Hewlett is a general merchandise retailer based in Greece. This report will analyze the companys credit worthiness by reviewing its recent financial performance while considering the influence of the Greek economic climate in the same timeframe. According to the financial statements for the year ended 30 June 2012, both sales and gross profitability have grown steadily over the last three years, although less so between 2011 and 2012 as compared to the 2010/2011 figures. Sales revenue grew 18.9% from A¢”šA¬1.85B in 2010 to A¢”šA¬2.2B in 2011 and then 13.6% to A¢”šA¬2.5B in 2012. Similarly gross profit grew 16.7% from A¢”šA¬600M to A¢”šA¬700M and then 7.1% to A¢”šA¬750M. These growth figures however, are put into perspective by the rising costs incurred in their sales process. Operating costs have risen 16.3% from A¢”šA¬550M in 2010 to A¢”šA¬640M in 2011 and then 9.3% to A¢”šA¬700M in 2012, causing operating profit (profit before interest and taxes-PBIT) to drop from A¢”šA¬60M in 2011 to A¢”šA¬50M in 2012. Not surprisingly, a dividend of A¢”šA¬20M has been proposed for 2012, down from A¢”šA¬30M the previous year. Again, to put this in perspective, consider that the company only has A¢”šA¬20M in profit after tax and interest for 2012; just enough to pay the proposed dividend. The current market size for Greek store-based retailing stands at about A¢”šA¬37B down from A¢”šA¬40B in 2011 and A¢”šA¬47B in 2010 as shown in figure 1 below.
With prosperity indexes being at record lows, it is no surprise that Greek retailing has suffered in recent years. The 5 biggest retailers in Greece by sales are AB Vassilopoulos, Sklavenitis, Lidl, Carrefour-Marinopoulos and Masoutis. While these 5 have maintained growth in total sales numbers over recent years, a look further down the list indicates companies with stagnant or reduced sales numbers from the “Greek Wal-Mart”, Jumbo, to Germanos and IKEA. With consumers becoming increasingly price conscious, retailers needing to keep the total sales level as high as possible have resorted to different tactics. In this regard, Hewlett has increased credit sales from A¢”šA¬300M in 2010 to A¢”šA¬400M in 2011 and then A¢”šA¬600M in 2012. Figure 1: Total market size of Greek store-based retailing (Euromonitor 2012) Even with these measures, the strain of the recession on retailers has caused a streak of consolidations as a number of retailers have closed down stores. For example, Atlantic Supermarket closed its doors and a number of its former outlets were acquired by Masoutis, Lidl Hellas and AB Vassilopoulos. Similarly, outlets under the Dia brand are now Carrefour supermarkets. In a clear indication of the extent to which finances have been strained, “since mid-2009, when the global economic slowdown began to bite, until mid-September last year, some 65,000 stores have been forced to shut their doors” (The Guardian UK, 2012). Even with prices reduced by about 70% at the end of 2011, cash-strapped Greeks have reigned in their spending. This is not surprising considering the inflation growth percentage reaching 4.7% in 2010 and 3.3% in 2011 as shown in figure 2 below. “Consumers suffering wage and pension cuts, rising inflation and a recession of a severity not seen since the Second World War ensured that shops had one of their worst Christmases on record, with retail sales down 30% on the previous year “(The Guardian UK, 2012). Subsequently, a series of retailers have filed for bankruptcy in 2012 leaving more space for oligopolies to expand. Figure 2: Country file – Greece (World Bank Databank 2012)
Since the sovereign debt crisis hit Greek banks in early 2010, Greek lenders have found themselves in a position where they do not have enough money to lend to businesses (Wall Street Journal, 2011). One of the reasons Greek banks are so cash strapped is the drop in bank deposits since 2010. The credit crunch and irregular practices have forced Greek banks to look towards consolidation to help control the liquidity crisis.
