Making decision on investment in which company needs to consider about several different aspects of the companies and make related comparisons. As a Financial Analyst working in a firm of stockbrokers which is a London based company, in order to provide the useful advice on investment opportunities in Debenhams Plc. or Next Plc. for a major potential investor, this report will be carried out to analyse these two companies to combine the practise with theories. Both Plc. and Next Plc. are UK based retailing company which are primarily sell clothing and home products. To be specific, the analysis will be developed into four main areas to look at different aspects of these two companies, which are Financial Performance, Financial Position, Corporate Governance and Corporate Social and Environmental Reporting. The brief descriptions of these four areas are presented as follows.
Financial performance primarily applied to estimate how well the company use its assets to generate revenue. On this respect, it will focus on the income statement of each company to seek out which company performs better. The general methods to measure companies' financial performance is through some profitability and investment ratios of company, such as net profit margin and return on equity. It is a good measure that can be used to compare companies located in the same industry over a given period of time for assessing the company's the overall financial health.
Financial position of a company is determined by its assets and its liabilities. In addition, it also includes the shareholders' equity. Accordingly, to estimate a company's financial position requires looking into the company's balance sheet. The related information can help the investors to assess the strength of company's financial position. The company with a stronger financial position represents it has stronger ability to meet its liabilities, which means its shareholders or investors will undertake a lower risk for investing in this company.
In addition to the financial aspects, corporate governance of company is also a significant aspect that investors should consider about. Corporate governance is a kind of regulatory, policy and legal mechanisms to help direct, manage and control the company. It indicates the relationships between the management of a company and its shareholders and other stakeholders, and also presents the goals that the company is going to achieve (Williamson, 2002). The corporate governance of a company can be found in the company's annual report, which could be used to appraise the company's management performance and check that does the company meet its goals.
Currently, an increasing number of companies begin to pay more attention on developing corporate social responsibility, which is another significant factor that the investors should focus on. According to the description made by McWilliams and Siegel (2001), CSR is defined as "actions that appear to further some social good, beyond the interest of the firm and that which is required by law." The CSR reporting, involving in environmental reporting, will tell the investors how the company treat and be responsible to its stakeholders. Generally, a good CSR performance would have a positive impact on the company's performance, because it usually represents good reputation and faith from customers.
This report will break down into these for broad areas to compare and analyse the related performance between Debenhams Plc. and Next Plc. The recommendations and conclusion about which company should be chose to invest in will be given in the final part.
Financial Performance
In order to estimate companies' financial performance, it needs to look into the companies' financial statements.
Literature Reviews (Theory and Practise)
In the past several decades, a lot of studies have been carried out to evaluate company's financial performance. Financial performance uses figures to represents the company's performance in the company's financial statements, including the income statement, balance sheet and cash flow statement. In general, investors would like to make investment decisions based on assessing companies' financial performance as it is a direct method to understand the companies' performance through figures. According to the statement made by Mokhtar, Karbhari and Naser (2005), the financial performance can be used to represent a company's profitability, health and eventually its survival. Indeed, companies with high financial performance usually are regarded as success stories with efficient and effective operation management that investors will be confident to invest in. On the other hand, the companies with lower financial performance mean they are lack of efficient management which are unlikely to bring benefits to investors (Makhamreh, 2000).
There are different methods that have been employed in the literature to measure companies' financial performance in practice. The instruments involve in some related ratios to figure out the companies' profitability and rate of return, such as net profit margin and return on equity, and some analysts would like to look deeper into the cash flow statement to check the situation of cash in the company (Heras et al., 2002; Haversjo, 2000; De With, 1996). The survey carried out by Sankaran (2002) applies a series of financial ratios, including liquidity, profitability, solvency and return on investment, to measure ten major international pharmaceutical companies' financial performance. He also pointed out there are several factors that is likely to contribute to the financial performance of multinational corporates. For example, the high net and gross profit margins were resulting from the rise in sales and better control of costs (Sankaran, 2002).
Comparison and Analysis about Next Plc. and Debenhams Plc. in Financial Performance
Under this report, it will employ a number of ratios involving sales growth rate, profitability ratios and investment ratios to evaluate the financial performance of Next Plc. and Debenhams Plc. The ratios can be seen from the Table 1 below.
Next Plc.
Debenhams Plc.
2012
2011
2010
2012
2011
Sales growth rate
4.3%
-3.2%
4.1%
0.9%
4.3%
Profitability Ratios
Gross profit margin
30.4%
29.3%
29.3%
13.6%
13.4%
Net profit margin
12.4%
11.9%
10.7%
5.6%
5.3%
Return on equity
191%
169%
274%
19.0%
17.8%
Investment ratios
Earnings per share (p)
282
221.9
118.5
9.8
9.1
Dividend per share (p)
90
78
66
3.3
3.0
Table 1
(Calculating based on the annual reports of Next Plc. and Debenhams Plc.)
