Fundamental Analysis of Woolworths and Wesfarmers in the Retail Industry of Australia

This report provides a fundamental analysis of Woolworths and Wesfarmers in the retail industry of Australia. It includes a top-down approach to evaluate the performance of the retail sector of Australia and a bottom-up approach to evaluate the financial performance of the two companies. The report includes ratio analysis, solvency analysis, and suggestions for investment decisions.

1
Principles of Financial Management

2
Executive Summary
The major objective behind the development of this report is to carry out a fundamental
analysis for the two publicly listed ASX companies. The companies selected for the evaluation
purpose are Woolworths and Wesfarmers operating within the retail industry of Australia. It has
been identified from the top-down analysis that Australia is presently having a favorable
environment to support the growth of retail companies. As such, they are expected to have a
positive state of growth and development supported by reduced unemployment, open trade
policies, positive GDP growth and lower level of inflation. In addition to this, the bottom-up
analysis has depicted that Woolworths and Wesfarmers are both having a strong financial
performance in the current that is expected to continue in the future.

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Contents
Executive Summary.........................................................................................................................2
Introduction......................................................................................................................................4
Top-down Approach to evaluate the performance of retail sector of Australia..............................4
Application of Bottom Up Approach to evaluate the performance of Wesfarmers and Woolworth
Companies.......................................................................................................................................7
Conclusion and Suggestions..........................................................................................................13
References......................................................................................................................................14

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Introduction
The investors are largely adopting the use of technique of fundamental analysis for
business valuation for taking significant investment decisions. This approach of value evaluation
of businesses integrated the use of top-down and bottom-up analysis that guides the investors to
estimate the likely changes that can occur within a company value in the future context. The
analysis will provide assistance to the investors to take accurate decisions regarding investment
within the companies. This report has evaluated the future economic and financial performances
of the two companies with the use of fundamental analysis technique, that are, Wesfarmers and
Woolworth. The selected companies are listed on the ASX and are recognized to be leaders
within the retail industry of Australia and thus face stiff competition from each other.
Top-down Approach to evaluate the performance of retail sector of Australia
This approach in the fundamental analysis consist of primarily examining the macro
economic factors for gaining a review of the market conditions as a whole to identify the
feasibility of macro-economic environment to support the growth of a specific industrial sector.
The macro-economic factors that are evaluated for conducting top-down analysis of selected
companies are stated as follows:
Rate of Interest & Inflation
Reserve Bank of Australia (RBA) determines the interest rate within the country through
the use of its monetary policy. There is a low interest rate of 1.5 per cent maintained at present
within Australia to achieve the economic growth objectives. The reduce growth realized in the
private sector and the inflation pressure within the country can be regarded as the major reason
behind this move of RBA. The inflation rate is maintained at 2.1% with slow growth realized in
the wages sector and higher uncertainty existing in relation to the U.S. international trade policy.
RBA is adopting the use of lowering the interest rate as a medium to restrict the increase in
inflation within the country for promoting the economic growth. This is because a control on the
level of inflation would helps in controlling the economic growth due to low recession, reduces
unemployment and increased spending power of consumers (Interest Rate in Australia, 2018).

5
The improvement in the growth rate of wage presents an opportunity to trigger the
inflation rate within the country. As such, the bank can tighten its monetary policy and
consequently can hike the interest rate by the end of the present year. This is because the rise
inflation would promote a hike in interest rate to promote fewer consumers spending and
reducing the borrowing power of companies resulting in reduced growth of economy and thus
the level of inflation. The interest rate within the country over the past few years is depicted as
follows:
(Source: https://www.news.com.au/finance/economy/interest-rates/the-interest-rate-warning-
sign-were-ignoring/news-story/1d861d2b262930557d1fa5354696c715)
Value of Australian Dollar
The value of Australian dollar is moving downwards over past few years and is presently
recorded at $0.74 due to RBA policy to keep the value of dollar low to maintain a low growth in
the interest rate. The central bank of the country has emphasized to maintain a low value of
Australian dollar in order to promote the trade and investment policies. This will promote the
export of mining products from the country as the foreign countries will be attracted to buy the
exports from Australia due to lower exchange rate. The products priced at Australian dollar will
be relatively cheaper for the foreign countries to buy and thus promoting the export of products
(Becker, 2018).
However, despite of the decreasing trend of the Australian dollar, the RBA has placed
emphasis on maintaining its value lower in the future years also. This is done to promote the

