Executive Summary

Strong, stable position in the grocery market Maintained revenue growth in both UK and International markets, 2009-10 saw a reduction in growth, attributed mainly due to poor performance in some European markets and the UK market, largely due to self-deflation of prices Revenue per store is consistent in the UK, however the international stores results are varied due to focus on expansion Revenue per square foot concludes Tesco is operating at a similar level to Morrisons and Sainsburys except on a larger scale as it has a greater sales area Well controlled gross margin and operating margin Strong quality earnings per share

Question to be answered: This report will seek to review the financial performance of Tesco plc compared to its competitors using the audited Annual Reports and Accounts of the companies concerned. Context
Tesco plc [Tesco] is the UKs largest supermarket chain holding a 22.5%1 share of the grocery market. The organisations core strategies are to grow the core UK, the international market, the non-food market and develop the retail services2. With its focus on many markets and an extension of growth internationally, Tesco clearly has an advantage over its competitors to retain this market share and continue growing. It would be fascinating to analyse the profitability of this well established organisation and determine how well it compares to its competitors. Wm Morrison Supermarket plc3 [Morrisons] and J Sainsbury plc3 [Sainsbury's], hold 12.6%4 and 16.1%5 of the grocery market respectively and these will be used to compare against Tesco. The annual reports and accounts used have all been independently audited therefore can be trusted to be accurate beyond reasonable doubt.6 In 2009 Tesco obtained sole ownership of Tesco Bank, after acquiring the Royal Bank of Scotlands 50% share7, this has had an impact on figures within the report and may be a contributing factor to some of the variances found within the report.

1 2

Figure extracted from pg 39 of the 2010 Tesco Annual Report and Accounts From pg 9 of 2010 Tesco Annual Report and Accounts - see appendix 3 Figures from Morrisons and Sainsburys have been extracted and calculated by author and checked with data obtained by [names of students] in my seminar group. Their ratios were also calculated using the audited accounts 4 Figure extracted from pg 5 of 2010 Morrisons Annual Report and Accounts see appendix 5 Figure extracted from pg 1 of 2010 Sainsburys Annual Report and Accounts see appendix 6 Tesco restated figures for 53 week period in 2009 and balance sheet of 2008 due to the requirement to account customer loyalty awards as a separate component of sales and to separate Tesco Bank revenue. From pg 75 and 82 of Tesco 2010 Annual Report and Accounts. Morrisons restated 2006 figures to change the format to match competitors in drug and retail sector pg 26 Morrisons 2007 Annual Reports see appendix 7 Extracted from pg 21 of 2009 Tesco Annual Report and Accounts

Income Statement Analysis

m8 Revenue 2006 39454 2007 42641 2008 47298 2009 53898 2010 56910

Tescos overall Group revenue has risen by 44% from 39.5bn to 56.9bn during the time period under review, representing an absolute change of 17.5 billion9. 49.3% of this growth was achieved from the UK market, 45% from the International market, and 4.9% from Tesco Bank10. Steady growth was experienced until the year 2009-2010 where Tesco achieved a small growth of 5.6%, compared to 14% the previous year9. Segmenting the UK revenue and international revenue may help to explain these discrepancies. Revenue11 m 12 Tesco UK 12 Tesco International 12 Tesco Bank 2006 29990 9464 2007 32655 9986 2008 34858 12440 2009 37650 16085 163 2010 38558 17462 860

International Revenue Revenue from international stores has shown exponential growth of 7.9bn representing a percentage change of 84.5%, suggesting strong growth in line with the organisations core strategies13. The international stores have seen a varied pattern of growth, from 5.5% to 29.3%, over the time period confirming Tescos international stores are in the early stages of development where fluctuations are likely to occur13. 2006-2007 experienced an increase of 5.5% which was found to be due to 2006 being recorded as a 60 week year for the international sector. The reports assert a 17.9% increase on a comparable 52 week basis like for like sales grew 2.0% and new space contributed the remaining14.This suggests much of the growth is reliant on the expansion through increasing store numbers. The years 2007-08 and 2008-09 achieved growth of above 24%13. This strong growth can be attributed to new space, which contributed 20.5%15 of the 24.6%13 growth in 2007-08. The

