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  • 8/14/2019 Tesco (2012) Merged Merged

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    We initiate coverage of Tesco with a BUY recommendation at

    485.50p. Tescos share price was undervalued and we recom-

    mended a BUY due to the company potential for continuous

    domestic & international growth and development as well as

    the tremendous performance over the recent economic down-

    turn.

    Exceptional Performance over and beyond. The four year period rec-

    orded an increasing revenues (7% on average) and comprehensive in-

    come. And expected to continue to do so for the foreseeable future.

    International Expansion. Borrowings have increased greatly in light of

    the reduced interest rate (0.5%) in financing capital (Tesco bank) ex-

    penditures and expansion abroad (Mostly Asia).

    Tescos courage and strength to survive downturn, and potential to

    outperform. With the financial downturn still looming in the economy.

    The increase in returns generated on assets coupled with the drop in bor-rowing costs were some of the main contributors for the continuous

    growth in return o shareholders.

    Dividends on the Rise. Tesco has certainly proved to be successful and

    confident in maximising shareholders wealth. Financial year 2011 re-

    vealed the 27th consecutive increase in dividends.

    FIVE YEAR SUMMARY 406.10p26 February 2011

    Summary

    Recommendation BUY

    Target price (p) 485.50

    Shares (millions) 8046

    ROCE (E2012) 13.93%

    Beta 0.709

    P/E (E2012) 2.34

    P/B (E2012) 14.12

    MV of Or!"ar# $are& (') 32707

    ANALYST REPORT

    olume 1, Issue 1

    TESCOUOB EQUITY REPORT

    UNITED IN!DOMARTICLE RESEARC"

    University of BirminghamEdgbaston

    Birmingham

    B15 2TT

    United Kingdom

    [email protected]#1$#1$%#1&

    University ID: 1032971

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    Com'a(y O)er)*e+

    O-e./*)e o0 Re'or/

    Share price movement between Tesco (Blue Line) and

    Sainsbury (Red Line) from 20082011

    Tesco is the third largest retail company in the world and the largest

    British UK retailer - in terms of profit. Tesco has proved to be a

    highly successful company as it comfortably operates in other sectors

    i.e. health, financial services - apart from its specialty, food and

    drinks. It operates globally in around 14 countries and continuously

    to gain a fine edge over its competitors (Tesco, 2013) in its ability to

    operate profitably, even during recession periods. Appendix 1.1

    summarises Tesco SWOT analysiswhich reveal its strengths, weak-

    nesses, opportunities and threats.

    This report will examine and analyse the financial state-

    ment for Tesco for the past five years - 2008 to 2012

    (including 2012E forecast). This report is divided into

    three different sections for full detail breakdown for

    a n a l y s i s a n d i n t e r p r e t a t i o n p u r p o s e s .

    The first section of the report will analyse Tescos finan-

    cial performance (Credit status and ROCE - profitabil-

    ity) over a four year period through the use of various

    useful financial analysis tools such as ratio analysis and

    common size analysis, in order to give a clearer trans-

    parency on Tescos performance. Tescos ratio perfor-

    mance will be analysed and compared with that of one

    of Tescos peer and major competitor - Sainsbury J Plc

    and the industry mean average where ever possible

    from a reliable source (industry average as at

    26/02/2011 - Thomson One Banker) - Appendix 3.3.

    The second section will involve the exercise of using the

    common size analysis, analysts projected revenue figure

    (2012E) and CAGR model to forecast the financial posi-

    tion and performance (Income Statement) of Tesco into

    its fifth financial year (2012) - this will be compared

    with its actual 2012 performance. In addition, I will uti-

    lise the annual compound growth model in order to form

    my perspective on Tescos forecast income statement.

    Finally, the final section will attempt to calculate the -

    (Tesco, 2013)

    - companys forecasted value of equity per share at the

    end of the fourth -financial year by using one equity val-uation model (the Residual Earning model).

    Page 2Volume 1, Issue 1 ID: 1032971

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    In order to make an effective equity analysis of Tescos financial position and performance through the use of ratio

    analysis, the financial statements (i.e. Income statement) were reformulated. Reformulation separates the operating

    and financing items in the financial statement, compared to the traditional credit analysis which classifies them into

    current and long term categories (Penman, 2010). Penman (2010) reveals that a benefit of reformulation allows addi-

    tional information to be brought from footnotes.

