INTRODUCTION
This report will discuss how Tesco’s changing operations and cost-cutting initiatives have affected the company’s risk position, financial objectives and financial strategy. The company has diversified geographically since the first store in 1931 in Middlesbrough, with over 6800 stores worldwide in 2017. This growth has been continuous, especially since 2008 where store numbers have almost doubled from just 3751 stores (Statista, 2018). In October 2018, Tesco represented 27.4% of the UK’s Grocery store market shares, with the likes of Sainsburys and morrisons following with 15.4 and 15.3% market share respectively. In 2015 Tesco announced its plans to save on costs by closing 43 loss making stores, and cancelling 49 planned store developments (Tescoplc.com, 2015). In addition to this, the company has also finalized a merger with Britain’s biggest wholesalers, Booker Group, in an attempt to cut costs by £1.5bn. Tesco’s £4bn takeover of Booker has now been backed by both sets of shareholders, and Booker shares are no longer listed on the London Stock Exchange.
TESCO’S CHANGING OPERATIONS AND INITATIVES EFFECT ON RISK POSITION, FINANCIAL OBJECTIVES AND FINANCIAL STRATEGY.
Extracted Data from the 2018 Annual Financial Statement
Balance Sheet
£(M) £(M)
2018 2017
NON CURRENT ASSETS
GOODWILL SOFTWARE AND OTHER INTANGIBLE ASSETS 2661 2717
PROPERTY, PLANT AND EQUIPMENT 18521 18108
INVESTMENT PROPERTY 100 64
INVESTMENTS 1549 1562
OTHER FINANCIAL ASSETS 1117 1303
OTHER NON-CURRENT ASSETS 7188 6682
TOTAL NON CURRENT ASSESTS 31136 30436
CURRENT ASSESTS
INVENTORIES 2263 2301
TRADE AND OTHER RECEIVABLES 1482 1475
CASH AND CASH EQUIVALENTS 4059 3821
CURRENT ASSET INVESTMENT 4074
OTHER CURRENT ASSETS 344
TOTAL CURRENT ASSETS 13726 15417
TOTAL ASSETS 44862 45853
CURRENT LIABILITIES
BORROWINGS 1479 2560
TRADE AND OTHER PAYABLES 8996 8875
OTHER CURRENT LIABILITIES 8763 7970
TOTAL CURRENT LIABILITIES 19238 19405
NET CURRENT LIABILITIES 5512 3988
NON CURRENT LIABILTIES
BORROWINGS 7142 9433
PROVISIONS 812 773
OTHER NON- CURRENT LIABILITIES 7212 9828
TOTAL NON CURRENT LIABILITIES 15166 20034
NET ASSETS 10458 6414
EQUITY
SHARE CAPITAL 410 409
SHARE PREMIUM 5107 5096
ALL OTHER RESERVES 735 601
RETAINED EARNINGS 4228 332
EQUITY ATTRIBUTABLE TO OWNERS OF THE PARENT NON-CONTROLLING INTEREST 10480 (22) 6438 (24)
TOTAL EQUITY 10458 6414
Extracted Data from the 2018 Annual Financial Statements
Income Statement
2018 2017
£(M) £(M)
REVENUE 57,491 55,971
COGS 54,141 53,015
GROSS PROFIT 3350 5.83% 2902 5.19%
ADMIN EXPENSES 1633 1995
P&L arising on property related items 120 110
OPERATING PROFIT 1837 3.20% 1017 1.82%
SHARE POST TAX PROFIT/LOSS OF JV 6 107
FINANCIAL INCOME 98 109
FINANCIAL COSTS 631 874
PROFIT BEFORE TAX 1298 2.26% 145 0.26%
TAXATION 306 87
P&L FOR THE YEAR FROM CONTINUING OPERATIONS 992 1.73% 58 0.10%
DISCONTINUED OPERATIONS 216 112
P&L AFTER TAX 1208 54
INTEREST RATE RISK
For Tesco PLC, the non-current liability in borrowings has reduced by 24.3% from 2017 to 2018, which has been a strong attempt by Tesco PLC in reducing their interest rate risk.