8 9

Figures extracted from Income Statement in Tesco Annual Reports from 2006-2010

Figures calculated using revenue figures from Income Statement in Tesco Annual Reports from 2006-2010 Figures calculated using revenue figures from Five Year Record of 2010 Tesco Annual Report 11 Revenue figures have been divided into UK and International as Morrisons and Sainsburys only operate in the UK. Figures from UK will be extracted where possible to ensure accurate comparison, however the Annual Reports do not always segment figures. Revenue from UKs other services (excluding Tesco Bank) could not be removed from UK revenue figure because it is not stated within the reports.
10 12 13 14

Revenue figures extracted from Five Year Record of 2010 Tesco Annual Report

Figures calculated using revenue figures from Five Year Record of 2010 Tesco Annual Report Extracted from pg 5 of 2007 Tesco Annual Report 15 Extracted from pg 4 of 2008 Tesco Annual Report

international stores contributed 7.7%13 of the 14%16 growth seen in 2008-09 for the overall group results, due to the strong growth seen due to the new space. Between 2009 and 2010 the revenue from Europe declined -1.4%13, which was masked by the international growth, and attributed to the small growth of the group result. The directors assert the decline in sales can be attributed to Slovakia as cross-bordering shopping was exhibited by customers as weaker currencies were in neighbouring countries17. Also it was claimed the Republic of Ireland experienced lower sales because of the recession and self-deflation of prices17. However the directors do not purport how much this affected the figures. UK Revenue The UK revenue has increased by 8.6 billion from 2006-2010 representing a total increase of 28.7% and an average year on year growth of 6.5% 13. Growth can be attributed to an increase in like for like sales and contribution from new stores18. Steady growth has been experienced except between 2009 and 2010 where UK revenue saw a small growth of 2.5%13, suggesting why the overall group revenue has suffered less growth in this time period. The directors assert this was due to lowering of prices and new discount brands, with the added effect of the decline in inflation19, however did not declare how much this affected the sales growth. m Morrisons Sainsburys 2006 12114.8 16061 2007 12461.5 17151 2008 12969 17837 2009 14528 18911 2010 15410 19964

Revenue Revenue21

20

Competitors Morrisons and Sainsburys have experienced similar growth to Tesco in the UK so it would be reasonable to conclude this is in line with industry expectations. Morrisons revenue increased 27.2% over the given time period, representing an absolute growth of 3.3 billion22. Sainsburys revenue increased an absolute growth of 3.9 billion, representing a 24.3% total increase over the time period23. Morrisons, and to some extent Sainsburys, also experienced a spike in growth between 2008 and 2009. It was explained in the Morrisons report this was due to rising fuel prices24, suggesting this could also explain why Tesco also saw an increase in this time period. Morrisons and Sainsburys out performed Tescos in terms of percentage change in sales in 2009-10, both achieving growth of 6.1%22 and 5.6%23 respectively. However this was also a reduction in growth of what these businesses have seen over the time period, suggesting this is in line with the

16 17

Figure calculated using revenue figures from 2010 and 2009 Tesco Annual Reports Extracted from pg 14-15 of 2010 Tesco Annual Report 18 See appendix and table marked Tesco UK growth 19 Extracted from Core UK section pg 17 of the 2010 Tesco Annual Report
20 21
22 23

Revenue figures extracted from Income Statement in Morrisons Annual Reports from 2006-2010 Revenue figures extracted from Income Statement in Sainsburys Annual Reports from 2006-2010
20

