Gross profit margin =Gross profit/Net sales
The formulae used in the calculations are listed in the appendix. ("Growth, Profitability, and Financial Ratios for Myer Holdings Ltd (MYR) from Morningstar.com," n.d.)
Generally, profitability ratios give someone an idea on how the company is utilizing resources to make the profit.
Myer has a lower gross profit margin compared to David Jones. The gross profit, net profit margins for Myer decline over the two-year period, 2012 and 2013. During the same time, David Jones improves marginally on the margins. This is an indication of changing fortunes in the industry, where one company gains as the other declines.
The two companies have a similar tax environment as tax expense is a third of the earnings, on average. The effective tax rate changes year to year, showing possible changes in the tax requirements. In 2013, both companies had almost the same tax rate, showing a possible realignment of tax measures.
David Jones has a better asset utilization model compared to Myer. The industry return on assets is decreasing, giving a sign of possible difficulties in the same industry or underutilized assets. On the other hand, a return on assets measure is above 5% showing the strength of the companies to utilize resources.
Myer has a very good return on equity, consistently, as shown in the table. On the other hand, David Jones return on equity declines considerably between the year 2012 and 2013 with a below 15%.
The measurement of the comprehensive return, using the return on capital employed formula shows string approach strong consistency by both companies. The profitability of the companies seems to be on track and attractive to investors. It may be because of the nature of the industry, where clothing and fashion forms a basic part of human beings hence ensuring profitability.
Myer has an exposed position in that the liabilities are not fully covered by the assets. Investors would be very keen on the way the company is going to solve that problem since they can easily make losses in the event of dissolution. The business is highly leveraged.
On the other hand, David Jones is healthy on this measure, as assets cover liabilities with a ratio of more than one. It means, too that Myer’s assets are pressured to produce enough returns to bridge the gap between assets and the liabilities.
- Capital structure
As mentioned earlier, Myer has a bigger debt financing compared to David Jones. The debt facilities for Myer show a company facing hard financial terms and with a pressure to repay long term liabilities or a threat of having to convert the debt to equity to pay lenders. The debt ratio for Myer is 55%, over 2012 and 2013 while for David Jones is 34%, showing the difference on how the two companies approach debt.
Other capital structure measures confirm the same thing as the company is grappling with a very big debt finance that has to be paid using proceeds from the business. The operating cash flow, for example, is far much less than the debt indicating that there may be problems repaying the debt financiers.
- Asset efficiency
Both companies have a very strong and consistent fixed assets turnover ratio. However, this ratio doesn’t measure the health of the company since the clothing industry requires heavy investment in fixed assets.
Both companies have similar operating cycles though Myer’s cycle is slightly longer than David Jones’. It means that management competence is highly comparable between the two companies.
Operating cycle measures management efficiency and consistency in ensuring that stocks are produced to ensure a very small gap between supply and demand.
- Market capitalization.
Both companies have a culture of paying out large portions of earnings per share to investors as dividends. A consistent payment of dividends ensures a consistent growth of the share price.
Golden Rule 2: Management assessment.
The second rule in analyzing companies using the Lincoln’s criteria is the management assessment. This stage concentrates on establishing the return on assets, return on equity, earning per share growth and revenue growth over the period in question.
These four indicators give an idea of how the company management is performing and the future outlook of the company. The expectation is that a strong management will result to better results over the given period. The following paragraphs will give out a breakdown, one by one.
- Return on assets (ROA); Myer’s return on assets reduced from 7.84% to 7.11% between 2012 and 2013. Over the same time, David Jones limited had a marginal decrease in the return on assets, from 8.14% to 8.19%. the two companies are in the clothing industry, with an expectation of at least 8% return on assets. David Jones has met this requirement, hence it is a better managed company compared to Myer, if the return on assets measure is used. However, the declining return on assets shows dwindling fortunes in the clothing industry, and management might be forced to diversify to ensure future profitability.
