Business of Woolworths and Wesfarmers

The analysis of financial performance is very much necessary for the investors as well as for the management of the company. It helps them to know about the position of the firm in financial aspect and assist in taking important decisions in respect of making investment in a particular company (Bragg, 2012). The report contains the analysis of two Australian companies competing against each other in the market. It covers both the financial and non financial aspects that reflect the financial performance and position of the companies.

The companies selected for the purpose of analysis are Woolworths Group Limited and Wesfarmers Limited. It starts with a brief introduction about the business of both the firms and their comparative advantages. In the later part, specific categories of ratios are calculated for the past three years and are compared against each other in order to measure their financial performance.  In addition, the share price movements of both the organizations are also noticed for the past three years along with the identification of the noteworthy factors that influences the share price of a company. The report also highlights about the dividend policies and beta values of the companies and compare the same. At last, a recommendation letter is provided to the client containing the reasons for selecting one company between the two for the purpose of including the same in the investment portfolio.

Woolworths Group Limited

It is an Australian company engaged in the business of retailing. It mainly operates through New Zealand and Australia and is considered as the second largest retailer in the country, after Wesfarmers. The other segments include Endeavour Drinks, BIG W, and Hotels segments. The company is also known as the largest take away retailer of Liquor in Australia. Its core activities include supermarkets, trading of alcohol, offering hotel and pubs services under the name Australian Leisure and Hospitality Group. However, the company reported a loss of $1.235 billion in 2016 which was considered as the biggest loss in company’s history. This was due to the failure of Big W business and Masters Business. Woolworths is listed on ASX and is traded with the symbol ASX: WOW (Bloomberg. 2018).

Wesfarmers Limited

It is a conglomerate company having its operations in Australia that include several types of businesses such as supermarkets, liquor, energy and fertilizers, office supplies, coal products, safety products and many others. The company is the largest private employer in the country having approximately 22000 employees in the organization. It was found in 1914 and got listed on ASX with a ticker ASX: WES. According to its report for year 2017, Wesfarmers has made revenue worth A$64.44 billion and net income of A$2.87 billion. The company has 883 liquor stores under the brand such as Vintage Cellars, Liquorland and First Choice, 801 Coles supermarkets, 89 hotels and 702 convenience outlets. It also offers insurance services related to home, car, credit cards and others (Bloomberg. 2018). 

Calculation and Comparison of Liquidity Ratios

Generally, two competing companies have a comparative advantage over each other. It means investing the same amount of funds in one company will give more benefits than the other. Considering Woolworths and Wesfarmers, the performance of Woolworths has increased in the recent financial year as it reported an increase of 9.9% in its EBIT. On the other hand, Wesfarmer’s EBIT reduced by 54.2% in 2017 which was due to the poor performance of Coles. In addition, Woolworths is now enjoying success around the year as its core supermarket does not have to bear any more losses which incurred due to the company’s failure into home hardware sector. So, it can be said that the improving and increasing performance of Woolworths is the comparative advantage for the potential investors as they can now clearly decide about investing their funds in the two largest retail companies of Australia (The Motley Fool. 2018).

Calculation and comparison of performance ratios

Ratio analysis is one of the methods which are used to measure the financial performance of the companies. It includes calculation of several categorized ratios which provides a snapshot of the organization’s position in financial aspect. The key ratio data of the company help the investors to judge the performance properly and to take correct and appropriate decisions related to their investment (Bragg, 2012). In case of Woolworths and Wesfarmers, following three categories of ratios are calculated for the past three years which evaluates the financial position and performance of both the companies.

Liquidity ratios

These ratios help in determining the financial health of the entity by reflecting its capability of paying off its short term obligations with its assets. The ratios show how efficiently a firm manages itscash balance and other liquid assets (Saleem and Rehman, 2011). There are basically two types of liquidity ratios which are calculated as follows.

Current ratio: It measures the capability of the firm to pay off its current liabilities with its current assets that majorly comprises of company’s inventories, receivables and cash balance. The ideal ratio is 2:1 which means the firm should have its CA double of its CL (Gitman, Juchau and Flanagan, 2015). 