Figures calculated using revenue figures referenced in footnote 21 Figures calculated using revenue figures referenced in footnote 24 Extracted from pg 7 of Morrisons 2009 Annual Reports see appendix

industry. In terms of absolute growth Tesco was achieving approximately the same levels of increase; Tesco achieved 938m13, Morrisons achieved 882m22 and Sainsburys achieved 1053m23. These figures conclude Tesco has seen a marginally better growth in sales compared with its competitors. Its overall revenue and absolute growth is significantly greater, demonstrating its larger size in the market. The international sector is experiencing more accelerated growth than the UK but the varied levels suggest it is currently not very stable growth. The UK supermarket industry is a stable and saturated market, thus Tescos growth is likely to remain stable. Revenue per Store m Tesco Group Tesco International25,26 Tesco UK25 Morrisons27 Sainsburys28
25

2006 14.8 12.2 15.8 31.8 21.4

2007 13.1 7.8 16.4 33.7 21.8

2008 12.6 7.6 16.5 34.4 21.7

2009 12.4 7.8 16.5 37.8 23.9

2010 11.8 7.5 15.5 36.0 22.9

The overall Tesco Group result suggests a focus on expansion through the number stores at the expense of revenue performance on a store by store basis (Tesco increased store numbers by 213929over the period under review; 155529 international and 58429 UK). However the UK results appear relatively stable, suggesting Tesco can maintain its revenue per store in the UK even during times of expansion, and new stores are able to contribute successfully to revenue. It can clearly be seen the international stores are not as strong a performer as the UK, and the overall Tesco result obscures this factor. The reduction in revenue per store for the international stores between 2006 and 2007 can be attributed to the fact that the number of stores increased by 65%29 whereas revenue only increased by 5.5%. The low level revenue increase has already been explained earlier in the report. Had the number of stores increased proportionally with the revenue, the result would have been 12.2m per store30. The business strategy appears to be to focus on international growth through expansion of stores, even if this is detriment to the revenue performance on a store by store basis. Both Morrisons and Sainsburys are showing substantially higher revenue per store. It should be noted here both Tesco and Sainsburys have smaller convenience stores, which will obviously not produce as much revenue as the larger stores due to their size and less diversified stock; this

25

Calculated using the revenue (Tesco Bank removed) and store figures in Five Year Record of Tesco 2010 Annual Report 26 Store figures calculated by subtracting UK store figures from Group figures in Five Year Record of Tesco 2010 Annual Report 27 Figures calculated using sales from store revenue figures note 2 in Morrisons reports and store figures from 2006-2010, and store numbers from pg 87 Supplementary Information of Morrisons 2010 Annual Report see appendix 28 21 Figures calculated using the revenue figures referenced in footnote and store figures from Five Year Financial Record, pg 103 2010 Sainsburys Annual Report see appendix
29 30

Figures calculated using store figures from Five Year Record in Tesco 2010 Annual Report Figure calculated by altering store number figure to 817 (5.5% increase from 774 stores)

explains why Morrisons appear to have better revenue per store. Sainsburys also has a fewer number of convenience stores, suggesting why it also has a better revenue per store. Revenue per Square Foot Tesco Group31 Tesco International31,32 Tesco UK31 Morrisons33 Sainsburys34 2006 715 323 1157 1132 960 2007 625 247 1175 1179 988 2008 620 266 1180 1189 996 2009 608 281 1203 1298 1132 2010 596 286 1170 1291 1125

These results show all three in the UK are operating at a similar level, suggesting Tescos larger size is the contributing factor to such a sizable revenue stream in comparison to Morrisons and Sainsburys. Morrisons and Sainsburys exhibit greater variation in their results, whereas Tesco remains relatively stable over the time period. UK has maintained revenue per square ft throughout its large growth in number of stores. It experienced a marginal decline between 2009 and 2010, revenue per sq ft dropped by 33, which is likely to have been due to revenue only increasing by 2.5%. The revenue per square foot in international stores is significantly lower than the core UK stores, operating at four times less the level of the UK stores. This can be due to international stores contributing to 30.7%35 of the overall revenue from almost double the amount of space as the UK stores. However it has fewer number of stores, suggesting it stores are larger than the UK stores. After the initial decline between 2006 and 2007, explained in previous section, the revenue per square foot in the international sector is steadily increasing. In 2008 and 2010 the revenue per store decreases slightly, which is not in line with revenue per square foot figures, suggesting some convenience stores were opened in these time periods which contribute a smaller square foot area.

