Financial

 Analysis  for  Management  IB91Z0  

Individual  Assignment  

Section A: Report

The Financial Analysis of Kingfisher’s Decision on the Acquisition of

HRG

Section B: Question 2

Student ID: 1352947

Date/Year of Module: 2013-2014

Submission Deadline: 23rd April 2014

Word Count: 2459

Number of Pages: 16

“This is to certify that the work I am submitting is my own. All external

references and sources are clearly acknowledged and identified within the
contents. I am aware of the University of Warwick regulation concerning
plagiarism and collusion.

No substantial part(s) of the work submitted here has also been submitted by
me in other assessments for accredited courses of study, and I acknowledge
that if this has been done an appropriate reduction in the mark I might
otherwise have received will be made.”
Executive summary
Home Retail Group plc (HRG) is a fast developing firm in the home improvement
industry in European market. Kingfisher who is a world leading company in the same
industry is considering acquiring HRG to further expand their current market power.
It is a comprehensive analysis to find whether this acquisition is worthwhile. From
some aspects of the financial ratios, HRG did not do as well as Kingfisher. For
example, the profitability of HRG measured by ROCE and profit margin is lower than
that of Kingfisher. However, from the view of position and potential, it shows a
strong and healthy financial performance with high PE ration, low dividends,
preferred gearing, etc. Combined with the HRG’s strong current strategies and
synergies from the acquisition, it could definitely increase the efficiency and provide
growth potential for Kingfisher. Therefore, Kingfisher should pursue this acquisition.

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Table of Content

1.0 Introduction…………………………………………………………………....3
2.0 Contexts & Overview………………………………………………………….3
2.1 External environment of the home improvement industry……………..3
2.1.1 Buying power is moderate………………………………………….3
2.1.2 Supplier power is low……………………………………………….3
2.1.3 Threat of new entrants is moderate………………………………..4
2.1.4 Threat of substitutes is low…………………………………………4
2.1.5 Degree of rivalry is strong………………………………………….4
2.2 Internal strategies of HRG…………………………………………………5
2.2.1 Strong market positioning………………………………………….5
2.2.2 Accelerate online channel sales…………………………………….5
3.0 Ratios……………….………………………………………………………......6
3.1 Profitability……………………………………………………………........6
3.2 Position……………………………………………………………...............7
3.3 Potential……………………………………………………………..............8
4.0 Evaluation……………………………………………………………..............9
4.1 Economic of scales………………………………………………………….9
4.2 Diversification reduce risk…………………………………………………10
4.3 Market power…………………………………………………………….....10
5.0 Conclusion……………………………………………………………...............10
Reference…………………………………………………………….......................12
Appendix……………………………………………………………........................13

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1.0 Introduction:
The Europe’s largest home improvement retail company Kingfisher plc is now facing
with a decision whether to acquire HRG, which is the second largest company in
British home improvement industry. In order to give some suggestions to Kingfisher,
this essay will be mainly based on key financial ratios to compare and contrast the
two companies’ recent performance so as to find out whether it is a good decision to
acquire HRG. In the meanwhile, the non-financial factors such as the current
strategies of both companies will also be taken into consideration regarding the
acquisition. This essay will use the CORE model to compare the performance of HRG
and Kingfisher to give Kingfisher some suggestions whether to acquire HRG or not.
CORE is a framework of strategic financial analysis consisting of context, overview,
ratios and evaluation.

2.0 Contexts & Overview

2.1 External environment of the home improvement industry
Porter’s five force of home improvement retail industry in UK indicated the external
business environment (Figure 1).

2.1.1 Buying power is moderate

There are large numbers of individual buyers within home improvement market,
which reduced the buying power. However, the economic recession in UK increased
customers’ price sensitivity, the overall spent on home improvement products
decreased.

2.1.2 Supplier power is low

The supplier power is diminished in two ways in home improvement market. Firstly,
the equipment and materials providers vary in size and types due to the diversification
characteristic of this industry. Secondly, the existence of low switching costs enabled
firms changing from one supplier to another without being punished.