By reducing borrowings Tesco has been able to demonstrate a competitive edge over other grocery stores in terms of investment opportunity. The company has been able to resume the payment of dividends to shareholders this year, after a three-year absence while Tesco was financially stabilising the business (Tescoplc.com, 2018). The balance sheet demonstrates the positives a shareholder can obtain by investing despite the considerably high borrowings, for example retained earnings increased by 1173.5% and total equity increased by 63%.
However, borrowings are still considerably high at £7142 mil. With the UK economy in recovery since the recession, interest rates have reached its highest point at 0.75% since mid 2009 (Tradingeconomics.com, 2018). Throughout 2018 alone, interest rates rose from 0.5% to the 0.75%. This is a risk for Tesco PLC as raising rates will mean higher borrowing costs on loans for the business, and reduces shareholders desirability to invest. As interest rates rise, prices of bonds fall. An increase in interest rate poses a threat to opportunity cost of holding a bond, as investors can identify that there may be better yields by switching to alternative investments that reflect a higher interest rate.
Despite this, it is clear from Tesco’s 2018 annual report and the comparison of 2017-2018 figures that Tesco has effectively managed to reduce its borrowings from what was considered a significant risk in 2017 (Tescoplc.com, 2018). However, Tesco’s current borrowings and interest rates are still a risk with the significantly high level of debt the company still faces.
Corporate financial goal 1;
As Tesco has already aimed to reduce costs and increase sales revenues to generate free cash to pay off debts, another strategy to further improve their debt to equity ratio is to restructure debt. I would suggest they refinance their existing debt, which will aim to reduce both interest expenses and monthly payments, and will further improve Tesco’s cash flow and profitability. Ideally this strategy would be reviewed at the end of the accounting year, and would be assessed through the current liabilities section balance sheet.
UNCERTAIN ECONOMIC ENVIRONMENT
The current economic environment in the UK is uncertain ,with Brexit posing a significant threat on the UK economy (Ft.com, 2018). This has potential to significantly impact Tesco’s operations in the UK and ROI, as the process of Brexit could impact Tesco’s labor supply and their supply chain network which will directly effect Tesco’s operations, operating costs and taxes. Following the Brexit vote, GBP dropped to a 31-year low, and has continued to fluctuate depending on political movements and statements regarding Brexit (Allen et al, 2016). Martin (2018) suggests that 20% further in a ‘no deal’ Brexit scenario could worsen inflation. This is then demonstrated when the pound dropped significantly after Theresa May’s assertations after an EU summit that “no deal is better than a bad deal”.
Following this statement The British Chambers of Commerce (BCC) warned that the possibility of the UK leaving the EU without a trade deal was a big concern for firms, with a no deal Brexit impacting prices, wages and living standards (Britishchambers.org.uk, 2018). Tesco CEO Dave Lewis has commented on the effects Brexit could pose on the UK retail and grocery industry, stating how prices are likely to increase as a result. He states, “we've seen inflation coming from a 10% move versus the dollar and a 15% move versus the euro. We've had three years of deflation, we've now got some inflation in the market. Are prices higher? Yes, they are.", and "In a no deal scenario, if there were to be tariffs, then actually that could impact the price of food," (Williams-Grut, 2018).
Corporate financial goal 2;
With the uncertain economic environment not looking to stabilize any time soon, I’ve identified that Tesco’s supply chain is particularly vulnerable. Brexit may cause an increase in tariffs and customs, and operating costs will increase, therefore identifying ways to minimize the effects of these is vital. Firstly I suggest that Tesco use a bilateral negotiations with buisnesses in other countries which can save costs. To decide on this, I’d recommend mapping and auditing supply chains. No matter how prepared Tesco may be for Brexit, it will be disturbed if a supplier cannot meet its contracts. By assessing the risks posed by suppliers, and knowing the location and potential tariffs on goods from suppliers in the EU, Tesco can be more prepared, and therefore its operation costs can be critically analyzed to avoid a large effect from Brexit.
REDUCING OPERATING COSTS
In the 2018 annual report, Tesco PLC highlights their encouragement of a cost cutting culture. By reviewing their store operating model, the company has made £541m in savings (Tescoplc.com, 2018).
