Understanding Financial Statements Journalist Guide: Fundamental Analysis Of Woolworths And Wesfarmers Limited

Overall Economic Environment Forecasted Changes in Economic Fundamentals

Discuss About The Understanding Financial Statements Journalist Guide.

The present report is undertaken for carrying out fundamental analysis of the two ASX listed companies operating in the same industry. The fundamental analysis consists of both top-down and bottom-up analysis for identifying the macro and micro factors that can impact the value of selected companies in the future context. The top-down analysis seeks to examine the overall economic environment and bottom-up analysis evaluates the current financial situation of the selected companies. The companies selected in this context are Woolworths and Wesfarmers limited operating in the retail sector of Australia.

Top-down analysis refers to gaining an examination of the overall economic environment in which an industry operates and then analyzing the impact of the economic trends on the industry growth prospects. The overall analysis is meant for identifying the macro trends that are in favor of the industry development (Samonas, 2015).  The selected ASX listed companies of Wesfarmers and Woolworths operates in the retail sector of Australia and as such this top-down analysis has specifically examined the overall economic environment in Australia that can have an impact on the performances of companies. The assessment of the overall economic environment in Australia in order to evaluate the impact of the forecasted changes in economic fundamentals on the company’s performance as follows:

Australia is recognized to be a wealthy nation and is presently in a state of major economic expansion after recovering from the period of year 2009 of global recession. This is largely on account of the stable political environment present within Australia that is driving the industrial growth and development. The Reserve Bank of Australia has maintained the interest rates at 1.5% and has decided to hold on this interest rate for a long-period of time. The interest rate of Australia is recorded to be lowest at present as compared to the past 18 months. The strategy is adopted by RBA for reducing uncertainty that is present in relation to the household consumption. The decrease in the income level of consumers and rising debt levels are posing uncertainty in the household consumption. As such, the RBA has decided to maintain the interest rates and inflation rates to be lower at 2% for supporting the growth and development of the country’s economy. The low level of interest and inflation rate will help in increasing the spending power of consumers and thus promoting the industrial growth and development. This will help in mitigating the high levels of household debt that is presenting a major risk against the financial stability of the country (Australian Economy, 2018).

Economic Analysis

The Australian dollar is expected to trade at 0.76 by end of the end of this quarter as predicted by the Trading Economics. Also, the current value of Australian dollar is expected to suffer a declining trend after the weaker performance of its retail and international trade sector. Also, the declining value of the country dollar is further expected to decline due to lower interest rates and declining economic growth (Chau, 2018). However, there are also some positive predictions regarding the growth in the Australian dollar on account of depreciation in the US. The speculations regarding the increase in the interest rates in the US will make it a more attractive place for investment to the foreign investors. This can reduce the money  invested in Australia and therefore causing a decrease in the demand of its local currency causing a weakening in the value of Australian dollar (Australian Dollar Showing Long-Term Negative Signs, 2018).

The Gross Domestic Product (GDP) is regarded as one of the major indicator for depicting the well-being of the economy of a country. It depicts the overall market value of final goods and service produced by a country in a given period of time. The GDP growth rate of Australia has depicted an increase of about 2.27 per cent in comparison to the previous year in the year 2017. Also, it has been predicted by the data provided by statistic that the GDP growth rate of Australia is expected to increase to large amount by the end of the year 2022. The growth rate in GDP of Australia on an average is 0.85 per cent from the year 1985-2017. The rising demand of raw commodities from the developing countries since the year 2000 has played a vital role in the growth of the Australian economy. The country has nearly maintained a positive growth in the past years and has only experienced a decelerated economic growth in the year of global financial crisis in 2009. As such, it can be said that Australia is presently in a state of positive expansion phase as it is economy is growing on a steady growth rate of 2-3 per cent every year (GDP in Australia, 2018). The growth rate maintained by Australia in GDP and the forecasted growth can be depicted as follows:

(Source: https://tradingeconomics.com/australia/gdp-growth)

The growth in the retail sector on the basis of the economic fundamental of Australia is predicted to be positive in the coming period of time. The lower interest and inflation rates will helps in increasing the spending power of consumers and thus supporting the growth of the retail companies. The trend is expected to continue in the next few years and it is also possible that RBA cam further reduce its cash rate if household debt increases (Madaan, 2009). Thus, stronger economic growth, reducing unemployment and low interest rates all provides a solid base for the growth in Australian retail sector. As such, on the basis of the forecasted economic fundamentals it can be said that the companies selected are likely to experience a positive economic growth in the coming period of time (Australia Retail Investment Outlook, 2016).

