JD Wetherspoon plc, is a company which owns and operates pubs throughout the United Kingdom. The company was established in 1979 (and incorporated in 1981) and is part of the FTSE 250 index. From a single pub in Greater London, the company now has an estate of 731 pubs. In the recent years, apart from the sale of alcohol, food has generated a substantial amount of the firms' profits.
The purpose of this assignment is to evaluate the performance and financial position of the company, by analysing and interpreting profitability, liquidity, management of working capital and capital structure accounting ratios. Reference was also made to the asset utilization ratios and also to alternative ways which may be used to analyse the financial performance and position of the firm. The financial statements are shown in Appendix A of the assignment, whilst the accounting ratio calculations are shown in Appendix B of this assignment.
All of the ratio calculations exclude exceptional items. Exceptional items were excluded from the analysis because they are not relevant for comparison purposes. In 2009, these included impairment of property and fixed assets, property disposals, litigation costs, and fair value gains/loss on derivatives. Although these exceptional items are not useful for comparison purposes, it is important to note that they have led to a reduction in net profit of 44.02% (Profit before exceptional items £45,201,000 - Profit after exceptional items £25,299,000).
2.0 An evaluation of the performance and financial position of JD Wetherspoon plc
2.1 Profitability
When considering the profitability of JD Wetherspoon plc for 2009, one would immediately realise that this has improved from the previous year. With the exception of the gross profit percentage, all the other profitability ratios show an improvement over the previous year. The graph below summarises the results obtained from the calculation of the profitability ratios.
Figure 1: Profitability Ratios
The Return on Capital Employed shows an increase from 14.2% to 18.9%. This indicates that management has improved its efficiency of utilising the resources available. Such improvement is due to the increase in profits (net profit before interest and tax and before exceptional items increased by 7.2%) and a reduction in equity and long term debt. Long term debt has declined by 24.5% (2008: £458,732,000 - 2009: £346,259,000).
Similarly, the shareholder's equity ratio has increased by 5.3% as a result of the reduction in equity and the increase in net profit. The reduction in equity is explained in the section relating to the capital structure. Despite the decrease in equity and the increase in profits, there was a decrease in asset turnover (refer to the discussion in the asset turnover section).
If one had to look further into the profit figures one would find out that the gross profit percentage in 2009 has remained at the same level of 2008 (14%). One could argue that management should consider looking into the cost of sales and assess whether there are ways on how it can be reduced. One would presume that the cost of sales (as a percentage of sales) was reduced marginally in 2009, but the reduction was offset by inflation. It is important to note that 2009 sales were the highest since the JD Wetherspoon was incorporated as a limited liability company in 1984.
There was an increase in net profit before exceptional items of 0.43%. This improvement can be partly attributed to a reduction in finance costs of 4.25% as a result of the decline in debt. A significant difference identified in Note 7 of the Financial Statements is the reduction in interest payable on US senior loan notes of £1,967,000. The company also reduced administrative expenses (2007: £37,337,000 to £36,707,000) by 8.6%. The Chairman's Statement indicated that there were increases in energy prices, excise duty and labour costs but these were offset by reduced energy consumption, lower stuff turnover and better buying practices. Furthermore between 2008 and 2009 there was a reduction in taxation as a result of a tax credit on the cash flow hedges' unrealised losses. Besides this on 1st April 2008, the UK standard rate of corporation tax was reduced from 30% to 28%.
Although the above analysis seems to imply that overall profitability has improved, this is not the case when taking exceptional items into consideration. The main exceptional item was an impairment of fixed assets amounting to £15,951,000 (£6,527,000 relates to an impairment under IAS 36, and £9,424,000 relates to a one off depreciation of assets (such as CCTV cameras) which were not being depreciated in line with the company's policies).
2.2 Liquidity
After analysing profitability, we can look at the liquidity position of the company by considering the current and acid test ratio. A decline in liquidity was reported in 2009 from 2008. A current ratio of 0.23:1, and an acid test ratio of 0.15:1 appears to be very low especially when compared to the previous years' ratios (0.36:1 and 0.24:1) respectively. In fact, current liabilities are much higher than current assets generating a net current liability. In order to determine whether these ratios are too low, it is essential to compare these with the industry average. To this respect, Elliot and Elliot (2006), pointed out that the current ratio for brewers is usually quite low. It is worth noting that the cash flow statement indicates that £36,899,000 was invested in new pubs and pub extensions. These new pubs are likely to increase the sales figures in the coming years and could have a positive effect on the liquidity of the firm in the future.
Despite the fact that there was an increase in current assets, current liabilities increased by more than double the amount of 2008. Further analysis reveals that such an increase is due to £87 million U.S. Loan notes which were due for renewal in September 2009. These were reclassified from long term liabilities into current liabilities as the company intends to repay these loan notes this year, from cash flows and remaining financing facilities. Had we to eliminate these loans from current assets (they are one-off events), the liquidity position would considerably improve. These loans were eventually repaid, and investors' concerns about these notes were extinguished.
However, despite the liquidity ratios appear to point out worsening liquidity positions, it is important to note that the company has increased its cash and cash equivalents by 43.2% (from £16,452,000 to £23,604,000). If one was to consider the free cash flow, this has increased in 2009 by 39.3% from the previous year of 2007, which is equivalent to an increase of 21.1 pence per share. This clearly shows an improvement in the cash flow position over the previous year. Besides this, the company has also increased the level of unutilised banking and cash facilities to £153.8 million. In the previous year, this was only £82.6 million.
2.3 Management of Working Capital
After analysing the liquidity position, the management of working capital was considered. An analysis of the inventory turnover ratio and the creditor days ratio and the average payment period ratio was made. The company has no trade debtors and as a result the debtor collection period ratio was not calculated. Furthermore, in view of this the working capital ratio is considered to be irrelevant.