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2.1.3 Threat of new entrants is moderate
The entry barriers is relatively low for this retail industry, the capital requirement is
low that it is not difficult to start up a small-scale firm, which can be specialized on a
narrow market segment. However, the economic of scale achieved by large firms
increased the competitive advantage in price, this gives the new entrants high barriers
to entre.

2.1.4 Threat of substitutes is low

Although there are some professional services as substitution such as builders,
painters and plumbers, it will cost consumers more time and more money than doing
their own home improvement work.

2.1.5 Degree of rivalry is strong

The major market competitors in this industry are similar in nature and the product
they sell. Thus, the competition is relatively strong. There are three major leading
retails in UK home improvement industry. Kingfisher Plc is the largest one with about
860 stores operating in eight countries. The second largest is Home Retail Group,
primarily operates in UK and Ireland, and followed by Tracis Perkins Plc, which
operates 16 businesses from more than 1800 sites across the UK (EBSCO, 2014). In
addition, there are also some small independent retails specializing in some market
segments.

Figure 1

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 Porter’s  >ive  force  of  home  
improvement  retail  industry  in  UK
Buying  power  
5  
4  
3  
2  
rivalry   Supplier  power  
1  
0  

Threat  of  new  

Threat  of  substitutes  
entrants  

(Level of degree 0 is week, 5 is strong)

2.2 Internal strategies of HRG

2.2.1 Strong market positioning
HRG has three business areas namely Argos, Homebase and Financial Service. Argos
is a general merchandise retailer positioned itself as a multi-channel, value-oriented
format and distinguished itself from the supermarket (EBSCO, 2014). Homebase is
one of UK’s largest home improvement retailers who are targeting at the similar
market as Kingfisher offering style-led home improvement products. Furthermore, the
firm has a clear scale advantage, which increased its price competitiveness compared
with its rivalry. From the view of strong market position of HRG, once acquired, it
could not only help Kingfisher achieve a wider economic of scales in the Homebase
sector, but also achieve diversification in Argos and Financial Service.

2.2.2 Accelerate online channel sales

In 2013, Argos announced a transformation of its position from the catalogue-led
business to a digital-led business (EBSCO, 2014). The Internet sales reached 42% of
Argos’s total sales in 2013. Furthermore, Homebase also started to launch Internet
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service and now presented 5% of its total sales (HRG, 2014). The online channel sales
are fast growing with the rapid rise in websites and mobile apps usage. Thus,
accelerating online channel sales can ensure a high growth prospect. Kingfisher’s
current sales channel is largely restricted to the traditional store-related channels, thus
a transformation of sales channel is necessary. The acquisition of HRG can transfer
HRG’s online selling technology and experience to Kingfisher and it may provide
Kingfisher with opportunities of further expanding its market.

3.0 Ratios
To assess the financial conditions and performance of HGR, different financial ratios
can be used. These financial ratios are grouped into three different categories,
profitability, position and potential. The following section will analyze the main
differences between HGR and Kingfishers in those financial ratios, respectively.

3.1 Profitability
Profitability is used to determine how well the business has done. The key indicators
are ROCE, profit margin, gross margin and net assets turnover. ROCE assesses the
ability of a company’s utilization of capital to generate profits (McLaney, 2013). Both
ROCE and profit margin indicates HRG is significantly lower than Kingfisher.
However, the gross margin of HRG (31.63%) is a little lower than Kingfisher
(37.41%), while both of them are great higher than average rate (22.29%) in home
improvement sector (Reuters, 2014). From the profitability gaps between HRG and
Kingfisher, one cannot judge that HRG is performing worse than Kingfisher. Those
gaps can be accepted when knowing the market dimension of both firms. Kingfisher
is a global market leader in the home retail industry whereas HGR’s main market is
merely in UK and EU; it is inevitable that the profit earning ability of HRG is not as
good as Kingfisher. Therefore, from the view of profitability only, it is hard to
estimate whether the acquisition is a good strategy.

