Kesko Corp is a diversified retail business headquartered in Helsinki, Finland. Founded in 1940, it deals with food trading, logistics, data and network management, building and home improvement alongside agricultural supplies, car and machinery trading. Apart from Finland, the company operates through subsidiaries like Kesko Food, Musta Porssi, Konekesko, Indoor, Intersport in Norway, Sweden, Russia, Lithuania, Estonia, Belarus and Latvia.
2. CORE: Context, Overview, Ratios and Evaluation
Context:
External
Kesko has around 2,000 stores structured as chain operations in parts of Nordic, Baltic, Scandinavian regions. Kesko and K-retailers comprise of K group which employs approximately 45,000 employees with year 2011 turnover stands at € 12 billion.
By 2011, Kesko Corporation has circa 19,000 employees with net-sales around € 9.46 billion. An increase of 7.8% from last year’s (€ 8.77 billion). Finnish net-sales rose by 7.3% and other countries operations increased by 10.1%. Main drivers of success were food trade, building, car and machinery business.
Earning-per-share of 2011 stands at 1.85 compared to 2.08 in 2010. A dividend of € 1.2, 65% of the EPS was issued.
Kesko’s market share is 35% and local major competitors are:
S-Group (45%)
Suomen Lahikauppa
International competitor includes:
Lidl
Internal
Kesko is controlled by its shareholders. Shareholders elect the Board of Directors and Auditor. Kesko Group is managed by the Board and the Managing Director who is also the President and CEO.
CEO and President are selected by the Board of Directors. The company has Corporate Management Board having 7 members that control different divisions and responsibilities of the group.
All Kesko Board members are non-executive directors. In 2011 it was decided by the Board that all of its members are independent of its company’s shareholders. The Board ensures that the company’s administration, operations and accounting as well as financial management controls are in place.
Shareholding as below:
The company’s share capital is € 197.2m. Total number of shares is 98.6m of which 31.7m are classed as A shares and 66.9m are B shares. Share A carries 10 votes and Share B one vote.
Key group strategies include:
Growth in Russian Regions
Investment in development of store network
Development of e-commerce
Healthy profitable growth and increase shareholder value.
All in all Kesko’s capital expenditure in growth stands at € 425m in year-2011. Six new K-citymarket stores, 17 K-supermarkets in food business, 4 new K-rauta stores in building and home-improvement, 1 Kodin Ykkonen departmental store.
The aim is to open 10 new stores in Russia with approx. €600m expenditure till 2015.
Overview:
Kesko:
YEAR
2011 €m
2010 €m
Turnover % Change
9,460
7.8%
8,776
Cost of Sales % Change
8163
8.17%
7546
Operating Profit
% Change
281
-8.4%
307
Profit after Tax
% Change
197
-8.8%
216
Operating Cash flow % Change
215
-51%
438
Capex
% Change
427
30.2%
328
Total Debt (Long + Short term)
% Change
400
-16.1%
477
Total number of Employees
% Change
18,960
4.1%
18,215
The difference between costs and sales determines the operating profit. Though turnover is healthy, decrease in operating profit can be attributed to increase in cost of sales. Expenses also increased and in totality affected the profit position. Increase in capital expenditure is due to expansion in international markets and machinery which impacted negatively on the cash-flow position. Total debt position decreased which shows a healthy sign of effective use of company resources. Employee number remains constant.
Koninklijke Ahold:
YEAR
2011 €m
2010 €m
Turnover % Change
30,271
2.5%
29,530
Cost of Sales % Change
22,350
3.4%
21,610
Operating Profit
% Change
1,347
0.8%
1,336
Net Income
% Change
1,017
19.2%
853
Operating Cash flow % Change
1,786
-15.4%
2,111
Capex
% Change
881
-21.1%
1117
Net Debt
% Change
1,088
47.6%
737
Total number of Employees
% Change
218,000
2.3%
213,000
In comparison to Kesko, Ahold is 3 times bigger company as above.
c).Ratio Analysis
The ratio analysis is made up of performance, working capital, liquidity/solvency and shareholder ratios.
