Traditional retailing business has become to be a fast-growing industry with globalisation and information technology development. This business report will pick up two famous international retailing companies, Tesco and Wal-Mart, as comparing subjects. Through analysing and comparing both financial statements, this report is aiming to choose a better company as long term investment project.
Since Tesco and Wal-Mart are reporting under different accounting standard, IFRS and US GAAP, respectively, the financial analysis strives to overcome the differences from two accounting frameworks. The financial strengths and weaknesses of both companies will be displayed from three major aspects: assets, revenues and expenses analysis and key ratio analysis, based on their financial report between 2004 and 2008. In addition, some significant changes in business operations and strategies of these two firms will also be discussed.
The second part of this report stands on the shareholders' position to analyse these two companies. The stock price and EPS will be used to evaluate the performance of both companies in the capital market.
Finally, this report will recommend Tesco as investment project to an investor who is willing to invest for maximum capital increase in the long term.
1.0 Introduction
With the information technology and globalisation development, traditional retailing business becomes to be a fast-growing and profitable industry. At current step, it is wise to invest in a famous multinational retailing company that has a worldwide customer market, strong competition ability, stable operation condition and good potential prospect. Thus, this report has selected two famous listed retail companies, Wal-Mart and Tesco, as comparing objects for investment project. The figure below shows that both companies have the ability to represent the industry.
Fig1: World ranking of Retailers
Sources: Euromonitor International
Wal-Mart is an American public corporation, known as the 'giant in the retail industry', that runs a chain of large, discount department stores, and in terms of revenue it is the largest public corporation in the world (Yahoo Finance, 2010). The Company was founded in 1962 by Sam Walton and is listed on the New York Stock Exchange since 1972. Today, Wal-Mart is not only the largest private employer and grocery retailer in the United States, but also has successful operations outside North America such as the United Kingdom, South America and China (Biesada, 2006).
Tesco is the largest British retailer in terms of global sales and domestic market share. Its business originally specialized in food and beverage has diversified into several areas such as clothing, consumer electronics and financial services recover (The Guardian, 2009, p. 3). Since 2006, the profit of Tesco firstly has exceeded £3 billion, Tesco has become the third largest global retailer based on revenues, but second largest based on profits, ahead of Carrefour (Tesco, 2008).
However, it is not easy to compare directly these two companies, because both use different accounting standard to prepare their financial statements. Wal-Mart is reporting according to US GAAP while Tesco using IFRS. In order to giving a more systematic and reliable investment recommendation, this report will analyse both companies' annual financial statements from 2004 to 2008. Moreover, this report will strive to give investors more accurate investment recommendation through overcoming the differences between both accounting standards.
The remaining parts of Part A are arranged as follow: In Section 2, this report will analyse both firms' financial position from total assets, revenues, expenses and some key ratios. In Section 3, this report will stand on the shareholders' position to analyse the performance of both companies in the capital market. In the conclusion, this report will give the final recommendation to the investor, who is willing to invest for maximum capital growth in the long term. Further, some comparing difficulties due to crossing accounting standard will be named.
2.0 Financial position analysis
2.1 Total Asset
Fig2: Total asset comparison from 2004 to 2008
Sources: DataStream
In 2008, Tesco's total assets increased from 20 million USD (2004) to about 47 million USD. In contrast to Tesco, Wal-Mart' assets have increased slightly from 120 million USD in 2004 to 160 million USD in 2008. It clearly shows that, in contrast to Mal-Mart, Tesco efficiently expanded his business by more than twice since 2004. According to Harvey (2007), the expansion of Tesco relied on a series of successful activities of overseas acquisitions. Furthermore, between 2004 and 2008, Tesco achieved to get a leading market position in Europe and in most Asian countries. From this evidence, the management team of Tesco seems to be more ambitious and aggressive.