    The profitability analysis (ROCE) is broken down into three distinct levels. The first level is the separation of operat-

    ing and financial profitability and the effects of leverage. The second break-down level are the drivers of operating

    profitability. Finally, the third level containsProfit margin drivers, asset turnover drivers and analysis of Net bor-

    rowing cost.

    I will evaluate the three break-down levels of profitably (excluding the full break-down analysis of net borrowing

    cost - due to lack of sufficient information in the annual reports). In addition to these ratios, I will also calculate oth-

    er Credit ratios to assist in solidifying my analysis.

    Reformulation

    !e "nalysis of Profitability #Ratios$

    Ratio analysis for TESCO PLC:

    Ratios (Level 1 & 2) Abbreviations 2008 2009 2010 2011

    Return on Common Equity ROCE 0.21 0.14 0.15 0.17

    Return on Net Operang assets RNOA 0.13 0.08 0.11 0.12

    Operang ro!t "argin PM 0.05 0.04 0.05 0.05

    Asset #urno$er A#O 2.44 2.13 2.28 2.35

    %inan&ia' (e$erage %(E) 0.*3 0.+* 0.70 0.5*

    Net ,orro-ing Cost N,C 0.001 0.01 0.04 0.03

    RNOA N,C 0.13 0.07 0.07 0.0+

    %(E) / RNOAN,C 0.08 0.07 0.05 0.05

    Operang (e$erage OLLEV 0.51 0.*4 0.71 0.74

    Ratio analysis for J SAINSBURY's:Ratios (Level 1&2) Abbreviations 2008 2009 2010 2011

    Return on Common Equity ROCE 0.14 0.0+ 0.10 0.12

    Return on Net Operang assets RNOA 0.11 0.04 0.08 0.10

    Operang ro!t "argin PM 0.04 0.02 0.03 0.03

    Asset #urno$er A#O 2.53 2.87 2.7* 2.7*

    %inan&ia' (e$erage %(E) 0.43 0.50 0.4* 0.41

    Net ,orro-ing Cost N,C 0.04 0.05 0.01 0.02

    RNOA N,C 0.07 0.0+ 0.0* 0.07

    %(E) / RNOAN,C 0.03 0.05 0.03 0.03

    Operang (e$erage OLLEV 0.42 0.50 0.47 0.4*

    Page 3Volume 1, Issue 1 ID: 1032971

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    !e "nalysis of Profitability #&ont'($

    0.15

    0.1

    0.05

    00.05

    0.1

    0.15

    0.2

    0.25

    2008 200+ 2010 2011

    ROCE(%)

    Year

    ROCE (200*2011)

    #es&o

    3ainsurys

    ROCE movements of Tesco & Sainsbury's between the four year period.

    ROCE(profitability) for Tesco and J Sains-

    bury's were positive over the four year peri-

    od - except for Sainsburys in 2009 where

    their profitability was negative. In 2009,

    Tescos profitability also declined. However,

    for both company after 2009 there was

    steady growth in their ROCE. The decline of

    ROCE in 2009, could have been due to the

    aftershock of the credit crunch and after this

    year there was improvements. We would

    need to break down the ROCE into different

    levels in order to evaluate in detail and try to

    explain their respectively effects on the over-

    all ROCE.

    RNOA for both retailers were growing steadily after 2009, although

    Sainsburys experienced a negative RONA in 2009 (Tesco also expe-

    rienced a fall in this ratio in 2009). It seems as though the recession

    affected Sainsburys more than Tesco even though they operate in the

    same industry - Tesco are the market leaders in the UK market and are

    able to resist the shocks of downturns in the economy better than its

    competitors. In Tescos defence for the fall in RNOA in 2009 was due

    to the decline in Operating Income in comparison to 2008. The causes

    of this must have been the losses on the benefit pension scheme and

    foreign currency translation differences. During this time the globalmarket was still unstable and losses were made on investments and

    overseas transactions.

    Sainsburys had a negative Operating Income in 2009, although they

    were able to cover their cost of sales - other costs exceeded their in-

    comes. In addition to the negative impact on RNOA was the losses

    made on pension schemes and lower finance income subsequently in

    2009 for J Sainsburys.

