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Financial Strategy

Analysis of

Sainsbury plc.’s Financial Strategy

Written by

Jason Cates

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© Jason Cates, 2012

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acknowledged source.

This paper has referenced appropriate sources in-line with Harvard Referencing.

Any queries regarding this publication should be sent to:

AdrJasonCates@GoogleMail.com or

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To be delivered to the University of Hertfordshire on or by

18 December 2012

Ordered by Jason Cates to be printed

14 December 2012

Printed in the United Kingdom

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Evaluate Sainsbury’s choice of sources of funds using appropriate theory Evaluate Sainsbury’s dividend policy by using appropriate theory Recommend an appropriate financial strategy for Sainsbury to be followed over the next 3 years.

Follow a report format.

Use Sainsbury’s financial data for the last 3-5 years in order to evaluate Sainsbury’s financial

strategy.

Use corporate life cycle theory to evaluate Sainsbury’s financial strategy.

Use other relevant corporate finance theory (e.g. M&M, Lintner, etc) to evaluate Sainsbury’s

financial strategy.

Take into consideration the current economic climate when recommending an appropriate financial

strategy for Sainsbury. Also, your recommendations should be based on the findings of your analysis

of Sainsbury’s financial strategy.

Use appropriate referencing

Use appropriate sources (for example, Sainsbury annual report, Refereed journals, Books). Do NOT

use sources such as Wikipedia, investopedia, etc.

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Table of Contents Introduction ............................................................................................................................................ 4

Aim ...................................................................................................................................................... 4

Setting the Scene ............................................................................................................................ 4

Part I ........................................................................................................................................................ 5

Sources of Finance .............................................................................................................................. 5

Long-Term vs. Short-Term Debt (Positive) ...................................................................................... 5

Trade Payables (Stable) ................................................................................................................... 6

Debt vs. Equity (Stable) ................................................................................................................... 7

Implications ......................................................................................................................................... 8

Gearing (Stable) .............................................................................................................................. 8

ROCE (Stable) .................................................................................................................................. 8

Cash and Cash Equivalents (Negative) ............................................................................................ 9

Boston Matrix (Positive) ................................................................................................................ 10

Part II ..................................................................................................................................................... 11

Dividend Policy .................................................................................................................................. 11

Cost of Capital (Stable) .................................................................................................................. 11

Shareholder Return ....................................................................................................................... 12

Recommendations ............................................................................................................................ 15

Debt Finance ................................................................................................................................. 15

Equity Finance ............................................................................................................................... 15

Cash Reserves ............................................................................................................................... 15

Part III .................................................................................................................................................... 16

Signatories......................................................................................................................................... 16

References ........................................................................................................................................ 17

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Introduction Aim This report is carried out with the aim of analysing and evaluating Sainsbury’s financial strategy and

makes appropriate recommendations regarding its future strategy over the next 3-5 years. This will

be carried out by evaluating Sainsbury’s current sources of finance and analysing their financial

implications. This will be carried out in the context of Sainsbury’s past financial strategy as well as its

long-term dividend policy.

Setting the Scene

In March 2012, Sainsbury’s total liabilities increased by £736m (12.32%). This is while equity,

including retained earnings and reserves, increased by £205m (3.78%). This included an 11.89%

increase (£278m) in long-term borrowings and a 5.51% (£143m) increase in trade payables. This

increase in trade payables was in-line with Sainsbury’s growth in revenue which stood at 5.65%

(£1.192bn). In total, long-term debt in 2012 made up 53.27% of Sainsbury’s total liabilities, up from

50.76% in 2011. (Sainsbury, 2012)

As stated above, Sainsbury’s use of debt grew faster than its use of equity. This increased

gearing from 33.4% in 2011 to 35.2% in 2012. This increase in debt for 2012 was fuelled by Sainsbury

increasing “investment in property, plant and equipment” and other revenue generating assets. This

is while Sainsbury’s net debt fell by 11.2% (£168m). This shows that increasing levels of Sainsbury’s

debt has been used to fund investment in cash and “other interest bearing assets”. In this context,

net debt made up 21.1% of capital employed, down from 23.6% the previous year. (Sainsbury, 2012)

