International financial statement analysis

A) Analyze the financial position and performance of the company you have chosen over the four financial years.
We have chosen Morrison Supermarkets for our project. We have used the four years data for the financial years 2002-03, 2003-04, 2004-05, 2005-06 that are represented in the form of 2003, 2004, 2005 and 2006 in line with the presentations and publications done by the company.
In our analysis, it is quite evident that the gross margin over the four-year period is in line with the industry averages (source: Reuters Industry Data). However the operating margin over the years 2003 & 2004 are higher than the industry benchmarks and for the years 2005 and 2006, the operating margin is lower than the industry benchmark. The reason is the amalgamation of the Safeway into the Morrison Supermarkets. The effect of the merger is visible from the increase in other operating costs in the last two years and these costs are affecting overall operating performance of the company.
The current ratio historically was favorable compared to the industry averages for the years 2003 and 2004. However, 2005 and 2006 saw tremendous growth in the current liabilities in terms of creditors and the net loss reported in 2006 that has significantly reduced the cash and cash equivalents, affecting the current assets in a negative manner.
The return on equity has also showing a dip in the last two years owing to the fact that the company has reported a loss in the year 2006 and also the takeover of Safeway has added to the equity without adding to the profits. For the financial years 2003 and 2004, the performance were more in line with the market and can be attributed to the positive earnings generated by Morrison Supermarkets on a stand alone basis.
B) In our prediction of the revenue for the fifth year, we have used the geometric mean and weighted moving averages method for the tabulation.
We have also used the weighted moving average method for the year 2005 and 2006 to capture the variations in the revenue stream in a more systematic way. The reason for taking the last two years for our tabulation stems from the fact that in 2003 and 2004, Morrison Supermarkets was having turnovers of GBP 4.29 billion and GBP 4.94 billion turnover company and with the merger with Safeway, in 2005, Morrison Supermarkets became a company with a turnover of over GBP 12 billion. This variance can introduce error in our prediction , hence we have used the more stable last two years as a base for our predictions.
Our calculations are based on the following assumptions:

• There will be no changes in the operating environment for Morrison Supermarkets and its competitors.
• The historic growth rate will continue and the stability in the revenue stream is expected to continue.
• There will be no new acquisition or spin off of assets and business by Morrison Supermarkets

Our prediction of the revenue for the year 2007 is based on our aggregate revenues for the company obtained by using the Weighted Moving Average Model and Geometric Mean Model. Our prediction for the revenue was at GBP 12,366 million compared to the revenue (actual) of GBP 12,461 million generated by the company. The variance between the predicted and actual revenue is less than one percent (0.77%) and indicates the accuracy of our prediction.

• The financial performance predicted by us and the actual results are quite similar. However, we must mention than if we take the weighted moving average for four-year period of 2003 and 2006, then our tabulation predicts revenue of GBP 11258 million and the variance between the predicted financial performance and the actual financial performance reaches 10.69%. The reason for the difference can be attributed to the fact that the historical revenues of 2003 and 2004 are fundamentally different in nature compared to the revenue streams of 2005 and 2006.The Safeway contribution was completely absent in 2003 and 2004, whereas the merger of the company has increased the revenue by 144.8% between 2004 and 2005. Thus we believe that taking the historical averages from 2005 and 2006 is more reflective of the future performance of the company. Our prediction is also limited by various factors and they are as follows:
• The use of limited number of years for prediction. Two years data is limited in nature and may fail to capture the long-term variations.
• The stability in the revenue can change and can affect the predictability.

C) Calculate the company’s fundamental value of equity per share at the end of the fourth financial year by using one equity valuation model.
To value the company, we are taking the income approach and using the discounted cash flow model for our predictions.
We have used the historical financial statements for the years 2003-2006 for our basis for projections. We have used the revenue growth rate at 2.1% as the basis for Revenue projections and historical average of 3% as the operating profit margin as achieved by the company over its historical period.
To project the Free Cash Flow statement of the projected period, we have used the historical indicators of working capital requirements for our tabulation. The period of 2003-2006 shows the trends in the working capital policies adopted by the company and we expect them to continue over our forecasted period.
We have also tabulated the capital expenditure schedule over the projected period to ensure that the asset turnover ratio in comparison to the revenue is kept at the historical levels and all the depreciated assets are replenished during the projected period.
We have also tabulated the depreciation rate based on our historical data. As we have not in possession of the operating assets schedule, we have taken the depreciation numbers on an aggregate basis and assumed that the overall aggregated depreciation will be in approximate match with the depreciation of the operating asset portfolio over the projected period. We have also assumed that the fixed asset usage is hundred percent for the operations of the company and they are nor redundant in nature. Thus, in our model we have taken that the assets will be fully used over the period of projections.
The surplus working capital requirement is indicative of the fact that the company is managing its credit structure in a very positive manner and this is going to add to the value of the company. The surplus working capital will increase the free cash flow to the firm and with the growth in the revenue stream the surplus will increase. We expect that this credit management is going to continue in future when we predict the terminal value of the firm.
The capital expenditure requirement is indicating the present operating assets are matching the asset turnover ratio required for the continuity of the operations .We have taken capital expenditure requirements at zero for the projected years 2007,2008 and 2009. The reasons being the depreciated asset levels are still higher than the operational asset requirement as per historical asset turnover ratio. In 2010, the depreciated asset levels are lower than the operational asset requirement as we have created the provision for capital expenditure.

The Equity Valuation of Morrison Supermarket:

Assumptions:

We have taken the risk free rate for the period at 6.5%
The equity risk premium is taken on the basis of Ibbotsons data on equity premium. We have taken the value of equity risk premium at 7.2% based on the aggregate equity return over the period 1926-2005.
We have taken the terminal growth rate at 3% .We have not adjusted for the inflation in our model. Subsequently the rate we have taken for the risk free rate is nominal risk free rate and not real risk free rate.
We have taken the 2010 as the terminal year for our projections and the terminal value is based on that.
We have used the sensitivity of the stock to the market (beta) at 0.3754 based on the data provided in the Yahoo financial website.
We have used this model as the income approach along with discounted cash flow model is more capable to capture the intrinsic value of the firm compared to other methods like capitalization of earnings method or residual earnings method due to the simple fact that this model considers more variables to reach the free cash flows compared to any other model.
The per share value of the company is three hundred and forty nine pence.
The limitations of our valuation model are as follows:

• The model is based on historic performances and any significant difference in future performance will affect the valuation.
• The valuation is also dependent on the macroeconomic factors like interest rates, and external factors like overall economic conditions. In our report we have used only the financial information and no due diligence is done on other factors.