    Operating Profit Margin (PM) was rather stable for both retailers

    in years 2008, 2010 & 2011 - apart from in year 2009 where both

    company had a decline in PM (negative in the case of Sainsburys).

    Although both retailers had an increased revenue in all four years the

    operating margin does not seem to be influenced favourably. One

    reason for the fall in this ratio in 2009 was due to the reason stated

    above (RNOA). During the rest of the other years, the stability in the

    ratio was caused by price wars during the recession periods. Other

    retailers such as Morrison's and Asda were forced to drop their price

    in order to compete. This explains the continuous rise in revenue, but

    also a proportionate rise in costs means the ratio is kept rather steady.

    Asset Turnover (efficiency) for Tesco and

    Sainsburys averages at 2.30 and 2.73 re-

    spectively. Over the four year period it has

    been fairly stable. Even though 2009 has

    been the main focus when analysing the oth-

    er ratios. Surprisingly there was an adverse

    impact on Tesco ATO while J Sainsburystriumphed during 2009. Although Tesco gen-

    erated a much higher revenue than Sains-

    burys during this particular period, it can be

    concluded that Sainsburys were more effi-

    cient in using their Net Operating assets to

    generate revenue - Tesco were inefficient. It

    is evidently clear from various sources that

    Tesco adopted a low-cost strategy especially

    during 2009. This must have trigger an antic-

    ipatory increase in demand and subsequently

    sales. Looking at the cash flow statement

    (Cash Investment) Tesco therefore invested

    heavily, the highest investment over the four

    year period - especially the extensive pur-

    chase in PPE and Investment property. Sains-

    burys on the other hand invested less in

    PPE. Thus if Tesco ought to improve their

    ATO they needed to recognise cautious peri-

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    - ods so investing in operating assets could

    be minimised. The analysis of both retailers

    level three break-down for ATO drivers

    (Appendix 1.2) looks fairly similar - PPE

    and Inventory turnover dominating the over-

    all ATO ratio.

    FLEV (Financial Leverage) - Tesco were

    much more highly geared in comparison to

    Sainsburys. Especially in 2009 FLEV ratio

    for Tesco was at 0.96 while Sainsburys

    stood at 0.50. The reason for the high gearing

    is due to the dramatically fall in interest rates

    to 0.5% in 2009 (BBC News, 2013) in the

    UK and also Asia (Japan). The government

    made it relatively easier to borrow funds in

    order to stimulate the economy. Tesco took

    advantage of the historic low interest rate

    drop while Sainsburys, still played very cau-

    tiously. During this year Tesco borrowed

    16,450m (highest over the four year period

    in comparison to the previous year -

    8,056m. After this year borrowings in 2010

    & 2011 didnt drop as far to 2008, rather

    stayed close to 2009 borrowings.

    On the other hand, Sainsburys increased

    borrowings from 2008 to 2009 was 129m

    compared to Tesco 8,394m. In my opinion

    Sainsburys could have been reluctant to bor-row due to the unstable financial markets.

    Although, borrowings are cheap it can bring

    financial distress to the firm. However, on

    the positive aspects of extra funds to support

    operations, according to Modigliani

    and Miller's models (Arnold, 2012) an in-

    crease in borrowings lead to a potential in-

    crease in returns to shareholders.

    0

    5000

    10000

    15000

    20000

    2008 200+ 2010 2011

    'M

    YE+R$

    ,O,+- BORRO.$ (200 *

    2011)

    #es&o

    ainsurys

    Net Borrowing costs (NBC) - effective cost of borrowings

    for Tesco was lowest during 2008 and 2009 and a sudden

    increase in 2010, followed by a drop in 2011. Unlike, for

    Sainsburys its NBC ratio was highest during 2008 and

    2009 and lowest during 2010 and 2011. From the Chart

    above and the line graph below are connected and it ex-

    plains clearly why both retail firms experienced differences

    in their Net borrowing costs. In 2010, Tescos finance costs

    were at the highest over the four year period as outstand-

    ing borrowings increased in the previous year. But in 2011,

    when borrowings started to decline, this is reflected on the

    NBC ratio - as financial costs also started to drop.