Impact on the Performances of Selected Companies

Bottom up approach refers to the investment strategy that helps to evaluate the individual stocks in order to prepare the report on the performance of the company. The main purpose of the bottom up analysis is to conduct the fundamental analysis of the selected companies so that economic performance of whole industry can be predicted. The performance of selected companies is compared with the industry average so that position of company in the market can be evaluated. Ratio analysis has been used as an important tool to conduct the fundamental analysis of Wesfarmers and Woolworth.

Ratio analysis is used to perform the quantitative analysis of financial information presented in the financial reports of the companies. It provides fundamental analysis of operating and financial performance of selected companies (Carbaugh, R. 2017).

(Wesfarmers: Annual Report, 2017) & (Woolworths: Annual Report, 2017)

(Note: Financial Data has been included in the appendix section of the report)

Profitability analysis measures the company’s ability to earn the revenue through use of available resources. There are multiple ratios that are used assess the profitability position of the company. The main motive of the company is to reduce the expenses and increase the revenue so that overall net income can be increased.

Net profit margin shows the percentage of profit earned on net revenue. It is highly important profitability ratio as it reflects the company ability to earn profit through earning maximum revenue and control the overall expenses. The net profit margin of the Wesfarmers has been increased from 0.62% to 4.20%. On the other hand net profit ratio of Woolworth has been negative 2.12% in year 2016 and it was increased to 2.76% in year 2017. That shows net profit ratio of Wesfarmers was much better than Woolworth in both the years. As compared with the industry average it was found that net profit position of Woolworth was worth in both the years as compared to Wesfarmers. Although Wesfarmers has better net profit ratio than Woolworth but it has also faced downgraded net profit as it was expected in both the years (Tracy, 2012).

Return on assets reflects the percentage of profit earned using the assets of the company. Assets refer to resources used to earn the revenue and return on assets reflects the management responsibility to make use of assets in maximum possible way so that overall profit can be increased. Wesfarmers has return on assets of 1 % in year 2016 and it has increased to 7.16% in year 2017. On the other hand, return on assets of Woolworth was negative 5.25% in year 2016 and 6.69% in year 2017. So it can be said that Woolworth has failed to make use of its assets in much better way as compared to Wesfarmers. Industry average shows Wesfarmers has been successful to meet the industry average while Woolworth failed to meet benchmark set by industry average.

Bottom-up Analysis

Overall profitability position of Wesfarmers was much better than the Woolworth during the last two years. It shows that Wesfarmers has been able to utilize its resources in much better way as compared to Woolworth (Samonas, 2015).

Liquidity refers to the company’s ability to meet the short term liabilities through use of it liquid asset resources. The liquidity performance of both the companies is evaluated with the use of current and quick ratio. The current ratio provides an assessment of the current asset base maintained by the companies for meeting its financial obligations that are due within the short-term. The current ratio of Woolworths has declined in the year 2017 as compared to the year 2016 while Wesfarmer’s have maintained a steady current ratio over both the years. The quick ratio predicts the most liquid asset resources held by the company such as cash resources for meeting its short-term financial liabilities. The quick ratio of both the companies have increased in the year 2017 as compared to the previous year and Wesfarmer’s quick ratio is better than Woolworths predicting its string cash position.

The liquidity performance of both the companies has predicted that Wesfarmers is able to meet the industry average for current ratio while both the companies have met the industry average for quick ratio (Taparia,  2004).