Table 1
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 KINGFISHER HRG HRG
Financial ratios Formula
2013 2013 2012
1. Profitability
Return on capital
Profit/(TA-CL) 10.21% 4.45% 3.29%
employed
Profit margin PBIT/Turnover 6.72% 1.72% 1.31%
Gross margin Gross profit/Turnover 37.41% 31.63% 32.04%
Net sales/Average total
Net assets turnover 1.52 1.29 1.39
assets

3.2 Position
Position is used to measure the liquidity of capital. The key indicators are current ratio,
gearing, interest cover, debtor days, inventory days and liquid ratio (McLaney, 2013).
Comparing the current ratio and liquid ratio of the two companies, HRG has a higher
liquidity than Kingfisher, which means HRG can pay liabilities more easily than
Kingfisher. This is a favorable condition for Kingfisher to acquire HRG. In addition,
in terms of gearing, HRG has a relatively lower debt rate. Therefore, the acquisition
of HRG can probably bring leverage benefit to Kingfisher. This will allow the
combined company to have a higher debt-to-capital ratio by making full use of HRG’s
unused debt capacity. In terms of interest cover, the PBIT of both companies exceed
interest expense. However, in terms of inventory days, HRG has a ratio of 91.86 days
in 2013, whereas Kingfisher has only 71.91 days of the same year. Thus, the
acquisition can be considered to improve the efficiency of inventory. From the
perspective of firms’ position, the acquisition is favorable for Kingfisher.

Table 2
Financial KINGFISHER HRG HRG
Formula
ratios 2013 2013 2012
2. Position
Current
Current assets/Current liabilities 1.07 1.73 1.73
ratio
Gearing Debt/(Equity+Debt) 14.75% 11.18% 12.67%
Interest
PBIT/Interest expense 37.37 2.85 2
cover
Debtor Receivables/turnover*365 1.35 42.46 38.9

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 days
Creditor
Trade payables/cost of sales*365 47.29 54.71 45.79
days
Inventory
Inventory*365/cost of sales 71.91 91.86 89.76
days
Liquid （Current Assets-Inventory)/Current
0.34 0.93 0.8
ratio Liabilities

3.3 Potential
Potential are used to predict the future performance of a company, which is measured
by earning per share, price earnings ratio, dividend yield and dividend covers
(McLaney, 2013). PE ratio indicates the market confidence of a company. A firm
with a higher PE ratio shows a potential growth opportunity. HRG has a very high PE
ratio (27.08) that doubled the rate of Kingfisher (13.72) so HRG in inferred to have
good growth prospects. Furthermore, the dividend yield and dividend cover of
Kingfisher are much higher than that of HRG. This indicates Kingfisher returned
more cash to shareholders whereas HRG retained the money to do reinvestment in
business. Myers and Majluf (1984) argue that there are two types of firm likely to be
acquiring targets: one is a high-growth firm, and another is a resource rich firm. HRG
is categorized into the first type. Furthermore, the growth-share matrix (Figure 2)
shows that HRG is similar to Question mark with a high growth potential and low
productivity, whereas Kingfisher is like a cash cow with higher profitability, but a
relative low growth (Grant, 2010). The acquisition of those two can bring them to the
category of Stars with both high productivity and growth potential. Thus, it is easy to
assume the availability of high growth of HRG could bring a prospect future of
Kingfisher after acquisition.
Figure 2

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Table 3
KINGFISHER HRG
Financial ratios Formula
2013 2013
3. Potential
Earnings per share Profit after tax/Number of
0.314 0.0807
(EPS) shares
P/E ratio Share price/Earnings per share 13.72 27.08
Dividend yield Dividend per share/Share Price 2.30% 1.42%
Earnings per share/Dividend
Dividend cover 3.20% 2.70%
per share

4.0 Evaluation
Basically, the acquisition can bring a better future to Kingfisher, through which, it can
achieve economic of scales, reduce risk through diversifying business portfolio and
increase market power. Nevertheless, some potential risks of acquisition such as
cultural resistance, complex organizational structures and lack of transparency also
need to take into consideration.

4.1 Economic of scales

Theoretically, mergers and acquisition can reduce repetition through creating a single
shared distribution network, information system and marketing forces. Besides, from
the intangible resource, brand reputation and technology can also be shared so as to

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reduce the marginal cost for firms involved in the merger process (Grant, 2010). The
acquisition will enable Kingfisher and HRG share the same infrastructure as
mentioned above, which can enhance the cost advantage and increase price
competitiveness among the home improvement industry.