Profitability
One off costs and gains have been removed for the basis of year on year analysis for gross profit margin and operating profit margin. The Pensions adjustment - Finance Act 2006 gain and Impairment of the Gerrards Cross site cost for Tesco has been highlighted in 2007. Also in 2006 Morrisons took over Safeway, thus a large one off cost was highlighted. Gross Profit Tesco Group revenue increased by 44.2% over the time period, but cost of sales increased marginally less with a total increase 43.6%36, suggesting an almost proportionate increase. However gross profit
31

Figures calculated using revenue (Tesco bank removed) and square foot figures in Five Year Record in Tesco 2010 Annual Report 32 31 Sq ft figures calculated subtracting the UK figure from overall Group figure referenced in 33 Calculated using sales from store revenue figures note 2 in Morrisons Annual Reports from 2006-2010 sq ft figures from Supplementary Information pg 87 from 2010 Morrisons Annual Report 34 21 Calculated using revenue referenced in and sq ft figures referenced in appendix 35 Calculated using revenue figures from Five Year Record of the 2010 Tesco Annual Report 36 Figures calculated using cost of sales figures from Income Statement in Tesco Annual Reports from 2006-2010

has steadily increased 1.6bnover the time period, representing a 52% increase overall37. Thus this marginal difference is having a positive effect on gross profit. To reduce such costs, Tesco introduced a step change programme. Over the time period, the step change programme has saved 2.1bn38 in costs, which may have attributed to reduce the increase in cost of sales. Gross Profit as a percentage of Revenue 2006 7.7% 2.7% 6.6% 2007 7.6% 5.1% 6.8% 2008 7.7% 6.3% 5.6% 2009 7.8% 6.3% 5.5% 2010 8.1% 6.9% 5.4%

Tesco Group39 Morrisons40 Sainsbury's41

The cost of sales accounts for over 90%42 of the revenue, this leads to a gross margin of less than 10%. This is in line with the supermarket industry as high cost of sales can be attributed to the low priced items that supermarkets stock, making a small gross margin on some items to attract customers. As revenue and cost of sales are increasing almost proportionately this has resulted in a level margin over the time period, compared with the competitors which have experienced variation. The rising gross profit margin is due to the cost of sales increasing less than the revenue as stated earlier. Overall it shows greater cost control compared to its competitors because Tesco is spending less on their direct costs in proportion to their revenue, whereas Sainsburys and Morrisons struggle to keep their gross margin level. However it must be noted international revenue has been included in the Tesco figure as it could not be segmented. Operating Profit A strong growth in operating profit was seen during the time period under review. Tescos overall operating profit increased from 2.3bn to 3.5bn, with an average year on year increase of 12.9%43. Growth can be attributed to growth in gross profit, as this increased 13% on average each year also37. Operating Profit as a percentage of revenue 2006 5.8% 6.0% 0.9% 2007 5.7% 6.4% 3.4% 2008 5.9% 6.2% 4.7% 2009 5.9% 6.7% 4.6% 2010 6.1% 5.9%

Tesco Group Tesco UK45 Morrisons46

37 38

44

Calculated using gross profit figures from the Income Statement in Tesco Annual Reports from 2006-2010 Figure calculated from extracting each year step change results from Tesco Annual Reports 2006-2010 see appendix 39 Calculated using gross profit and revenue figures from Income statement in Tesco Annual Reports from 2006-2010 40 Calculated using gross profit and revenue figures from Income statement in Morrisons Annual Reports from 2006-2010 41 Calculated using gross profit and revenue figures from Income statement in Sainsburys Annual Reports from 2006-2010 42 Calculated using cost of sales and revenue figures from Income Statement in Tesco Annual Reports from 2006-2010
43
44

