After the shock of the financial crisis, the global economy is experiencing a period of relaxation. Consumer spending has been increasing over the years, which has helped revive the retail industry. David Jones Ltd (DJs), as one of the top companies in this industry, is performing well. This report will focus on DJs’ recent performance and analyze both public information and numerical data provided by DJs Ltd. Additionally, we will calculate DJs’ value using three different methods.
The report includes five main parts: Macroeconomic analysis, Accounting analysis, Financial analysis, Prospective analysis, and a recommendation that is helpful for investors to make decisions regarding investing in David Jones Ltd.
1.0 Macroeconomic Analysis
According to the Australian Bureau of Statistics (ABS), GDP growth was 2.3% in 2011 (Australian Bureau of Statistics, 2011). Most countries around the world experienced economic downturn due to the financial crisis in 2008. As a result, the cash rate set by Reserve Bank of Australia (RBA) fell by 50 basis points during the whole year in 2011.
On the other hand, the inflation rate is relatively low. The Reserve Bank of Australia announced that it is 1.6%, a bit lower than the target inflation rate of 2%-3% (Reserve Bank of Australia, 2012). The exchange rate has not shown any obvious changes. In this case, export goods and services during 2011 rose by only 0.8% (Australian Bureau of Statistics, 2011).
Industry Analysis
Rivalry Among Existing Organizations
According to ABS’s Household Expenditure Survey, expenditure from June 2009 to June 2010 increased by 38% compared to the previous survey conducted in 2003-04 (Australian Bureau of Statistics, 2010). This is good news for the department store industry as increased spending from households positively relates to the industry’s growth rate.
For the department store industry in Australia, BigW, Kmart, Target and Myer are its main competitors. DJS and Myer are two dominant companies in this industry when considering their relative size. However, there is a relatively high concentration of brand retail stores that sell similar products as department stores.
Thirdly, although department stores offer a wide range of products, the high concentration of other brand retail stores within them means that switching costs for consumers are relatively low. Additionally, online shopping further reduces these costs. Another factor is that the main assets in this industry are the products themselves, so there is little specialization and low exit barriers.
Due to the high costs of developing new channels, the entry barriers for this industry are relatively high, and first mover advantages are obvious. The range of products in this industry is wide, which means customers can consume the same products in different stores. Therefore, the threat of substitutes is quite high. Because price sensitivity is also high, consumers are willing to choose identical products with lower prices and have a strong bargaining position. On the contrary, suppliers have relatively strong bargaining power due to the high concentration of this industry.
In the DJ’s annual report for 2011 (David Jones Ltd 2011), their major point of differentiation from competitors is their home of brands” strategy. This involves continually updating their brand portfolio and offering exclusive brands to reinforce their position as Australia’s fashion authority. According to Palepu et al. (2010, pp. 37), DJ’s has succeeded in retailing in Australia by emphasizing exceptionally high customer service.
For example, if a customer wants to buy a g-star shirt, DJ’s provides a wide range of products that includes this shirt, offering consumers options without additional spending. By differentiating themselves through these strategies, DJ’s has achieved a competitive advantage.
Overview: SWOT analysis involves analyzing a company’s strengths, weaknesses, opportunities, and threats. This analysis can help the company choose a competitive strategy.
Internal Perspective: Customer service is one of the most crucial elements for gaining a competitive advantage.
DJS has developed its customer service by implementing specific staff training. Additionally, the organization’s strengths include a wide range of domestic and international brands and a convenient location for the target customer. Furthermore, the credit card business of DJs, in cooperation with American Express, has generated huge profits for their shareholders. In 2002, earnings increased by $4.3 million to $14.9 million (David Jones Ltd 2002). However, total sales declined by 4.4% from 2010 to 2011 and basic earnings per share (EPS) decreased by 2%. These weaknesses may lead to a loss of confidence among external investors.
From an external perspective, online spending has grown at an average annual rate of more than 15% since 2005, according to the report by RBA (2011). As DJs has repositioned its online store, this could be a valuable opportunity. Referring to the annual report of DJs in 2011, the organization has developed risk management and internal control procedures to avoid possible threats in 11 categories. The effective control environment includes 13 detailed procedures.
Furthermore, DJs may encounter threats from macroeconomic factors such as economic downturns, rising labor costs, rent, and other expenses. The industry experienced its worst two years from 2009 to 2011 in the past two decades, with accumulated sales dropping by 3.3% (David Jones Ltd 2012).