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growth of a slowing economy of Australia. The weakened value of Australian dollar will help in
reducing the unemployment rate within the country and promoting the economic stability. Also,
it is providing boost to the Australian economy by promoting the export of natural commodities
such as iron and coal to the foreign countries. This is providing to be a major source of revenue
realization for Australia after the occurrence of mining boom. Thus, all these factors have caused
a weakened Australian dollar that might continue this trend in the future to boost the slower
economic growth within the country (Mulligan, 2015).
(Source: https://www.macrobusiness.com.au/2018/07/australian-dollar-become-weakling/)
GDP Growth Rate
The Gross Domestic Product (GDP) of the county has recorded an increase of about 3.4
per cent in the present year as compared with that of the previous year. The GDP of Australia is
regarded to have an value of about A$1.69 trillion as of the end of the year 2017 and it is
regarded to be one of the wealthiest nation in terms of wealth per adult. It is presently regarded
as a healthy economy on account of having a balance rate of inflation and unemployment that is
surging its economic growth causing rises in its GDP growth rate. This indicates that the
Australian economy is growing at a higher pace supporting by high consumer spending and
mining boom. The country is having a fastest annual growth rate of since the year 2012 after the
occurrence of mining boom. In addition to this, the household sector with an increase in the

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wages growth can be regarded as the major contributor of the growth rate realized within the
GDP of the country. The strong labor market with improving arte of employment within the
country is further supporting the rise of GDP (Australia Real GDP Growth, 2018).
Business Cycle
Australia in the recent years has particularly undergone the major economic changes that
have promoted the growth and development of its industrial sector. The lower rate of interest to
keep the inflation low and weakening value of Australian dollar is all the policies adopted by the
central bank to promote growth within the Australian economy. The country is presently
regarded to have a growing economy in which economic growth is rising steadily as per the
growing value of industrial production particularly from the mining and services sector (Reasons
why we should expect a lower Australian dollar, 2013).
Impact of the Macro-economic factors on Selected Companies
It can be stated from the overall analysis of the macro-economic environment of
Australia that the increasing GDP and weakened Australian dollar presents a state of positive
growth for the retail sector. This is because the increasing GDP will help in maintaining a low
level of inflation promoting the consumers to spend more on buying retail goods and services. In
addition o this, the weakens Australian dollar will promote export of retail goods from the
country to foreigners as they have to pay less money for buying the products from Australia due
to lower exchange rate. This will promote the growth of the retail products in the foreign
countries thus promoting their production and revenue realization. In addition to this, the growth
of retail sales in the recent years due to growing savings rate of households also presents a
positive sign for the growth to be realized within the retail industry of (Australia Productivity
Commission Inquiry Report, 2011).
Application of Bottom Up Approach to evaluate the performance of Wesfarmers and
Woolworth Companies
Bottom up analysis is the part of the fundamental analysis and it aims to analyze the
financial performance of individual stocks to provide opinion on whole industry. The purpose of
bottom up analysis is to provide the detailed investigation of financial performance and market

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position of individual stocks that falls in same industry (Higgins, 2012). In this report, financial
performance of Wesfarmers and Woolworth that belongs to the retail industry of Australia has
been examined. In order to measure the financial performance of the selected companies and
compare them with each other or with the industry averages it has been decided to perform the
ratio analysis for last two years for both the companies.
Ratio analysis
The accounting tool or method used to analyze the financial performance through
calculation various accounting ratios is referred as ratio analysis. Ratio analysis can be
performed through analysis the profitability performance, solvency position and market position
of both the companies.
Evaluation of performance of selected companies through use of profitability ratios
Profitability measurement is very important part of ratio analysis as it helps to find out
the strength of company to convert or use the resource available with them to earn the maximum
revenue. The profitability analysis aims to measure the performance of management through
evaluating their ability to convert the resources into revenue. In this section the most important
profitability ratios used to evaluate the performance of both retail companies are net profit ratio,
and return on equity.
Profitability Ratios Wesfarmers Woolworth
2017 year 2016 year 2017 year 2016 year
Net Profit Ratio 4.20% 0.62% 2.86% -4.38%
Return on Equity 12.00% 1.77% 16.13% -26.74%
(Source of financial data can be found in appendix section)
Net income/profit Ratio: Net profit is an important ratio from the investor’s point of view and it
also helps in evaluating the management performance to provide the maximum profits to their
investors. This ratio measures the ability of company to utilize the resources in such manner that
results in maximum profits.
Formula: Net profit/Sales revenue or net sales (Robinson, 2015)