4.2 Diversification reduce risk

Diversification can reduce idiosyncratic risk by investing in different portfolios. In

particular, through diversification, earning volatility can be reduced, profit can be
stabilized and potential value can be increased. Apart from Homebase, Argos and
Financial Service are the other two major businesses in HRG, which are operating
differently from Kingfisher. Argos positioned itself as a multi-channel, value-oriented
format retailer and Financial Service as a complementary service offers credit and
insurance products to customers (HRG, 2014). Hence, when acquiring HRG, the
specific risk of Kingfisher can be diversified away from Argos and Financial Service
sectors.

4.3 Market power

Increasing market power means growing the size of the company relative to other
companies in the same industry. Market size is the crucial factor in a long-term battle
with rivals and it allows a firm to outlast its rivals (Myers and Majluf, 1984). Since
they have already becoming the leading firms in the industry, the combination of
Kingfisher and HRG can definitely extend their market power.

5.0 Conclusion

In conclusion, this essay use CORE model to analyze current financial performance
and position of HRG. At the beginning, it analyzed the context and overview of the
external industrial environment where the Porter’s five force is applied. Furthermore,
the current strategies of HRG show a shift of traditional sales model to the digital and
multi-channel model, which creates new shopping experience to the customers. This

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provides a positive condition for Kingfisher to acquire HRG. When analyzing the
financial ratios, one can infer that the good position and potential of HRG will enable
Kingfisher to grow faster and become more efficient after acquisition. Finally, the
non-financial factors are analyzed in the evaluation part to support that acquisition is a
preferred strategy for Kingfisher’ future performance. Although buying HRG will be
expensive, its health financial ratios with the strong current strategies can provide
Kingfisher with a good potential of future expansion.

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Reference

EBSCO (2014) Kingfisher, PLC SWOT Analysis, pp. 1-7, Business Source Premier,
viewed 14 April 2014.

EBSCO (2014) Home Retail Group Plc SWOT Analysis, pp. 1-7, Business Source
Premier, viewed 12 April 2014.

Grant, R. M. (2010) Contempoary Strategy Analysis. Barelona, Spain: Thomson

Digital.
 
Home Retail Group PLC (2013) Annual Report and Financial Statements 2013.

Home Retail Group (2014): https://www.homeretailgroup.com Accessed on 12 April

2014

Industry Profile, (2013) Home Improvement Retail Industry United kingdom,

Marketline.

Kingfisher (2013) Kingfisher Annual Report and Accounts 2012/13

McLaney, E. J. (2013) Accounting and finance for non-specialists Harlow, England:

Pearson, 8th edition.

Myers, S and Majluf, N (1984) “Corporate Financing and Investment Decisions When
Firms Have Information that Investors do not Have”, Journal of Financial Economics,
13 (1), pp. 187-221.

Reuters Financials Kingfisher PLC

http://www.reuters.com/finance/stocks/financialHighlights?symbol=KGF.L Accessed
on 12 April 2014

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Appendix 1

KINGFISHER HRG HRG

Financial ratios Formula
2013 2013 2012
1. Profitability
Return on capital
Profit/(TA-CL) 10.21% 4.45% 3.29%
employed
Profit margin PBIT/Turnover 6.72% 1.72% 1.31%
Gross margin Gross profit/Turnover 37.41% 31.63% 32.04%
Net assets turnover Net sales/Average total assets 1.52 1.29 1.39
2. Position
Current ratio Current assets/Current liabilities 1.07 1.73 1.73
Gearing Debt/(Equity+Debt) 14.75% 11.18% 12.67%
Interest cover PBIT/Interest expense 37.37 2.85 2
Debtor days Receivables/turnover*365 1.35 42.46 38.9
Creditor days Trade payables/cost of sales*365 47.29 54.71 45.79
Inventory days Inventory*365/cost of sales 71.91 91.86 89.76
（Current
Liquid ratio Assets-Inventory)/Current 0.34 0.93 0.8
Liabilities
3. Potential
Earnings per share
Profit after tax/Number of shares 0.314 0.0807
(EPS)
P/E ratio Share price/Earnings per share 13.72 27.08
Dividend yield Dividend per share/Share Price 2.30% 1.42%
Earnings per share/Dividend per
Dividend cover 3.20% 2.70%
share