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Part I Sources of Finance

Long-Term vs. Short-Term Debt (Positive)

Long-term debt has played an increasing part of Sainsbury’s financial strategy. In 2008, long-

term debt made up 48.4% of Sainsbury’s total debt. However, by 2012 this proportion had increase

to 53.27%. This increase in long-term borrowings has helped fund investment in PPE and other

revenue generating assets. (Sainsbury, 2012)

(Sainsbury, 2012)

This long-term financial strategy will provide Sainsbury with more time and flexibility to

repay this debt, thus reducing its financial risk. This long-term financial policy will promote long-term

stability and help minimise the long-term costs of capital.

This increasing use of long-term debt has helped facilitate Sainsbury’s growth in both in-

store and online sales. (IR, 2012) This growth in “multi-channel” sales helps to diversify Sainsbury’s

revenue streams and helps to ensure long-term sustainability by reducing overall business risk. This

includes investing in growing markets such as China whilst locking in lower interest rates over the

long-term. (Sainsbury, 2012)

48.80% 48.40%

52.57% 50.76% 53.27%

51.20% 51.60%

47.43% 49.24% 46.73%

40.00%

45.00%

50.00%

55.00%

60.00%

2008 2009 2010 2011 2012

Long-Term vs. Short Term Debt

Non-Current Liabilities Current Liabilities

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Trade Payables (Stable)

(Sainsbury, 2012)

Over the last two years, growth in trade payables has remained in-line with revenue.

However, in 2010, Sainsbury repaid some of its trade payables after growth exceeded that of

revenue in 2009. Since then, trade payables have remained at roughly 12.3% of revenue. This is

lower than Sainsbury’s closest competitor Tesco with trade payables of 19% of revenue, but higher

than that of Morrison’s with 11.5%. (FT, 2012c)

In 2012, Sainsbury’s trade payables equated to 47.4 payable days, declining from 50.8 days

in 2009. (Sainsbury, 2012)This reduction will provide Sainsbury with greater financial flexibility as

market growth staggers and trading conditions remain tough. This policy, if maintained, with help

promote long-term flexibility and growth. However, Sainsbury must ensure it can maintain this debt

over the long-term as not to increase its financial risk.

-5.00%

0.00%

5.00%

10.00%

2009 2010 2011 2012

Growth in Revenue and Trade Payables

Revenue Trade Payables

11.50%

12.00%

12.50%

13.00%

13.50%

2008 2009 2010 2011 2012

Trade Payables as a Proportion of Revenue

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Debt vs. Equity (Stable)

This report will now analyse Sainsbury’s use of debt in proportion to equity as a source of

finance. This report will also consider Sainsbury’s net debt which includes deductions such as cash

and other interest bearing assets.

(Sainsbury, 2012)

Sainsbury’s debt has remained relatively stable over the last five years increasing

proportionately with equity. As such, gross debt has remained at roughly 1.16 times equity.

Furthermore, Sainsbury’s net debt, which deducts cash and other “interest bearing financial assets”,

has also remained stable at roughly 0.29 times equity. As par the annual report, Sainsbury’s increase

in gross debt during the financial year 2012 was due to increasing “investment in estate

development”. (Sainsbury, 2012)

0

0.5

1

1.5

2008 2009 2010 2011 2012

Debt vs. Equity

0

0.1

0.2

0.3

0.4

2008 2009 2010 2011 2012

Net Debt vs. Equity

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Implications

Gearing (Stable)

(Sainsbury, 2012)

In 2012, Sainsbury’s gearing stood at 35.2%, up from 33.4% a year before. However, overall

this gearing has remained relatively stable over the last 5 years ranging from 30% in 2008 to 38%

2009 and then falling back again in 2010. Therefore, this paper considers Sainsbury’s gearing to be

stable with no corrective action being required at the present time. More recent increases in gearing

can be associated with the financing of new revenue generating assets such as new stores and other

relevant PPE. As such, once these assets reach their full operational capacity, gearing will naturally

full back towards 30% as time progresses. (Sainsbury, 2012)