    In the case of Sainsburys, finance costs rose steadily over

    three years and dropped to its lowest in 2011. Its NBC ra-

    tio was expected to drop in 2011 as finance costs declined..

    0.000

    0.010

    0.020

    0.030

    0.040

    0.050

    2008 200+ 2010 2011

    (%)

    Year&

    BC (200 * 2011)

    #es&o

    ainsurys

    Profitability "nalysis #&ont'($

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    Profitability "nalysis #&ont'($

    Page 6Volume 1, Issue 1 ID: 1032971

    Operating Liability Leverage - Overall

    Tesco proclaimed a higher average OLLEV

    ratio in comparison to Sainsburys. This

    simply could be due to the fact that Tesco are

    a bigger group and generate more revenue

    and therefore more operating liabilities.

    Tescos OLLEV seems to continue growing

    over the four years. While, j Sainsburys

    OLLEV are falling after its peak in 2009.

    Tescos higher OLLEV seems as though its

    not of concern as its generating more revenue

    each year to cover its operating liability.

    However while analysing the cash flow state-

    ment (the bar chart on the right), there was

    decrease in cash in two years and a subse-

    quent increase in 2010 & 2011. Tesco might

    have found it rather difficult to pay the liabili-

    ties falling due in 2008 and 2009 because of a

    loss on cash.

    Sainsburys OLLEV peak in 2009 was partly

    due to a gradual increase in Trade and other

    payables and a lower NOA figure. Sains-

    burys also experienced a steady sales

    growth, however in three out of the four year

    period delivered a decrease in cash. In thiscase, it seems like good news that their

    OLLEV is falling. But if it falls too much, it

    might impact adversely on sales.

    instead it rose again. This was due to a slight decline in borrowings and increase in Financial As-

    sets.

    Operating Spread (SPREAD) (RNOA>NBC) - was favourable during the four year and three year (08 10 and

    11) period for Tesco and J Sainsburys respectively, where Positive spread is likely to generate higher return for

    shareholders as it suggests that the company earns more on its operating assets than its borrowing costs. Sainsburysearned a negative spread in 2009 - as (RNOA

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    Along with the profitability ratio and its break-down, I will utilise other commonly well known credit rati-

    os to evaluate the performance of my chosen company (Tesco's) and its fierce competitor (J Sainsburys).

    Debtors Days - On average, Sainsburys has a much shorter debtors days in comparison to Tesco

    and the industry average (11.48 days). The impact of a shorter debtors days would mean a more

    healthy cash flow for J Sainsburys. However, less sales on credit for Sainsburys customers thus; this

    strategy may have limited additional potential revenues that could have been gained. While in the

    case of Tesco seems to be offering more sales on credit to customers should lead to improvements in

    revenue, but could also increase the likelihood of bad debts. The strategy based on how much sales

    credit is offered depends on both retailers management (cash flow to sales ratio is the closest to reveal

    an insight into this). Over the four year period, debtors days for Sainsburys seem rather stable, while

    Tescos ratio continues to rise steadily. Reason for the rise could be due high levels of unemployment

    during economic downturn and offering more credit sales to attract more these type of customers.

    Creditors Days - Sainsburys has lower creditors days compared to Tesco over the four year period. This isnt much

    of a surprise as Tesco are the market leader, price setters and have the ability to obtain large economies of scale,

    hence obtaining better payment terms with suppliers. Tesco can be seen to have a much higher bargaining power than

    that of its competitors. As these days increases over the four years, the better cash flow is expected to be. Tesco are

    taking longer to pay its suppliers than J Sainsburys. Tesco have succeeded in maintaining good relationship with its

    suppliers as stated in its mission statement, in order to improve their chances of maintaining better contracts from

    suppliers (Clark, 2010). Sainsburys have a similar believe in maintaining closer relationship with its suppliers, but

    this is not reflected from this ratio. Because over the four years creditors days seems to be decreasing.

