The assignment comprises two related sections:
- Conduct a Top-Down analysis of the overall economic environment and consider how forecast changes in economic fundamentals will impact on the performances of companies in the industry your group has chosen. Consider questions including, but not limited to: What is the current interest rate? What is the current value of the $AUD? What is current GDP? What is the inflation rate? What business cycle is the economy currently operating in
- Conduct a Bottom-Up analysis of companies’ current financial situation. Consider accounting ratios and measures of a firm’s performance, how these need to be compared to the industry and company history,
Solution
Executive Summary
This report is going to look at two stocks operating in the retail segment of the Australian economy. The comparison is based on its financial characteristics and the health of its operations within the Australian economy.
The economy of Australia is considered well enough to be positioned above the regional and world averages. The Australian economy with its $1.2 trillion of GDP has a GDP growth rate of 2.5% and per capita GDP of $48,899.
It is facing sharp changes owing to the lower prices of the commodities impacting the mining industry. However, the effective government system has aided to provide a dynamic entrepreneurial environment. Still, it cannot be said the Australian retail market is performing outstandingly well. However, there is substantial potential for steady growth in coming years. Fueled from the lower interest rates, and the need of the consumers to eat and drink, the retail giants can survive until the disposable income of the consumer rises. The luxury and discretionary sections of the retail are anticipated to see some declined growth as the consumer consumption declines. Though, the steady growth provides hope for a better future. As for the two stocks discussed, the Woolworths stock shows its strong financial health and has been found to be more rewarding to the investors yielding higher Earnings per share and payout ratio.
Introduction
Overall, the Australian economy is expected to improve and grow in the coming years at a steady pace. However, the uncertainty around household consumption, downsides and deflationary risks caused by financial instability and slower wage growth are the major challenges. This report is going to look at two stocks operating in the retail segment of the economy. The comparison would be based on its financial strengths and weaknesses and the health of its operations within the Australian economy.
Firstly, the Top-Down analysis of the Australian Economy is conducted which will look at the macro and micro-economic measures for analyzing its potential and growth opportunities. Further, the analysis of the Australian retail industry is conducted to understand better the dynamics in which the two chosen companies are operating.
Looking at the Australian economy, the weaker private consumption growth is expected to more hit the retailing the industry with regards to the discretionary goods. On the contrary, the government spending on the infrastructure promotes business in construction, building, and other related industries. The lower interest rates facilitate the financial condition of the borrowing capital for business investment. The low wage growth rate aids in the reduction of the business cost in many industries (Price, 2917).
Figure 1: Snapshot for Australian Economy
Top-Down analysis:
Australian Economy Analysis:
The Economy of Australia is considered as the 5th freest economy on the 2018 Economic index of Reform. The overall score of the Australian economy has declined this year by 0.1 points due to the decline that was seen in the labor freedom and property rights. On the other hand, better scores were recorded in the government spending and government integrity indicators. The economy of Australia is considered well enough to be ranked above the regional and world averages.
The Australian economy with 24.3 million of the population and $1.2 trillion of GDP has a GDP growth rate of 2.5% and per capita GDP of $48,899. It is facing sharp structural changes due to the lower prices of the commodities seen globally. However, the effective system of the government of Australia has benefited from providing a vibrant entrepreneurial environment in the country. Having almost all of its industries open to the skilled workforce and foreign competition, it continues to be considered as an attractive and dynamic point for investment. With the government debt lowered substantially after the financial crisis and inflation rate at 1.3%, the economy has seen an inflow of foreign direct investment of about $48.2 billion in 2018. Generally, the corporate tax rate is a fixed 30% and the tariff rate applied is at 1.9 percent. However, the government does not substantially interfere in foreign investment, and the financial sector and other sectors are significantly open and competitive for foreign investment (Heritage.org, 2018).
