No. 3/2012
17
SAINSBURY’S VS. MORRISONS – AN INVESTMENT
DECISION BASED ON FINANCIALANALYSIS
Zuzana Kalmárová
Roehampton University Business School
Southlands College, 80 Roehampton Lane, London, SW155SL
zuzana.kalmarova@gmail.com
Abstract: This paper deals with financial analysis of two large supermarket chains
in the United Kingdom, namely Sainsbury’s benchmarked against Morrisons. The purpose
is to evaluate whether Sainsbury’s is worth investing in at the market price. To measure
the performance of the food retailers mainly Annual Financial Reports and key
performance indicators will be used as a tool. Given the financial data, findings show that
Sainsbury’s is a company worth investing in at the current share price for both
conservative investors and those looking for growth industries. There is a high probability
that Sainsbury’s will grow in the future.
Keywords: Sainsbury’s, Morrisons, investment decision-making, financial analysis,
performance indicators
JEL Classification: G30
Introduction
J Sainsbury plc (Sainsbury’s) is one of the nation’s oldest retailers founded in London
in 1869 (Sainsbury’s & Boswell, 1969). This retailer with a long tradition is the third
largest supermarket chain in the United Kingdom (UK) with its market share
approximately 16% (Shannon, 2011). Sainsbury’s primarily provides groceries
and marginally it is interested in property and banking.
The aim of this article is to analyse whether Sainsbury’s is worth investing in
at the market price. Secondly, an evaluation of the market position will be provided along
with future prospects.
A case study on Sainsbury’s and Morrisons will be used as a research design in order
to investigate the trends and future prospects for the companies. This research design was
chosen in order to answer the question whether it is worth investing in Sainsbury’s
at the market price. Various ratios were taken into a consideration. All the used formulas
and calculations are provided in the Appendix.
First part (financial analysis) will focus on profitability ratios, efficiency ratios, liquidity
ratios, investment ratios as well as ratios based on share price. In the second part
limitations of ratios will be explained in order to understand the differences
and imperfections in the analysis.
Financial Assets and Investing
18
The main source for the analysis will be companies Annual Reports. The company will be
benchmarked against Morrisons due to the fact that Morrisons has a comparable market
share. Morrisons is the fourth largest supermarket chain in the UK with a market share
of approximately 12% (Morrison plc, 2011).
The added value of this article is that it provides a comparison of two similar companies.
Moreover, it provides an analysis of Sainsbury’s during the period 2006-2011 in order
to have a deep understanding of why ratios have changed and what could be the cause.
The investor then can evaluate all the important ratios during the last six years and
compare them to the main competitor and decide whether to invest in Sainsbury’s or not.
In terms of similar analysis, usually only short term analyses are provided with focus
on certain aspects.
Financial analysis of Sainsbury’s
As it was stated in the introduction, this section will focus on the financial analysis
of Sainsbury’s predominantly based on performance ratios and benchmarked against
Morrisons. A few ratios are based on different kinds of company’s profit. The concept
of profitability is the base for a decision-making for investors. If the investors are satisfied
then the business serves the purpose (Fraser, 1990).
The decision whether to invest in Sainsbury’s or not will be based on ratio analysis.
The source for the analysis will predominantly be the income statements, balance sheets
and cash flow statements. There are many definitions which can be used for each ratio,
therefore, the list of ratio and formulas used can be found in the Appendix A.
The key steps in financial ratio analysis have been followed. The selected ratios have been
calculated based on the income statements, balance sheets and cash flow statements.
These will be interpreted and finally the judgement will be formed on the produced
information. Firstly, the focus will be on a brief evaluation on the market position.
Secondly, profitability, efficiency and liquidity ratios will be analysed. Thirdly,
investment ratios will be examined along with explaining Sainsbury’s dividend policy.
Finally, the gearing ratios will be discussed as well as ratios based on the share price.
In spite of the global recession at the end of 2008, sales (exc VAT) have been steadily
growing, as it can be seen in Table 1. Consequently, one would expect a decline in 2009;
however, food retailers have an advantage of an inelastic demand (McAleese, 2001:84).
Food is a necessity; therefore customers will not reduce the amount of food consumption
although they cut their costs generally (Mankiw, 2007). This means that in a recession
food retailers have a relatively stable demand and do not suffer from losses.
