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    Finance

    HI5002: Finance for Business

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    HI5002: Finance for Business


     Introduction  

     The report will be based on two selected companies and they are Wesfarmers and Woolworth. In this report, the comparative advantage of the two selected companies will be indentified. Then the financial ratio of the two selected companies will be discussed and calculated. Then the share price movement of the two selected companies in the market will be analysed. Then the value of beta and return rate of the two companies will be calculated using CAPM model. Then the dividend policies of the two companies will be observed and analysed. Then a recommendation letter will be given to the client about the investment in these two selected companies. At last a brief conclusion will be given.
     
    Description of operation and comparative advantages of the two chosen companies 
    Wesfarmers is the market leader in the Australian market in the retail industry. The group revenue was $62.4 billion in the financial year 2017. The sustainability report of the company indicates that the company strategy in the long-term is to increase the wealth of all the stakeholder of the company, which will help them survive in a long period of time. The main comparative advantage of Wesfarmers over Woolworths is that they have bigger market share and market presence in the market. which increases the awareness of their product in the market (Wesfarmers.com.au.,2018). 
    Woolworths groups has 202,000 employees working under it. The company sells a variety of product at low price in different market. The revenue of the company in the financial year 2017 is around $55 billion. The company is the biggest competitor of Wesfarmers in the Australian market. The net profit of the company is $1593 million in the financial year 2017. The main competitive advantages of Woolworths over Wesfarmers is comparatively lower price of their product compared to Wesfarmers.
     
    Financial ratio analysis of Wesfarmers and Woolworths
    The analysis of the liquidity ratio of the two selected companies shows that the company Wesfarmers liquidity is slightly better in term of consistency than Woolworth’s group. The analysis of the profitability ratio shows that the profit margin of Wesfarmers is far better than Woolworths. The analysis of the leverage ratio of the two selected companies shows that the capital structure of Wesfarmers is far better than Woolworths. In addition, the amount of profit remained with Wesfarmers to repay its financial obligation in the market is far better than Woolworth. Therefore, the overall financial ratio analysis of the two companies show that the financial performance of Wesfarmers is far better than Woolworths.
     
     Analysis of monthly share prices movements 
     
    (1) Preparation of graph for showing the movements in the monthly share price over the last three years for the companies Wesfarmers and Woolworths against the All Ordinaries Index
    According to Zhao et al. (2015), the all ordinaries index, which is also called the All Ords Index, is the oldest index of the shares in Australia and the index is made up with share prices of 500 largest corporations listed under the ASX (Australian Securities Exchange). The graph that has been provided below shows the comparison of the movements that have been recorded in the share prices of both Wesfarmers Ltd and Woolworths Ltd during the last three years against the movements recorded in All Ords Index -
     
    (2) Report on the comparison of the movements in the companies’ share price index to the All Ords Index.
    In order to compare the movements that have been present or recorded in the share prices index of a company to any other index, the systematic risk, which is also known as the beta value of the share prices of the company can be computed (Savor and Wilson, 2016). From the comparison of the share price movements of both Wesfarmers Ltd and Woolworths Ltd, it can be seen that the beta value of the companies are 0.94 and 0.73 respectively. As stated by Babenko et al. (2016), in case if the value of beta of the share prices of any company are lower than 1.0, the shares are considered less volatile than the market share prices and vice versa. However, in case of Wesfarmers Ltd and Woolworths Ltd, both the companies show that their shares are less volatility than the All Ordinaries Index. 
    It can be implied from the comparison of the movements in Wesfarmers Ltd and Woolworths Ltd’s share price index with that of the All Ordinaries Index that their shares are 94% and 73% less volatile than the All Ords Index. This shows that both these companies have share prices lower than that of All Ords Index and are less risky in nature. However, since the risks associated with the share prices of these two companies are low, the returns for investors of these shares also have the tendency of being low. 
     
    3. Significant factors which may have influenced the share price
    There are various factors, which have an influence over the changes taking place in the share prices of a company. For example, mergers, acquisitions, changes in the management, macroeconomic factors, writing off abnormal or unusual items, and macroeconomic factors are the some of the main factors, which can be influencing the share price index of a company. Different factors have had an impact on the movements or changes that have taken place in the monthly share prices of Wesfarmers Ltd and Woolworths Ltd over the span of the last three years as well. For example, after becoming a public company in 2001, Wesfarmers Ltd has diversified its interests through acquiring other business organizations. During January 2016, Wesfarmers Ltd acquired the Home Retail Group, the retail bsuines of home improvement and the garden center Homebase from Britain (Wesfarmers.com.au, 2018). This is a significant change in the company Wesfarmers Ltd and this has attracted various consumers towards the company, thereby increasing its share prices. 
    At the same time, Wesfarmers Ltd announced the restructuring of its departmental stores businesses during February 2016 into one single division with the name Department Stores, in which each brand will be having the authority of continuing its operations independently (Wesfarmers.com.au, 2018). It is another major change that has affected Wesfarmers Ltd’s share prices by increasing them largely. These two major factors might have affected Wesfarmers Ltd’s share prices in the past three years. Similar to Wesfarmers Ltd, significant acquisitions can also be noticed in Woolworths Ltd. During the year 2015, Woolworths Ltd acquired the iconic retailer in Australia, David Jones with ZAR 2.2 billion (Woolworthsgroup.com.au, 2018). This acquisition has increased the interest of investors in the company Woolworths Ltd as well, thereby affecting its share prices. 
    Another significant change that has taken place in Woolworths Ltd during the recent past is that the company has changed its operating model during the year 2016 and has brought about other strategic changes during the year worth 155 million AUD (Woolworthsgroup.com.au, 2018). As a result, this initiative of the company has also had an effect on its share price movements during the past three years. Hence, these are the significant changes, which have taken place in Woolworths Ltd as well as Wesfarmers Ltd during the years 2015 and 2016, thereby influencing its share price movements over the last three years. 
     