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Part B 2
Question A:
Option 1
Initial investment=150,000+20,000=170,000
!,!!!∗! !",!!!∗! !",!!!∗! !",!!!∗! !",!!!∗!
Present value of cash inflow= !!!"% + !!!"% !
+ !!!"% !
+ !!!"% !
+ !!!"% !
+

!",!!!∗!
!!!"% !
=342,604.9

!",!!! !",!!! !",!!!

Present value of running and maintenance costs= !!!"%
+ !!!"% !
+ !!!"% !
+

!",!!! !",!!! !",!!!

!!!"% !
+ !!!"% !
+ !!!"% !
=123,342.2

!",!!!
Cost of capital= !!!"% ! =10,132.6

NPV=-170,000+342,604.9-123,342.2+10,132.6=59,395.3

Option 2
!"#,!!!
Initial investment=60,000+20,000+ !!!"% ! =176,090.3

!,!!!∗! !",!!!∗! !",!!!∗! !",!!!∗! !",!!!∗!

Present value of cash inflow= !!!"% + !!!"% !
+ !!!"% !
+ !!!"% !
+ !!!"% !
+

!",!!!∗!
!!!"% !
=342,604.5

!",!!! !",!!! !",!!!

Present value of running and maintenance costs= !!!"%
+ !!!"% !
+ !!!"% !
+

!",!!! !",!!! !",!!!

!!!"% !
+ !!!"% !
+ !!!"% !
=128,386.7

!",!!!
Cost of capital= !!!"% ! =10,132.6

NPV=-176,090.3+342,604.5-128,386.7+10,132.6=48,260.1
NPV1>NPV2

Question B:
Merits of IRR:
Firstly, IRR method is clear and easy to apply. When the projects with IRR exceed the
cost of capital, then it can be accepted. Managers prefer to use IRR method since it is
easier to compare to the required cost of capital. Secondly, the IRR method takes into

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account the time of value of money, and it helps to recognize the time value to money.
Thirdly, different from NPV, IRR is a rate quantity, an indicator of efficiency of a
project. When there are two or more competing projects, the one with a higher IRR
can be chosen.

Merits of NPV:
Firstly, NPV method allows for easy comparison between investment decisions. It
considers all costs and benefits of each investment opportunity, and help firm
maximizing the firm’s value. Secondly, the discount rate in NPV can be customized
to reflect market factors such as risk. Thirdly, it reflects all potential future incoming
cash flow, which is good for evaluate long-term projects.

Question C:
Good investment appraisal is critical to success. According to the investment
appraisal framework, four factors need to be considered through the evaluation of
investment (PWC). The first factor is strategy, which should dictate the risk premium
and targeted returns so that the whole investment process can follow this requirement.
The second factor is the decision making process, in which the value drives, key
sensitivities, value creation and realization strategies need to be clearly understood
and tracked. The third factor is the post-investment management, which required an
active tracking on value creation and risk recognition. The final factor is the
measurement, by using measures such as NPV, IRR to track the financial returns.

The risk of the project should be included in the decision. As the decision is taken
before the unknown things, the potential risk is inevitable (McLaney, 2013). For
example, the machine may not meet the expected capacity as it has risk of break down,
or the revenue from the products may less than estimated, etc. Furthermore, the cost
of capital in the case study is estimated as 12%. This only includes the systematic risk,
whereas ignored the idiosyncratic risk, which varies from firms. Using the CAMP
model can make the decision more precise when the market risk can be included.
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Reference:

McLaney, E. J. (2013) Accounting and finance for non-specialists Harlow, England:

Pearson, 8th edition.

PWC, Critical success factors: Underpinning the right investment strategy

http://www.pwc.com/gx/en/deals/sovereign-wealth-investment-funds/investment-fra
mework.jhtml accessed on 20 April 2014.

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