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Tab. 1 Sales, sales growth and market share of Sainsbury’s (2006-2011)
and Morrisons (2011)
Sainsbury’s 2006 2007 2008 2009 2010 2011
Morrisons
2011
Sales (exc VAT) m £ 16,06 17,15 17,84 18,91 19,94 21,10 16,48
Sales Growth (%) 5.65 6.79 4.00 6.02 5.57 5.70 6.94
Market Share (%) 14.70 14.90 14.80 15.90 16.10 16.30 12.80
Gross Profit 1,067 1,172 1,002 1,036 1,082 1,160 1,148
Operating Profit 229 520 530 673 710 851 904
Source: Annual Financial Reports of Sainsbury’s and Morrisons
One of the internal factors that could influence the sales growth is the fact that Sainsbury’s
opened 92 stores in 2011 as also the article from BBC (2011) pointed out. Selling space
has grown by almost 16% since 2009. A stable market share indicates the loyalty
of customers. Furthermore, Sainsbury’s has been able to gain one million additional
customers during 2011. All these factors have contributed to the good performance and
have given Sainsbury’s a competitive advantage to remain one of the biggest food retailers
in the UK. This is consistent with findings of BBC (2011).
Gross and operating profits are driven by sales. Morrisons results in terms of these profits
are comparable. Morrisons did not add as much selling space (just 15 new stores)
as its competitor did, therefore the market share and sales are lower. Sainsbury’s has
higher gross profit, but lower operating profit than Morrisons, which means that
Morrisons is able to operate at lower costs. In 2006 Sainsbury’s had a poor operating
profit compared to the year after. This was due to high administrative expenses before
2007 (Sainsbury’s, 2007).
Tab. 2 Profitability ratios of Sainsbury’s (2006 - 2011) and Morrisons (2011)
Sainsbury’s 2006 2007 2008 2009 2010 2011
Morrisons
2011
Operating Profit Margin 1.43 3.03 2.97 3.56 3.56 4.03 5.49
Gross Profit Margin 6.64 6.80 5.62 5.48 5.41 5.50 6.97
ROCE* (%) 6.10 7.70 8.80 10.10 11.00 11.10 12.80
Return on equity (%) 1.46 7.45 6.66 6.60 11.80 11.78 11.66
* ROCE is calculated on a pre-tax, adjusted basis
Source: Author’s calculations and Annual Financial Reports of Sainsbury’s and Morrisons
As previously stated, gross and operating profit margins are driven by sales. Generally,
food retailers tend to operate on low prices thus it is typical that their profit margins are
Financial Assets and Investing
20
relatively low (Attrill and McLaney, 2011). For every £1 of sales revenue an average
of £0.297 was left as operating profit after paying the cost of goods sold and expenses
of operating the business in 2008. The moderate decline in ratio can be explained by
looking at the gross profit margin.
The gross profit margin ratio is a measure of profitability in producing and selling goods
before any other expenses are taken into account. Cost of sales represents a major expense
for food retailers (Atrill, 2000:58); a change in this ratio can have a considerable impact
on the profit for the year. A moderate decline in the ratio between 2007 and 2010 explains
the fact that the gross profit was lower in relation to sales revenue. This means that cost
of sales was higher relative to sales revenue within the period. This may be explained
by a slight increase in cost of sold goods. When benchmarking against Morrisons,
Morrisons seems to be more profitable than Sainsbury’s across all available profitability
measures.
Return on capital employed (ROCE) measures the efficiency with which new cash is
invested and through which existing capital delivers profit (Collier, 2009: 106-113).
ROCE growth in 2011 was lower than last year partly due to the cumulative effect
of Sainsbury’s accelerated investment in space growth since 2009 (Sainsbury’s, 2011).
This initially shrank profits whilst increasing the value of capital employed. Considering
the previous five years, ROCE has significantly improved since 2006 and continues
to reach high values. This profitability ratio of Morrison is moderately higher, hence
Morrisons is able to gain more profit on average capital employed.
Tab. 3 Efficiency ratios of Sainbury’s (2006 - 2011) and Morrisons (2011)
Sainsbury‘s 2006 2007 2008 2009 2010 2011
Morrisons
2011
Asset
Turnover
1.26 1.79 1.76 1.88 1.84 1.85 1.80
Return per
employee (£)
166,95 179,59 184,65 194,36 205,18 212,51 173,13
Sales per sq ft
(£ per week)*
18.40 19.30 19.69 20.01 20.42 20.04 20.80
*Sales per week (including VAT, excluding fuel) divided by sales area
Source: Author’s calculations and Annual Financial Reports of Sainsbury’s and Morrisons
Asset turnover ratio determines the amount of sales that are generated from each pound
of assets. Companies with high profit margins have low asset turnover (Collier, 2009).
