Executive Summary
This is a business analysis report prepared to analyse two companies using financial statement ratios for the years 2010 and 2011. Profitability, Liquidity, Efficiency and Financial Stability ratios are included. The profitability ratios conducted indicate that David Jones is a more profitable company than Premier Investments. The efficiency ratios show that each company is efficient than the other in two ways. This makes them equal in this regard. The short-term financial stability ratios favour Premier as the more financially stable company in the short-term. Similarly, the long-term financial stability ratios favour Premier as the less risky company in the long term.
Other business sources of information indicate that David Jones had a difficult year on the stock market in 2011. Premier Investments employed a former member of the David Jones management team as its Head of Retail.
Considering all the available information, the better David Jones is the better company to purchase shares.
Introduction
Premier Investments Limited and David Jones Limited are both Australian companies listed on the stock exchange. Premier Investments is concerned primarily with equity investments while David Jones Ltd is in the retail business. Both companies prepare and publish Financial Statements annually. The aim of this report is to compare the attractiveness of these two companies as investment opportunities. This will be done primarily through ratio analysis on the 2010-2011 financial statements of both companies. Mr David Jones founded the David Jones Limited company in the early 1800s. His vision was to create a convenient department store to meet all his customers’ needs. David Jones specializes in building and operating large and glamorous department stores (Invest Smart 2012). Currently, it is the largest and oldest player in this segment.
Experienced financial analysts run Premier Investments Limited. The company gains returns by making favourable equity investments in prospering firms. Premier acquires controlling interest in Australian companies and uses this to maximize shareholder returns. Retail and import companies are Premier Ltd’s focus. Premier also focuses on distribution companies. Currently, Premier’s largest investment is in the Just Group. The company plans to use its stake to leverage its profits in this market. These two companies are similar for investment purposes because they both have operations in the retail sector. David Jones is in this sector through its department stores while Premier investments is in the retail business through its subsidiary, Just. Premier Investments own 100% of Just Group.
Ratio Analysis
Profitability Ratios
Profitability ratios indicate how well management has used the company’s assets to generate profits. Higher profitability ratios indicate efficiency in management of resources (Drever et al. 2007). There are several profitability ratios. In this analysis, we will consider the Gross and Net Profit margins and return on Assets and Equity.
Gross Profit Margin
The Gross Profit Margin is computed by dividing the gross profit by sales revenue. This ratio is useful in analyzing a company’s management of its cost of goods and pricing.
Premier Investments Limited posted a GPM of 59.09% in 2010. This dropped slightly to 59.51% in 2011. The difference is (-0.42). The drop in performance could be due to the general decline in equities during the year 2011. This may have had an impact on Premier since its primary activity is investing in equities.
This company generally has a high gross profit margin compared to other trading companies. This could be because Premier is not directly involved in trading. Rather, it is in the retail business through its subsidiary. The company’s principal activity is investing in other firms’ stock. The high gross profit margin means that almost 60% of every dollar the company earns is its gross profit. Premier has low COGS since it is not a trading company.
David Jones Limited posted a lower gross profit margin in both years compared to Premier. DJ posted a GPM lower than Premier’s by over 20%. The company posted a similar decline in GPM of (-0.62). In this case, the decline could be explained by the difficult economic times, which forced consumers to spend less. DJ is in the retail business and it felt the impact of the reduced spending.
Net Profit Margin
This ratio analyzes the efficiency of the company in managing its total expenses and the resultant effect on profit. We compute NPM by dividing the net income after tax by the sales revenue.
Premier Investments suffered a great decrease in the NPM by (-6.57%). The company incurred strategic review costs that were not incurred in previous years. Premier also suffered losses on currency translation and on its cash flow hedge. These contributed to the decline in the GPM.
David Jones managed to improve its NPM slightly by 0.52. The company spent less on leases and advertising. This contributed to the increased margin.