By simplifying the shopping experience, Tesco PLC aim to generate £9bn of retail cash from operations and improve operating margins to between 3.5% and 4.0% by 2019/20. Operational costs such as logistics have been reduced by investment in Scan as you shop handsets, now in over 500 UK stores, and by making till receipts optional in smaller stores, generating savings of around £3m (Tescoplc.com, 2018). By adopting Electronic funds transfer systems (EFTPoS), electronic points of sale (EPosy) and making use of electronic scanners has been shown to greatly improve efficiency and distribution, subsequently reducing operating costs (Finch, 2004).
In addition to this, one major cost cutting initiative in regards to operating costs consisted of cutting 1700 job roles, mainly those appointed as “people managers” and “compliance managers” in large UK stores, as well as “customer experience manager” from 226 stores (The Independent, 2018). In an effort to avoid redundancies and restructure the business to focus on smaller retail stores, 900 new positions were also created (Tescoplc.com, 2018). This shows that the company has aimed to demonstrate to its shareholders that there making big advancements in reducing operating costs, however they are backing out of the majority of job cuts by creating the 900 new positions, associating this with ‘restructuring’.
Tesco’s effort to generate free cash continues, and retail cash generated has increased by 495m this year alone. They have done this by reducing stockholding, and improving the way deliveries are received in addition to strong working capital management. To reduce transport costs, full trucks of produce are ordered from supplier, and despite the occasion where orders are required to be “rounded up”, the company has analysed orders and subsequently been able to save on operations by eliminating trucks and unnecessary journeys (Tescoplc.com, 2018).
These cost cutting initiatives have seen an increase of £820m in operating profit compared to the 2017 income statement. This further solidifies Tesco’s financial position, with operating profit increasing and operating expenses decreasing.
There is however, a concern regarding customer service due to staff cuts, however there is little literature to suggest an negative effect on market share and profitability in the long run, however Tesco still remains the largest in market share in the UK grocery industry (The Conversation, 2018).
MAXIMISE VALUE FROM PROPERTY
With a substantial property portfolio, Tesco identified opportunities to better use space to benefit customers while also increasing their proportion of freehold property in the UK and ROI from 41% to 52% (Tescoplc.com, 2018). Tesco has aimed to provide customers with a better shopping experience by repurposing space, and generated 1.1m sq. ft of space. This has allowed Tesco to bring partner stores into the space, offering customers a more divers shopping experience, with retailers such as H&M and Decathlon units within larger stores (Tescoplc.com, 2018).
When increasing the proportion of freehold property, Tesco has managed to lessen
their financial risk position. This is due to the significant increase in the market value of the companies freehold property to £20.7bn from £0.8bn, with an excess of £2.5bn over the net book value (NBV). In addition to this, Tesco also regained ownership of 17 stores in the UK over 2018, which resulted in an annualised rental saving of £26m (Londonstockexchange.com, 2018).
Working Capital (WC) Management
Tesco PLC Morrisons J Sainsburys
Description 2017 2018 2017 2018 2017 2018
Working capital ratio 0.79 0.62 0.41 0.38 0.66 0.76
Net working capital (3,988) (4,450) (1,688) (1,440) (2,261) (2,280)
Working capital days (26.03) (28.26) (37.76) (30.47) (31.47) (29.25)
Description 2017 2018
Revenue 55971 57491 2.7% up from 2017
In addition to establishing Tesco’s financial risks, it is also vital to analyse its working capital (WC). Working capital analysis is used to determine the liquidity and sufficiency of current assets in comparison to current liabilities (Bragg, 2018).
Tesco’s net working capital has improved by £462m, WC day increases by 2.23 days, and WC ratio has decreased by 0.17 compared to 2017. Though this is not the healthiest data, there are many positives. The increase in net working capital indicates that Tesco has managed to pay off some short term creditors whilst also increasing current assets and receivables. It also suggests that by using interest free credit extended by suppliers, Tesco has funded some of their operating expenses.
Supplement to this, Tesco’s working capital days has increased by 2.23 days. Analysist are generally apprehensive to a decrease in days working capital, as it is seen to generally suggest a company is having difficulty maintaining or growing sales and is becoming overleveraged. Increases in days working capital, in contrary suggests a company is underleveraged, is experiencing high sales growth and is potentially paying its bills too slowly (Investinganswers.com, 2018).