13.7 -2.9 13.3 +7.5 14.3 A proper credit analysis of Hewlett must consider its ability to remain viable as a business; profitability is a concern. The company’s current return on capital employed (R.O.C.E) numbers indicate stagnation in this regard. It decreased from 13.7% in 2010, to 13.3% in 2011 and then increased to 14.3% in 2012. Stagnation in profits while interest payments rise gradually reduces the company’s ability to make those payments (Attril & Mclaney 2012, p. 336). The gross profit ratio enables further understanding of the success of the company at trading. Considering the industry involved (retail), a low profit margin percentage (averaging 31% over the past three years) is understandable as there is not a significant production process with raw materials and manufacturing costs that can be deducted from sales. In addition, “retail firms tend to have much higher turnover ratios, much lower profitability on sales and much shorter operating cycles than primary manufacturing companies” (Gombola & Ketz 1983, p. 46). If the ‘cost of sales’ is understood here as the ‘cost of merchandise’, then the low figures indicate the inability of Hewlett to control costs, perhaps due to inflation. In addition, as the costs of sales have increased from year to year, Hewlett appears to have failed in passing this on to the consumers resulting in wastage and a decreasing gross profit margin. Admittedly, it is difficult to increase prices in a retail sector that has witnessed a severe drop in sales. Nevertheless, it is important to note that in many stable businesses, retained profits represent the main source of income and even though they are not directly equivalent to cash, they are useful when interest rates are high (Jones 2006, p. 211). The stagnation in the net profit margin (5.5% in 2011, 5.6% in 2012) confirms that the company has not been successful in controlling overhead costs. This explains why the borrowing has increased from year to year; to cover expenses. A glance at the income statement reveals that the cost of sales increased by 20% in 2011 and 16.7% in 2012. The company might be making some profit, but that does not necessarily translate to cash-in-hand, available for spending.
0.97:1 +11.3 1.08:1 -4.6% 1.03:1 The current ratio, which gives an understanding of the liquid position of the company, has varied from 1.74:1 in 2010, to 2.12:1 in 2011 and then 2.02:1 in 2012. This is understandable considering an efficient retailer does not pile up stock but instead keeps stock at a manageable level with turnover as quick as possible. With the ratio trending above 2:1 in 2011 and 2012, the indication is that the company has sufficient current assets to turn into cash in order to meet its financial commitments. However, considering the fact that in a crisis, it is more difficult to turn stocks into cash compared to the other current assets, a more prudent measure of the ability of this company to pay its short term obligations is the quick ratio (Weetman 2010, p. 294). Similar to the current ratio, the quick ratio varied from 0.97:1 in 2010 to 1.08:1 in 2011 and then 1.03:1 in 2012. As shown by the increase in inventory from A¢”šA¬540M in 2011 to A¢”šA¬620M in 2012, poor stock control has contributed to the weakened liquidity. In the embattled Greek economy, retail sales levels have dropped as disposable income has reduced. In a country where the annual disposable income has fallen from approximately US$240B in 2011 to US$223B in 2012, consumers do not have the money to maintain previous years’ sales numbers. In a worst case scenario where a retailer such as Hewlett is unable to turn stock to cash quickly enough, the ratio of 1.03:1 indicates that in the short run, Hewlett has the ability to pay off its current debt without selling its inventory.
599 -16.3 502 -23.7 383 In order to remain in this favorable position, the company must efficiently manage operations. Unfortunately, accounting profit is subject to arbitrary adjustments in-house and is not an entirely reliable tool when judging the efficiency of the company. The stock turnover rate increased by 1.9% in 2011 but decreased by 5.3% in 2012 as a result of the significant increase in stock levels. This indicates an inability of the company to sell its merchandise fast enough. The company is averaging 3 inventory turns per year; this is of particular concern to a retailer which should be capitalizing on stock that consists of fast moving consumer goods To keep stock levels manageable and encourage consumers to buy more, Hewlett appears to have encouraged more credit sales. Consequently, this has increased from A¢”šA¬300M in 2010 to A¢”šA¬600M in 2012. If debtors are slow to pay, the company will run into cash flow problems reducing its ability to cover debt. The trade debtor collection period has decreased from 599 days in 2010 to 383 days in 2012, still a considerably high figure. This is because credit sales have increased at a faster rate than the average number of debtors. So, while Hewlett might be selling more on credit, it appears to be doing so to a manageable number of debtors who appear to be paying on time. This is good for the company’s immediate cash flow.