Calculated using operating profit figures from Income Statement Tesco Annual Reports from 2006-210

Figures calculated using the operating profit and revenue figures from the Income Statement of the Tesco 2010, 2008 and 2006 Annual Report and Accounts. Confirmed using Five Year Record 2010 Tesco report 2007 result different because one off cost and gain removed see appendix 45 Figures calculated using the operating profit and revenue figures from the Five Year Record of the Tesco 2009 Annual Report. Confirmed using operating margin on Five Year Record 2009 Tesco Annual Report see appendix 46 Figures calculated using the operating profit and revenue figures from the Income Statement of the Morrisons 2010, 2008 and 2006 Annual Reports

Sainsburys47

1.4%

3.0%

3.0%

3.6%

3.6%

The operating profit margin of Tesco remains high and stable over its competitors. Tescos UK result is marginally higher than the overall Tesco result, suggesting Tesco in the international market has a lower operating margin. The Tesco results take a similar pattern to the gross margin suggesting the other net costs and income are taking on average 1.9%48 of the revenue during each year. However this obscures the factor that both profit from property-related items and administrative costs are growing at a varying degree. Profit from property-related items increased by 59.7%49 between 2009 and 2010 representing 144m; without this increase the operating profit would stand at 5.8%50. This increase in profit from property-related items is also offsetting the increase in administrative expenses. Administrative Expenses Administrative expenses have increased by 85%51 from 825m to 1527m over the time period within Tesco. During 2008-09 and 2009-10 each year saw a 21.9% increase in administrative expenses51. The reasons behind this have not been explained in the reports, but I can deduce from the activities of Tesco that the acquisition of Tesco Bank may have caused such an increase. Finance Costs /m Tesco Group52 2006 241 2007 216 2008 250 2009 478 2010 579

Tesco has a high amount of finance costs in part due to the acquisition incurred in 2009 and also its focus to expand by purchasing new stores. The directors assert that the increase in finance costs were linked to the acquisition in 2009 and foreign exchange movements53. An increase in borrowings by 96.9% from 8bn to 15.8bn was experienced between 2008 and 200954, suggesting why the finance costs increased by 91% during this year. Interest Cover 2006 946.1% -505.6% 147.7% 2007 1225.9% 783.3% 486.0% 2008 1116.4% 1020.0% 401.5% 2009 663.0% 1118.3% 454.7% 2010 597.1% 1511.7% 479.7%

Tesco Group Morrisons56 Sainsburys57

47

55

Figures calculated using the operating profit and revenue figures from the Income Statement of the Sainsburys 2010, 2008 and 2006 Annual Reports 48 Calculated by subtracting the profit margin from the gross margin for each year and creating an average 49 Calculated using the profit from property-related items figures from the Income Statement of the Tesco 2010 Annual Report
50
51

Calculated using operating profit without increase from profit from property related items

Figures calculated using the administrative expenses from Income Statement of Tesco Annual Reports from 2006-2010 52 Figures extracted from Income Statement in Tesco Annual Reports from 2006-2010 53 Extracted from pg 34 of 2009 Tesco Annual Report 54 Figures calculated using Borrowings figures in Balance sheet in Tesco Annual Reports from 2006-2010 55 Calculated using finance costs and operating profit from Income Statement in Tesco Annual Reports from 2006-2010 56 Calculated using finance costs and operating profit from Income Statement in Morrisons Annual Reports from 2006-2010

Over the time period, Tesco has shown a strong ability to cover its interest. The increase in finance costs has had an impact on Tescos ability to cover its interest. Between 2008 and 2009 there is a drastic decline, which is due to the increase in finance costs stated earlier. It is still in a strong position as it can cover its interest up to six times over and is in a better situation than Sainsburys. Net Profit after tax /m Tesco Group50 2006 1576 2007 1899 2008 2130 2009 2138 2010 2336

Net profit after tax has steadily increased within Tesco. The steady growth can be attributed to steady growth in operating profit. 0.4%58 growth was experienced between 2008 and 2009 because finance costs increased by 228m and tax increased by 106m59, which can be attributable to the Tesco Bank acquisition.