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2017 2016
-5.00%
-4.00%
-3.00%
-2.00%
-1.00%
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
Net Profit Ratio
Percentage
The above bar graph represents the net profitability of Wesfarmers and Woolworth in last
two years (2016 and 2017). The graph clearly shows poor performance in year 2016 with some
improvement in year 2017. In year 2016, Woolworth has suffered net loss of 4.38% in year 2016
and in year 2017 it increase to 2.86%. It indicates that Woolworth profitability position has
improved but it is not enough to cross the profitability position of Wesfarmers in respective year.
It can be said that either company has very good profitability position net profit percentage of
both companies was not satisfactory.
Ratio that measure percentage earned on shareholder’s equity (Return on Equity): This is
the most significant and widely used performance ratio as it indicates the management efficiency
to make use of equity capital in such a way that it derives maximum profit to the investors. This
ratio provides how management has applied the equity capital to earn the maximum revenue.
Formula to calculate the return on equity: Net income available to shareholder’s / Total equity
shareholder capital (Damodaran, 2016)

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2017 2016
-30.00%
-25.00%
-20.00%
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
Return on Equity
Percentage
As this ratio is crucial for investment point of view, it is important to give emphasis on it.
On looking at the above table it has been found that in year 2016, return on equity of the
Wesfarmers was good as compared to Woolworth but in year 2017, there has been significant
increase in return on equity ratio of Woolworth that makes it greater than return on equity ratio
of Wesfarmers.
Overall profitability performance of Wesfarmers was satisfactory in both the years with
some growth seen in year 2017. On the basis of review of performance of retail companies in
Australia it can be said that overall profitability of this sector was poor in year 2016 due to less
consumer spending power.
Solvency Analysis
It is also refers as the debt analysis as shows the leverage position of company at the end
of particular period. The ratios calculated under solvency analysis helps to evaluate the strength
of the company to pay the long term debts as and when they get due. Some of important
solvency ratio calculated to analyze the leverage position of both the company is debt to equity
ratio and interest coverage ratio.
Solvency Ratios
Wesfarmers Woolworth
2017 year 2016 year 2017 year 2016 year

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Debt to Equity ratio 67.56% 77.71% 132.03% 167.62%
Interest Coverage ratio 16.67 4.37 12.01 6.09
(Source of financial data can be found in appendix section)
Debt/Equity ratio: This ratio shows the relative proportion of company’s debt and equity that
has been used by the management to make available for the assets. This is the reason why this
ratio is also known as financial leverage.
Formula: Total debt divided total shareholders’ equity (Krantz, 2016)
2017 2016
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
120.00%
140.00%
160.00%
180.00%
67.56% 77.71%
132.03%
167.62%
Debt to Equity Ratio
Percentage
The debt to equity ratio of Woolworth was 167.62% in year 20116 and it has been
reduced to 132.03% in year 2017 that indicates company has paid some of their debt and
increase the amount of equity through issue of new shares. On the Wesfarmers has debt to equity
ratio of 77.71% in year 2016 that was decreased to 67.56% in year 2017 reflecting improvement
in the leverage position of company.
Interest Coverage Ratio: This ratio measures the ability of company to meet the interest
payments that arises on debt capital. Company uses earnings to pay the interest expenses and it
must sufficient enough to cover all the debt expenses with significant left for the equity
shareholders.
Formula: Earnings earned before interest and tax/Interest expenses (Hooke, 2010)

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2017 2016
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
Interest Coverage Ratio
Times
The above graph clearly indicates that both companies earn significant portion of
earnings before tax and interest to pay the interest liabilities. There was significant increase in
this ratio in case of both the companies that shows that there was some improvement in leverage
condition.
The overall solvency position was improved in year 2017 as compared to previous year
as there was decrease in debt capital with apparent increase in equity capital and also interest
liabilities have been lowered to some level.
Current Market position of Wesfarmers and Woolworth (Comparison with industry)
Market Performance
Companies EPS P/E Ratio P/E Growth Dividend Yield Mkt. Cap.
Wesfarmers 1.02 18.6 10.01% 4.51% $ 56,034 M
Woolworth 1.15 22.4 4.61% 3.35% $ 36,418 M
Retail Industry 1.02 16.00 4.61%
(Source: Investsmart: Wesfarmers, 2018 and Investsmart: Woolworth, 2018)
Earnings per share (EPS): EPS calculates per share earnings earned by the company on per
dollar invested in each share. This ratio is very important form investor’s point of view as this
ratio provide information on holding period return that one received if they invest in this

