Investment Analysis Report free essay sample

This implies that higher amount cash was tied up in operations in 2011. SECTION B I. Introduction This report analyses Majestic Wine plc as a potential investment in the proposed Stable Growth Fund. Majestic Wine is the largest retailer of wines in the UK with 166 stores and has 3 stores in France also. The company sells wines and spirits to both retail and business customers and business customers now account for about a quarter of total sales. It also has an online presence to generate sales. The company is listed on the AIM and had a market capitalisation of ? 264 million on 19th October 2011. II. Historical operating performance Majestic’s revenues increased in all of the last 4 years. The growth was aided by acquisition of a small business in France in early 2009. The increase in sales in the last two years is impressive and is partly due to opening of new stores. It also reflects company’s culture in training its retail staff to high standards so that they can provide knowledgeable and better service to individual customers. The profit margins of the business were stable in the last 5 years with an exception of 2009 when the company took a significant write-down on the value of its assets in France. The pre-tax profit and net profit margins were 7. 9% and 5. 5% respectively in the year ended March 2011. The near constant profit margins on increasing sales resulted in stable growth in earnings. The business was highly cash generative with net cash from operations of ? 17 million in 2011. This was achieved in spite of cash conversion cycle of 25 days. The high inventory days were compensated by lower debtor days as the retail customers pay immediately at the point of sales. III. Financial health The financial health of Majestic is very strong because of very low gearing. The total debt at 28th March 2011 was ? 5. 77 million ? 0. 87 million current debt and ? 4. 90 million long-term debt (Majestic annual report 2011, 2011, p. 29). This resulted in a debt-to-equity ratio of 8. 9% only, which is extremely low for a business with high proportion of tangible assets. The very low gearing also resulted in a very high interest cover ratio of 49 (? 20. 67 million / ? 0. 42 million). This shows that the company can easily meet its interest payments from operating profits. The current ratio was also marginally more than 1 in 2011 and hence bankruptcy concerns are extremely low. The reason for low gearing is that the business generates high amount of cash to invest in growth. In both 2010 and 2011, the net cash from operations was significantly higher than the cash used in investing and financing activities. IV. Opportunities and threats The company believes that it can increase its growth by doubling the number of stores in the UK after reduction in regulatory minimum purchases. Even if the number of stores is increased by 25%, this will significantly increase the number of customers. With only a very limited presence in France, international growth opportunities are also strong. However, fluctuations in foreign exchange rates may hamper growth and profits. Also, increased competition from superstores may limit the growth of the company along with worsening economic conditions. V. Share price performance Majestic’s share price increased every year in the last three years with a total gain of 198% in the period. It outperformed the overall market as the FTSE 100 Index increased by only 34% during the corresponding period. This demonstrates investors’ expectations of continued increase in profits as seen during the last five years. The company plans to double the number of stores because of reduction in minimum purchase requirements from 12 to 6 bottles (Preliminary results, 2011). The higher expectations are also reflected in company’s high P/E ratio. The high and predictive cash generative nature of the business also positively influences its share price, as investors prefer stable and growing businesses. However, the relatively high P/E ratio and sharp increase in share price over the last three years may limit future increases in the market value. VI. Valuation The net asset value and net tangible asset value per share are close to ? 1, which is almost one-quarter of the share price. However, the net asset prices do not reflect the value of company’s brand and its ability to generate high cash flows in the future. Analysts estimate earnings per share of 26 pence in March 2012, which indicates a forward P/E of 16, a reasonable ratio for a growing company. The dividend discount valuation method indicates that market price is at a 10% discount to the theoretical value. However, the rate of return based on CAPM was lower than the assumed constant growth in dividends. An average of CAPM rate and rate calculated using 2010/11 net profits and equity was used for calculating the price. The above valuations indicate that the market reasonably values the company. However, the share price may benefit as and when the company decides to move to the main exchange, as it will bring in more investors. The market valuation may also increase because the strong financial health and high cash generative nature of the business imply that the management has a scope to increase dividends or offer one-off high cash payment to shareholders. This will have a positive impact on the market value. VII. Conclusion