It can be observed from the above table that current ratio of Woolworths is continuously decreasing over the period of three years. In 2016, it was 0.83 which reaches to 0.78 in 2018. This constant reduction was due to the continuous increase in company’s current liabilities in the past three years. Moreover, its CA has also reduced during the time period. However, when compared to Wesfarmers it is observed that the firm has the same CR of 0.93 for 2016 and 2017. The reason was the minor reduction in its CAs and CLs. The same further reduces to 0.87 in 2018 due to a significant decrease in its cash and cash equivalents. However, it is still more than that of Woolworths.

Calculation and Comparison of Profitability Ratios

Quick ratio:Anotherliquidity ratio which checks the potentiality of the firm in meeting its short term debt obligations with the help of its most liquid assets. The ideal quick ratio is 1:1 and quick assets include all the current assets except inventories and prepaid expenses (Jenter and Lewellen, 2015).

A fluctuating trend is been noticed in the QR of Woolworths. In 2016, it was 0.28 which rose to 0.29 in 2017 and then again falls to 0.28 in 2018. Such fluctuation was due to the changes in firm’s QA. Most of the company’s assets are tied up in its increased inventory in FY 2018 which brings a reduction in its ratio. On the other hand, Wesfarmers’s ratio has also been reduced in 2018 from 0.30 to 0.27. This was due to the decline in its cash balance and increase in its receivables. However, it can be observed that Woolworth has high quick ratio than its competitor. 

It is another category of ratio which is used for the evaluation of companies. It basically deals with the assessment and evaluation of the profitability position of the firm. Investors usually prefer looking at such ratios to have an idea about the amount of return they get on their investment in a particular company (Parrino, Kidwell and Bates, 2011). Following are ratios calculated for WES and WOW.

Net profit margin: It shows the amount of net profit earned by the entity from its total revenue after paying all the operating and non-operating expenses. The profit amount is expressed as a percentage of company’s total sales (Tracy, 2012).

The above table shows that in 2016, WOW has reported a loss of $1235 million which resulted in a negative ratio of 2.12%. However, the company improved its profitability in 2017 and recorded a profit worth $1534 million. This brings an upsurge in its NPR and it reaches to 2.76%. The trend follows in the coming year also and the ratio of WOW is at 3.03% in 2018. A continuous hike can be noticed in the net margin of the company along with the constant increase in its profits. On the other side, the profitability of WES reduces from 4.22% to 1.80% in 2018. This is due to the significant reduction in its EBIT and net income. However, the revenue of the firm also declines in 2018. In 2016, its NPR was 0.62% which increased to 4.22% in 2017 due to a noteworthy upsurge in WES’s revenue. Overall, it is interpreted that Woolworth has better profitability position than Wesfarmers.

Share Price Movements

Return on Assets: This ratio measures the amount of return generated by the company by employing its assets and other resources in the business. A high ratio is considered favorable for the company (Gibson, 2011).

The same trend is followed in Woolworth’s ROA as it has been constantly increased over the three financial years. In 2016, it was -5.25% because of the loss made by WOW and then it rose to 6.69% and 7.32% in 2017 and 2018 respectively. This was due to the considerable rise in company’s profits and minor fluctuations in its total assets. In comparison to this, the Wesfarmers is not able to generate sufficient returns on its assets as it ratio reduces to the great extent from 7.16% to 3.24% in 2018. This is because of the significant decline in company’s profits and total assets during the year.

Return on Equity: It showcases the capability of the company in offering returns to its investors on their invested capital. A high ratio indicates that the firm is making profits and is able to pay high returns to its shareholders.

Just like the other two ratios of WOW, the ROE of the company also rises with the time as the profit takes an upward turn. With the upsurge in profits, the company is able to attract more investors which ultimately increase the amount of its shareholder’s equity. Its ROE rises from -14.58% to 16.10% in 2018. However, the reverse trend is noticed in WES’s ROE. With the reduction in its net income, the equity also falls that eventually results in the reduction of company’s ROE form 12% to 5.26%. Overall, it can be said that Woolworth is more profitable than Wesfarmers. 

These ratios assess the financial risk taken by the company and evaluate the capital structure of the firm. They measure the debt and equity component of the firm against each other and help the investors in knowing about the degree of financial leverage taken by the organization (Lee, Lee and Lee, 2009).