    4. Calculation of beta values and expected Rates of Return using the CAPM 
    As per the statistical report, the calculated beta for Woolworths Limited is 0.76 and the calculated beta for Wesfarmers Limited is 0.85.
    Expected rate of return for Woolworths Limited as per CAPM:
    Rate of return = 0.05 + 0.76 * (0.06 – 0.05)
    = 0.05 + 0.76 * 0.01
    = 0.05 + 0.0076
    = 0.0576 or 5.76%
    Expected rate of return for Wesfarmers Limited as per CAPM:
    Rate of return = 0.05 + 0.85 * (0.06 – 0.05)
    = 0.05 + 0.85 * 0.01
    = 0.05 + 0.0085
    = 0.0585 or 5.85%
    Considering the above calculations it can be stated that the shares of Wesfarmers Limited are more lucrative to the investors because under the CAPM calculation its rate of return is higher than the rate of return of Woolworths Limited. Hence, from this point of view, it must be stated that the investment in the shares of Wesfarmers Limited is expected to be more profitable for the investors.
     
    5. Dividend policies 
    Determining a proper dividend policy is very important for every business. Dividend is paid by the companies to satisfy its equity shareholders in a better way. Considering the cases scenario of Woolworths Limited and Wesfarmers Limited, it must be mentioned that the managements of these two retail giants must have adopted particular policies for paying dividend to their shareholders. Here, the dividend policies of the two organizations are discussed below:
     
     
    Dividend policy of Woolworths Limited:
    If the dividend payment history of Woolworths Limited is considered, it will be very clear that in last five years the company has provided 100% franking dividend to its shareholders. It means the company has adopted the policy of paying only the franking dividend to its shareholders. Franking dividend is one type of dividend in which the company pays the amount of tax associated with the dividend. The shareholders do not requires paying any tax on the dividend; however, the shareholders remain liable for the amount of tax that the company has already paid to the government (Woolworthsgroup.com.au, 2018). The following image is showing the dividend payment history of Woolworths Limited for last three years:
     
    6. Recommendation Letter
     
    To 
    Mr / Mrs …
    RE: Recommendation for the investment portfolio of Woolworths Ltd and Wesfarmers Ltd 
    Respected sir/madam, 

    From all the discussions that have been made in this report, it can be seen that Wesfarmers Ltd and Woolworths Ltd have had quite a few changes taking place during the three past years. The analysis of the ratios of the company shows that Woolworths Ltd has a poorer performance in comparison to that of Wesfarmers Ltd over the past three years. As a result, it can be implied that both financial health and financial performance of Wesfarmers Ltd is better than that of Woolworths Ltd. Since the financial performance shown by Wesfarmers Ltd is better, it is obvious that investors investing into the equity shares of the company will be able to earn higher returns or dividends from the company. At the same time, the movements in the share prices of the two companies indicate that the volatility in the share prices of Wesfarmers Ltd is slightly higher than the share prices of Woolworths Ltd. This yet again indicates that any investor investing into the shares held in Wesfarmers Ltd has a better opportunity of earning higher returns, as risky shares tend to yield higher returns for shareholders. 
    Considering the dividend policies of the two companies, it can be stated that both the companies have almost similar type of dividend policies. Woolworths Limited as well as Wesfarmers Limited has provided 100% franking dividend to their shareholders. Providing 100% franking dividend both the companies have helped their shareholders in reducing the tax burden. In this context, it can also be noted that the rate of dividend paid by Woolworths Limited during the last three years was lower than the rate of dividend paid by the Wesfarmers Limited during the same period. The rate of dividend of the Wesfarmers Limited was much high in the last year. Hence, from this perspective the investment in Wesfarmers Limited will be more viable.
    However, if the evaluation is made from the return perspective, it can be identified that the expected return percentage is high if the investment is made in the shares of Wesfarmers Limited. The CAPM calculations have proved that the expected return will be bit high in Wesfarmers Limited. However, in this context, it is important to be mentioned that the as the return is high, the risk level is also high in the shares of Wesfarmers Limited because the beta of Wesfarmers Limited is showing bit high value than the beta of Woolworths Limited. However, it is also required to be noted that the difference between the risk and return levels of the two companies are not that large.
     
    Conclusion 
     This report contains overall performance of the two selected companies. The selected companies in this report are Wesfarmers and Woolworths. The comparative advantages and operation of the two selected companies had been discussed. Then the financial ratio of the two selected companies had been analysed. Then the share movement of the two selected companies had been observed. The factors influencing the movement of share price had been identified. The beta and rate of return of the two companies had been calculated. Then the dividend policies of the two companies had been evaluated. Then at last a recommendation letter had been given to the client advising him investment in the two selected companies.