    Ratio analysis for TESCO PLC:

    Cre!t $tat& Ra5o& 2008 2009 2010 2011

    Cre6itors ays *0.82 *2.08 *5.8+ *8.4+to& #urno$er ays 20.31 1+.44 1+.04 20.**

    Current Rao to 1 0.*1 0.78 0.73 0.*7

    9ui& Rao to 1 0.38 0.*3 0.5* 0.4+

    etors ays 10.12 12.08 12.11 13.8*

    :nterest Co$er mes 11.4* *.+4 *.03 8.01

    ;ross ro!t "argin

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    "nalysis of &re(it *tatus #&ont'($

    Page -Volume 1, Issue 1 ID: 1032971

    0.00

    0.20

    0.40

    0.*0

    0.80

    1.00

    2008 200+ 2010 2011

    Rat!o

    Year&

    ,e&o (C4rre"t 6 74!8 Rat!o)

    Current Ratioto 1

    9ui& Ratioto 1

    0.00

    0.10

    0.20

    0.30

    0.40

    0.50

    0.*0

    0.70

    2008 200+ 2010 2011

    Rat!o

    Year

    9 $a!"&:4r# (C4rre"t 6 74!8 Rat!o)

    Current Ratioto 1

    9ui& Ratioto 1

    Current Ratio - Looking at the charts, in general

    Tesco and Sainsburys are not holding enough

    current assets in order to cover their current obli-

    gations. Tescos current ratio are higher on aver-

    age (0.7:1), compared to Sainsburys (0.61:1) &

    industry (0.6:1 - Year 2011). Sainsburys current

    ratio looks to be fluctuating over the four years,

    while Tescos ratio seems to increase in 2009 and

    starts to drop steadily again in 2010 & 2011.

    Again, in reference to 2009 it is thought to be a

    difficult year for all retailers in this industry.

    However, it attained the highest current ratio in

    comparison to all other years due to the fall in

    interest rate and in turn Tescos borrowings to

    increase cash held. This in turn increased current

    assets and in turn favoured the ratio. In addition,

    Tesco might have needed the cash in order to sur-

    vive in the short-term during 2009. Because after

    2009, the cash held by Tesco (Statement of Finan-

    cial position) started to decline; having studied

    their statement of financial position, some of these

    cash were used for Investments.

    Quick Ratio - my calculation of quick ratio is the

    ability for the firm to survive excluding stock.

    Also this ratio gives an insight as to how reliant

    the retailers are on stock. Once again by looking

    at the illustrations, Tesco seems to rely more on

    stocks in 2008 in comparison to other years.

    Through a deeper analysis, Sainsburys relied on

    stock the most in 2011 and relied less on stock in

    2009 - as the difference between the current ratio

    and quick ratio revealed this insight. It comes as

    no surprise that in 2011, thats when cash held by

    Sainsburys was at its lowest over the four year

    period. Does this suggest confidence from Sains-

    burys in their stocks to sell within one year, andprojected prediction for better revenue in years to

    come? I personally think this is true as the econo-

    my gets better. However, in 2011 industry...

    Stock Turnover - Sainsburys has a much lower stock turnover

    days than Tesco and the industry average (23 days) - both aver-

    aging at 14 and 20 days respectively. Both retailers did better

    than industry average. Tesco took six days longer to replenish

    its inventory, compared to J Sainsburys. This is mainly due to

    the fact that Tesco holds more stocks than Sainsburys as they

    expect more demand, therefore takes longer to sell. Both retailer

    ratios seems rather steady. This is the case, if other functions of

    the organisation (such as marketing) have done their market re-

    search well enough to know how much demand they are expect-

    ing, in order to be able to hold the right amount of stocks they

    are able to sell. However, if these stocks are piled up as demand

    has been wrongly forecasted, costs can be incurred to the retail-

    ers - i.e. storage costs.

    Both retailer seems to have succeeded to a certain degree in

    forecasting the demands for its goods. Because over the four

    year period stocks are increasing for both retailers and the ratio

    remains fairly constant.

    ...average stood at 0.31:1.

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    "nalysis of &re(it *tatus #&ont'($

    Interest Cover - Tesco had a higher interest

    cover than Sainsburys in each year over the

    four year period. In 2008 Tesco had a high

    twelve times interest cover. In 2010 Tesco ratio

    fell due to higher finance costs (579m), this

    must have been due to the increased in borrow-

    ings in 2009 (refer to borrowing chart in previ-

    ous pages). It makes sense for the ratio to be

    adversely affected, especially if the borrowings

    in 2009 was a short-term borrowing (< 1 year)

    and it falls due in 2010. If this ratio was part of

    the determinants in dividends policy by Tesco

    directors in this particular year; hypothetically

    ordinary shareholders are less likely to receive

    dividends - but dividends was actually received.