ROCE (Stable)

(Sainsbury, 2012)

Between 2008 and 2010, Sainsbury’s return on capital employed increased steadily until

levelling out at 11% in 2010 and rising to 11.1% the following year. This stability is attractive to long-

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

2008 2009 2010 2011 2012

Gearing

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

2008 2009 2010 2011 2012

Pre-Tax Return on Capital Employed

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term investors who look to base their returns on high dividend yields rather than through increasing

capital value. In addition, ROCE has remained stable whilst liabilities and equity have increased. This

shows that this additional finance has been appropriately invested in revenue generating assets as

to maintain this stable return. (Sainsbury, 2012)

Cash and Cash Equivalents (Negative)

(Sainsbury, 2012)

Sainsbury’s cash level has remained relatively stable over the last 5 years ranging from

£837m in 2010 to £501m in 2011. Cash more recently stood at £739m in the financial year 2012.

(Sainsbury, 2012) Furthermore, between 2008 and 2010, cash remained at an average rate of 13% of

liabilities. (Sainsbury, 2010) However, in 2011, this proportion fell to 8.4%; such falls would be

unsustainable in the long-term and could potentially increase Sainsbury’s business risk. (Sainsbury,

2011) This is due to cash acting as a safety barrier if and when trading activity declines. Therefore,

Sainsbury must ensure it retains adequate cash reserves to mitigate this business risk associated

with corporate growth, especially when expanding into the area of banking. Furthermore, cash is

required to fund investment in new ventures and helps provide companies with new long-term

growth opportunities. (Watson & Head, 2010)

0

200

400

600

800

1000

2008 2009 2010 2011 2012

Cash and Cash Equivalents

0.00%

5.00%

10.00%

15.00%

2008 2009 2010 2011 2012

Cash and Cash Equivalents

Cash/Assets Cash/Liabilities

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Boston Matrix (Positive)

(Sainsbury, 2012)

As shown in the matrix above, growth in Sainsbury’s in-store sales are likely to remain

stagnant for the foreseeable future. Thus, Sainsbury is now required to look elsewhere in regards to

future growth prospects. Therefore, this in-store retail is now used as a “cash cow” to fund new

ventures such as online retail which could be considered a “Star”. (IR, 2012) More recently,

Sainsbury expanded into banking which could be considered a “Question Mark”, but verging on

becoming a “star”. (Sainsbury, 2012) This broad mix of cash generating business alongside new high

growth ventures will help to ensure Sainsbury’s long-term sustainability and growth. This increased

diversity will also help reduce Sainsbury’s overall business risk. (Watson & Head, 2010)

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Part II Dividend Policy

Cost of Capital (Stable)

(Sainsbury, 2012)

In recent years, Sainsbury’s long-term cost of equity has increased in-line with gearing. In

addition, Sainsbury’s cost of debt increased to 5.2% in 2012, up from 4.64% a year before. Overall,

Sainsbury’s cost of capital stood at 10.8%, up from 10.4% in 2011, but has remained relatively flat

since 2009. This stability is due to the increasing costs of maintaining equity being offset by the

lower cost of debt. (Sainsbury, 2012)

These costs are likely to remain stable for the foreseeable future as long as gearing remains

stable. However, if gearing does start to increase, this will increase the company’s financial and

bankruptcy risk and thus increase its cost of equity. However, if this debt is largely made up of long-

term debt, this will lock in the current interest rate for a greater length of time. This will allow

Sainsbury more time to take corrective action as required. (Watson & Head, 2010)

In-line with Miller and Modigliani’s first theorem, changes in Sainsbury’s cost of equity has

remained in-line with gearing. However, decreases in gearing have resulted in the cost of equity

remaining flat rather than fall. Additionally, Sainsbury’s cost of debt has also fluctuated, lagging a

year behind gearing. This suggests that gearing also has an effect on a company’s cost of debt.

