY) and the Reject Shop Limited (TRS) for two financial years alongside other significant information from the stock markets such as the stock price movements. Based on the analysis TRS is more risky than CTY, thus TRS is recommended for risk-taker while CTY is best for risk-averse.
Introduction
The Country Road Limited is listed on the Australian Stock Exchange (ASX) as CTY; it creates and sells quality home wares, associated accessories and apparel in New Zealand, South Africa and Australia (Asx.com.au, 2011). It provides “menswear, babywear, childrensware, womensware, gift wraps, tailoring and gift cards” (Asx.com.au, 2011). CTY retails its products to its market through 80 concession channels, an online retail store and 60 stores under the Trenery and Country Road brand names and via a subsidiary of Woolworths International Pty Limited; the firm was instituted in 1974 and is located in Richmond, Australia (Investsmart.com.au, 2011).
The Reject Shop Limited runs a discount store in the retail sector and serves a wide array of value-conscious clients in Australia who are concerned with products that are low priced in well located shopping stores that have potential to acquire good deals (Rejectshop.com, 2011). The company provides a broad assortment of common merchandise with specific concentration on; daily needs like “cosmetics, toiletries, individual care products, home-wares, basic furniture, hardware, kitchenware, snack food, confectionery and domestic cleaning products” (Asx.com.au, 2011). This is in addition to seasonal merchandise and lifestyle items such as wrappings and cards, leisure items, home decorations, seasonal gifts and toys; the Reject Shop Limited’s stock is traded at the ASX as TRS (Asx.com.au, 2011).
The main objective of this report is to analyze and interpret the financial ratios presented for the financial year 2009 through 2010 alongside other significant information and make a recommendation on the best company stock (CTY and TRS) to invest in.
Financial Ratios
Profitability
Profitability is usually measured by the profitability ratios; profitability ratios measures the management effectiveness as shown by the turnover generated on sales and investment (GoldmanSachs.com, 2011). This means that if a firm can be able to make a profit it will be able to meet its short term obligations and also pay dividends to its owners. The major ratios in this category include: net profit margin, gross profit margin, return on equity, and return on assets among others (GoldmanSachs.com, 2011).
Gross Profit margin
Gross profit margin measures the firm’s ability to control its cost of sales or production (GoldmanSachs.com, 2011); CTY’s Gross profit margin reduced by 1.36% to 58.16% in the year 2010 compared to 2009 as shown on Table1, this decrease was due to harsh times that were being experienced by the store particularly in the women’s wear and the impact of fall in housing market which deals with accessories and furnishings sector (Cummins, 2011). This decrease can also be explained by the increase in the cost of sales which reduced the profit margin meaning that CTY was inefficient in controlling its cost of sales as shown by the drop in the ratio. On the other hand, TRS’s gross profit margin increased by 1.76% to 46.95%, this was due to increase in income by 14.22% to $470.953 million in the financial year 2010 compared with year 2009. This implies that TRS was efficient in controlling its cost of sales as indicated by the increase in the gross profit margin. Additionally, CTY compared to TRS is performing better in terms of profitability keeping in mind that the higher the ratio the better the efficiency or profitability (GoldmanSachs.com, 2011).
Net Profit margin
This ratio measures the firm’s ability to control its cost of sales or production, operating and financing costs (GoldmanSachs.com, 2011). As shown on Table 1 CTY’s net profit margin decreased by 24.45% to 4.85% this was due to decrease in income and also increase in the costs or expenses of the firm. This implies that CTY was inefficient in controlling its costs of sales, operating costs and financing costs as shown by the reduction in the ratio by 24.45%. Conversely, TRS’s profit increased in the year 2010 compared to 2009; this means that the firm was efficient in controlling its cost of sales, financing costs and operating costs as shown by the increase in the Net Profit Margin by 0.58% in 2010 to 6.95% from 6.91%. Based on this TRS is more preferred than CTY since it has the highest ratio.
Return on Equity (ROE)
This measures the earnings attributable to owners of the firm with the book value of common shareholders’ investment in the business and measures the efficiency with which the firm uses owner supplied funds to generate return on equity or the common shareholders value; the higher the ratio, the higher the firm’s profitability (GoldmanSachs.com, 2011). CTY’s profitability dropped by 30.33% to 14.54% in the year 2010 compared to 2009 and the CTY’s inability to generate returns on shareholders’ value from owners’ supplied funds declined as well due to decrease in the profit of the company in 2010. TRS profitability as well as inability to generate returns to shareholders from owners’ supplied finances declined by 5.90% to 45.30%, this was due to decrease in the firm’s profitability by a huge proportion and TRS is therefore preferable than CTY because it has a higher ratio.