Sainsbury’s asset turnover is relatively low, meaning that it makes a high profit
on its products, but low profit margin. Asset turnover has not dramatically changed since
2007, but between the years 2006 and 2007 there was a significant change. This was
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due to the notable drop in the assets, especially in ‘amounts due from Sainsbury’s Bank
customers and other banks’ totalled £3,361m (J Sainsbury, 2007). Morrisons has a very
similar ratio, this is understandable as it operates in the same kind of business.
Companies seek to have the highest possible revenue per employee. This ratio measures
productivity of the company (Mc Laney & Atrill, 2009). The overall trend indicates that
Sainsbury’s is becoming more efficient. When considering return per employee, the fact
that Sainsbury’s expands and continues to hire people makes its performance even
stronger. When benchmarking against Morrisons, it can be seen that return per employee
is noticeably lower, Morrisons still has the potential and capacity to perform better.
Trading intensity during the period 2006-2010 continued to grow. However, in 2011 this
progression reverted due to a large number of new stores with their sales still
in the growth stage. Secondly, it was also created by a higher proportion of space
dedicated to non-food products, which trade less intensively. As a consequence, average
trading intensity decreased this year.
Tab. 4 Liquidity ratios of Sainsbury’s (2006 - 2011) and Morrisons (2011)
Sainsbury’s 2006 2007 2008 2009 2010 2011
Morrisons
2011
Current Ratio 0.79 0.70 0.61 0.54 0.64 0.58 0.55
Quick Ratio 0.67 0.49 0.35 0.36 0.39 0.30 0.24
Source: Author’s calculations and Annual Financial Reports of Sainsbury’s and Morrisons
Current ratio compares liquid assets with current liabilities. Supermarket chains have
a relatively low ratio, as they hold only fast-moving inventories of finished goods and all
of these sales are made for cash immediately (no credit sales). The higher the ratio,
the more liquid the business is, which is vital for business. On the other hand, too high
current ratio is not demanded because the resources could be used more efficiently
(Collier, 2009). The liquidity is relatively stable although it has slightly decreased during
the last year due to an increase in the liabilities. Trade and other payables rose during
the last year by £131m. Morrisons has approximately two thirds of assets as well as
current liabilities, but the figures are comparable, therefore the ratio closely resembles
the Sainsbury’s ratio.
Quick ratio is very similar to current ratio, but it represents a stricter test. It can be argued
that inventories cannot be converted into cash quickly, so it may be better to exclude them
when measuring the liquidity. The minimum level is often claimed to be 1.0 times,
however it is not unusual for food retailers to be below 1.0 (Atrill & McLaney, 2011).
The overall trend during the last six years in quick ratio is similar to a trend in the current
Financial Assets and Investing
22
ratio, except the years 2008 and 2009. This means that if inventories are excluded,
the company is more liquid.
Tab. 5 Investment ratios of Sainsbury’s (2006 – 2011) and Morrisons (2011)
Sainsbury’s 2006 2007 2008 2009 2010 2011
Morrisons
2011
Earnings
per Share
3.8 18.9 18.6 16.4 31.6 33.8 23.43
Dividend
per Share
8.0 9.75 12.00 13.20 14.20 15.10 9.60
Dividend cover 1.30 1.50 1.63 1.67 1.68 1.75 2.40
Source: Author’s calculations and Annual Financial Reports of Sainsbury’s and Morrisons
In the year 2007 Sainsbury’s experienced a sharp increase in earnings per share going
up by 497%. This was caused by the change in profit for the financial year attributable
to equity holders from 64 to £325m. Another positive shock occurred in 2010 when
diluted earnings went up from 289 to £591m, primarily due to the revaluation
of properties. It is important that assets are revaluated in order to keep the real value
of assets on balance sheet. Earnings per share in 2011 increased by 7% to 33.8 p,
reflecting the improvement in the operating profit and the effect of the additional shares
issued in 2009, more importantly due to the property profits. Morrisons earnings per share
compared to Sainsbury’s are one third lower. This is driven by smaller profit and the fact
that Morrisons is a smaller sized supermarket chain.
Dividend cover needs to be sustainable in the future. The reason behind it is that
if the dividend cover is too low, there is a possibility that the company will not be able
to pay out the investors. If the investors are not satisfied, they may invest their money
in another company. Dividend cover of Sainsbury’s says that earnings available for
dividend cover the actual dividend by 1.58 times on average during the last six years.
Table 5 demonstrates that Sainsbury’s uses a different strategy than the competitors in this
sector. According to Atrill (2009), food retailers have slightly higher dividend cover 2.6
on average. This is not ‘a bad’ sign as long as Sainsbury’s justifies its dividend policy.