When comparing Tesco’s days working capital to competitors, Sainsburys and morrisons, Tesco’s is the only company to demonstrate an increase. This suggests that, alongside the comparisons between companies net working capital and working capital ratio, Tesco’s is more efficient and has better management of its working capital.
When comparing Tesco’s WC to its 2017 performance, it is undoubtable that there has been an valiant effort to improve the company’s working capital management. They have been able to go from a negative net working capital in 2017, to a significantly positive 2018 net working capital. By doing this, Tesco’s has been able to reduce the associated risks of having a negative working capital, and demonstrate the company’s current financial strengths.
Description 2017 2018
Sales outstanding (days) 9.63 9.41
Creditors (days) 61.10 60.65
Inventory (days) 15.84 16.12
Receivables 5.65bn 6.13bn
Payables (bn) 8,88 9
Inventories (M) 2,301 3,396
Accounts Receivables
In comparison to 2017, Tesco’s accounts receivables increased by 8.5% whilst revenue has risen by just 2.7%, and it takes only 0.22 days less to collect payments from customers. From this, the volume of doubtful debts is likely to increase. I’d therefore recommend Tesco reduce payment terms, and begin collecting bills faster. I suggest sending invoices to customers immediately after transactions, followed by a reminder if outstanding payments are due. By doing this it will ensure for a sufficient cash flow, and avoid delays of any payments, subsequently reducing the likelihood of doubtful debts increasing.
Inventory
In comparison to 2017, inventories has worsened a further £1095m, and Tesco have been unable to uphold its inventory days management. This has been demonstrated in an increase of 0.2 days where inventory is stored. By having a considerably large inventory at 3,396m, capital is tied up, while earning a zero financial return. In addition to this, higher inventory days and an overall increase in inventory are both associated with operational costs such as storage, transport and shrinkage of stock.
In consideration to this, it is advisable that Tesco reduce its inventories, shorten their inventory days and inventory turnover ratio. I’d recommend that Tesco adopts a Just In Time (JIT) management strategy for inventory. Tesco sell on multiple channels, such as click and collect and delivery etc, and often demands of goods are often seasonal. By adopting a JIT management strategy, Tesco will be able to meet customers’ needs while holding minimal stock supplies. The strategy will reduce inventory costs, markdowns and smaller, more frequent inventory orders will allow product defects to be identified easier, reducing the number of production errors (SPS Commerce, 2017; Atrill & McLaney, 2017).
Accounts Payables
Comparing to 2017, payment to suppliers has enhanced by 1 day, and there is only a 2% increase in payables, while COSG has increased by 14%. By demonstrating lower creditor days ratio, Tesco is currently paying suppliers more efficiently than 2017, however when they had higher creditor days, there were indicating a more effective usage of suppliers funds and therefore increasing Tesco’s liquidity.
It is important for Tesco to maintain their creditor days , as the effects of adopting JIT has potential to cause problems if suppliers cannot manage deliveries within schedule. By paying their suppliers one day earlier, Tesco has strengthened relationships with the supplier to avoid suppliers not reaching target. It is advised that Tesco do not further shorten its creditor days, and maintain them around 60-61.
A consideration of the company’s plans to cut costs, increase efficiency and reduce their activity both in the UK and abroad, in relation to the company’s future development, concerning capital investment and appraisal and the financing of future expansion projects.
two alternative measures of return the Directors should employ when considering the viability of opening a new production division in the future.
Your analysis and conclusions explaining how the company might fund a long term development while cutting costs, including the advantages and disadvantages of debt and equity funding in this case.
Tesco’s Merger with Booker Group
The Tesco Booker merger has allowed Tesco to bring together the retail and wholesale expertise of the two business, accessing new opportunities to grow. Between the two companies, they employ 310,000 staff in the UK, and serve 117,000 independent retailers, working with 7000 suppliers. Tesco initiated the vertical merger in an attempt to bring benefits to customers, suppliers and shareholders by being able to provide better availability, choice, price and service.