0.00%

5.00%

10.00%

15.00%

20.00%

2008 2009 2010 2011 2012

Cost of Capital

Cost of Debt Cost of Equity WACC

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However, in 2012, Sainsbury’s use of debt did produce a tax shield worth £23.04, thus helping to

mitigate any rise in overall costs of capital. (HMRC, 2012)(Sainsbury, 2012)

(Sainsbury, 2012)

Sainsbury’s interest cover increased significantly in 2010 reaching 8.7 times, up from 5.6

times a year before. However, since then it has gradually declined having fallen to 7.5 times by 2012.

(Sainsbury, 2012)This suggests that Sainsbury’s current business model gradually reduces the

company’s effective interest cover with corrective action thus being required every few years. This

may be of concern during the years in which corrective action is required due to potential

investments being forsaken to carry out such corrective action.

Shareholder Return

(Sainsbury, 2012) (HL 2012)

As shown in the graphs above, Sainsbury’s dividend yield (Short-term cost of equity)

remained at 4.3% between the years 2009 to 2011 and then rose to 5.3% in 2012. (JL, 2012) This is

0.00

2.00

4.00

6.00

8.00

10.00

2008 2009 2010 2011 2012

Interest Cover

0.00%

2.00%

4.00%

6.00%

8.00%

2008 2009 2010 2011 2012

Cost of Capital (Dividend Yield)

Cost of Debt Dividend Yield WACC0.00%

2.00%

4.00%

6.00%

2008 2009 2010 2011 2012

Dividend Yield

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higher than its main competitive rivals Tesco (4.38%) and Morrison (4.1%). In addition, since March

2009, Sainsbury’s share price has fallen by 1.17%, significantly less than Tesco at 13.84% and

Morrison with 3.52%. (FT, 2012a) (FT, 2012b) This description of Sainsbury is similar to that of a

mature company with shareholder returns being in the form of dividends with the value of capital

invested remaining stable.

Relating this to Sainsbury’s cost of equity, the dividend yield reflects the changes in

Sainsbury’s share price as well the rate of dividend. Simply, the dividend yield illustrates the cost of

issuing new equity whilst the overall cost of equity illustrates the cost of maintaining equity.

(FT, 2012c)

This type of dividend policy appeals more to long-term investors such as pension funds. This

is due to their desire for high dividend paying investments with little need to cash out. Therefore,

minor changes in share prices may not be an overwhelming factor in their decision-making process.

However, short-term investors will be turned off by such a policy due to their desire for higher

capital growth over dividend pay-outs. Therefore, Sainsbury must consider which type of

shareholder it wishes to attract which will raise them the most finance at the lowest cost, as well as

the signalling effects this may have. (Watson & Head, 2010)

Relating this to Lintner’s theorem, changes in Sainsbury’s rate of dividend directly reflects its

earnings per share in the sense that it has have remained broadly flat. In addition, any increase in

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dividend is only implemented once increased earnings are secure and are proven to be sustainable.

This is to ensure such changes in dividend do not then have to be reversed at a later date which may

give the wrong impression in relation to the signalling effect. Thus, Sainsbury’s dividend policy is in-

line with Lintner’s theorem and is appropriate for its stage in the corporate life cycle. (Johnson,

Scholes, & Whittington, 2008)

(Sainsbury, 2012)

In relation to Sainsbury’s ability to maintain this dividend, we must consider the dividend

cover. As shown in the graph above, between 2008 and 2011, Sainsbury’s Earnings per share

increased to a greater extent than its dividend payments, thus increasing its overall dividend cover.

However, the dividend cover remained flat in 2012 due to Sainsbury’s higher rate of dividend. This

general trend shows that Sainsbury will be in a position to maintain this dividend for the foreseeable

future with no corrective action being required. (Sainsbury, 2012)

0.00

0.50

1.00

1.50

2.00

2008 2009 2010 2011 2012

Dividend Cover

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Recommendations Overall, Sainsbury’s financial outlook remains stable. However, we do recommend minor

alterations to take place over the next 3 years which will help promote long-term sustainability and

help mitigate Sainsbury’s long-term financial risk. These recommendations are based on the

assumption of economic actively remaining flat for the foreseeable future. Any improvement or

decline in such activity will therefore require a change in short to medium term financial strategy.

