Gearing Ratios

One of the main, long term priorities for a business is to grow and expand their
operations, services and projects to become more successful and lucrative. In
order to achieve this, a business must raise finances either through debt
financing (external funds) or equity financing (internal funds). This is referred to
as gearing. Generally, a small business would look towards debt financing to
raise cash as they would either look to take out loans from banks or from a third
party. As for a bigger firm, they may want to raise finances through equity
financing as they have sufficient internal funds. Generally, debts are a safer
option as they are cheap and stable but they carry a risk in that the business has
an obligation to pay and has to offer collateral if the debt is not repaid. Equity
financing is more expensive as shareholders expect a high rate of return for the
level of risk they are undertaking, but is a little less risky as dividends do not
have to be paid. The main indicator is risk as the higher the companies gearing,
the riskier it is considered to be. We will be analysing two ratios: gearing and
interest cover.

The average gearing ratio for Tesco is slightly greater than Sainsburys from
2014 to 2016, as can be seen on the ratio summary. However, both companies
experienced a large increase in 2015, Sainsburys by approximately 4% and Tesco
by 27%, before settling back down again in 2016. This may be the case as
Sainsburys had 305m more non-current liabilities in 2015 than the previous
years whereas Tesco had a 3,290m increase in 2015 compared to 2014. The
reasons for Tescos gearing ratio increasing by a larger amount than Sainsburys
could be due to higher amounts of borrowing. During this time, Tesco may have
struggled to acquire loans from banks as they would have been comprehended
as more risker and more liable to default in repayment than Sainsburys.
Consequently, Tesco may have had to consider equity financing to raise cash
which is more expensive whereas Sainsburys would have been able to attain
long term borrowing easier.

The interest cover ratio is an indicator to measure a companys ability to cover

their interest expenses using operating profit. It ultimately measures the margin
of safety of a business for paying interest in a given period, which a business
needs to survive any unexpected future hardships. From the summary table, we
can deduce that Tesco had a positive interest cover ratio from 2014-15. However,
in 2016, the figure became negative meaning Tesco may have struggled to pay
back unexpected interest expenses with their operating profit. This may
decrease the number of potential investors as having a negative interest cover
ratio can be seen as a flag for impending bankruptcy. However, the interest
cover ratio for Sainsburys was negative from 2015-16 with the figure reaching
-29.46. Compared to Tesco, this may have been interpreted as a warning for the
financial world, from banks to investors as it portrays the inability to repay
interest when required.

Investment Ratio

Investment ratios are calculated to give an indicator on the attractiveness of an

investment in a company. The calculations are based upon price of shares,
dividends and earnings.

We will begin by analysing earnings per share (EPS) of Sainsburys and Tesco.
EPS relates to the portion of a companys profit allocated to each outstanding
share of common stock. It is generally regarded as the single most valuable
variable in determining a shares price. In 2014, both companys had a stable,
positive figure for EPS, with Sainsburys leading Tesco by approximately 14 per
share. However, from 2015, both companys EPS shot down to negative values.
This situation may have arisen as both companies were not efficient in using
their capital to generate income; the stock price of both companies may have
taken a severe hit due to this compared to previous years. As Tescos EPS was
less than Sainsburys, investors would have been less likely to invest as the risk
of making a loss was greater.
Relative to EPS, Price/Earnings (P/E) is a market ratio used to value a company by
valuing the market value per share to EPS. We can see from the summary table
that for Tesco in 2015, the P/E figure was negative before climbing again in 2016.
This may be the case as their EPS value was severely negative which impacted
their market value per share. For Sainsburys, the P/E value was the highest
compared to the years 2014 and 2016.

We will now be discussing the dividend cover and yield ratios for Tesco and
Sainsburys. Dividend cover ratio refers to the company earnings that can be
used to pay shareholders dividends. Dividend yield ratio is used by investors to
compute the cash flow they are receiving from their stocks.

Focusing on dividend yield ratio, the figure for Tesco increased drastically by
4.52% from 2014 to 2015. However, in spite of this, the board decided not to pay
out dividends to shareholders in 2015 which is mentioned in their 2015 annual
report. This decision may have been influenced by the fact that Tesco did not
generate enough profit for that year and felt that it would be better to hold on to
the earnings. On the other hand, the board may have wanted to use the earnings
for future expansions which is valued by long term investors. For Sainsburys, the
dividend yield ratio was consistently average from 2014-2016. From the 2015
annual report, Sainsburys announced a new dividend policy fixing their
dividends by two times cover for the next three years. This may suggest that
Sainsburys are confident that their financial position will improve; this is
particularly appealing to investors as it portrays market confidence.

As for dividend cover ratio, both companies showed consistent figures from
2014-2016, with the Tescos average being slightly higher than Sainsburys. This
indicates that both companies were able to utilize their earnings to cover
dividend payments. Again, this is a positive indicator for potential investors as it
suggests that dividends would be paid on schedule.