- Return on equity (ROE); Myer return on equity has declined from 16.22% to 14.57% over the period under review. The same period, David Jones also had a return on equity decline from 13% to 12.7%, again, a marginal decrease. As indicated earlier, the above pattern may be because of factors outside the sector like general economic performance or entry of new players.
Both companies are struggling to ensure that they guarantee investors as much returns on their share contribution as the previous years. The companies, also, don’t meet the expected threshold of 14% return on equity over the same time, raising doubts on the creativity of management.
- Earnings per share growth (EPS); the earnings per share by Myer has reduced significantly from 24 cents to 22 cents between 2012 and 2013. David Jones had maintained constant earnings per share over the same period. As noted earlier, both companies are struggling to grow. The stagnation of earning per share raises a doubt on the management competency of the two companies.
- Revenue growth; As indicated by the above measures, revenue growth has also stagnated for both companies. David Jones has had a year to year decrease in revenues while Myer has been stagnant, showing difficult conditions for both companies.
Golden Rule 3; Forecast
The final results for 2014 for Myer are already published while David Jones has not yet published 2014 results. For this rule, then, consideration will be given to the outlook one year ago using financial times data.
The forecast on Myer holdings had been to hold a share, since February 2013 when profits started dwindling. Analysts expect the company to return to profit ways. On the other hand, the forecast on David Jones has been to sell as the management has been facing difficulties in restructuring the business to make profits.
The outlook for 2014 and 2015 is even glummer, as income is expected to decrease and by extension the share price will go down.
An attempt by Myer to acquire David Jones was rejected, with DJ (as David Jones is commonly called) opting to consider South African’s buyer, Woolsworth. A share price of $4 recommended by Woolsworth is far much better than the prevailing market price.
The short term forecast before the take-over bid can be finalized has been to hold, in the hope that shareholders will make good proceeds on the proposed share value that is 12 times the book value for the DJ shares.
Analysts at Citigroup believe that DJ has found it difficult to survive on the tough business environment with competition from low-cost companies from Spain and China. Going by the Lincoln measure, Myer and DJ are not star stocks.
Golden Rule 4: Share price value
As stated in Golden Rule three, David Jones shares are valued at $A four as at April 2014. This is a 12 times the book value of the shares. The company has had a 52 week low of $A 2 and the price has been increasing on the anticipation of a take over from South Africa’s Woolsworth. (BusinessDay - ASX Quotes & Charts, n.d.)
The value for Myer share, on the other hand, has been changing for the last twelve months. Data from financial times shows a one-year low of $A 1.50 and an expected high of $A 2.55 in the next one year. The company released a SWOT analysis paper last year, giving its outlook and management expectation in a move to change the direction of the business to make profits. (Myer Holdings Ltd, MYR:ASX forecasts - FT.com, n.d.)
Among its peers, Myer is making the best effort to thrive in business as counterparts like DJ opt to get a buyer. Woolworth Australia, a company unrelated to Woolsworth South Africa, the potential buyer for DJ is also facing decreased fortunes and consumers change their expenditure patterns and budgets for clothing as well as the wake of new cheaper producers.
Golden Rule 5: Share price sentiment
Lincoln’s measure requires an investor to study the share price of the company with the aim of establishing a disconnection between the price and value of the share. By analyzing this disconnection, an investor can adequately decide on which shares he will definitely cash on and make profits in the future.
Myer and DJ shares have been on the decline for the last two years. The Australian All share index has been growing over the same time, beating the individual DJ and Myer shares. A study of the history of the Myer and David Jones shares reveals a strong growth and performance, before decrease n profits in 2011("Myer Holdings Ltd, MYR:ASX forecasts - FT.com," n.d.)
The decision, however, lies with the position of the investor regarding the shares. For those investors who already hold the share, they are faced with a difficult decision either to sell or to hold. Mark you, the shares in this study case have been on a downward spiral and cashed them would mean accepting already incurred losses.
The companies, Myer and DJ, have a history of paying dividends, a practice that gives investors a very good chance to hold, with the hope that the share prices will increase in future, and if that is not the case, they will receive some dividends. The impending buy out (as of April 2014) of David Jones by Woolsworth South Africa gives shareholders a speculative advantage to make gains on the take-over deal.