Debt Finance

Due to the recent falls in Sainsbury’s cost of debt, we recommend locking in this rate by

replacing short-term debt with longer term debt. This will reduce the volatility in Sainsbury’s cost of

debt and help encourage long-term sustainability. This will reduce Sainsbury’s financial risk and

allow more time to take corrective action if and when these costs start to increase.

Equity Finance

In addition, any increase in the use of equity as a source of finance should be issued in such

a way that doesn’t significantly impede the company’s long-term dividend cover. This means any

increase in in the use of equity should be lower than or equal to Sainsbury’s growth in net profits.

This will help ensure Sainsbury’s rate of dividend and overall costs of equity remain sustainable in

the long-term. Simply, Sainsbury’s current dividend policy should remain in place with any change

being proportionate to long-term sustainable profits.

Cash Reserves

In order to mitigate long-term business risk, Sainsbury should retain cash at a level

proportionate to its liabilities. This is especially the case if Sainsbury is to consider expanding into the

retail banking industry. Therefore, this paper recommends Sainsbury maintain cash levels equal to or

greater than 10% of Sainsbury’s total liabilities. This cash will act as a safety barrier against any

increases in overall business risk.

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Part III Signatories I commend this paper to the University of Hertfordshire to be delivered on or by 18 December 2012.

Jason Cates

___________

Mail: AdrJasonCates@GoogleMail.com

Portfolio: SlideShare.net/AdrJasonCates

LinkedIn: LinkedIn.com/in/AdrJasonCates

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References Financial Times (2012a) Tesco PLC. Available at:

http://markets.ft.com/Research/Markets/Tearsheets/Summary?s=TSCO:LSE [Accessed: 7th

December, 2012]

Financial Times (2012b) WM Morrison Supermarkets PLC. Available at:

http://markets.ft.com/research/markets/Tearsheets/Summary?s=MRW:LSE [Accessed: 7th

December, 2012]

Financial Times (2012c) J Sainsbury PLC. Available at:

http://markets.ft.com/research/Markets/Tearsheets/Summary?s=SBRY:LSE [Accessed: 7th

December, 2012]

Hargreaves Lansdown (2012) Sainsbury (J) plc Company Overview and Comment. Available at:

http://www.hl.co.uk/shares/shares-search-results/s/sainsbury-j-plc-ordinary-

28,47p/research&ei=I7u_UIj1LtC10QWClID4DA&usg=AFQjCNFU4grqJmWscd7RFqf8h_b8jQmwQA

[Accessed: 14th December 2012]

HMRC (2012) Corporation Tax Rates. Available at: http://www.hmrc.gov.uk/rates/corp.htm

[Accessed: 7th December 2012]

Internet Retailing (2012) Sainsbury’s claims number two spot in online grocery market. Available at:

http://internetretailing.net/2012/03/sainsburys-claims-number-two-spot-in-online-grocery-market/

[Accessed: 7th December 2012]

Johnson, G., Scholes, K. & Whittington, R. (2008) Exploring Corporate Strategy. 8th edn.

Harlow:Pearson

Sainsbury (2009) Annual report 2009. [Online] Available at: http://www.j-

sainsbury.co.uk/media/171784/ar2009_report.pdf [Accessed: 23rd November 2012]

Sainsbury (2010) Annual report 2010. [Online] Available at: http://www.j-

sainsbury.co.uk/media/171797/ar2010_report.pd [Accessed: 23rd November 2012]

Sainsbury (2011) Annual report 2011. [Online] Available at: http://www.j-

sainsbury.co.uk/media/171813/ar2011_report.pdf [Accessed: 23rd November 2012]

Sainsbury (2012) Annual report 2012. [Online] Available at: http://www.j-

sainsbury.co.uk/media/649393/j_sainsbury_ara_2012.pdf [Accessed: 23rd November 2012]

Watson, D. & Head, A. (2010) Corporate Finance: Principles and Practice. 5th edn. Harlow:Pearson

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