Return on Assets (ROA)
It measures the efficiency with which a firm uses capital employed to generate returns to the providers of funds; both equity and debt (Drake, 2009). In 2010, CTY was less efficient in generating returns to the providers of funds as shown by the drop in ROA by 10% to 13.97% compared to 2009. TRS’s ROA in 2010, decreased by 17.53% to 24.46% compared to 2009 implying that the TRS was inefficient in 2010 compared to 2009. The decrease in both companies was due to decrease in profitability of the company in the year 2010 but TRS is more preferred than CTY since it has a higher return on assets invested.
Efficiency
The efficiency ratios measure the effectiveness with which a firm uses its assets to generate turnover; they are also known as activity ratios/ turnover ratio since they indicate the rate at which assets are converted into sales (Drake, 2009). A balance of sales and the assets reflect that the assets are well managed (Drake, 2009). These ratios as shown by Table 2 show how efficiently a company has managed its short term asset and long term liabilities.
Asset Turnover
Asset turnover indicates the level of sales generated by the assets of the company and the efficiency with which a firm uses its assets to generate sales (Drake, 2009). In 2010, CTY generated 2.88 of sales from every dollar invested in assets, representing an increase of 19% compared to 2009; this was due to decrease in the assets during the year compared to 2009. While TRS asset turnover also decreased by 18.18% to 3.51 times in 2010 compared to 2009. TRS has a higher level of sales in both years compared to CTY, thus it is more preferred than CTY Company.
Inventory turnover
This ratio shows the number of times that stock is turned over or converted into sales within a year (Drake, 2009). In 2010, the CTY stock was turned 87 times, representing a decrease of 10.31% from 97 times in 2009 this implies that there was a decrease in the efficiency of converting stocks into sales and also means that the company had more idle stock in 2010. In 2010, TRS inventories were turned 74 times, which is an increase of 13.85%; this implies that there was an improvement in the efficiency of converting stock into sales and that the company had less idle stock in 2010. Based on this analysis CTY is more preferred because it has the highest ratio meaning that it sells more than TRS.
Debtors Turnover
The ratio shows the number of times that debtors pay within a year; it shows how efficient a company has been in its credit management policy and the higher the ratio the more efficient the company is in its credit management (Drake, 2009). In 2010, CTY ratio increased by 100% to 6 days meaning that the firm was more efficient in 2010 compared to 2009. While TRS has no credit management policy because it does not sell on credit but sells on cash-basis only.
Creditors Turnover
This indicates the number of times that creditors are paid by the firm during the year (Drake, 2009). In 2010, the company paid its creditors 61 times which was a decrease of 11.59% this means that the company decreased its purchases from suppliers and also negotiated its credit terms with creditors. While in 2010, TRS paid its creditors 30 times, an increase of 15.38% meaning that the firm purchased more from the creditors due to increased demand.
Thus, TRS is more preferred than CTY because its number of times is less meaning it does not have to part with more cash to pay its creditors.
Financial stability
Liquidity ratios
These ratios as shown on Table 3 measures the firm’s ability to meet its short term maturity obligation as and when they fall due (Meir, 2008). They measure liquidity risk of the firm, where by the lower the liquidity ratio the higher the liquidity risk and vice versa (Meir, 2008).
Current ratio
This measures the company’s ability to meet it short-term maturity obligations as and when they fall due (Meir, 2008). It is a measure of a firm’s solvency; a current ratio of more than 1 represent a margin of safety for the creditors where the higher the ratio the more liquid the firm is and the more confident the creditors will be in doing business with the company (Meir, 2008). In 2010, CTY ratio increased by 19.82% compared to 2009 meaning that the liquidity improved in 2010 due to the decrease in the current liabilities from AUD 63.2 million to AUD 40.2 million. In 2010, TRS also improved its liquidity by 17.51% to 1.02 meaning that the TRS’s current assets covered current liabilities 1.02 times in 2010; the increase was due to the corresponding increase in current assets from $47,198 million to $55.657 million. Therefore, CTY is more liquid than TRS since it has a higher ratio in both years.
Quick ratio
Current ratio is not an adequate measure of liquidity as it includes inventory, which is not easily converted into cash; a quick ratio of 1 is satisfactory for the firm since the higher the ratio the more the ability of a firm to meet its short term maturity obligations (Meir, 2008).
In 2010, CTY’s ratio decreased by 29.79% to 0.33, this implies that the firm was holding much of its current assets in inventory and the firm’s liquidity is not satisfactory in both years while TRS’s ratio increased by 313% to 0.095 in 2010 compared to 2009. This is because the firm was not holding much of its current assets in inventory but this is not yet satisfactory as it is less than 1; clearly, in both years, CTY is more liquid than TRS.
Gearing ratios
These ratios as shown on Table 4 measures the extent to which a firm uses assets financed by non-owners supplied funds i.e. they measure financial risk of the company (Meir, 2008).