Performance ratio is how well the company manages its assets and converts them into revenue and how efficiently converts its sales into cash. The better these ratios are the better value for shareholders.
Kesko in comparison with Ahold
Performance
calculations
2011
2010
Change in 2011
Ahold 2011
Gross margin
2011:
13.7%
14.0%
-0.3%
26.17%
1297/9460
2010:
1230/8776
Expenses/sales
2011:
18.1%
18.4%
-0.3%
21.72%
1721/9460
2010:
1622/8776
Net margin*
2011:
2.9%
3.5%
-0.6%
4.45%
281/9460
2010:
307/8776
Asset turnover
2011:
3.6
3.4
0.2
2.92
9460/2565
2010:
8776/2550
Return on
2011:
12.5%
13.9%
-1.4%
12.99%
Capital
281/2233
employed *
2010:
307/2210
Gross margin has declined because of increase in cost of sales sub-sequentially affecting the net margin. Slightly better asset turnover shows improved sales performance by every € invested in the given year. Given the retail nature of the business this is normal.
ROCE is not a matter of huge concern, however needs to be monitored closely. The ROCE decline could be the reduced profits attributed to shareholders.
Ahold on the other hand shows big numbers. From retail perspective, Kesko’s performance is not bad at all. There are few dips in the numbers which are usual for a transactional retail business.
d).Working capital is used to measure the company’s short-term financial health. It is also called operational liquidity for the period of 12 months. Positive working capital can prove that the company can pay its short-term liabilities well. Negative working capital will increase the risk of default on short-term liabilities.
Kesko’s working-capital ratios
Working Cap
Calculations
2011
2010
Change
Ahold 2011
Inventory days
2011:
38.8 days
36.6 days
2.2
23.9
(divided by CoS)
867 x 365/
8,163
2010:
757×365/7,546
Debtor days
2011:
27.0 days
25.8 days
1.2
9.1
(divided by
700 x 365/9,460
sales)
2010:
620×365/8776
Creditor days
2011:
51.3 days
52.4 days
-1.1
39.8
(divided by CoS)
1148 x 365/
8,163
2010:
1,085 x 365/
7,546
Some difference year-on-year. Increase in inventory days shows negative cash-flow and control on inventory. Increase in debtor-days is bad for cash hence the cash position. This could be poor collection or price negotiations for discounts. Also seems like customers are taking longer to pay. Early payments to creditors depict the decrease in creditor-days, a virtuous gesture for suppliers but not good for cash.
(d).Liquidity and Solvency ratios also a measure of company’s ability to pay its short-term obligations also called a ‘Quick ratio’. This means that the current assets should outweigh current liabilities to stay positive. It also indicates the company’s ability to meet interest payments. Higher the level of capital compared to debt, the lower these ratios are.
Liquidity
calculations
2011
2010
Change
Ahold 2011
Current ratio
2011:
1.33
1.49
-0.16
1.13
2161/1625
2010:
2407/1616
Acid test
2011:
0.80
1.02
-0.22
0.81
2161- 867/1625
2010:
2407-757/1616
Solvency
2011
2010
Change
Ahold 2011
Interest cover
2011:
13.40
18.05
-4.65
281/21
4.01
2010:
307/17
Gearing
2011:
0.18
0.21
-0.03
0.56
400/2233
2010:
477/2210
Decrease in current ratio is due to in-efficiencies in debtor and inventory turnover. Shortfall in cash has deteriorated acid test which is more conservative than current ratio. Variation in interest cover is an imminent concern given its retail landscape and possible inability to meet its debt obligations. Kesko’s cost of sales needs to be addressed to better manage profits sub-sequentially improving its cash reserves to shield the interest-cover shortfall. Decrease in gearing is a positive sign, showing Kesko’s good portion of equity is in place displaying monetary strength.
e).Shareholders and Investment ratios
Return on equity is the measure to see how much profit is left for shareholders. Higher this ratio, higher the profit for shareholders. Shareholders can decide to withdraw this profit or keep it invested in the business as retained earnings.