Cash Flow Statement

All three businesses exhibit strong cash flow statements; this is mainly due to the supermarket industry where cash sales occur rather than credit sales. Quality of Earnings Ratio
60

Tesco Group Morrisons Sainsbury's

2006 1.50 -1.18 3.41

2007 1.33 1.66 1.60

2008 1.47 1.24 1.88

2009 1.57 1.44 1.79

2010 1.72 1.11 1.70

Tesco shows what could be regarded as strong quality of earnings, with all results significantly over 1. In 2007 there was a decline in the quality of earnings which is significantly due to the one off gain and cost mentioned earlier. Without the one off gain and cost, the earnings ratio is 1.4661 see appendix, which is more in line with the pattern of results. Aside from 2007, Tescos quality of earnings is continually improving. This is due to net cash flow (excluding tax and interest) increasing by 2.5bn62 over the time period, whereas operating profit has increased 1.2bn. Both Morrisons and Sainbury's have mixed results over the time period; a low result for Morrisons in 2006 can be attributed to the takeover of Safeway during that year. Without this takeover Morrisons would have an earnings ratio of 2.7961. This suggests Tesco is more stable compared to its competitors as there are no erratic movements from year to year.
57

Calculated using finance costs and operating profit from Income Statement in Sainsburys Annual Reports from 20062010 58 50 Calculated using net profit after tax figures referenced in 59 Calculated using tax figures from the Income Statement in Tesco Annual Reports 2008, 2009 60 Calculated using net cash flow (exc tax and interest) from cash flow statement and operating profit from Income statement in Tesco, Morrisons and Sainsburys Annual Reports from 2006-2010 61 Calculated by extracting one off cost and gain from operating profit figures 62 Calculated using net cash flow figures from Cash Flow Statement in Tesco Annual Reports from 2006-2010

Balance Sheet
Net Assets Balance sheet appears to be regarded as strong, net assets have consistently grown 13.9% on average each year, from 9.4bn to 14.7bn63. Tesco has a high level of non-current assets because it owns a large amount of property, over 70% of property is freehold64, thus keeping the net asset level strong. Current Ratio
65

Tesco Group Morrisons Sainsburys

2006 0.5 0.4 0.8

2007 0.5 0.4 0.7

2008 0.6 0.5 0.6

2009 0.7 0.5 0.5

2010 0.7 0.5 0.6

Tesco show a growing strength in their liquidity. A steady, stable pattern can be seen for Tesco, compared with varying results from Sainsburys and Morrisons. This suggests Tesco is in a better position in terms of liquidity.

Z-score
Tesco66 2.25 Morrisons63 3.42 Sainsburys63 3.05

The general rule of thumb is a score higher than 3 suggests the organisation is unlikely to fail. Tesco falls below this line; however given its high market share of the grocery market, it can be reasonably assured that Tesco is unlikely to fail. Its competitors, show more robust results. The reasons behind its low score can be attributed to having a high book value of debt, more current liabilities than assets and a high level of total assets compared to revenue. Tescos high liabilities can be attributed to borrowings required for the acquisition of Tesco Bank and expansion on the number of stores.

Conclusion
Tesco shows robust results over the time period under review, see executive summary as this was completed after the report. Comparisons could have been made with competitors from the international sector or with more competitors from the UK sector such as Asda or Waitrose who are other key players in the UK supermarket industry; however time did not permit this.

63 64

Calculated using net asset figures from Balance Sheet in Tesco Annual Reports from 2006-2010 Extracted from pg 40 of 2010 Tesco Annual Report 65 Calculated using current assets and current liabilities figures from Balance Sheet in Tesco, Morrisons and Sainsburys Annual Reports from 2006-2010 66 Calculated as shown in appendix Z- Score