With the rapid expansion, the sales revenues of Tesco rose from 34 million pounds in 2004 to 54 million pounds in 2008, which equals to an increase of 59%. Meanwhile, the cost of goods sold, which increase 60%, rose from 30 million pounds to 48 million pounds during this period, and the operating expense also increased 64%. However, Wal-Mart is relatively stable on the cost items. For example, the increase of Wal-Mart's COGS and Operating Expenses is relatively low, only 41% and 39% respectively. Thus, it is necessary for Tesco to control its costs in the future. In fact, Tesco seems to realize that it should reduce its costs. In order to lower the taxes, in May 2007, Tesco's headquarter moved to Switzerland (Foxwell and Mills, 2007). After that, in a short period, Tesco reduce the costs of goods, such as CDs, DVDs and electronic games, through selling them via web site without charging VAT (Tesco plc, 2010). However, this operation was quickly banned by authorities, who feared damage to the Island's reputation (Foxwell and Mills, 2007). Finally, in June 2008, the government formally announced that it was closing a tax loophole used by Tesco (Leigh, 2008).
In addition, another Tesco's tax strategy, previously identified by Private Eye, involved depositing £1 billion in its Swiss partnership, and then loaning out that money to overseas Tesco stores, thus profit can be transferred indirectly through interest payments. This strategy is still in use and is estimated to be costing the UK exchequer up to £20 million a year in corporation tax (Murphy, 2008). Richard Murphy, a tax expert, has provided an analysis of this avoidance structure and tried to find a solution to cope with it (CNN, 2006).
Compared with Tesco, on January 31 2008 (the end of fiscal year), Wal-Mart reported a net income of $13 million earned through a turnover of $ 403 million (3.2% profit margin). From this perspective, it is clear that Wal-Mart was standing on the absolutely advantage side. Furthermore, during 2004-2008 period, like Tesco, Wal-Mart also positively conquer different market segment to enlarge its revenues. For example, in 2006, Wal-Mart announced a new pilot program to sell generic drugs at just $4 per prescription. This pilot program was initially launched at stores in the Tampa, Florida. At the beginning of 2007, the drug selling program expanded to all stores in USA (Silberner, 2006).
Although the data in Figure 3 shows that Wal-Mart is good at controlling its costs and has an absolute advantage at the amount of revenues, the grow rate of net income of Tesco (61%) is twice bigger than Wal-Mart's (30%). Tesco seems to keep a fast pace to develop and it still has grow space in the future due to its aggressive expansion policy.
2.3 Ratio analysis
Fig.4: Profitability ratio comparison from 2004-2008
Source: DataStream
After calculating these ratios, it is clear that both companies put their focus on the working capital management. The objectives are to maximize the profitability, guarantee the liquidity at any time and at the same time to minimize the gearing. The Figure 4 clearly shows that although both firms' gross profit ratios kept stable between 2004 and 2008, other important ratios changed considerably during that period. Because of the large growth in sales of both companies, receivables and inventories increased rapidly.
As mentioned before, the sales revenues of Tesco increased by 59% between 2004 and 2008. The costs have also risen significantly (Figure 3) during that time so that operating profit margin of Tesco decreased from 5.89% to 4.78% in 2008. The annual report reveals that the selling, general and administrative expenses doubled since 2004, and the depreciation charges also increased significantly (Tesco, 2010). However, Tesco has a higher net profit margin during all the years, and advantage became much bigger after 2005.
In contrast to Tesco, Wal-Mart's gross profit margin had steadily grown in the previous years, but its operating profit margin and net profit margin had tended to decrease. Due to the increasing in acquisitions in overseas, the turnover grew by 2.35% during the previous years. Such as sales in 2006 for Wal-Mart's UK subsidiary, Asda (which retains the name it had before acquisition by Wal-Mart), accounted for 42.7% of sales of Wal-Mart's international division. In contrast to Wal-Mart's US operations, Asda was originally, and still remains, primarily a grocery chain, but with a stronger focus on non-food items than most UK supermarket chains and unlike Tesco (Ann and Kris, 2006).