8.9:1 -2.2 8.7:1 +1.1 8.8:1 As the company has financed itself more and more through loans in recent years, the bank’s concern regarding increased lending is understandable. Loans increased by 62.5% in 2011 and a further 17% in 2012. As a direct result, and exacerbated by the fact that the loans to Hewett are unsecured, the interest payable ballooned from A¢”šA¬25M in 2010 to A¢”šA¬60M in 2011 and then A¢”šA¬110M in 2012. That translates to a 140% increase in 2011 followed by an 83% increase in 2012. Although profit before interest and tax (PBIT) has increased from A¢”šA¬95M in 2010 to A¢”šA¬140M in 2012, the strain of the interest payments is shown on the company’s bottom line. Even though taxes have decreased, the net profit available (after tax and interest payments have been deducted) decreased from A¢”šA¬47M in 2010 to A¢”šA¬20M in 2012. To give a clearer picture of the long-term financial position of the company, the capital gearing ratio shows just how much of the company is currently financed by loans. This ratio has increased considerably from 46.2% in 2010 to 62.1% in 2012; the company is highly geared. This combined with falling net profit indicates that the company may have trouble paying interest in the future. Ideally, business financing should be a healthy combination of equity and loans, and this is not the case with Hewlett. Reserves have remained stagnant in the presence of rising loans.
The balance of capital is unhealthy, especially in a depressed economy. This is shown further by the decrease in interest cover. Hewlett could cover its interest payments 3.8 times over in 2010 but can only do so 1.3 times over in 2012. In essence, the company is over committing itself in its borrowing. Looking past interest, and at the overall debt situation, liquidity ratios give an understanding of Hewlett’s current ability to pay off debt based on historic numbers. To make a projection about how much of a factor debt will be in the overall picture in the future, the debt ratio must be considered. This is because it gives an idea of the company’s reliance on debt for asset formation. Hewlett’s debt ratio has increased incrementally from in 0.71:1 in 2010, to 0.75:1 in 2011 and then 0.78:1 in 2012. This indicates that the company has increased its reliance on debt for asset formation. The increasing debt to equity ratio buttresses this point. This has increased from 2.3:1 in 2010, to 2.7:1 and then 3.3:1 in 2012 as bank loans and other interest borrowings have increased. The company is trending towards being over-leveraged resulting in a debt repayment burden that may eventually prove too much to bear. Consideration must be given to the fact that the Greek stock market has suffered greatly in the past three years as figure 3 below shows, with stocks most recently dropping an average of 50 index points in October 2012. This indicates that the company is hamstrung by the current economic climate and unable to significantly increase equity. Figure 3: Greek stock market performance (Trading Economics 2012) In essence, because increasing equity is difficult, Hewlett will have to cover any debt with its own cash generated. The debt leverage ratio has remained fairly constant, from 8.9:1 in 2010, to 8.7:1 in 2011 and then 8.8:1 in 2012. Ostensibly, the company’s ability to cover its debt with its operating cash flow has worsened. The possibility of the company defaulting on its loans is a reality.
Hewlett’s profitability has decreased while liquidity and the efficiency of operations have fluctuated while gearing has increased. The company is overcommitted as earnings before interest and tax (EBIT) are not increasing fast enough to keep up with rising interest payments (due to the unsecured nature of the loans) resulting in lower retained profit. Based on recent performance, the ratio analysis shows that increasing lending to the company will most likely accelerate the process by which the company will eventually default on its interest payments and then ultimately its loans. To ensure the continued, profitable operations, the bank should advise the company to reduce the scale of its operations like a number of retailers in Greece have done by closing some stores. This will help to ensure the company only keeps in operation the number of stores for which it can cover expenses.
There are a number of limitations that have hindered this analysis. First of all, parts of the financial statements generating process are subject to internal manipulation. Secondly, this analysis is based solely on numbers and does not take into account issues like product quality and employee performance which are key factors in financial performance. Also, ratio figures for companies in the same industry are not available for comparison. Therefore this analysis cannot prove for certain that the issues faced by Hewlett are peculiar or industry wide. The inventory turnover ratio is based on year end stock levels; access to monthly or weekly levels would give a better indication of how well the company turns over its stock. Similarly, access to information regarding the company’s credit purchases would give an idea of the length of time the company is currently taking to pay its short term creditors. In addition, while the projections in this analysis are based on the current economic climate in Greece, the situation is poised to change due to planned bailouts from the Eurozone and so performance trends might change.
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