The purpose of accounting analysis is to evaluate the accounting quality of David Jones Ltd’s financial statements and accurately present its business situation based on the company’s Annual Report.
Key Accounting Policies
Critical Success Factors
It is necessary for an organization to identify the factors that successfully achieve its mission. David Jones, as the oldest continuously operating department store, currently has 37 stores located in most Australian states and territories, which is definitely a key to success. Cost leadership means having the lowest cost of operation in the industry. David Jones Ltd achieves cost leadership through its style of business, which helps DJs gain bargaining power with suppliers.
A low-cost leader will discount its product to maximize sales, especially if it has a significant cost advantage over the competition. By doing so, it can further increase its market share. In 2011, Customer Service DJs increased its investment in customer service initiatives. For instance, DJs invested more in frontline service hours as a relative proportion to sales. Additionally, they are increasing the quantum of payment made under the Reward and Recognition” incentive designed to encourage employees to drive sales and productivity.
In addition, new training initiatives are being introduced for all floor staff, regardless of tenure. These initiatives will focus on ensuring that sales assistants are continually trained in delivering superior customer service.
Effective Use of Assets
Asset turnover measures a firm’s efficiency at using its assets to generate sales or revenue. In 2011, DJs had an asset turnover rate of 161.52%, while Myer had a rate of 134.83%. Despite Myer having higher revenue and total assets than DJs, DJs is doing better in generating sales or revenue than Myer. Additionally, DJs provides its accounting policies to achieve its objectives.
An item of property, plant, and equipment is stated at its cost less any accumulated depreciation and impairment losses. This is similar to Myer. DJs uses the straight-line depreciation method. If parts of an item have different useful lives, they are accounted for as separate items over their useful lives. However, Myer may have a different residual value for its assets.
According to AASB 102, inventories are assets held for sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the rendering of services. The finished goods on hand or in transit are stated at the lower of cost and net realizable value. Cost is primarily determined using the retail inventory method, which is also used by Myer. However, Myer determines cost using the weighted average cost method.
David Jones recognizes its revenue in four sections: sales revenue, disruption allowance, financial services, and interest. Sales revenue is recognized when significant risks and rewards of ownership are transferred to the buyer along with legal entitlement. Revenue from gift cards is acknowledged when a customer uses their gift card, and the balance of the card is fully or partially redeemed to purchase goods. Disruption allowance represents a reimbursement for rent incurred during major refurbishment and compensates for associated loss of sales and gross profit as it is received as a result of building works under the sale and leaseback arrangement.
Financial service fees revenue related to customer loans is deferred and recognized over the instrument’s expected life on an effective interest rate basis. Revenue from interest is recognized as it accrues. David Jones has limited flexibility in changing accounting policies for revenue recognition as a retail industry and must follow rules set by AASB. For Property, Plant, and Equipment (PPE), the David Jones consolidated entity reviews and adjusts asset residual values and useful lives at each balance sheet date if appropriate. This accounting strategy reduces expense recognition and increases net profit during the financial year.
David Jones recognizes revenue when it is probable that economic benefits will flow to the entity. The company uses accrual accounting, which means it considers revenue when the sale occurs, not when the payment is received. On the other hand, for Myer, the total sales value presented on the income statement represents proceeds from the sale of goods from sales. Revenue from the sale of goods (excluding lay-by transactions) is recognized at the point of sale after deducting taxes paid and does not include concession sales. Myer’s share of concession sales is recognized as income within other operating revenue at the time of sale.
Interest income is recognized using the effective interest method on a time proportion basis. Dividends are recognized as revenue when the right to receive payment is established. The management of David Jones considers both methods, but it’s hard to determine which one is better.
The financial statements are general purpose financial statements prepared according to Australian Accounting Standard (AASB). The disclosure provides up-to-date material developments for a wide range of users, such as shareholders and investors, in making economic decisions.
The annual report does not state the reason for using these policies, but only addresses the significance of accounting policies. DJ’s annual report also provides discussions on the results of their company’s performance by product and service type for the financial year. During the financial year, segment accounting policies had not been changed that may affect segment information. The employee benefit policy in David Jones has been built for nearly ten years. This policy helps to measure the performance of employees, executive directors, and non-executive directors and motivates them through monetary and non-monetary benefits.