Fig 5: D-E ratio comparison from 2004-2008
Sources: Data Stream
Furthermore, the debt to equity ratio gives a good overview about the solvency of the companies and hence, indicates the risk level of a bankruptcy. The figure above shows that D/E ratio of Tesco did not have very significant change between 2004 and 2007 but suddenly jumped to 95.35% in 2008. The balance sheet shows that the liabilities increased from 18 million pounds in 2007 to 33 million pounds in 2008. Traditionally, the ideal current ratio is around 2 and the ideal quick ratio is 1. However, most business of the retail industry use the just -in-time system (JIT) and result in little inventory and few receivables. The current ratios of Tesco were closer to 1 than those of Wal-Mart, and Tesco's quick ratio is very lower, which could indicate that working capital is not being used efficiently.
The table above shows the stock price development of both companies from 2003, Dec to 2008, Dec. From The blue line representatives of Wal-Mart, and it tended to be stable in past years and have not huge fluctuations. However, Tesco stock price performed quite well and increased gradually from 2004 and got to a peak in 2007, but it began to go down in 2008 due to financial crisis.
Sources: Euromonitor International
From the chart, EPS of both firms have tended to increase, and EPS of Tesco is always 7 pound higher than Wal-Mart's. Although this gap tends to be smaller over time, it is oblivious that Tesco has generated higher returns for its shareholders than Wal-Mart.
From the data of stock price and EPS, Tesco has a better performance than Wal-Mart in the capital market. It is easy to conclude that standing on the shareholder's point, investing in Tesco is a better choice than Wal-Mart.
4.0 Conclusion
To sum up, after carefully analysis financial strengths and weaknesses of both companies, based on their financial report between 2004 and 2008, Tesco should be considered as a long term investment subject. In order to maximum capital growth in the long term, investors should choose the company that has a high historical growth rate, a better financial condition and offers good future prospects. Although in terms of pure amount, Wal-Mart is really a giant in retailing industry. Tesco is an undeniable winner in terms of ratios comparison and leverage effects. Thus, Tesco can bring more capital growth in the longer term.
However, it is essential to point out that Tesco and Wal-Mart are under different accounting standard, IFRS and US GAAP, respectively, and there are various differences of items exist between IFRS and US GAAP. Some of these differences are small enough to accommodate with slight changes in current practice application, but some of them make a comparison difficult. For example: IFRS requires to calculating goodwill impairment as the difference between the business fair value and its book value. US GAAP on the other hand calculates the impairment based on the implied fair value of goodwill. Furthermore, IFRS allows fixed assets to impair and inventories have to be reversed as long as the conditions that caused the impairment vanished. Such a reversal is prohibited under US GAAP. These differences influence the evaluation of assets, but not in such way that the entire comparison and its results are changed.
Part B
It is vital to acknowledge that convergence is being conducted between IFRS and US GAAP. In October 2002, the FASB and the IASB arranged a meeting to issue a memorandum of understanding to formalize their agreement to the convergence of US GAAP and IFRS (Pacter, 2005, p.72). Considerable progress was made on this project by the SEC in June 2007, firms were allowed to have a right to prepare their financial statements in accordance with the English language version of IFRS without reconciliation to US GAAP (Zeff, 2007, p.298).Furthermore, recently, in August 2008, the SEC announced a proposed roadmap that could require US issuers to use IFRS beginning in 2014(SEC, 2008).
It seems that the roadmap for convergence between IFRS and US GAAP set forth a view that these two accounting standards could coexist in the international marketplace (IASB, 2008). Hope (2007, p. 147) claims that in the near future, only two accounting standards, IFRS and U.S.GAAP, can exist in the world. Nevertheless, the convergence between IFRS and US GAAP still continues. Currently, in most countries, national standards are based either on IFRS or US GAAP (Pacter, 2005, p.73). The convergence between these two dominant accounting sets would bring more influence to the entire global economy beyond solely accounting meaning. Ali (2005) states that macroeconomic factors, such as the growth of global capital markets and increasing numbers of multinational companies, should be considered as the reasons for driving convergence.