Earning per share is a measure of firm’s profitability. Dividend cover is the number of times a firm’s dividends to shareholders is paid from its net profits. Higher the cover, more the ability to pay the shareholders. PE ratio measures price compared to earnings. The bigger the earning, more potential of rise in future earnings.
Shareholder
Calculations
2011
2010
Change
Ahold 2011
Ratios
2011:
ROE
197 / 2,233
8.8%
9.7%
0.9
17.3%
2010:
216 / 2,210
2011:
1.85
2.08
0.1
0.92
EPS
197 / 99
2010:
216 / 99
2011:
Dividend Cover
1.85 / 1.20
1.54 times
1.6 times
0.06
2.30
EPS / Dividend
2010:
Per share
2.08 / 1.30
PE Ratio
2011: 24.1 / 1.85
2010: 34.70 /
2.08
13.0
16.82*
-3.82
11.48
Low ROE is result of low profit. Debt in the company also affects ROE, but in Kesko’s case debt has been reduced which might not be relevant for decline in ROE. Kesko’s increase in intangible assets can also result in low ROE. EPS is declined resulting from decline in operating profit, and possible increase in capital expenditure from last year. But still manageable and shows strong growth potential. Dividend cover is constant but relatively lower than Ahold. PE ratio is declined from previous year. This may show low market confidence in 2011.
*http://www.kesko.fi/en/Investors/Share-information/Key-indicators-by-share/
f).Conclusion and Recommendation:
Kesko is a strong company with year-on-year growth. However year 2011 has underperformed. The year seems a bit challenging ranging from its high cost of sales and higher volatility in its share price. Given its higher interest payments shows a possibility of higher borrowing costs. Increase in intangible assets (Computer Software, Licences) and expansion cost in the form of CAPEX is also a driver of declining cash-flows.
The seasonal nature of operations arising from seasonal fluctuations took a toll on profits which are not earned throughout the year. Depending on Kesko’s segmental characteristics these profit variations are possible.
Kesko
Strengths
Diversified product portfolio
Effective Business model
Growth in E-commerce
Strong chain support functions
Weaknesses
High dependency on euro-zone.
Lack of skilled labor
Foreign exchange risks
Changes in the Group’s structure by creating a new subsidiary in Russian market and transferring 36 stores to the subsidiary has also affected Kesko’s performance.
Uncertainties in the euro zone, volatility in consumer demand is affecting the appetite for CAPEX in the euro zone.
Hence the reason of strong expansion in Russia. E-commerce is booming with international customers creating alternative benefits for Kesko.
Future looks favorable for Kesko. Low investment in euro-zone will offset high CAPEX in Russian region. Steady growth in the food business expects to continue. Home and building business is expected to balance against consumer demand. Net sales are expected to grow next year i.e. 2013.
All in all the growth-story looks good for Ahold. Ahold has the means to acquire Kesko. However my recommendation would be hold the acquisition desire for now till numbers become promising. As an alternative a 20% shareholding now will be suitable for Ahold. In both scenarios, if Kesko does well in the future, Ahold is sure to benefit from its interest in Kesko.
Answer 3:
The cash-flows of the project are below:
Year 0
2014
2015
2016
2017
2018
Sales Revenue
0
300,000
510,000
680,000
450,000
240,000
Loss of Contribion
(35,000)
(35,000)
(35,000)
(35,000)
(35,000)
Variable Costs
(160,000)
(240,000)
(280,000)
(210,000)
(140,000)
Fixed Costs
(22,000)
(22,000)
(22,000)
(22,000)
(22,000)
Op Cash flow
65,000
195,000
325,000
165,000
25,000
Working capital
(70,000)
(70,000)
(70,000)
(70,000)
(70,000)
Capital Cost
(500,000)
Residual Value
100,000
Net Cash flow
(500,000)
78,000
338,000
598,000
278,000
98,000
Depreciation of 80,000 is not included in fixed costs as it does not affect cash. Head office overheads are also not a constant fixed cost over 5 year period so not including in the fixed costs.