Debt-Equity ratio: It compares the debt and equity of the entity against each other and determines the portion of company’s assets that are financed through debt and the one which are funded by equity (Nikolai, Bazley and Jones, 2009).

From the above table, it can be observed that the D/E ratio of Woolworths has reduced from 51.45% to 26.74%. This was due to the significant reduction in its short and long term debt from $3028 million to $2803 million in 2018. Along with this, the company’s shareholders’ equity has continuously increased during the periods. On the other hand, Wesfarmer’s ratio also declines from 31.82% to 18.12% in 2018. However the company’s debt portion is still more than that of Woolworths.

Beta Values

Debt ratio: It reflects the portion of the firm’s assets that are financed through debt. It measures the total liabilities of the company against its total assets.

The debt ratio of Woolworths reduces from 2016 to 2018 due to the constant decline in its total liabilities. In relation to this, the assets of the company increases which results in the reduction of its DR from 58.4% to 55.51% in 2016. When compared to Wesfarmers, it is observed that the firm has low debt ratio because of high volume of total assets. Its DR also falls from 47.73% to 38.39% in 2018 due to the reduction in its liabilities. Overall, it can be interpreted that Wesfarmers is less risky as compare to Woolworths in financial terms.

Woolworths Group Limited

(Source: Yahoo Finance. 2018).

The above graph shows the movements in the average return of Woolworths compared with the average market return. At a glance, the trend lines in the graph are almost overlapping each other but there are some variations recognized during the period of three years. Initially in 2016, both the market and company’s returns were negative and falling throughout the year. However, the trend got reversed and Woolworth’s share price started generating positive returns in the start of 2017 where the market also turned positive. In the middle of the year, WOW’s reflected a hike in its return whereas the market remains the same. However, after facing the fall at the end of 2017, the average returns of the company turned positive in 2018 along with the market showing positive and high returns.

Therefore, it can be said that the stock performance of WOW is highly impacted by the changes in market return and is completely dependent on the market performance.

Wesfarmers Limited

(Source: Yahoo Finance. 2018).

The graph depicts large fluctuations in the average return of the Wesfarmers whereas the market seems to be steady in comparison to it. Moreover, the trend line of the company’s return is far from the line showing market return. It can be observed that in the start of 2016, the company has high negative returns as compare to the market returns. Also, when WES reflected positive average return, the market was going down and becoming negative. Later in mid of 2017, the share price of Wesfarmers delivered high and positive returns whereas the market was still negative. After facing a downfall at the end of 2017, the firm started delivering high returns along with the upsurge in the market.

Recommendation Letter

Therefore, it can be said that the performance of Wesfarmer’s stock is not highly dependent on the market and moreover, it is less affected by the fluctuations and the trends going on in the market.

The announcements that affect the share price of both the companies are as follows: 

Woolworths Limited

• On 5^thJuly, the company announced about entering into a long-term strategic alliance with Caltex for wholesale food, redemption, loyalty, convenience and fuel supply.  Such alliance will result increasing the network of fuel sites and help the company to expand its business of petrol (Woolworths Group. 2018).
• The company declares its financial results of FY2018 that reflected an increase in its EBIT and overall profitability. According to the report, its revenue rises along with the increase in number of employees (Woolworths Group. 2018).

Wesfarmers Limited

• On March 15, 2018 WES announced about its intention to demerge its Coles division with the due approval of all the investors and shareholders. The demerger will allow the company to focus more on growth opportunity within the business (Wesfarmers. 2018).
• The company made an announcement about the sale of Curragh coal mine on 29 March 2018. The sale resulted in the after tax profit of $110 million approximately which will be included in the result of FY 2018 (Wesfarmers. 2018).

The calculated beta for Woolworths is 0.83 and for Wesfarmers is 0.72. The required rate of return for both the companies by using CAPM method is as follows.

Woolworths

Wesfarmers

The policy state the amount of dividends paid by the company to its shareholders. It has been observed that Woolworths is paying regular dividends from the past nine years. In 2017, its DPS was 84 cents which increased to 103.0 cents in 2018. This was due to the increased profits of the firm (Woolworths Group. 2018). Wesfarmers also pay regular dividends to its investors. In 2017, the firm declares dividends 223 cents per share which was more than the DPS of 2016 worth 186 cents. So, it can be said that both the companies follow regular dividend polices offer high rate of dividends to their shareholders and investors.