Furthermore, this company’s annual report outlines its employee benefit policy. In summary, the financial statement provides an accurate and honest financial report for users. Any potential red flags will be thoroughly explained in the financial analysis.
Undo Distortions
David Jones does a good job in their footnotes and also explains the reason for changes that have occurred, so customers can be assured of their accounting practices. The financial reports are explained well in detail in the footnotes. Therefore, there is no reason to undo any accounting information.
Financial Analysis
In this section, a variety of financial ratios will be used to analyze several important aspects of DJs, including liquidity, solvency, profitability, and efficiency. Myer has been chosen as a competitor due to its similar business size.
3.1.1 Analyzing Liquidity
The short-term liquidity ratios indicate the firm’s ability to meet short-term obligations. The current ratio and quick ratio will be used to measure this ability of DJs and Myer.
The current ratio is calculated by dividing current assets by current liabilities. For DJs, this ratio has been steadily increasing. Meanwhile, Myer’s current ratio has remained below one and has fluctuated over the past three years.
DJs experienced a slight decrease in their total current assets, while their current liabilities decreased by 17.7 percent. On the other hand, Myer saw a significant increase in cash from 2009 to 2010 (up by 420 percent), resulting in a 100 basis point increase in their current ratio. However, from 2010 to 2011, as cash returned to normal levels, Myer’s current assets decreased and their current ratio decreased again.
The Myer indicator has been less than one for the past three years, suggesting negative working capital and a potential liquidity crisis. The quick ratio is calculated by dividing current assets minus inventories by current liabilities. This measure of liquidity is more stringent as it excludes non-liquid assets like inventories. A high ratio indicates less reliance on inventory sales to meet obligations. Table 1 shows that DJs experienced a stable decrease in their quick ratio from 0.6 to 0.14 over three years, while Myer’s quick ratio mirrored the movement of its current ratio, with the highest in 2010 and lowest in 2012.
Solvency ratios measure a firm’s financial leverage and ability to meet its long-term obligations. These ratios include various debt ratios based on the balance sheet and coverage ratios based on the income statement. Table 2 displays the financial leverage, D/E ratios, and interest coverage ratio for DJs and Myer.
The debt-to-equity ratio is calculated by dividing total debt by total equity. It shows the financial flexibility and capital structure of the company. For DJS, the debt-to-equity ratio decreased from 14.82 percent in 2009 to 13.97 percent in 2010 but increased to 16.8 percent in 2011.
Compared to Myer, DJS had a lower debt-to-equity ratio even though it increased over time while Myer’s decreased from 56.50 percent in 2009 to 48.71 percent in three years.
This indicates that Myer had a higher level of debt as a source of financing than that of DJs since the total equity of DJs increased by 14.27 percent from 2009-2011.
The financial leverage ratio is calculated by dividing the average total assets by the average total equity, and it serves as an indicator of a company’s use of debt financing. The financial leverage ratio for DJs decreased from 163.99 percent in 2009 to 154.63 percent in 2011. On the other hand, Myer’s ratio was higher, although it decreased from 251.22 percent in 2009 to 227.88 percent in 2010 and increased slightly by 1.76 percent in 2011.
The result of the financial leverage ratio was consistent with that of the D/E ratio: Myer preferred to rely on debt financing as a source of funding. Specifically, Myer’s total debt amounted to $419.6 million, which was three times larger than that of DJs.
The interest coverage ratio is calculated by dividing earnings before interest and taxes by interest expense. This ratio helps determine the firm’s ability to repay its debt obligations. For DJs, the interest coverage ratio was at a reliable level, averaging 32.55 during the three years, although it decreased slightly by 3.23 in 2011. On the other hand, Myer’s ratio was not favorable due to an average of 5.44 during the period; however, an increasing trend may be good news.
Profitability ratios measure the overall performance of the firm relative to revenues, assets, equity, and capital. Several ratios will be used as following. Table 3 shows net profit margin, ROE and ROA for DJs and Myer. Net profit margin is found by dividing net income by revenue, and this is a important operating ratio which looks at how good management is to turn the efforts into profits. For both companies, the gross profit margin was experiencing an increasing trend during the three years. The ratio of DJs increased from 7. 67 percent in 2009 to 8. 33 percent in 2011 while the ratio of Myer increased from 3. 19 percent to 5. 86 percent during this period.