    Sainsburys had a lower interest cover rate com-

    pared to Tesco simply because Tesco had a

    higher Operating Income before Interest. In

    2011, the Interest Cover ratio for Sainsburys

    was at its highest over the four year period be-cause the finance cost was at its lowest over the

    four year period. One reason is because Sains-

    burys reduced its short-term borrowings in

    years 2010 & 2011 dramatically. It is unclear as

    to why this strategy was implemented, even

    when interest rate was still low (0.5%). More

    positively, Operating income before interest in-

    creased during 2011.

    0.00

    2.00

    4.00

    *.00

    8.00

    10.00

    12.00

    14.00

    2008 200+ 2010 2011

    Co;er(,!

    e&)

    Year&

    /"tere&t Co;er (200 * 2011)

    #es&o

    ainsurys

    0

    50

    100

    150

    200

    2008 200+ 2010 2011

    ('M)

    Year&

    $*, Borro

    #es&o

    ainsurys

    Although revenue improved gradually over the these period, the

    rate at which cost of sales was increasing was faster than the rate

    in which revenue was increasing. This adversely impacted on

    the ratio. In the fourth year Sainsbury performed below the in-

    dustry benchmark

    The fall in gross profit shows that maybe Sainsburys are not

    bargaining for the lowest costs when purchasing from suppliers

    or they were not willing to switch to a more cheaper supplier.

    Page 9Volume 1, Issue 1 ID: 1032971

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    "nalysis of &re(it *tatus #&ont'($

    The reason was because the rate of inflation in

    the UK from 2008 to 2009 fell from 3.2% to

    2.2% (BBC News, 2013). This is expected to

    deliver a lower cost of sales in proportion to

    sales, but instead the gross profit margin de-

    clined. Furthermore, Inflation rate in 2011 rose to

    4.5%, this is expected to adversely affect the

    Gross profit ratio, but instead gross profit im-

    proved during this year in comparison to previ-

    ous years (2009 & 2010). This should be further

    investigated, as it illustrates some inconsisten-

    Cash flow to Assets measures the efficiency ofthe retailers. How well each company use their

    assets in producing cash from operating activities

    This ratio for Tesco was very unstable over the

    four year period. This is affected through the

    buying and selling of fixed assets in responds to

    growing cash from operating activities in years

    2008, 2009 & 2010. Tesco were very efficient in

    2008. However, in 2011 where total assets was at

    the highest over the four year period, the ratio fell

    to its lowest. This indicates inefficiency from

    Tesco during this year, as less cash from opera-

    tions were produced in comparison to 2010, even

    when there was more assets.

    Sainsburys ratios likewise were quite volatile

    over the four year period, with it being least effi-

    cient in year 2011. Although there were more

    assets, Sainsburys achieved less cash from oper-

    ations in comparison to year 2009 & 2010. In

    these years (2009 & 2010) they were more effi-

    cient compared to 2011.

    Cash flow to sales measures the proportion of cash from operat-

    ing activities to sales. Using this ratio, it gives a slight insight

    into the cash sales offered by each retailer. Tesco experienced an

    improvement in this ratio during the first three years, and a de-

    cline in 2011. The main reason was due to the fact that there was

    a decrease in cash from operations during 2011, even when reve-

    nue continued to grow. We can conclude to an extent Tesco of-

    fered more credit sales during 2011, which has impacted the cash

    from operations. To fully conclude on the specific cause of the

    ratio, Tesco credit sales policy to customers needs to be scruti-

    nised in depth to bring some other facts to light.

    Sainsburys cash flow to sales ratio similarly followed Tescos

    ratio trend. Although revenue improved over the years, cash from

    operations decreased. Tesco and Sainsburys could have both

    used this strategy (more credit sales) to attain more revenue.

    Tesco performed above the industry average of 5.66, while Sains-

    burys this ratio.