However, the primary power should come from capital market participants, such as listed companies and capital investors. Accounting rules need to converge to a single international standard to make global financial communication more efficient and clear. A single, high quality and understandable global accounting standard can help participants in the worldwide capital markets and other users make decisions more efficiently and more accurately (Pacter, 2005, p. 67). Since the US stock market wants to attract more money from global investors, it is clear that multiple accounting systems create difficulties in comparing financial reports in different countries. In addition, Beuren et al (2008, p. 632) points that a single accounting standard can help stock markets reduce the problem of asymmetric information. He further maintains his opinion with the evidence that many non-American companies, in order to perform in US stock market, have to restructure their financial statement and adapt to the US GAAP. However, in many respects, different countries have their own accounting norms, these conversions can generate asymmetry of information that can prejudice the decisions of investors, in relation to what is disclosed on various stock markets. In fact, through the research conducted by Pacter (2005, p.78), the results clearly show that the majority of European companies who are registered with the SEC are expected to switch to IFRS for US filings in 2005, whilst the SEC staff is willing to review IFRS statements rather than reviewing financial statements using 20 or more different European GAAPs.
Furthermore, the successful extent of the convergence largely depends on the result of the conflict between two different accounting cultures. It widely accepts that IFRS is a typically principle-based accounting system while US GAAP is labeled as rule-based. Researchers hold different opinions about the directions of the convergence. The principle-based advocators suggest that the convergence between IFRS and US GAAP needs to consider in moving towards more principles-based standards (Bennett et al, 2006, p.201). They believe that a universal accounting standard should be designed to be principle-based to attract different interests to the same accounting framework. Meulen et al (2007, p.124) casts strong evidence of that in the recent past, FASB, the counterpart of IFSB, tried to search for a way to change US GAAP to be more concept-based. According to Schultz and Lopez (2001), FASB may realize that compliance with a rigid set of narrowly articulated rules does not necessarily guarantee economic relevance of the resulting data, and the debate continues.
Nevertheless, some critics argue that IFRS allows too many alternatives to reduce specificity. Buchanan (2003, p.70) believes that the evolution of accounting convergence will inevitably result in a strong resemblance to US GAAP. He further explains that the attraction of American capital market and the pressures exerted by the SEC and the FASB will undeniably draw in the US mega-markets. Furthermore, some critics believe that a pure principles-based standard would not exist, it is clear that the rules, which are essential for a standard, can either clarify the conceptual framework or stop potential accounting abuse (Bennett, 2006, p.196). The empirical evidence has shown that IFRS will inevitably move from a focus mainly on principle to the direction of more rules, it can be clearly found from increasing length and greater detail of the IASB's pronouncements (Zeff, 2007, p.293).
Although the no result debate exists, the convergence may progress more smoothly than the expectation. Some researchers concluded that common law is more appropriate for global harmonization of financial reporting to converge into a single standard (Buchanan, 2003, p.67). The US is a country that is based on a systematic common law set, and it means that the adjustment of US GAAP will meet less inherent challenges from the legal system. In addition, accounting convergence can be conducted in two ways: in practices and in norms (Weffort, 2005, cited in Beuren et al, 2008, p.634). Now the primary difficulties occur in combining the accounting norms, so the exercise should choose the other way to go. In order to converge in practice, a single conceptual framework is needed before the FASB-IASB convergence project (Bennett et al, 2006, p.202). Also the framework should make no conflicts between IFRS and US GAAP rather than meaning word-for-word identical standards.
To sum up, the convergence has already been tried to put into practice step by step, although some conflicts still exist. And an efficiently universal accounting framework will definitely boost global economic communications and corporations. Meanwhile, it is important to realize that a successful convergence requires various leadership and commitment, such as SEC, national regulators, firm finance directors and professional accounting institutions, to support, and therefore achieve ideal international accounting convergence.
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