Debt asset ratio
This measures the proportion of debt finance in relation to total capital employed in the firm, a company that is highly geared will have this ratio being more than 50% (Meir, 2008). Therefore, in both years the CTY was not highly geared as the ratio was less than 50% and in 2010 it decreased by a further 26.98% to 34.07%. While TRS was highly geared in both years and in 2010 the ratio decreased by 12.58% to 51.51% as a result of decrease in debt. Therefore, TRS was financially risky than CTY in both years.
Debt Equity Ratio
In both years, CTY was less geared as the ratio was below 100% which is the preferred proportion (Meir, 2008). In 2010, CTY gearing decreased by 41.12% to 52.37% due to the reduced loan, while TRS was highly geared in both years; in 2010 the firm added its debt increasing the leverage by 11.44% to 159.80%. Despite this TRS has a high financial risk compared to CTY.
Time Interest Earned
This shows the number of times that earnings can cover the current interest charges; a very high ratio implies that the firm is very conservative in using debt and is thus not using debt to the shareholders advantage while a low one shows excessive use of debt by the firm (Meir, 2008). In 2009, the CTY was more conservative in the use of debt as the ratio was very high at 186.49 times compared to a decrease of 83.78% in 2010. In 2010, TRS’s cover increased by 25.49% to 24.47 times compared to 2009 which is not as high as CTY’s ratio.
Other information
TRS’s stock has been increasing throughout the years from $9.01 on October 10, 2008 to a high of $18.51 on November 5, 2010 as shown by Chart 1 this means that the market was more bullish during this period from October 2008 to November 2010. Then the price started to decrease to a low of $9.61 on August 12, 2011 implying that the market for this stock was more bearish. On the other hand, CTY’s stock as shown by Chart 2 on October 10, 2008 was selling at $3.50; the market did not fluctuate much but remained bearish until October 30, 2009 (Morningstar.com, 2011). The market later became bullish and the price increased from $3.24 to $3.75 on January 15, 2010, then the price decreased to $3.10 on February 26, 2010 before again fluctuating to $3.72 on June 11 same year (Morningstar.com, 2011).
CTY’s stock price ranged between a low of $3.00 to $3.91in the last three years. Therefore, TRS’s stock fluctuated more than CTY’s stock implying that those who invested in TRS earned higher capital gains or losses compared to CTY and the fluctuation may be due to the company’s life cycle stage. For instance, CTY is in maturity period and that why it’s not undergoing much growth than TRS (Morningstar.com, 2011).
Limitations, Conclusion and Recommendations
Ratio analysis is a good measure in condensing accounting information presented by the firms in their annual reports; nevertheless, it has limitations which the user of ratios should put in mind. The limitations include; irrelevant and in adequate information in making future decision and do not address qualitative issues such as human resource policies, management quality, experience, and morale of employees. Furthermore, different users of accounting information will use different terms to depict financial information; for example referring to return on capital employed as gross capital employed (Universalteacher4u.com, 2011).
In conclusion, CTY is less risky compared to TRS based on the gearing ratio but when measured in terms of profitability TRS is more profitable because the superior the risk the superior the return. TRS is taking more risks by using more long-term debts to finance its activities, thus it benefits from interest-tax advantage which improves the firm’s profitability meaning investors earn more compared to CTY’s shareholders. From the stock point of view, TRS is more risky and as stated above the superior the risk the superior the return therefore a risk-taker would opt for TRS’s stock and a risk-averse would prefer CTY’s stock.
CTY’s EPS increased by 44% to $0.26 in 2011 compared to 2010 and its book value per share increased by 8.1% as shown on Table 5 meaning that shareholders in 2011 obtained an increase of 44% on returns from the CTY. If the firm is liquidated today they would earn even higher returns by 8.1% compared to 2010. On the other hand, TRS’s shareholders received $0.89 in 2010 and if the firm was liquidated in that particular year they would have earned $1.97 for investing in the company (Morningstar.com, 2011).
So in summary, based on the above analysis TRS’s stock would be best for risk-takers while CTY’s stock would be best for risk-averse since TRS is more risky than CTY based on the stock price fluctuation, EPS as well as financial risks undertaken by the firm. Thus, an investor may choose any based on his or her risk-profile but should also keep in mind that this analysis has some limitations as mentioned above and therefore advisable for the investor to gather more information on the firm especially the non-financial information like the management quality, staffs’ experience and among others.
References
Asx.com.au. 2011. Company information. Web.
Cummins, C. 2011. Country Road Sales take a dive. Web.
Drake, P. 2009. Financial ratio analysis, Web.
GoldmanSachs.com. 2011. BRICs. Web.
Investsmart.com.au. 2011. Country Road Limited. Web.
Meir, L. 2008. Financial ratio analysis, Web.
Morningstar.com. 2011. Quote overview. Web.
Rejectshop.com. 2011. Company Profile. Web.
Universalteacher4u.com. 2011. Ratio Analysis, Web.
Appendices
Table 1: Profitability ratios.
Table 2: Efficiency ratios.
Table 3: Liquidity ratio.
Table 4: Gearing ratios.
Table 5: Investment Ratios.