(a)
REPORT
To: Investor
From: Financial advisor
Date: December 2013
Subject: Garner Stores
This report is based upon the summarised financial statements of Garner Stores for the year ended 31 October 2013.
Profitability
The gross profit margin has deteriorated from 31.9% in 2012 to 29.1% in 2013. In 2012 it was in line with the sector average but is now well below it. However this is in line with the new company policy to sell low priced goods. Revenue itself has seen an increase of 35% in 2013 which appears to be as a result of:
• the lower sales price resulting in higher sales volume;
• the advertising campaign attracting new customers;
• the opening of five new stores.
Despite heavy expenditure on refurbishments and advertising combined with the fall in gross profit margin the drop in operating profit margin is only 0.7% and the 2013 margin is only 0.5% below the industry average. This indicates strong control of overheads. Indeed return on capital employed has increased even after considering the overdraft as debt indicating good use of the funds available.
The cause of the increases in returns to providers of capital is the increased net asset turnover figure. Overall the net assets of the company are being used in 2013 to earn more revenue per $1 than in 2012. However, the non-current asset turnover figure has slightly reduced in 2013 and is now substantially lower than the industry average. This may reflect the new investment in stores which may have taken place later rather than earlier in the year meaning that their full potential has not yet been realised.
Efficiency
It has been noted above that there was a significant increase in net asset turnover and this is due to the much reduced investment in working capital.
Inventory days have decreased from 74 days to 43 days which reflects management's success in negotiating short notice delivery periods with the new local suppliers. Allied to this, the payables payment period has increased by 5 days which indicates that Garner is not having to pay more quickly for this service.
Receivables days have reduced from 8 days to just 5 days. However, this is an average based on all sales rather than just credit sales. In a retail environment a long receivables period would never be expected but this reduction indicates possibly more cash sales or maybe a move away from any credit finance given to customers. The 5 day period would indicate a small proportion of credit sales but most sales being for cash and debit/credit card or cheque, all of which are settled quickly.
Liquidity
On the face of it the current ratio would seem to be excessively low at 0.51 : 1 and also
considerably lower than at the end of the 2012 accounting period. However in a retail environment it would be expected for there to be a fairly low current ratio due to low receivables figures. This is therefore perhaps not a concern as the figure is also made artificially low by the large bank overdraft at the end of the 2013 accounting period.
The bank overdraft in itself must be of some concern. There has been considerable investment in non-current assets during the year but only $1 million of additional loan finance has been raised to cover this. The remainder of the investment has been covered from operating cash flows and the use of this overdraft. Presumably the bank is happy to offer such a large overdraft figure but the interest on this is almost certain to be considerably higher than the 8% payable on the loan stock.
It is generally unwise to finance the purchase of long term assets with short term finance. As well as being more expensive, there is a risk that the bank could withdraw the overdraft facility.
However, the interest on the 8% loan notes would have been $320,000 (if they had been in issue all year), making the interest on the overdraft $40,000. This low interest would imply that the bank overdraft is a relatively recent feature which may well be reduced from operating cash flows during 2013.
Gearing
The gearing level of the company, although slightly increased, looks comfortable, even after considering the overdraft as debt. The interest payments are easily covered by profits.
However, as the 6% loan notes have been replaced with 8% loan notes in the year, this implies that either the market perceives Garner Store to be at greater risk of default or that there has been a general increase in interest rates.
Dividends
From an investor's perspective the dividend per share of 5.6 cents in 2012 would appear quite healthy and with an increase to 8.1 cents per share investors should be quite happy. However from a cash flow pers pective a dividend pay-out of $650,000 when the overdraft stands at over $1 million might not have been such a good idea.
Conclusion
There have been some fairly dramatic changes in the financial performance and position of the company between 2012 and 2013 however, these seem to be generally in line with the stated aims of the new management. The company would appear to be fundamentally profitable,growing and making good use of available loan capital.