Retail Industry:
There are almost 140,000 retail businesses in the Australian economy, which is accounted for the 4.1 percent of its GDP and employs about 10.7 percent of its total employees. The retail industry of Australia shows diversity regarding its region, size of business, competition within the sectors, retail formats, and like the goods sold. The long-term trends and the current trading scenario are challenging. The retail sector has seen revenue growth decline in the past half-decade as the consumer has started to save more of their rising incomes and more portion of their spending is directed towards the non-retail services.
The retail industry is very competitive. The high competition of the retail companies in the industry has provided a variety of options at good rates to the consumers. However, it becomes challenging for the industry as a whole, making it less productive as compared to the other countries. The productivity gap has been found to widen over time. (Austrlian Government Productivity Commission, 2011)
Online retailing represents another important portion of this sector. The sector analysis shows that the online retailing makes up about 6 percent of the total Australian retail sales. It is comparatively lower than the other overseas countries. Retailers have been operating in Australia under various regulatory regimes which have restricted the competitiveness of the retailers and its innovative ability (Majumdar, 2018).
Industry Growth Rate:
The Australian retail industry has continued to maintain its momentum in the current slowed global economic conditions. Economic and social development drives the key factors of the retail industry. The rising population, robust economic growth of the Australian economy, and the rising purchasing power are the key factors aiding in the expansion of this industry. The industry of retailers is expected to grow and expand at the growth rate of 2% over the coming two years. The growth rate of the retail industry in Australia is the second lowest in the Asia Pacific region.
Interest Rates:
The Australian market is a very flexible market. The sudden changes in the retail sector are a common thing in Australia. The overall size of the Australian retail market was about USD 122 in 2011. The lower interest rates of the Australian market have provided relief to the retail sector in the past. The lower interest rates of the economy have caused the high purchasing power of the customers, increasing their consumption of the retail sector. However, in the coming years, it is expected that the interest rates are going to increase. The general analysts’ consensus is that there is an expectation for more of a hawkish outlook regarding the interest rates of the market. It is driven by upward revisions of GDP expectations, and downward revisions for unemployment expectations. The current and continued lack of the increase in wages pressure even with the tighter labor market, and consumer caution shows that the interest rate can also remain steady in the future.
Business Investment:
Another important measure to look at the economy of Australia is to analyze its business investment growth. The Australian business investment seems to be picking up at a modest pace. The downward pressure from the mining-related business investment and increasing commodity prices has played its role. The key drivers of business investment are positive business conditions and continually improving business confidence. On the other side, the uncertainty around the private consumption more specifically in the retail segment and the margin pressures which are seen in the business due to intense competition exacerbated by globalization are the risks faced by the business investment.
Figure 2: New Business Capital Expenditure in Australia (Manufacturing, Mining, and other Industries)
Disposable Income:
Another major factor which is responsible for the growth of the retail sector is the higher disposable income of the consumers. The increasing high worth of the individuals and their high consumer confidence has driven the growth in the Australian retail industry (Modor Intelligence, 2017).
Household Consumption:
Household consumption is another major area which yields information on the health of an economy. It is an area of uncertainty. The retail trade, which is one of the proxies for household consumption, has been cyclical; however, the trend is more of a decline from as long as 1986 to present. From 2016, it has been witnessed decline more substantially. The digitations in the form of online shopping and increased competition and pressures on price has exacerbated this trend. The lower wage growth and the increasing household debt have been the driver of the lower household consumption.
Bottom-Up Analysis:
Wesfarmers Limited Vs. Woolworths Limited:
From the Bottom-Up Analysis, the companies that are chosen operating within the retail industry of Australia are the Woolworths Group Limited and Wesfarmers Limited. Both are retail giants who operate in a diversified range of services. The retail war between Coles (owned by Wesfarmers Limited) and Woolworths is no secret. The main rivalry is, however, between its liquor businesses. Coles has shown about 4.6% growth in its food and liquor division, while Woolworths increased its past performance by 2.9%. For Woolworths, its liquor sales have accounted for 18% of the overall group’s liquor and food sales. Coles operations have a substantial legacy. However, there is significant underinvestment and outdated IT systems there.