Return on Equity
The ROE indicates how well the company is using shareholders’ funds to earn profits. Premier Investments Posted a declining ROE by 5.19%. This indicates that the company earned less profit using shareholders’ funds. In contrast, DJ posted a slight decrease in ROE of 1.46%. By this measure, David Jones would be considered a better investment option than Premier.
The decrease in Premier’s ROE can be explained by the 6% increase in its equity. Increasing the ROE denominator with a corresponding decrease in net profit resulted in the poor results. DJ reduced its equity by 2%.
Return on Assets
This ratio indicates how efficient the company is in using its assets to generate profit. Premier’s ROA decreased by 4.09%. This large decrease could be explained by the 2% decrease in sales revenue and 2% increase in assets. The company invested more but made less using these investments.
David Jones incurred a slight decrease of 0.42%. The decrease in sales revenue caused this decline. DJ demonstrates better asset management than Premier.
Efficiency Ratios
Asset Turnover
The asset turnover ratio indicates how well a company is using its long-term assets to generate (Weetman 2007). Premier Investments have maintained an almost constant asset turnover ratio, dropping by 0.01 in 2011. This indicates that the company has been using its non-current assets at the same rate of efficiency over the two years. This is also the case with David Jones, whose asset turnover dropped by only 0.1. However, David Jones posted a significantly higher asset turnover than Premier by almost one time in both years. This indicates the fact that Premier is not using its non-current liabilities as efficiently in generating profits.
Inventory Turnover Days
The Inventory turnover day’s ratio indicates the time taken by companies to convert the items it holds in inventory to sales. Premier Investments posted shorter turnover days than David Jones in both years under study by approximately 10 days. However, both companies posted longer inventory turnover days in 2011 than 2010. The slow-down in consumer spending which affected all retailers probably caused this. It seems David Jones suffered more since the increase in its days is five while Premier posted an increase of 2 days.
Debtors’ Turnover Days
Debtors’ turnover indicates how long a company takes to obtain payment for any items sold on credit terms. Premier Investments posted an improved DT in 2011 by 1 day. This could be due to the decrease in the total debtors. On the other hand, DJ posted a poorer DT in 2011 by 0.8 days. In 2011, the difference in the DT is low and can be considered insignificant. Though DJ has a better figure, Premier could soon catch up if the current trend continues.
Creditors’ Turnover Days
This ratio is an indication of the length of credit period a company is allowed by its debtors. Both companies had DT of slightly over 30 days. In 2011, both companies faced decreased CT. Premier’s DT reduced by 7 days while DJ reduced by 5 days. This is an indicator that creditors demanded their money faster in 2011. However, both companies also posted reduced trade payables in 2011. This may have contributed to the decline in CT days too.
Short- Term Financial Stability Ratios
Current Ratio
A higher the current ratio indicates that it is easier for the company in question to meet its liabilities as they arise (Seal et al. 2008). This indicates that the company is stable in the short-term and cannot run into problems due to inability to meet current liabilities.
Premier Investments had an impressive current ratio of 4.27 in 2010. However, there was a drastic decline by 2.53 in 2011. This can be explained by the huge increase in current liabilities in 2011. The balance sheet indicates increases in derivatives, provisions and interest bearing liabilities.
DJ maintained its current ratio over the 2 years. In fact, in 2011, the company posted a slight improvement in its ability to meet its short-term obligations.
Quick Ratio
This ratio eliminates the distortion effect of inventory in the current ratio. It is useful in evaluating companies with long inventory turnover periods. However, in this case, both companies are engaged in the retail business where inventory is fast moving. This explains why the quick and current ratios are not significantly different.
As in the current ratio, Premier posted a drastic decline in 2011. DJ also posted a slight improvement in 2011. This indicates that the company is getting better at its short-term financial stability.
Long-Term Financial Stability
These ratios indicate the attractiveness of a business for investment for periods over twelve months. A business may be financially stable in the short-term but show potential for financial trouble in the long-term.