First of all, looking at the sales growth rates for these two companies from the year 2010 to the year 2012, it is obvious to find out a decreasing trend of sales in Debenhams Plc. from 10.7% in 2010 to 0.9% in 2012. Referring to the Next Plc., even though there is a sharp drop in sale growth in 2011 which is a negative growth, the growth rate of sale for the company has increased back to 4.3% in 2012, which shows a good trends. It means Next Plc. might have done some improvement to stimulate its sales growth.
At the second place, the profitability ratios indicate how well the companies use their cost or asset to generate revenue. On this respect, both Next Plc. and Debenhams Plc. perform well with relatively stable gross profit margins and net profit margins for these three years and actually there exist light increasing trends in these two margins, which mean these two companies have continuously enhanced the efficiency of costs and management. However, what needs to be mentioned about is that these two margins for Next Plc. are much higher than Debenhams Plc.'s for the recent three year. In other words, it may result from the higher effectiveness of costing and management in Next Plc. In terms of the return on equity, it is obvious that the Next Plc. has much higher figure in this ration for the recent three years, which all exceed one hundred per cent and in 2010 the return on equity was over 200%. The too much higher ROE does not always represent good things as the company may have too many liabilities so that the shareholders' equity would be lower. Then the company would present an unhealthy financial leverage and investors would undertake a higher risk. On the other hand, although the Debenhams Plc. has a normal return on equity at around 19%, looking deeper into the balance sheet, it figures out that the Debenhams Plc. presents too much intangible assets valuating over £800 million, which accounts around fifty per cent of total asset. The too much intangible assets will also bring a higher risk for investors as the value of intangible assets is volatile.
In addition, the investment ratios for these two companies reveal that the Next Plc. with higher earnings per share and dividend per share is likely more attractive to investors rather than Debenhams Plc.
Financial Position
Referring to assessing the companies' financial position, it needs to check the assets, liabilities and shareholders' equity form balance sheet.
Literature Reviews (theory and practice)
To evaluate companies' financial position, it needs to look at the companies' status of the assets, liabilities, and shareholders' equity (Kieso, Weygandt and Warfield, 2007), which are reflected in the balance sheet of companies financial statements. Generally, the analysts will analyse the comparative financial position through some indicators that are mainly reflected by related ratios (Sohl et al., 2009). The related ratios involve in liquidity ratios and solvency ratios. Liquidity ratios are applied to assess the companies' ability to use their assets to meet short term liabilities (less than one year) and solvency ratios are applied to evaluate whether the companies are able to use their assets to meet long term liabilities (more than one year) (Tracy, 2004). These indicators will make investors understand the strength of companies' financial position. A strong financial position or condition will lower the risk that the investors need to undertake and investors will be confident to contribute their money in the company.
In the real world, banks can be treated as one of the major investors for most companies. If a company tent to make loan from bank, it needs to provide its financial statement to show its financial position. In the balance sheet, there will be a list of significant assets and a list of significant liabilities of company. Then the bank would use this information to appraise the strength of financial position. In other words, the bank wants to make sure the company have the sufficient ability to repay the loan in the future. The bank would lend money to the company based on the value of assets so as to prevent the loss of default from company. Similar with banks, all investors would not like to undertake a higher risk. Therefore, it is important to assess the companies' financial position before making a decision for investiment.
Comparison and Analysis about Next Plc. and Debenhams Plc. in Financial Position
For the purpose of comparing and analysing the financial position of Next Plc. and Debenhams Plc., it will carry out through using liquidity ratios and solvency ratios, including current ratio, quick ratio and gearing ratio. The relevant ratios can be seen from the Table 2 below.
Next Plc.
Debenhams Plc.
2012
2011
2010
2012
2011
Liquidity Ratios
Current ratio
1.54
1.28
1.37
0.63
0.59
Quick Ratio
1.03
0.84
0.97
0.17
0.14
Solvency Ratio
Gearing Ratio
296.2%
256.6%
463.5%
62.4%
62.6%
Table 2
(Calculating based on the annual reports of Next Plc. and Debenhams Plc.)