This year is the sixth year of growth and it has enabled Sainsbury’s to maintain a good
level of shareholder returns as the previous dividends show. The recommended dividend
for this year was 15.1p, which is 1.5 times more than Morrisons. In terms of dividend
cover, Sainsbury’s has its policy based on their calculations to maintain the dividend cover
between 1.50 – 1.75 times. They were able to provide this cover since 2007 when they
introduced the policy. For the year 2011 Morrisons dividend cover is 2.4 times. They
No. 3/2012
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claim that it is in line with the European food retail sector average (Morrisons, 2011).
This has resulted in dividend growth of 17% compared to the previous year.
According to Modigliani & Miller (1958; 1963) share valuation is independent of the level
of dividend paid by the company. However, this conclusion has been made on several
strict assumptions such as perfect information, no transaction costs, no individual can
influence the market price, no corporate or personal taxes and no costs associated
with issuing securities.
Since we do not live in a perfect world, the dividend relevance theory is more applicable
in this case (Gordon, 1963 & Walter, 1967). Hence, dividend policy matters
to shareholders. When taking into account a signalling theory, Sainsbury’s will try
to maintain the dividend constant or steadily increasing. Dividend increases are kept
in line with long term sustainable earnings to avoid reducing dividends (Arnold, 2008).
In terms of dividend per share, it can be seen that Sainsbury’s policy is to slightly increase
dividend every year. As you can see in Table 5, Sainsbury’s did not decrease the dividend
during the last six years. It actually rose every year and has doubled during the year 2011
when compared to 2006. This is consistent with dividend relevance theory as well
as ‘steadily increasing’ dividend policy.
Tab. 6 Gearing and investment ratios of Sainsbury’s (2006 – 2011) and Morrisons
(2011)
Sainsbury’s 2006 2007 2008 2009 2010 2011
Morrisons
2011
Gearing Ratio (%) 36.0 32.0 30.0 38.0 32.1 33.4 15.0
Interest Cover 45.8 – 5.9 5.6 8.7 7.9 30.0
Source: Author’s calculations and Annual Financial Reports of Sainsbury’s and Morrisons
Gearing is a comparison of the amount borrowed by the company (external resources)
and the funds that shareholders possess (capital available within the company). Lower
figures are more acceptable, demonstrating that the company is predominantly financed
by equity whilst high gearing shows that the majority of the capital company needs is
financed by borrowings (Fraser, 1990).
Morrisons gearing ratio was 15%. A decrease by 4% between 2010 and 2011 is notable
due to a strong balance sheet. Sainsbury’s net debt steadily decreased during the years
2006-2008. However in 2009 the net debt increased (core capital expenditure), then it
went down because of the reduction in net debt and the increase in net assets. In 2011 net
debt went up again by £265m, primarily as a result of property disposals and gearing
increased to 33.4%.
Financial Assets and Investing
24
The interest cover ratio demonstrates the relationship between the amount of operating
profit available to cover interest payable. The lower the level of operating profit coverage,
the greater the risk to shareholders that lenders will take action (Atrill, 2008). Sainsbury’s
levels of operating profit are higher than the interest payable. This means that if
the operating profit shrank 7.9 times, the interest payable would be still covered. The
interest payable was considerably reduced in the years 2006/2007, which also high rates
of interest cover show.
Tab. 7 Ratios based on share price (01/12/2011)
Sainsbury‘s Morrison Food and Drug FTSE 100
P/E 10.60 12.50 12.64 9.84
Dividend yield 5.0 3.6 3.73 3.65
Price 304 322 - -
12 High 395.7 324.4 - -
12 Low 258.0 178.6 - Source:
Financial Times (2011)
Dividend yield defines what percentage return a company pays out to shareholders
in the form of dividends (Collier, 2009). Older companies tend to pay out a higher
percentage than younger companies and their dividend history can be more consistent.
When looking at Sainsbury’s ratios based on share price, it can be seen that P/E ratio is
somewhere between the Food and Drug and FTSE 100’s P/E. Food and Drug’s P/E is
considerably higher than FTSE 100.This could be due to the anticipated recession, where
as noted above, the food retailers share prices are not likely to fall whereas FTSE 100 is
more likely to be influenced by the recession. Sainsbury’s dividend yield is high when
benchmarking to Morrisons, Food and Drug and FTSE 100, which is good news
for shareholders of Sainsbury’s.
Lastly, when evaluating price it seems that Sainsbury’s price is in the lower half
of the price range during the last 12 months, whereas Morrisons share price almost
reached the top level of price. This implies that Sainsbury’s seems more profitable
in the future, whereas Morrisons could experience a downturn. The question is whether
Morrison’s P/E indicates strong growth in the future or the overpriced shares.
From the given data and ratios, the second case is more probable. Sainsbury’s business
seems to be neither extremely risky, nor too conservative.