Debt Asset Ratio
This ratio indicates the percentage of the company’s assets, which are financed by debt capital. Increased debt means increased financial risk for a company in the long term. Premier Investments Limited has a significantly lower Debt-Asset ratio than DJ. In fact, DJ’s ratios are double of Premier’s ratio. This means DJ has more assets financed by debt than Premier does. This is true since Premier prides itself in being a low-leverage company.
The year- on year comparisons, show DJ reducing its leverage by 2% while Premier increased by 2%. Both companies increased their liabilities, but Premier increased its assets less than the corresponding increase in liabilities. The drastic increase in short-term liabilities impacted Premier’s ratio.
Debt Equity Ratio
This ratio compares a company’s use of debt capital and equity capital. It reinforces the previous ratio. As indicated earlier, Premier uses much more equity financing than debt financing. This ratio indicates that in 2010, Debt was only 18% of equity. This figure rose slightly to 22% in 2011. Premier might have borrowed the money to cover its operating expenses in the difficult financial conditions.
DJ seems to be a highly geared company. Debt was 60% of equity in 2010. This reduced to 54% in 2011. This means that DJ finances over half of its operations using debt. This could be quite risky for the company in the long-term.
Times Interest Earned
This ratio compares the interest obligation of a company with the profit earned. It indicates the number of times a company can be able to cover its finance charges from profits. Companies will run into financial trouble with debtors if they are unable to cover their interest. Surprisingly, DJ has a significantly higher TIE than Premier does. This indicates that Premier is more likely to run into financial trouble with its lenders in the long term than DJ. Both companies posted decreased TIE in 2011. However, it seems that the additional debt Premier took on was expensive. The TIE decreased by more than 9%. This should be a cause for alarm.
Limitations of Ratio Analysis
The ratio analysis done on David Jones and Premier is limited by a few factors. First, the analysis is conducted over only two years. One may need to conduct this analysis over a longer period such as five years to confirm that the conclusions arrived at are true. Secondly, the figures used in conducting ratio analysis are obtained from the financial statements, which may have been prepared using different Accounting Policies. This means that the figures are not perfectly compatible. Finally, ratio analysis is incapable of portraying qualitative factors, which are equally important in investment decision making.
Recommendation
The profitability ratios conducted indicate that David Jones is a more profitable company than Premier Investments. The efficiency ratios show that each company is efficient than the other in two ways. This makes them equal in this regard. The short-term financial stability ratios favour Premier as the more financially stable company in the short-term. Similarly, the long-term financial stability ratios favour Premier as the less risky company in the long term.
Other factors investors should consider include the stock market performance of the company and company leadership. Unfortunately, David Jones finished the year 2011 as the worst performing company in the stock exchange. This year, the company already issued a warning to investors that profit is expected to decline by almost 35%. As expected, this negatively affected the stock price as it reduced by 10% (Financial Review 2012).
Premier Investments acquired its head of retail Mark McInnes from its competitor David Jones (The Age 2011). Mark has vast experience in the retail business. He will be a good strategic fit for Premier’s plan to increase its presence in the sector (Australian News 2011).
I would recommend David Jones as the better investment company. Despite its poor performance in the stock market recently and relatively high leverage, the company seems more stable and profitable in the long term. Investors should buy this sock while its price is still low for increased benefits in the future. In the past, David Jones got through several business crises. It is guaranteed to pull through the current crisis. However, investors who are afraid of financial risk caused by debt finance should opt for Premier sock.
References
Australian News, 2011, Mark McInnes faces tough test at Premier, Herald Sun, Web.
Drever, Santon, & McGoan 2007. Contemporary Issues In Accounting, John Wiley, Australia.
Financial Review, 2012, Premier Investments, Financial Review, Web.
Invest Smart, 2012, David Jones Limited, Invest Smart, Web.
Seal, Garrison, & Noreen 2008. Management Accounting, McGraw-Hill, New York.
The Age, 2011, Business, The Age, Web.
Weetman, 2007, Financial and Management Accounting: An Introduction, Prentice Hall, Chicago.