Loyalty programs had been the key medium for picking up traffic for stores and lifting basket size. Coles has recently lifted its Fly Buys program with the appointment of comedian Dawn French for strengthening its campaign. They have been targeting discounts on their favorite products as compared to putting it all across the board providing serious brand loyalty. The Fly buys programs are positioned well to reap benefits in the future.
On the other hand, the discretionary division has remained a challenge for both groups. However, Woolworths Big W is significantly the better performer here and can prove difficult for other retailers to achieve the same level of growth.
For the Wesfarmers, the hardware store Bunning’s is the clear winner. It is its Dan Murphy. Dan Murphy is the heart for the Woolworths, showing its leverage in liquor. Woolworths has initiated making roads into the do-it-yourself hardware market making Master stores by joining hands with the hardware giant of US, Lowe’s. Thus, Master stores for Woolworths will eventually become a threat for the Wesfarmers Bunnings.
During this time of uncertainty and market turbulence, the consumers tend to cut back their luxuries. However, everyone eats and drinks. It is one of the defensive necessities which is a positive thing going on for retailers like Woolworths and Wesfarmers. The increased rivalry would yield price wars making the consumers and the shareholders the ultimate beneficiaries (Anne, 2012).
Ratio Analysis:
To look at both companies from a financial perspective, let’s dig into their statements and conduct ratio analysis for better evaluation.
Table 1: Financial Ratios
| Ratios | Woolworths | Wesfarmers | ||
| 2017 | 2018 | 2017 | 2018 | |
| Return on Assets | 6.61% | 7.42% | 7.10% | 3.11% |
| Return on Equity | 17.04% | 17.23% | 12.25% | 5.13% |
| Net Margin | 2.75% | 3.03% | 4.22% | 1.80% |
| Total Assets Turnover | 2.40% | 2.45% | 1.68% | 1.73% |
| Price Per Earnings Ratio | 24.89 | 23.36 | 17.47 | 21.5 |
| Dividend Per Share | 0.99 | 0.72 | 2.23 | 2.23 |
| Payout Ratio | 86.66% | 75.50% | 77.89% | 97.03% |
Return on Assets:
Figure 3: ROA
The Return on Assets computes the return utilized with the use of the assets. It computes the efficiency with which the assets have been utilized for yielding returns. The Return on Assets for Woolworths for its last five years has been higher than the Return on Assets of Index that is 5.58% for Index and 5.88% for the company. While for Wesfarmers Limited, the five-year return on assets had been lower than the index at 4.71%. Woolworths has been significantly performing well in 2018 yielding a return on assets of 7.42%, while Wesfarmers has yielded a return of 3.11%.
Return on Equity:
Figure 4: ROE
The Return on Equity is calculated by dividing the net income of the total equity owned by the company. The ratio shows how much return the company has earned using equity funding. The Return on Equity is important for the investors to measure the operating performance of the company. The Return on Equity for Woolworths has increased in the last three years from 17.04% to 17.23%. For Wesfarmers, the Return on Equity has been quite lower at 5.13% in 2018 declining from 12.25% in 2017. It shows that comparatively, Woolworths has been more efficiently using its equity for the yielding of return.
Profit Margin:
Figure 5: Net Margin
The profit margin of Wesfarmers Limited has not been phenomenal. The company earned a net margin of 1.80% in 2018 which was substantially lower than the index (22.99%) and its past margin of 4.22% in 2017. On the other hand, Woolworths has a net margin better than Wesfarmers at 3.03% in 2018. Even though it is still quite lower than the average index, margin, the company has improved from its past margin of 2.75% in 2017 and a negative -2.12% in 2016. Therefore, comparatively, in this respect as well, Woolworths are the clear better performer.
Asset Turnover Ratio:
Figure 6: Total Asset Turnover
The asset turnover ratio shows how much revenue has been earned by the company through the utilization of its total assets. The ratio is a better measurement of the efficiency of the company. The asset turnover of Woolworths has been found to be slightly improved from last year 2.40 to 2.45 in 2018. Comparatively, Wesfarmers total asset turnover has been found at a lower level of 1.73 which has improved from 1.68 in its last year. Therefore, regarding efficiency, Woolworths have better utilized its resources.