Dear Client,

This is to inform you that the analysis performed above compare the financial performance of Wesfarmers and Woolworths for the past three years.  It is recommended to you that it will be better to invest in Woolworths Group Limited as it has high profitability, stable liquidity and reduced financial risk as compare to Wesfarmers. It gives high returns on its shareholders’ equity and has shown an increasing trend in its profits. Furthermore, the share price of the firm rises along with the increase in market return. It has low debt portion and relies more on equity which reduces its financial risk. Moreover, it offers high dividend and is considered to be best suited for the client’s portfolio.

Conclusion

It can be concluded that it is very important to carry out a financial analysis of the companies so as to know about their financial position and performance. This will help the investors to take better and appropriate decisions in relation to their investment and also makes the comparison easier between the two competing companies. 

References

Bloomberg (2018).Company Overview of Wesfarmers Limited.[Online]. Available at: https://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=875660

Bloomberg (2018).Company Overview of Woolworths Group Limited.[Online]. Available at: https://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=874687

Bragg, S. M. (2012). Business ratios and formulas: a comprehensive guide (Vol. 577). New Jersy: John Wiley & Sons..

Bragg, S. M. (2012). Financial analysis: a controller’s guide. New Jersy: John Wiley & Sons.

Gibson, C. H. (2011). Financial reporting and analysis. USA: South-Western Cengage Learning.

Gitman, L.J., Juchau, R. and Flanagan, J. (2015). Principles of managerial finance. Australia: Pearson Higher Education AU.

Jenter, D. and Lewellen, K. (2015).CEO preferences and acquisitions.The Journal of Finance, 70(6), 2813-2852.

Lee, A. C., Lee, J. C., & Lee, C. F. (2009). Financial analysis, planning and forecasting: Theory and application. Singapore: World Scientific Publishing Co Inc.

Nikolai, L. A., Bazley, J. D., & Jones, J. P. (2009).Intermediate Accounting. USA: Cengage Learning.

Parrino, R., Kidwell, D. S. and Bates, T. (2011).Fundamentals of corporate finance. USA: John Wiley & Sons.

Saleem, Q. and Rehman, R. U. (2011).Impacts of liquidity ratios on profitability.Interdisciplinary Journal of Research in Business, 1(7), 95-98.

The Motley Fool (2018).Better buy: Woolworths Group Ltd or Wesfarmers Ltd? [Online]. Available at:https://www.fool.com.au/2018/04/06/better-buy-woolworths-group-ltd-or-wesfarmers-ltd/

Tracy, A. (2012). Ratio analysis fundamentals: how 17 financial ratios can allow you to analyse any business on the planet. RatioAnalysis.net.

Wesfarmers (2018).Intention to demerge Coles and senior leadership change.[Online]. Available at:https://www.wesfarmers.com.au/docs/default-source/asx-announcements/intention-to-demerge-coles-and-senior-leadership-changecd83516999c863f7bfccff00000e9025.pdf?sfvrsn=0

Wesfarmers (2018).Sale of Curraghcoal mine – completion. [Online]. Available at:https://www.wesfarmers.com.au/docs/default-source/asx-announcements/sale-of-curragh-coal-mine—completion.pdf?sfvrsn=0

Woolworths Group (2018). Annual Report.[Online]. Available at:https://www.woolworthsgroup.com.au/icms_docs/195402_2018-woolworths-group-annual-report.pdf

Woolworths Group (2018). Woolworths Group enters Convenience and Loyalty Allianceand new 15-year Wholesale Fuel arrangement with Caltex.[Online]. Available at:https://www.woolworthsgroup.com.au/icms_docs/189696_woolworths-group-enters-new-alliance-with-caltex.pdf

Yahoo Finance (2018).Wesfarmers Limited (WES.AX.). [Online]. Available at: https://au.finance.yahoo.com/quote/WES.AX?p=WES.AX

Yahoo Finance (2018).Woolworths Group Limited (WOW.AX.). [Online]. Available at: https://finance.yahoo.com/quote/WOW.AX?p=WOW.A