Current ratio equals to current assets over current liability, which measures the company's liability to meet short term liabilities. The better current ratio should be at around two, which means the company has enough ability to repay its current liabilities. On this respect, Next Plc. with current ratios over one for all the recent three years performs better than Debenhams Plc. Even though there is an increasing trend in the current ratio for Debenhams Plc., it is still much lower than Next Plc.'s. Moreover, as both Next Plc. and Debenhams Plc. are retailing company primarily providing clothing and home products, they have a large number of inventories as current assets which are not easy enough to transfer into cash. Therefore, it is significant to calculate the quick ratio for them to find out the truer liquidity condition of these two companies. The quick ratios of Debenhams Plc. for the recent three years are all under 0.2. It means Debenhams Plc. are likely unable to repay its short term liabilities. On the other hand, Next Plc. plays much better with quick ratio at around 1. However, in terms of the ability to repay the long term liabilities, Next Plc. has showed a much worse figure. The gearing ratios, also the debt to equity ratios, of Next Plc. are 463.5%, 256.6% and 296.2% for 2010, 2011 and 2012 respectively. The higher gearing ratio means Next Plc. has a higher degree of leverage, which is considered riskier if investors tend to invest in. Compared with Debenhams Plc. with a lower gearing, Next Plc. would be more vulnerable to go downturns in business cycle as it has to use its revenue to repay its liabilities and need to try to continuously increase sales.
Corporate Governance
The corporate governance is reflected in the corporate governance report from the company's annual report.
Literature Reviews (theory and practice)
Corporate governance is topic that investors and other stakeholders pay an increasing attention on. Sifuna (2012) defines the corporate governance as "a system of law and sound approaches by which corporations are directed and controlled focusing on the internal and external corporate structures with the intention of monitoring the actions of management and directors and thereby mitigating agency risks which may stem from the misdeeds of corporate officers." Based on a recent research made by Mercer Investment Consulting, forty-six per cent of institutional asset owners have considered about the corporate governance of company when they tend to make investing decisions (Fombrun, 2006). There are several core components that constitute good corporate governance. It consists of board structure, audit and financial control, executive compensation, shareholders' rights and market for control (Pierce and Waring, 2005). Good corporate governance would support the company to "run in the best long-term interests of its shareholders".
Currently, in order to help investors and other stakeholders of company to make relevant decisions, there are three main organisations that provide governance rating, which are Governance Metrics International (GMI), Institutional Shareholder Services (ISS) and The Corporate Library (Fombrun, 2006). Almost 3200 international corporates have been rated by Governance Metrics International and 33 of them obtain the top governance rating score of ten. A large number of companies would like to improve their corporate governance because investors may be likely to contribute more money in the companies with higher level of governance rating. Indeed, according to the report carried out by McKinsey & Company, investors are willing to contribute a premium of twelve to fourteen per cent to the companies with better corporate governance in Western Europe and North America, and the premium rate will be even higher in new developing areas.
Comparison and Analysis about Next Plc. and Debenhams Plc. in Corporate Governance
The comparison and analysis about the corporate governance for Next Plc. and Debenhams Plc. will be primarily developed into three core areas that investors will focus on, which have discussed before: board structure, audit and financial control and shareholders' rights (Pierce and Waring, 2005).
Both Next Plc. and Debenhams Plc. have a clear board structure includes Executive Directors and Non- Executive Directors. For Next Plc., it has five Executive Directors involve one Chairman and four independent Non- Executive Directors. Compared with Next Plc., Debenhams Plc. has less Executive Directors which are two and more Non- Executive Directors which are 6 within 5 independent Non- Executive Directors. The more independent Non- Executive Directors in Debenhams Plc. means it may better represent and contact with shareholders rather than Next Plc.
With the purpose of providing clear, accurate and timely financial disclosure, both Next Plc. and Debenhams Plc. have established audit committee with independent outside auditors. The audit committee of Debenhams Plc. appoints PricewaterhouseCoopers LLP as its external auditors and Ernst & Young LLP has been the Next Plc.'s auditors for over 20 years. Additionally, the two companies' external auditors also provide non-audit services to enhance the independence and objectivity of external auditors. The better audit control will guarantee the financial statements offered by these two companies are true and faithful.
On the respect of shareholders' rights, both Next Plc. and Debenhams Plc. claim that all the ordinary shareholders are entitled to attend the Annual General Meeting and have voting rights with the ability to select or reselect directors. The shareholders' rights will promote the directors to more actively communicate with shareholders and be responsible for them.
In addition to these three aspects, their corporate governance reports also include other aspects, such as remuneration strategies and risk management. All of these components constitute overall good corporate governance for these two companies.