When executing a merger, it is vital for the company directors to evaluate all possible risks and returns, as it is not a general obligation for a business to disclose all relevant information to a potential buyer (Yeoh, 2017). In history, many past merger transactions have failed, with failure rates between 60% to 80% (Armstrong, 2014 ; Christofi et al, 2017). For example, the Skype Ebay merger, where in 2005 eBay purchased skype for $3.1b. Just four years later, eBay then sold the majority of its stake to an investment group for just $1.9 billion, over $1bn less than the original merger price. The failure of this merger was explained through the two companies being unable to successfully integrate their technological systems. This demonstrated the need for due diligence.
The process of due diligence (DD) was important for Tesco as they needed to gain an insight into Booker’s business in terms of profitability, liability and exposure. It was also needed to consider any underlying issues and complications in the integration of Booker’s operations with Tesco’s.
There are a number of key issues Tesco considered when conducting due diligence;
Ownership (brand, asset, reserves)
Finances (revenue, costs, profits and sales)
Valuation of assets and the cost of capital repayment
Cultural and PEST factors
Market share and competitors
Outstanding litigations
Valuation of tangible and intangible assets
Cost of harmonisation and synergizing (management, systems, branding)
Legal and licencing issues
Deloitte (ND) is an audit, consulting, financial advisory and tax service. They suggest that Tesco’s due diligence should have included several review processes, such as legal DD, financial DD and commercial DD. These reviews aim to identify any potential risks and exposures of Bookers group, in areas comprising of Bookers past financial performance, market share and competitors, outstanding litigations and commercial management. By producing an assessment on Bookers financial reporting procedures and management capabilities, along with the terms and conditions negotiations that will be built for the sale and purchase agreement (SPA) Tesco was able to protect itself from any potential risks and exposures identified throughout the process of due diligence. It is important to highlight the need for Tesco’s to appoint independent auditors to check for any ‘key issues’ booker may have had financially. It was vital that Tesco’s analysed markets to support goodwill and brand loyalty valuation, alongside conducting PEST and SWOT analysis’.
Issues which may affect the congruity of Tesco’s financial strategy and business operations and how the risks to the business could be reduced in this regard.
Tesco Booker Merger – Success or Failure
In Tesco’s 2018 annual report, it is stated that the combination of Tesco and Booker has allowed Tesco to bring together the retail and wholesale access new opportunities for growth. In the three months after to the booker takeover, Tesco has seen rising sales for the 10th quarter in a row, and group sales has grown by 1.8 per cent. Tesco’s underpins the companies 2018 success with the Booker merger, which allowed for less price aggression, fresher food and better produce, whilst maintaining a good marginal profit.
Tesco chief executive, Dave Lewis, stated: “Our growth plans are on track and we are pleased with the momentum in the business. We remain well placed to serve our customers better and deliver on our medium-term financial ambitions.”
For any merger, synergizing the two businesses pose some difficulties. Tesco expressed its plan of earing £200m pa after 3 years in synergies, with £25m from revenue gains, £175m in cost savings. Tesco has posted pre-tax profit of £1.3bn in the year to March 2018, up 795.2%, and above analyst expectations of £1.2bn (Javed, 2018). In addition, Group sales were up 2.3% at £51bn last year compared with the previous year (Javed, 2018). Operating profits have increased by over 25%, and Booker’s like-for-like sales rose by nearly 10%. This overall demonstrates the mergers success in developing and maintaining revenue synergy.
Tesco and bookers cost synergy has seen the merger to be highly successful. By ‘joining forces’, Tesco CEO Dave Lewis announced how the company’s integration with Booker is on track to deliver its £200m annual savings target. Booker has been able to reduce costs by using space in Tesco warehouses, which has in turn made it easier to speed up deliveries to customers and in turn improve customer relations. Tesco on the other hand has begun distributing bookers best-selling items in some stores, along with making price cuts in fresh food brands, such as potato’s and mince beef.
Financial synergy
Come with similar values booker and tesco both agree on cutting costs, no data
CEO dave lewis expresses the companies views on the synergy benefit of the merger, “We are delighted with initial progress on Booker, and are focused on delivering the synergy benefits that our merger brings.”