Price/Earnings Ratio:
Price per Earnings Ratio is used to compute how much of a dollar amount the investor is expecting to invest in a company for yielding of one dollar of its earnings. It is also referred to as a price multiple as it shows how much an investor is willing to pay for a dollar of earnings of the company. The Price per Earnings ratio for Woolworths is 24.89 which is higher than the index average of 16.74. It has improved from 15.24 in 2016. The price-earnings ratio for Wesfarmers in 2017 has been at 17.47 which has declined from 116.41 in 2016. Comparatively, it can be seen that the investors are more favorably investing in Woolworths as compared to the Wesfarmers for a dollar of earnings of the company (Morningstar.com, 2018).
Payout Ratio & Dividend per Share:
The dividend per share for Wesfarmers has been at 2.23 per share in 2017 and 1.86 in 2016. For Woolworths, the dividend per share distributed among the shareholders in 2017 has been 0.99 and 1.10 in 2016. In this aspect, Dividend per share has been more distributed for Wesfarmers. Woolworth’s payout ratio has been 86% in 2017 while for Wesfarmers it has been at 77% in 2017. Comparing the payout ratio, it can be seen that even though Wes farmer is distributing more revenues, Woolworth is distributing a higher portion of its earnings among the shareholders (Morningstar.com, 2018).
Summary & Recommendations
Concluding, it can be said that even though the Australian retail market is not performing outstandingly well, there is potential for steady growth in coming years. Furthermore, the lower interest rates and the need of the consumers to eat and drink remains the defending point for its growth. The luxury and discretionary sections of the retail are expected to see some down side growth as consumer consumption declines. However, the steady growth provides hope for a better future. Regarding the two stocks discussed, the Woolworths stock not only shows its strong financial health, but also has been found to be more lucrative to the investors, yielding higher Earnings per share and payout ratio.
It is recommended that an investor should opt for investing in Woolworths as compared to Wesfarmers because of its strong financial, and the potential for stock rising providing options for capital gains. Furthermore, the company is also following a steady improvement plan to provide discounted prices via its loyalty programs, and thus consumers can gain from it. Whatever the case, with all the intense competition and price pressures, it is evident that the consumers and shareholders are the true beneficiaries of this industry.
Bibliography:
Anne, C.S., 2012. Wesfarmers versus Woolworths. [Online] Available at: https://www.morningstar.com.au/stocks.mvc/article/wesfarmers-woolworths/4878/4 [Accessed 26 September 2018].
Austrlian Government Productivity Commission, 2011. Economic Structure and Performance of the Australian Retail Industry. [Online] Available at: https://www.pc.gov.au/inquiries/completed/retail-industry/report/retail-industry.pdf [Accessed 23 September 2018].
Heritage.org, 2018. Australia. [Online] Available at: https://www.heritage.org/index/country/australia [Accessed 23 September 2018].
Majumdar, D.R., 2018. Australia: Steady and good growth despite risks. [Online] Available at: https://www2.deloitte.com/insights/us/en/economy/asia-pacific/australia-economic-outlook.html [Accessed 23 September 2018].
Modor Intelligence, 2017. Australia Retail Market. [Online] Available at: https://www.mordorintelligence.com/industry-reports/retail-industry-in-australia [Accessed 23 September 2018].
Morningstar.com, 2018. Wesfarmers. [Online] Available at: https://www.morningstar.com/stocks/XASX/WES/quote.html [Accessed 26 September 2018].
Morningstar.com, 2018. Woolworths Ltd. [Online] Available at: https://www.morningstar.com/stocks/pinx/wolwf/quote.html [Accessed 26 September 2018].
Price, J., 2917. Australian Economic Outlook – forecasts for 2018. [Online] Available at: http://blog.jpabusiness.com.au/blog/2018-australian-economic-outlook [Accessed 26 September 2018].