Corporate Social and Environmental Reporting
Literature Reviews (theory and practice)
There are a number of theories discussing on the corporate social responsibility. Milton Friedman (1970) descried an agency theory the CSR is a signal of agency problem of company which would misuse the company's sources to some values-added internal projects. Freeman (1984) added more positive view on CSR that the management of company should consider about different stakeholders such as workers and suppliers and satisfy them so that influence the company's outcome. After that, the stakeholder theory had been expanded by Donaldson and Preston (1995). Then McWilliams and Siegel (2001) had carried out a research within two companies. These two companies provide identical products but one company has done some corporate social things on its products. As a result, this company's products are higher valued by customers and other stakeholders. Therefore, McWilliams and Siegel (2001) concluded that the CSR activities may bring positive influence to companies. In their following study, they introduced resource-based view of firm. They believe that if CSR strategies are supported by political strategies, it will be used to generate sustainable competitive advantage for companies (McWilliams and Siegel, 2002).
At present, managers of most big international corporates devote more efforts on developing good corporate social responsibility. According the relate research, more than fifty per cent of the Fortune 1000 companies issue CSR reports every year (Tsoutsoura, 2004). Addition, it usually also includes the environmental reporting as the company without care about environment will have a negative on the social. It is known that the oil spill of BP in Gulf of Mexico in 2010 has not only the serious negative influences on the environments and the people living around that disaster, but has extremely bad effects of the company's reputation, which make the company lose a lot. Therefore, the Corporate Social and Environmental Reporting is also significant to evaluate by investors when they tend to make investment decisions.
Comparison and Analysis about Next Plc. and Debenhams Plc. in Corporate Social and Environmental Reporting
Next Plc. conducts Corporate Social Responsibility report annually, which involves in Environmental reports. Its CSR report indicates how the company use CSR activities to support it business activities' success and continuously growing with responsibility to all its stakeholders, including suppliers, customers, employees, environments and community. Next Plc. announces that the business will be run in a responsible way through acting in an ethical manner, considering about their employees, being responsible and taking care about the impact they made on the environment, providing supports by charitable contributions and delivering faithful value to their customers. On the basis of its good performance in Corporate Social Responsibility, Next Plc. has been selected as one of 2012 London Olympics Games partners. In addition, on the respect of environment, Next Plc. continued to fulfil its objectives of reducing impact on environment and obtained some achievements in 2012, which include reducing the use of energy by 5% compared with last year, overall 85% operational waste having been recycled and 9% reduction of distribution compared with last year.
Compared with Next Plc., Debenhams Plc. does not carry out an individual Corporate Social Responsibility report. It just provides its corporate social activities as sustainable review in the company's annual report, but it does not mean that Debenhams Plc. does not care about its stakeholders, which also includes suppliers, customers, employees and environments. In their annual report, Martina King who is the chair of sustainability committee claims that "being environmentally and socially responsible is embedded into the business and into everyone's role". In terms of the environmental area, Debenhams Plc. also aims to reduce impact on environments to support sustainable business. In addition, Debenhams Plc. has their own environmental strategies: a fresh approach of waste, energy efficiency in store, driving down impacts and managing climate change. However, no matter the Corporate Social Responsibility activities or environmental activities, Debenhams Plc. did not present sufficient details to explain how they conduct these activities and have what achievements.
Conclusion and Recommendations
To sum up, taking the performance of all these four areas into account, investors should choose Next Plc. to invest in. From the perspective of financial performance, Next Plc. has a better performance rather than Debenhams Plc. Next Plc. has an increasing trend in sales growth rate but Debenhams Plc. has decreasing trend. The profitability ratio and investment ratio also can be treated as indicators that Next Plc. will bring more benefits to investors. Especially, the earing per share and dividend per share of Next Plc. are much higher than Debenhams Plc.'s. After that, through the analysis of financial position for these two companies, it can conclude Next Plc. has a stronger ability to meet its short-term liabilities with relatively higher current ratio and even the quick ratios for the recent three are all at around 1. Compare with Next Plc., Debenhams Plc. performs much worse in its liquidity. In particular, the quick ratio is even lower under 0.2. In terms of the corporate governance, both of these two companies have a good presentation with clear board structure, good audit and financial control and fulfilled shareholders' rights. Finally, on the respect of Corporate Social and Environmental Reporting, Next Plc. has conduct an individual Corporate Social Responsibility report including environmental report detailing the activities the company did and is going to do in the future to support ethical and successful business, which did better than Debenhams Plc. as well.
On the other hand, even though Next Plc. has an overall better performance in different areas, there still exist some potential problems that should pay attention on if investor is going to invest in. The most significant problem is that Next Plc. has an extremely higher return on equity and a higher level of leverage (gearing), which means investors will undertake a higher risk if they contribute money in. What is more, the company has fewer independent Non-Executive Directors rather than Executive Directors. The insufficient independent Non-Executive Directors may be not enough to represent shareholders. Therefore, the company had better to increase the number of independent Non-Executive Directors, which will be more beneficial for shareholders.