On the other hand, Myer shares are slated to grow to a maximum of $A 2.55 in the next twelve months due to expected change of fortunes as the company enters into its core stage of the implementation of the business repositioning. (Myer Holdings Ltd, MYR: ASX forecasts - FT.com, n.d.)
However, the figures might be misleading especially when the share prices are affected by announcements or short term dips in share prices. In such a case, the investor will be keen on the establishing how the company is maintaining its fundamental qualities.
Golden Rule 6: Liquidity and size
This rule advises investors to consider the traded volumes of the company shares and company size. The main objective in this rule is to know how easily an investor can buy or sell the shares when he needs to.
In the case scenario, Myer shares are very liquid in the Australian stock market. For example, on October 3rd 2014, 3.97 million Myer shares were traded, although the price had moved down 35 points.
The positive outlook on Myer shares comes from the commitment of the management to change the fortunes of the company. The attempt to purchase David Jones signifies the financier’s commitment to ensuring that the company expands to previous heights so as to make money for investors.
On the liquidity and size perspective, Myer edges out David Jones because the Myer shares are liquid and easily traded. The financial forecast is also very positive, and investors buying the share today stand to gain one Australian dollar if the company performs to expectations.
Golden Rule 7: Principle activities
The seventh rule requires investors to research on the fundamental activities of the company and the opportunities surrounding it.
Myer and David Jones are two up-market departmental stores in Australia. Both companies have very similar operation strategies and locations. Myer departmental stores have a wide range of products, from clothing to home appliances and phones.
The emergence of online shopping pits Myer and David Jones against modern online markets like Alibaba and Amazon, creating a direct challenge to creatively restructure the business operations so as to take advantage of online shoppers.
The opportunity is that online selling increases the customer base while the same time is keeping old customers.
Perhaps the biggest threat is competition from multinationals such as Inditex and H&M. The clothing industry has been changed to a cut –throat competition ground where success depends on how fast a company can adapt to the market, introduce new fashions and construct a cheap manufacturing formula.
Golden Rule 8: Price sensitive announcements
Announcements such as buy-outs, profit or losses annual announcements change of management or legal proceedings can have negative or positive effects on the share price.
For example, DJ’s shares have moved upwards drastically after South Africa’s outlet, Woolworth, announced the intention to buy the company at a premium to the trading share price. Most shareholders of David Jones are, therefore, holding onto the shares with the expectation of an increased share demand from the general public due to the anticipation.
On the other hand, Myer announced the 2014 results in September 2014, opening up debates on the outlook of the shares in the future. Some investors have casted a doubtful eye on the future of the company, given the year to year decrease in revenues and earnings to shareholders.
Golden Rule 9: Follow all the above rules
After taking into consideration the rules, the investor should select the most appropriate stock, or a group of stocks. For this case scenario, Myer is a better investment, compared to David Jones.
Ratios & formulas
1. Net profit margin = Net income / Revenue
2. Gross profit margin = Gross profit / Revenue
3. Operating profit (EBIT) margin = Operating profit / Revenue
4. Pretax margin = Pretax profit / Revenue
Diluted EPS = (net income – preferred dividends) + (convertible preferred dividends) + convertible debt interest (1-t) / Weighted avg. shares + potential conv. preferred shares + potential conv. debt shares + potential stock option shares
Liquidity ratios are employed by analysts to determine the firm's ability to pay its short term liabilities.
1. Current Ratio
Current assets/current liabilities
2. Quick ratio
Cash + marketable securities + Receivables/current liabilities
Cash conversion cycle = average days of receivables + average days of inventory - average days of payables.
Cash + cash equivalents + invested funds/current liabilities.
Inventory turnover = Cost of goods sold/inventory
Return on assets/Average total assets.
Return on equity/Average shareholders’ equity.
Return on capital employed = Net income/Capital employed.
Capitalization ratio = long term debt /long term debt + shareholders equity.
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