The Payback time is approx. 2 years 6 months.
Net Present Value calculation is below with discount rate of 15%.
Year
Cash flow
PV Factor
PV
0
(500,000)
1.0
(500,000)
1
78,000
0.870
67,860
2
338,000
0.756
255,528
3
598,000
0.658
393,484
4
278,000
0.572
159,016
5
98,000
0.497
48,706
NPV
424,594
NPV is positive, so recommendation to the board is to go ahead with the project
With adding back depreciation of 40,000 i.e. 80,000 x 5 at the end of 5 year:
Year
Cash flow
PV Factor
PV
0
(500,000)
1.0
(500,000)
1
78,000
0.870
67,860
2
338,000
0.756
255,528
3
598,000
0.658
393,484
4
278,000
0.572
159,016
5
98,000
0.497
48,706
Depreciation
(400,000)
NPV
24,594
NPV is still positive, so recommendation to the board is to go ahead with the project.
The IRR is 43.7%, where NPV becomes zero.
Answer 4:
Usefulness of Company accounts to assess value of companies
Hello friend,
In order to understand company accounts, the financial accounting statements provide a representation of financial position and performance of the company.
Company accounts are made up of 3 statements:
Balance Sheet (aka Statement of financial position)
Income Statement ( aka Profit and Loss account)
Cash-flow statement
Cash-flow statements show how much cash came in or went out in a particular period.
For example, I started a business of selling flowers with £40. On Tuesday morning, I bought flowers worth £40 and sold three-quarters of flowers for £45 cash that day. My cash-flow position during Tuesday will look like this:
Cash invested by me: £40
Cash from sales of flowers: £45
Cash paid to buy flowers: (£40)
Closing balance of cash £45
Income statements show how much wealth i.e. profit is generated or lost by the company over a period of time. Profit and loss can be defined as increase or decrease in wealth through trading activities.
For income statement it shows wealth generated on Tuesday. It represents the difference between the value of the sales made and the cost of goods sold.
Sales revenue: £45
Cost of goods sold (3/4 of £40) (30)
Profit £15
It is the cost of flowers sold that is matched against the sales revenue to get profit. Not the whole cost of flowers is shown as unsold flowers in my case ¼ of £40= £10 will adjusted against the future sales revenue that it will generate.
Balance sheet shows accumulated wealth of the business at the end of the given period. It also shows what form have that wealth taken?
For balance sheet the wealth created at the end of Tuesday trading. It will show list of resources held at the time.
Cash (closing balance) £45
Stock or inventory for resale £10
Total assets £55
Equity £55
Equity is the stake of the owner in the business. Where-as assets include cash and stock.
Cash is a vital resource for a business to function. It is used to retire debt and or for the purchase of stock. However, reporting cash alone will not portray the health of the business. The changes in cash do not tell us how much profit is generated. That’s why income statements are used.
A balance-sheet on the other hand shows total wealth of the business. Cash is only one form in which wealth can be held, however in bigger businesses there are land, machinery and equipment is also classed as wealth in the balance-sheet.
A combination of these statements states the financial position and health of the company.
The relationship of these statements can be seen by a figure below:
Another way to valuing a business is through company assets, price of parallel business and finally the cash-flow. Company assets are appraised to assess their value deducting any liabilities. The sales of similar business are valued in the area of your business. Location is very important in valuing the business though the limitations include undermining the value of your business by management and sales.
The most effective way is the liquidity of the business i.e. cash position minus liabilities. You know what is coming your way.
Issues:
Issues related to these statements are the way they are presented. Use of creative accounting can somehow alter the real picture and position of the company.
Audited company accounts are seldom used by investors or potential buyers, primarily for the reason of creativeness.
Depending on the nature of your query for valuing the company, apart from simplified company accounts mentioned above, it can vary from share price to ratio analysis to cost of capital or debt and so on.