Figure 1 illustrates the total shareholders return (TSR) performance of an investment
of £ 100 in Sainsbury’s shares over the last five years compared with an equivalent
investment in the FTSE 100 index. The fact is that Sainsbury’s outperformed the FTSE
No. 3/2012
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100 during the whole period. This is remarkable as it also includes years before crisis,
when presumably FTSE 100 (not only food retailers, but also other companies) performed
well.
Fig. 1 Performance graph for Sainsbury’s (2011)
Source: Annual Financial Report of Sainsbury’s (2011).
Limitations of ratios
During the financial analysis of Sainsbury’s certain limitation of ratios emerged. Firstly,
it is necessary to say that all ratios depend on the sector which the company operates in.
Thus, for food retailers gross and operating profit margin will be lower. Secondly, one
of the crucial factors is the size of the company; this has an impact on the gross and
operating profit as well as sales. Thirdly, every company has an individual accounting
adjustments and policies. For example, companies use different depreciation methods
which can have an impact on the operating profit and the profit for the year.
Companies have also different financial year ends, which plays a crucial role when
evaluating some ratios. For example, Sainsbury’s financial year ends in March, whereas
Morrisons year ends in January. When calculating TSR (comparing the performance
of the companies), market price of the companies extremely varies during the year
and tomorrow share price can be completely different. Seasonal fluctuations also play the
role in terms of cash flow.
Conclusion
According to financial analysis Sainsbury’s is a company worth investing in at the current
share price. Sainsbury’s sales (exc VAT) have been steadily growing; they are going to
expand their market share. Moreover, growth in sales is notable, which drives gross
and operating profits, therefore shareholders dividends. Also interest payable is covered
and managed according to their policy. They improved the return per employee and
outperformed Morrisons. They have high dividend yield and combined with the relatively
Financial Assets and Investing
26
low price during the last 12 months this implies that buying shares would be a wise
choice.
The TSR graph indicates that Sainsbury’s is a good choice for both conservative investors
and those looking for growth industries. There is a high probability that Sainsbury’s will
grow in the future, according to the key performance indicators, therefore it is highly
recommended to buy the shares. It is necessary to bear in mind that if Sainsbury’s
continues to grow, the price will increase since it is now in the lower half. It would
probably be wise to invest now rather than later.
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Appendix A - Formulas
Tab. 1 Sales, sales growth and market share of Sainsbury’s (2006 – 2011) and
Morrisons (2011)
Sales Growth = Sales (exc VAT) in the year Y1 – Sales (exc VAT) in the year Y0 /
Sales (exc VAT) in the year Y0 (1)
Tab. 2 Profitability ratios of Sainsbury’s (2006 – 2011) and Morrisons (2011)
Gross Profit Margin = Gross Profit / Sales (exc VAT) (2)
Operating Profit Margin = Operating Profit / Sales (exc VAT) (3)
ROCE = Operating Profit / Average Capital Employed (4)
Return on Equity = Net Income/Shareholder's Equity (5)
Tab. 3 Efficiency ratios of Sainsbury’s (2006 – 2011) and Morrisons (2011)
Asset Turnover = Sales (exc VAT) / Totral Assets (6)
Return per Employee = Sales (exc VAT) / Number of Employees
(Full Time Equivalent) (7)
Sales per Square Foot = Total Net Sales / Square Feet of Selling Space (8)
Tab. 4 Liquidity ratios of Sainsbury’s (2006 – 2011) and Morrisons (2011)
Current Ratio = Current Assets / Current Liabilities (9)
Quick Ratio = (Current Assets – Inventories) / Current Liabilities (10)
Tab. 5 Investment ratios of Sainsbury’s (2006 – 2011) and Morrisons (2011)
Earnings per Share = Diluted Earnings for Calculating Diluted Earnings
per Share / Total
Number of Shares for Calculating Diluted Earnings per Share (11)
Dividend Cover = Underlying profit after tax from continuing operations
attributable to equity shareholders / Total value of dividends declared during
the year (12)
Tab. 6 Gearing and investment ratios of Sainsbury’s (2006 – 2011) and Morrisons
(2011)
Interest Cover = Operating Profit / Interest Payable (13)
Gearing Ratio = Net Debt / Total Equity (14)
Tab. 7 Ratios based on share price (01/12/2011)
P/E = Market Value per Share / Earnings per Share (15)
Dividend Yield = Dividend Yield per Share / Market Value per Share (16)
TSR = dividend paid during the period + (minimal value of shares
at the end of the period – nominal value of shares at the beginning
of the period) / nominal value of shares at the beginning of the period (17)