The capital structure analysis has been carried out with the use debt-equity and debt ratio for depicting the efficiency of both the companies in maintaining an optimal capital structure that will prove it the maximum returns (Robinson, 2015). The debt-equity ratio of Wesfarmer’s and Woolworths have reduced in the year 2017 as compared to 2016 depicting that they have reduced its financial leverage in comparison to equity in its capital structure. Also, the debt ratio of both the companies is declining which means that they are incorporating less use of debt in financing their assets.

However, on comparison to industry average it can be said that Woolworths is meeting the industry average in marinating an efficient capital structure by the use of a balanced proportion of debt and equity to gain larger returns in the future period of time (Robinson, 2015).

The earning per share of Wesfarmer’s has declined in the year 2017 and that of Woolworths have increased in the respective year. However, Wesfarmers earning per share is relatively good as compared to Woolworths as depicted from their EPS ratios calculated. Also, both the companies have reduced the dividend paid to the shareholder sin the year 2017 but Woolworths has maintained an aggressive dividend policy as it is paying well dividend in comparison to its EPS. However, Wesfarmer’s is following a conservative divided policy as it has reduced its dividend in comparison to the earnings in the year 2017.

The top-down analysis has predicted a positive growth for Wesfarmers and Woolworths on the basis of expansion phase of Australian economy supporting a favorable economic environment for retail sector of Australia. It can be said from bottom-up analysis that financial performance of Wesfarmer’s is better than Woolworths as analyzed from their financial outcomes. However, Woolworth’s financial performance is improving in the current phase and it is expected that the company will perform good in the future period of time as predicted from its capital structure and market analysis. It is recommended to both the companies to implement strong financial measures for improving their performances as economic outlook of Australia is supportive for the growth of the retail sector.

References

Australia Retail Investment Outlook. 2016. [Online]. Available at: file:///C:/Users/user/Desktop/Cushman_Wakefield_Australia_Retail_Investment_Outlook_Report_2016.pdf [Accessed on: 29 May 2018].

Australian Dollar Showing Long-Term Negative Signs. 2018. [Online]. Available at: https://www.poundsterlinglive.com/aud/8755-the-australian-dollar-is-showing-long-term-negative-signals [Accessed on: 29 May 2018].

Australian Economy. 2018. Reserve Bank of Australia leaves interest rates unchanged amid market turmoil. [Online]. Available at: https://www.theguardian.com/australia-news/2018/feb/06/reserve-bank-of-australia-leaves-interest-rates-unchanged-amid-market-turmoil [Accessed on: 29 May 2018].

Carbaugh, R. 2017. Contemporary Economics. M.E. Sharpe.

Chau, D. 2018. Australian dollar in 2018-19: Experts clash on whether it will crash or surge. [Online]. Available at: https://www.abc.net.au/news/2018-01-05/australian-dollar-forecast-2018/9292304 [Accessed on: 29 May 2018].

GDP in Australia. 2018. [Online]. Available at: https://www.focus-economics.com/country-indicator/australia/gdp [Accessed on: 29 May 2018].

Madaan, K.V. 2009. Fundamentals of Retailing. Tata McGraw-Hill Education.

Robinson, T. 2015. International Financial Statement Analysis. CFA Institute Investment Series.

Samonas, M. 2015. Financial Forecasting, Analysis, and Modelling: A Framework for Long-Term Forecasting. John Wiley & Sons.

Taparia, J. 2004. Understanding Financial Statements: A Journalist’s Guide. Marion Street Press, Inc.

Tracy, A. 2012. Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet. RatioAnalysis.net.

Wesfarmers. 2017. Annual Report. [Online]. Available at: https://www.wesfarmers.com.au/docs/default-source/default-document-library/2017-annual-report.pdf?sfvrsn=0 [Accessed on: 29 May 2018].

Woolworths Group. 2017. Annual Report. [Online]. Available at: https://www.woolworthsgroup.com.au/icms_docs/188795_annual-report-2017.pdf [Accessed on: 29 May 2018].

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