    0

    1000

    2000

    3000

    4000

    5000

    *000

    2008 200+ 2010 2011

    ('M)

    Year&

    Ca&% fro Operat!"= +t!;!t!e& (200

    * 2011)

    #es&o

    ainsurys

    0

    10000

    20000

    30000

    40000

    50000

    2008 200+ 2010 2011

    'M

    Year&

    ,O,+- +$$E, (200 * 2011)

    #es&o

    ainsurys

    Page 10Volume 1, Issue 1 ID: 1032971

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    This aim of this second sectionis to be able to calculate Tescos forecasted value of equity per share at the end of

    the fourth year (2011). Through this I am able to give my own opinions based on the calculated value of Tesco and

    thus advice my clients as to their next course of action - Buy, Hold or Sell Tesco shares.

    I believe that the Residual Earnings model was the best choice in valuing the share price of Tesco Plc as the share

    price valuation derived from this formula will be compared to actual share price of Tesco as at 26th February 2011.

    During this process, I utilised the use of the Compound Annual Growth Rate (CAGR) model. I chose this

    model in forecasting year 2012 Revenue, as it incorporates growth rate changes from year to year throughout the

    four year period and eliminates and smoothen volatile rate changes (by providing a rate as a result). Beginning val-

    ue = 2008 Revenue figure & Ending value = 2011 Revenue figure.

    The rate that was derived (6.54%) from the CAGR formula was multiplied by the revenue for 2011 to obtain my

    revenue prediction (64,916m). However, the revenue prediction does not include much macroeconomic infor-

    mation and the calculation was based on past data. I found a way to incorporate analysts revenue figures before I

    arrive at my final Revenue. Analyst are specialists in the monitoring companies and experts in finance field and they

    would have take numerous accounts of macro economical information the CAGR model hasnt taken into considera-

    tion. Therefore, I worked out an average between four figures that includes the three individual analyst revenue fig-

    ures along with the CAGR model revenue prediction (64,916m) - this resulted in my final Revenue (65,773m)

    that takes account of CAGR and macroeconomic factors. Below explains the process behind my theory.

    C+R Moe> Rate *.54*4?+1*

    +"a>#&t Re;e"e&

    @niCre6it >*4?+43

    C=ar'es tan'ey >*7?500

    E$o'uon e&uries >*5?734

    ?!"a> +;era=e Re;e"e '[email protected]

    CAGR Formula - INVESTOPIDIA a, 2012

    My predicted Revenue was surprisingly close to the actual 2012 Revenue. The next process was to be able to calcu-

    late the cost of equity as this will be needed for the calculation of Tescos share price through the Residual Earnings

    m o d e l .

    I obtained twenty-four years worth of Tesco share price and FTSE ALL SHARE Price Index. I calculated returns

    from the price indexes for both Tesco and FTSE ALL SHARE from DataStream. This enabled me to draw a re-

    gression analysisand to be able to obtainBeta(Appendix 1.3).

    Coefficients

    StandardError t Stat P-value Lower 95%

    Upper95%

    Lower95.0%

    Upper95.0%

    Intercept 0.005649666 0.00317605 1.778834 0.076325 -0.000601639 0.011901 -0.0006 0.011901

    X Variable 1 0.709382196 0.063222352 11.22043 1.82E-24 0.58494391 0.83382 0.584944 0.83382

    From the result analysis Summary Output, the figure that is circled is the BETA and this was used with CAPM to

    calculate the Cost of Equity Beta measures the sensitivity of Tescos stock in relative to market changes. From

    this figure (0.709) - Tesco is not very sensitive to changes in the market environment, this truly reflects the compa-

    ny.

    Page 11Volume 1, Issue 1 ID: 1032971

    Foreasting an( *!are Prie Valuation

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    Foreasting an( *!are Prie Valuation #&ont'($

    Page 12Volume 1, Issue 1 ID: 1032971

    CAPM is a model that describes the relationship between risk and expected return and that is used in the pricing of

    risky securities. (Investopidia b, 2012).

    Calculation: cost of equity, ke

    CA" R gi$en equity eta "t ris premium equit eta / "t ris premium

    4.20< 0.70+3821+* 0.054* 0.0387322*8

    ke 8.07