Return on Capital Employed Essay
The finding shows that Tesco has stably increased net profit margins from 5. 4% to 5. 9% and gross profit margins remain static by 7. 6% over the last five years. This suggests the business is being managed in a stable way. Tesco may have a healthy pricing strategy which is evident in both ratios. Its inventory management is good, its raw materials and factory wages hasn’t gone up a lot, or that its selling prices are changing as fast as the costs of the goods it sells. When we compare the gross and the net profit margins, we can see the cost structure of the business.
The difference between average gross profit margin 7.6% and average net profit margin 5. 6% is not significant. It means that the cost of sales, operating costs, administration and similar expenses are relatively low at Tesco. Return on Assets Turnover (excluding VAT) of Tesco increased strongly from i?? 17. 158 billion in 1999 to i?? 26. 337 billion in 2003 by 9. 55%, 11. 66%, 12. 70% and 11. 35% respectively. However, the company employed further long-term debt resulting in more strongly increased growth of capital employed of 13. 5%, 15. 1%, 16. 1%
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As a result, Assets turnover of Tesco has been falling over the last five years. Return on Capital Employed This ratio compares the profit earned (usually before interest and tax) to the funds used to generate sales. In this report, ROCE of Tesco reveals that its relative profitability has been falling slightly over the last five years. However, the net profit margins have increased slightly year by year over the last five years and gross profit margins have remained static. Therefore, the fall in return on capital employed is due to decrease of Assets turnover, i. e. the new investment.
Tesco has a large capital expenditure programme mainly due to its huge investment in space for new stores. It added 1. 14 million square feet in 2002, which is an overall 6% net increase in space. In addition, Tesco is expected to open 59 new UK stores this year, and over 2. 5 million square feet of net additions over the next three years. A drop of ROCE from 15. 5% to 13. 8% is relatively significant in year 2003 and suggests that the assets being used have sharply increased by 27. 2% from i?? 8747m to i?? 11129m but the profits increased by 13. 8% from 1354m to i?? 1541m in this year.
As a result, a fall in the efficiency of the business as a whole (ROCE) exists and as it affects the shareholders’ ROSF. However, the sharp increase in the assets base may of course have occurred near the end of year 2002, such as Tesco’s late 2002 investment into West-midlands based convenience store group T&S in the UK and its benefits therefore may not have yet appeared. Tesco’s general growth and ROCE show no sign of abating. In the UK, Tesco’s late 2002 investment into West-midlands based convenience store group T&S was billed as the most aggressive move into the neighbourhood market by a big-name retailer so far.
Space growth is expected to drive growth in the UK over the next year. This is an expansion that is more wide-reaching and aggressive than any of its competitors. Tesco has only just begun to develop its non-food segment in the past few years. This represents a greater opportunity for Tesco to expand further. In central Europe and Asia, the low economic growth has meant that land prices and a number of operating costs were lower, meaning that Tesco was able to generate better operating margins and achieve its profit targets. From the table 3, we can see good performances of Tesco in terms of sales and profit.
The Asian sector shows the strongest growth in terms of sales and profits, although it has the smallest base among the three segments. The rest of Europe is also relatively strong, meaning that the UK, the largest segment in the business is pulling back overall growth. Profitability is climbing steadily, although not exceptionally; but returns on shareholders’ funds and capital employed are weak to poor. Benchmark Tesco against J Sainsbury In order to judge whether Tesco is doing well or badly, we need to compare the results of Tesco with one of other similar firms in the same sort of industry- Sainbury’s.
Compared to Sainsbury, the finding clearly shows that Tesco is more profitable over the last five years as Tesco has a higher ROCE, net and gross profits margin. 17% and 5. 7% in 1999 was the only year Sainsbury had a higher ROCE and NPM than Tesco had over the last five years. The higher ROCE earned by Tesoc suggests better management by the company of the finances entrusted to it by its shareholders. A better net and gross profit margin suggest that Tesco is better at converting sales into profits. Tesco can achieve a higher unit of sales price or that its unit cost of raw materials is lower.
The same level of asset turnover ratios for both two retailers suggests that assets are being used productively to generate sales at the same level of them. The ROCE of Sainsbury has declined from 17% in 1999 to only 10% in 2003. We can see from the table 2 that it seems that net profit margin which decreased from 5. 7% in 1999 to 4. 2% in 2003 was the main cause of the problem. The improvements in 2003 are very clear- gross profit margin is the highest over the last five years and both net profit margin and return on capital employed the best since 2000.
Tesco is trading at premium of 161%. It may happen when demand exceeds supply. The company is performing outstanding and more investors are buying into the fund. Tesco’s total shareholders’ funds has been increasing continuously from i?? 4382m in 1999 to i?? 6516m in 2003, which means that existing shareholders were getting more confidence on Tesco’s performance and so there could be more demand of existing and new shareholders to buy Tesco’s shares in the stock market.
Moreover, the rise of Tesco’s underlying earnings per share and dividend per share over the last five years also shows the confidence of shareholders on Tesco. Part 3 Comment on the usefulness of the performance graph and an analysis of whether total shareholder return is a good indicator of company and management performance. Tesco’s Total Shareholder Return (TSR) performance graph shows that Tesco’s performance was good in that its TSR was significantly higher than Financial Times Stock Exchange (FTSE) 100 index of companies from February 2000 to February 2003.
Total shareholder return (TSR) is the measure of the returns that a company has provided for its shareholders during a given period time, i. e. the sum total of appreciation in share price plus dividends declared during the period. The absolute size of the TSR will vary with stock markets, but the relative position reflects the market perception of overall performance relative to a reference group. It is, therefore, a good indicator of a company’s overall performance. Over the last five years, Tesso initially performed poorly till 2000.
But unlike many stocks in retail and non-retail companies of similar scale to Tesco suffering falls, Tesco has increased in its stock price during the last three years. In the last year, total shareholder return in Tesco was 31. 9% compared to the FTSE average of 24%. The share price is driven by the difference between expected and actual performance and by changes in expectations than by the current level of performance as such. (Deepak Mittal) The companies that have improvements in expectations of future performance can deliver a significant increased TRS.
Thus to achieve total returns consistently greater than the cost of equity requires beating the expectations consistently. As performance of an enterprise improves, the expectations rise. If a company has performed well over the years, the marker expectation is very high. Continuously beating the expectations would eventually become impossible and hence the company might find hard to deliver a high TRS. Hence share price appreciation or TRS, though is a good indicator of corporate performance it cannot be applied in isolation for all companies in all situations.