The reason for the lower ratio of Myer may be due to higher operating expenses each year, even with the same level of sales (2834 million for Myer and 2017 million for DJs in 2011). Return on assets (ROA) is calculated by dividing net income plus after-tax interest expense by average total assets. It is used to measure operating performance independently of financing and is not sensitive to the leverage position of the firm. This ratio fluctuates for both companies but remains within a smooth range. DJs’ ratio increased from 14.46 percent in 2009 to 14.70 percent in 2010 and decreased to 14.9 percent in 2011, while Myer’s ratio increased from 9.08 percent in 2009 to 9.97 percent in 2010 but decreased to 9.59 percent.
The lower ratio for Myer is due to its huge amount of goodwill, averaging 363 million, which is twelve times that of DJs in 2010 and 2011. This led to a higher level of total assets and total equity. Return on equity (ROE) is calculated by dividing net income minus preferred stock dividends by average common stockholders’ equity. It measures the return to common shareholders after subtracting operating expenses, cost of debt financing, and preferred stock.
For DJs, the ratio increased from 14.46 percent in 2009 to 14.70 percent in 2010 but then decreased again to 14.29 percent. Myer had a similar movement in the ratio, but with an average of only 9.55 percent. Return on Equity (ROE) can be broken down into two components: Return on Assets (ROA) and financial leverage. Myer’s lower ROE was due to a heavier weight in lower ROA despite using relatively higher financial leverage.
The efficiency of a firm can be measured by activity ratios, including days of receivables, days of payables, days of inventory, and asset turnover. The asset turnover ratio is found by dividing revenue by average total assets. For both companies, the ratio decreased during this period. DJs’ ratio decreased from 180.94 percent in 2009 to 166.09 percent in 2011 while Myer’s ratio decreased from 176.11 percent in 2009 to 140.36 percent in 2011 despite increasing their total assets from $1854 million in 2009 to $1978 million in 2011. A decreasing amount of asset turnover ratios suggests that both companies had an increasing amount of capital tied up in their asset base.
Days of inventory is calculated by dividing 365 by inventory turnover, resulting in the average number of days that inventory is on hand. For DJs, this ratio increased from 43.82 days in 2009 to 52.26 days in 2011 due to an increase in average inventory and a decrease in inventory turnover. Myer experienced a similar trend, with their ratio increasing from 39.69 days in 2009 to 50.12 days in 2011.
Days of receivables can be found by dividing 365 by receivable turnover, which represents the average number of days it takes for customers to pay their bills.
The receivable turnover ratio increased from 0 in 2009 to 1.89 in 2011, despite a slight decrease of 4.27 percent in sales. This led to a decrease in the receivable turnover. Meanwhile, the Myer ratio fluctuated, decreasing from 3.69 days in 2009 to 2.06 days in 2010 and then increasing again to 2.15 days in 2011.
The days of payables is determined by dividing the number of days within a year (365) by the payables turnover rate, which represents the average amount of time it takes for a company to pay its bills.
For DJs, their ratio decreased from an average of 48.68 days in payable turnover during the year ending on June 30th 2009 down to an average of only 39.16 days for that same period ending on June 30th 2011 due primarily to lower average payables leading up to an increase in their payable turnover rate.
Compared to Myer, the payables turnover ratio of DJs increased from 52.43 in 2009 to 54.7 in 2011 due to a decrease in purchases. The balance sheet of DJs presents its financial position at the end of each fiscal year, including assets, liabilities, and equity. Table 1 displays common size balance sheets for all accounts of DJs for the years 2009, 2010, and 2011. In a common size balance sheet, each item is listed as a percentage of total assets.
The percentage of cash and cash equivalents and receivables accounts in relation to total assets remained constant at 1% and 2%, respectively. However, the net receivable amount from suppliers increased from $8,633,000 in 2010 to $10,463,000 in 2011. The age of the accounts receivable indicates how long ago the sale that generated the receivable was made. In 2011, for DJs, 80% were current or less than 30 days old. This represents a decrease from the previous year’s figure of 92%. Additionally, 10% were between 31-90 days old while another 10% were over 90 days old; both percentages increased compared to those of the previous year.
From 2009 to 2010, current assets increased by 13 percent. The majority of this growth occurred in inventories, which increased from 22 percent to 24 percent of total assets. However, this percentage remained unchanged in 2011.