JD Wetherspoon plc's inventory turnover ratio has remained constant between the years 2008 and 2009 (8 days). Although this figure seems to be low (implying proper stock management), one needs to compare this to the industry average. One should also review further whether there is any possibility of reducing this any further, particularly since the stock owned by the pub chain has a limited shelve life.
With regards to creditors days, the company has made an overall improvement between 2008 (25 days) and 2009 (33 days). Although this is a positive sign, the company should ensure that by paying later, the reputation of the firm with the supplier is not being tarnished in any way. This should have a positive effect on the cash balance and hence is increasing overall liquidity. JD Wetherspoon plc, should consider further this ratio by monitoring whether there are any suppliers which are able to provide better credit terms. If there are suppliers which offer better terms, the firm should consider the implications of changing suppliers - for example if purchases with the existing supplier are carried out as a result of a contractual agreement, there could be penalties which would be incurred upon termination of the agreement.
2.4 Asset Turnover
Apart from the ratios related to the working capital, one can also compare the turnover with the assets that the business has used to generate that turnover by having a look at the asset utilisation ratio. The asset turnover has fallen from 1.06 times in 2008, to 0.11 times in 2009. After subdividing this ratio further, one realises that the reduction is not attributable to the fixed assets because fixed asset turnover ratio in 2009 increased. In fact, the fixed asset turnover ratio has increased. Apart from the increase in sales, this due to a reduction in fixed assets. Despite the fact that the company opened 39 pubs during the year, the company has made a number of disposals and provided for an impairment of £15,951,000 as outlined in the introduction.
The reduction in the asset turnover is due to the current assets. Current assets have increased by 28.5% from the previous year but sales only increased by 5.2%. The increase in current assets is partly attributable by an increase in cash (which has to be used in order to repay the Notes Payable which became due after year end), increases in prepayments and accrued income, as well as property amounting to £1,135,000 which is being held for sale within the next twelve months.
2.5 Capital Structure
JD Wetherspoon is a highly geared company, although it has reduced its gearing ratio from 71.8% in 2008 to 67.4% in 2009. There was a reduction in long term loans, but since the senior US Bank Loans expiry in September 2009, the drastic decrease is partly attributable to a reclassification of the same loans from non-current liabilities to current liabilities. Borrowings have declined, notwithstanding that the firm opened 39 new pubs in the current financial year. The company decided not to pay any dividends for 2008/9, in order to reduce further the debt during the next year. This is also due to the fact that the company's revolving debt facilities are due to expire in December 2010, and therefore the company will be seeking refinancing during the next financial year possibly by means of a rights issue.
Equity has reduced as well, primarily as a result of a cash flow hedge loss taken to equity. The management has indicated in Note 22 that the cash flow hedge was highly effective, in fact £35,934,000 were recognised as an unrealised loss in equity, with a resulting deferred tax credit of £10,062,000. The cash flow hedge is a fixed rate swap used as a hedge for floating rate borrowings.
The high gearing ratio needs to be compared to the industry average in order to be better analysed. The financial statements indicate that the company has one of the lowest net debts to earnings before interest and tax ratios when compared to the other listed companies in the same sector. Besides this, the gearing level is within the company's targets.
Although the company is highly geared, at the end of the year ended 31 July 2009, the company can cover the interest 3.1 times by its profits, an improvement over the 2.8 times of 2008. A value above 2 is usually considered reasonably safe, but once again one would have to look further in the industry averages.
As shown in the graph below, the interest cover ratio is at the same level as 2007.
Figure 2: Interest cover ratio
3.0 Conclusion and commentary on the use of ratios
Overall, the company has performed well when compared to the previous year with regards to profitability, but it appears that the company needs to improve its liquidity position, even though one has to compare this to the industry. Although the company is highly geared, its aim is to reduce the debt further in the next accounting period. As explained earlier, the level of debt is still one of the lowest when one considers the listed pub sector companies and therefore this should not be the cause of increasing concern.
The above analysis was carried out using financial ratios which have several limitations. Without placing any doubt on JD Wetherspoon's financial statements, it is a well known fact that the reliability of financial statements can be questionable (e.g. in the recent Indian software company Satyam scandal there was fraudulent representation) or there could be window dressing (for example - despatch of defect goods at year end in order to show them as sales). Also in the analysis we are using year-end balance sheet figures, in which there could be seasonal fluctuations. Another concern of using intra-firm comparison of ratio would be that their could be peculiarities of the trade which make it difficult to interpret ratios, for example in this case a gearing ratio of 67.4% may appear too high unless the ratios of similar firms operating in the same industry are considered.
Different methods of analysing the financial position and performance of JD Wetherspoon, apart from the use of the traditional accounting ratios, could have been considered. Trend analysis could be used in order to analysis the financial statements over a series of years (e.g. 5 years) and then percentage changes are calculated to analyse whether the rate is increasing or decreasing. A difficulty with this method would be to remove the effect of inflation. Another method which may be used is Horizontal Analysis. Percentage changes between to periods are calculated for each item in the financial statements, hence permitting comparison over two successive years. Vertical analysis could have also been used, but this method concentrates only on one year. Under this methodology all items in the financial statements are expressed as a percentage of another item. Several authors such as Altman, have also suggested the use of multivariate analysis, in particular Z-Scores, which attempt to replace the traditional ratios, with "scientifically analysed" ratios which could indicate corporate stability and even predict corporate failures. Other innovative methods are the H-Score, which is an enhancement of the Z-score but focuses more on the balance sheet. Historical summaries may also help in the analysis of the performance and financial position of the company. All JD Wetherspoon plc provided a historical summary on page 42 of the Annual Report, it failed to adjust for inflation and hence the use of such figures may be limited.
