Financial Analysis Performance Task

Financial Analysis

Reitmans

Alimentation Couche-Tard

Sales

COGS

Gross Profit

Depreciation + Exp

Operating Profit

Investment Income

Interest

EBIT

Tax Exp

Net Income

Cash

AR

Inventory

Prepaid Exp

Current Assets

Investments

Capital Assets

Goodwill

Future Income Tax

LTA

Total Assets

Taxes payable

Current LT Debt

Current Liabilities

LT Debt

Other LT Liabilities

Total Liabilities

Equity

L + E

Reitmans was able to improve its profitability in 2005, compared with 2004. The company's gross profit improved to 13.55% from 9.99%; its operating profit improved to 9.7% from 5.98%; and its net profit improved to 7.33% from 4.7%. This shows that the improvement in the company's profitability is largely attributable to the improvement in the top line, with the cost of goods sold being a lower percentage of revenues in 2005 than 2004. Whether this is a function of driving down costs with suppliers or increasing prices to consumers cannot be ascertained from the financial statements, but from the comments in the annual report. Reitmans achieved superior gross margins in a couple of ways. The most important was advanced purchases of U.S. dollar inventories when the Canadian dollar was at a high value, lowering the cost of the goods in C$ terms. The company also cited "effective cost containment at both the store and overhead levels and the significant efficiency improvements in the operation of our supply chain activities" (p.12, 2005 Annual Report). For its part, Couche-Tard saw its profit only improve marginally, from 1.54% to 1.84%. The gross and operating profits saw very little change over the course of the two years.

3-4.

Reitmans

Couche-Tard

2005

2004

2010

2009

Current Ratio

1.70631

1.909195

1.167743

1.070342

Debt-Equity

0.408824

0.699933

1.289971

1.45543

Gross Margin

13.55%

9.99%

15.53%

15.44%

Net Margin

7.33%

4.70%

1.84%

1.54%

Equity-Asset

70.98%

58.83%

43.67%

40.73%

From this analysis, both firms have improved the debt-equity and asset-equity ratios. However, the improvement for Reitmans is significantly better than the improved for Couche-Tard. Reitmans paid down a substantial amount of its debt over the course of the year, and this allowed it to reduce its debt-equity ratio from 70% to 41%. Couche-Tard's debt-equity ratio is lower than it was at 1.28 compared with 1.45, but is still much higher than Reitmans. Couche-Tard did not add any new long-term debt, but it did not pay any down, so its improvement was not as great.

5. In the long run, Reitmans would make the better investment. There are two reasons for this recommendation. The first is that the company has improved its financial ratios significantly. By paying down so much of its long-term debt, Reitmans has set the stage for a dramatic improvement in its equity market value in the coming years. With less of the company's profits going towards debt service, more of those profits are going to retained earnings. For the equity investor, this can only be viewed as a good thing. The other reason is that the company is continuing to grow. Reitmans is consistently adding stores, and new concepts to its lineup. This is allowing the company to grow its operations steadily over the years, despite being in a relatively mature market. That they are able to do this will simultaneously paying down their debt is impressive from a financial management standpoint. In comparison, Couche-Tard is also growing, but has not taken the step aggressive approach to paying down its debt. It has a much higher level of indebtedness to begin with, and for the equity investor this high level of debt is perhaps less enticing when compared with Reitmans.

In the short run, the company may not be a good investment. One of the things that you look for in a good investment is for companies to be underpriced. There is no indication that this is the case. However, it can be inferred that Reitmans probably has a stable market value because the company's finances are so stable. With no dramatic changes in the company's finances, it is unlikely that it would be significantly undervalued. The changes to the company's financial health in the short run are unlikely to be large. The annual report indicates that the same pattern of slow but steady growth is expected to continue for the foreseeable future. Thus, the financial ratios for each are expected to be roughly the same in the coming years as they are now, but with slightly larger numbers as the company continues to grow.

In the short-run it is also worth consideration that the company's liquidity position has deteriorated. Under normal circumstances, as investor would not want to see this happening, and would instead be wary of investing in a company that is losing liquidity. But there are two things worth keeping in mind here. The company's liquidity is still strong, just not as strong as in the past. The second thing worth keeping in mind is that Reitmans has improved its long-term solvency. Under normal circumstances, a decline in short-term liquidity is acceptable if long-term solvency is being improved. As that is the case with Reitmans, the short-term liquidity drop is something to be taken lightly.

However, it is still best to examine the cause of the change in liquidity. The current assets have changed very little -- most are at virtually the same level as they were in 2004. In the current liabilities column, Reitmans has seen a couple of notable increases. Income taxes payable has increased, but this is probably good news in that it reflects a more profitable firm. The increase in accounts payable, however, is something that should be taken with some caution. There is no discernable reason why this should have increased so much, unless the company decided to stretch payables in order to free up cash to pay down long-term debt. Again, while the change is not significant, it is something do keep at eye on lest it become significant in the future.