With UK multiples currently achieving ROCE levels of approximately 10.5% to 13%, it might be felt that this level of performance was simply a reflection of extraordinary business pressures arising from the global financial crisis, apparently affecting all four multiples ‘equally’…
However, this would be acceptable were it not for the fact that Walmart, the elephant in the global room, were not achieving an ROCE of 19.2%, and have been doing so every year since they opened their first store in 1961.
During the current financial crisis, bankers have in theory set new standards in business returns because of the low levels of interest they give on deposits whilst charging high levels of interest on loans to those businesses too big to refuse…
In effect, the banks are providing a classic illustration of a process of privatising gains and socialising losses, in other words any profits are credited to the banks whilst losses are shared with the taxpayer. Whilst the savvy consumer will eventually vote with their feet on this issue, NAMs will probably be more concerned with optimising the profitability of the supplier-retailer relationship in the current environment.
Essentially, ROCE drives a company’s share price, and investors use current rates of interest as a reference point. However, the current low levels of interest are commercially ‘artificial’ in that these rates will eventually revert to ‘normal’ as more pressure is put on the banking business model. Meanwhile, the current ROCE levels of UK multiples will continue to be ‘tolerated’ by investors until such time as the Walmart differential becomes impossible to ignore. At that point the investors will sell the shares of UK multiples, driving the price down, thereby making it more expensive for them to borrow money and acquire other retailers, whilst suppliers will demand earlier payment and will be more selective in their choice of ‘invest’ trade partners.
Meanwhile, the ‘coincidence’ of changes of senior management and corporate structures in each of the multiples provides an ideal opportunity for the CEOs to make a difference by adopting strategies of achieving ROCE levels comparable with Walmart globally.
In practice this means reducing working capital by taking longer to pay, and increasing rotation of capital i.e. stock. However, at 40-45 days, credit periods are stretched to the limit politically, making it virtually impossible to take the 30+ extra days that would make an impact on the bottom line. Incidentally, some retailers are negotiating extra credit from suppliers by offering access to preferential bank borrowing against their invoices. This is essentially invoice-factoring, meaning that the face value of the invoice is discounted by an amount that covers the banks’ cost. However, financially astute NAMs are capable of evaluating this ‘concession’ in negotiation…(see KamBlog)
The other obvious routes to improved ROCE are via reductions in cost prices and the raising of selling prices. However, as all multiples are operating to approximate gross margins of 25% (buying at 75 and selling at 100) and suppliers are operating at the limits of cost-cutting moves, any additional cost-price pressure from retailers would jeopardise availability, whilst raising shelf prices in tandem would obviously be in breach of competition legislation. This leaves two routes to improved ROCE available to retailers: internal cost-cutting and better asset utilisation (space-management).
With Sainsbury’s and Asda producing net margins (3%) before tax of approximately half that of Tesco and Morrisons there has to be increasing pressure to cut costs significantly to avoid takeover in the case of Sainsbury’s, and a sell-off/buyout in the case of Asda. In practice, in these circumstances, Qatari could complete their acquisition of Sainsbury’s for approximately £5.5bn, and Walmart would acknowledge the virtual impossibility of scaling up Asda in the face of a combination of UK planning and competition legislation. Their probable exit route would be via a (China/Russia) sovereign wealth funded buyout, releasing capital for Walmart development in India/China.
Meanwhile, Tesco and Morrisons, having reached their Net Profit limits, need to focus upon increasing their asset utilisation, especially in the case of new stores and development land. This means optimising store traffic by a combination of tailored ranges and improved space productivity.
Thus all four multiples now have individual needs that are related and overlapping in terms of their responsiveness to tailored proposals from their suppliers. However, such proposals will have more impact if they are directly linked to each retailer’s real financial agenda, the return to normal levels of ROCE, fast…