In terms of non-current assets, property, plant and equipment as a percentage of total assets remained steady over the three years. However, PP&E did increase by 5 percent from 2010. Land and buildings saw an increase of 21 percent, integral plant and equipment increased by a whopping 200 percent, computer equipment increased by 38 percent and fixtures and fittings rose by a solid 32 percent.
On the other hand, deferred tax assets decreased by a significant margin of 21 percent due to lower gift card non-redemption provisions and share-based payments compared to prior data.
Between 2010 and 2011, current liabilities decreased by 15 percent. The most significant decrease was observed in trade payable used for inventories. Payable as a percentage of total assets decreased from 20 percent in 2010 to 18 percent in 2011. Additionally, other current liabilities such as current tax liabilities, provisions, financial liabilities, and other liabilities also decreased by varying percentages.
Long-term debt increased by 27.7% from 2010 to 2011 and by 1% from 2009 to 2010. The percentage of total assets represented by long-term debt ranged from 8% to 11%, with unsecured bank loans comprising a larger portion in 2011.
Total equity to total assets indicates the percentage of a company’s assets owned by shareholders, with creditors claiming the remainder. For DJs, ownership increased from 61% in 2009 to 65% in 2011. Equity for DJs included contributed equity, reserves, and retained earnings.
However, the actual amount of net income fluctuated slightly during the three years, rising to 171 million in 2009 and then decreasing to 168 million in 2010. This fluctuation may be due to changes in revenue.
The cash flow statement provides information beyond that available from the income statement, which is based on accrual accounting rather than cash accounting. The cash flow statement can be divided into three parts: cash flow from operating activities (CFO), cash flow from investing activities (CFI), and cash flow from financing activities (CFF).
Especially the dividend yield, 11. 38%, was higher the average level of 3. 63% in sector and 4. 62% in market. And DJs paid off prior debt and did not borrow any funds in 2009 while the borrowing increased from 1 million in 2010 to 28 million to 2011 and no any debt repaid. Besides DJs did not issue any bonds or new shares. It only relied on external financing. Table 5 shows working capital, free cash flow to the firm and free cash flow to equity for DJs (2009-2011). The management of working capital of DJs was favorable because of the amount of this item increasing year by year.
Consequently, the company has the flexibility to invest in long-term assets for future growth. The free cash flows for both equity and debt holders decreased by 18.06% from 2010 to 2011. However, overall the trend was increasing and the cash flows were sufficient to make interest and principal payments to debt holders, pay dividends, and buy back shares from equity holders. The movement of free cash flows for all holders was mirrored by that of equity holders, increasing by 260% from 2009 and 3% from 2010. The significant difference between these increase rates could be attributed to a decrease in net debt issuance ($170 million) in 2009.
Prospective Analysis
Forecasting Assumption:
Based on the information we have gathered, the OECD countries have experienced an economic downturn since the GFC. The recovery of the economy will take a long period of time and will fluctuate in following years. However, Australia’s economy has been recovering due to the booming mining sector, robust employment, and strong consumer confidence. Companies focusing on discretionary spending, such as David Jones, are in a good position.
Based on this analysis, it is reasonable to expect that sales growth will trend upwards. However, due to fluctuations in the market in the following years, it will ultimately remain stable at around 6% in the long run. This is due to increased competition within the industry. David Jones has adopted a sustainable strategy of differentiation rather than cost leadership, resulting in a NOPAT margin that will remain within normal levels at 7%. As the economy recovers, working capital is expected to increase. With viable locations for new stores becoming increasingly scarce in Australia and New Zealand, there will be a decline in the ratio of long-run assets to sales over time.
The current share price of DJSs is $2.19. The estimated value per share using the discounted FCF method is $2.49, using the discounted abnormal earnings to equity method is $2.69, and using the discounted abnormal earnings to capital method is $2.77. Based on these estimates, DJSs appears to be undervalued.
Conclusion and Recommendation
In this report, we evaluated the performance of DJSs from four aspects: strategy analysis, accounting analysis, financial analysis, and prospective analysis. Based on the information and data we have acquired, we strongly recommend all investors to buy this stock. Despite the long-run growth being only 1%, the estimated value per share also shows that DJSs can provide something of value to investors.
Other valuable information from the annual report indicates that many significant investment institutions hold shares of DJSs, accounting for around 44 percent. Analysts from these companies are confident that David Jones will have sustainable profits in the future.