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company for a particular period. Both companies have very good EPS in current year and it was
equal or greater than industry average.
Price Earnings Ratio: This market ratio calculates times the share price of the company in
comparison to its EPS. Every company demand higher P/E ratio in order to increase their market
value. Woolworth has highest P/E ratio as compared to Wesfarmers.
Conclusion and Suggestions
The macro-economic environment analysis of Australia has depicted a positive growth
environment for the retail industry as inferred through the use of technique of top-down. The low
rate of inflation supported by weakening Australian dollar and positive growth rate of GDP are
the driving forces to support the growth of retail sales within the country in future context. The
bottom-up analysis has also supported the findings of top-down valuation approach as it ahs
depicted the improvisation in the financial outcomes of the selected companies during the
financial period 2016-2017. As such, the investors are recommended to wait and analyze the
future financial performance of the companies before taking investment decision. This is further
supported by the findings of top-down analysis as per which low interest rate and positive GDP
growth will support the spending power of consumers. This will help in promoting the sales of
retail products and services and such the financial performance is expected to improve in the
coming period of time.

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References
Annual Report: Wesfarmers. 2017. [Online]. Available at:
https://www.wesfarmers.com.au/docs/default-source/default-document-library/2017-annual-
report.pdf?sfvrsn=0 [Accessed on: 27 September, 2018].
Annual Report: Woolworth. 2017. [Online]. Available at:
https://www.woolworthsgroup.com.au/icms_docs/188795_annual-report-2017.pdf [Accessed on:
27 September, 2018].
Australia Real GDP Growth. 2018. [Online]. Available at:
https://www.ceicdata.com/en/indicator/australia/real-gdp-growth [Accessed on: 27 September
2018].
Becker, C. 2018. Why the Australian dollar has become a weakling. [Online]. Available at:
https://www.macrobusiness.com.au/2018/07/australian-dollar-become-weakling/ [Accessed on:
27 September 2018].
Damodaran, A. 2016. Damodaran on Valuation: Security Analysis for Investment and Corporate
Finance. John Wiley & Sons.
Hooke, J. 2010. Security Analysis and Business Valuation on Wall Street: A Comprehensive
Guide to Today's Valuation Methods. John Wiley & Sons.
Hutchens, G. 2018. Australia's GDP growth jumps to 3.1% on back of mining exports. [Online].
Available at: https://www.theguardian.com/business/2018/jun/06/australias-gdp-growth-jumps-
to-31-on-back-of-mining-exports [Accessed on: 27 September 2018].
Interest Rate in Australia. 2018. [Online]. Available at:
https://www.focus-economics.com/country-indicator/australia/interest-rate [Accessed on: 27
September 2018].
Investsmart: Wesfarmers. 2018. [Online]. Available at:
https://www.investsmart.com.au/shares/asx-wes/wesfarmers-limited [Accessed on: 27
September, 2018].

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Investsmart: Woolworth. 2018. [Online]. Available at:
https://www.investsmart.com.au/shares/asx-wow/woolworths-group-limited [Accessed on: 27
September, 2018].
Krantz, M. 2016. Fundamental Analysis for Dummies. John Wiley & Sons.
Mulligan, M. 2015. Australian dollar explainer: why is it falling? [Online]. Available at:
https://www.smh.com.au/business/markets/australian-dollar-explainer-why-is-it-falling-
20150708-gi7ida.html [Accessed on: 27 September 2018].
Productivity Commission Inquiry Report. 2011. Economic Structure and Performance of the
Australian Retail Industry. [Online]. Available at:
https://www.pc.gov.au/inquiries/completed/retail-industry/report/retail-industry.pdf [Accessed
on: 27 September 2018].
Reasons why we should expect a lower Australian dollar. 2013. [Online]. Available at:
https://theconversation.com/reasons-why-we-should-expect-a-lower-australian-dollar-15386
[Accessed on: 27 September 2018].
Robinson, R. 2015. International Financial Statement Analysis. John Wiley & Sons.

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Appendix
Financial data Wesfarmers Woolworth
2017 2016 2017 2016
Amount in $ million
Net Profit
$
2,873.00
$
407.00
$
1,593.40
$
(2,347.90)
Net revenue
$
68,444.00
$
65,981.00
$
55,668.60
$
53,663.70
Shareholder Equity
$
23,941.00
$
22,949.00
$
9,876.10
$
8,781.90
EBIT
$
4,402.00
$
1,346.00
$
2,326.00
$
1,494.90
Interest Expenses
$
264.00
$
308.00
$
193.60
$
245.60
Total Debt
$
16,174.00
$
17,834.00
$
13,039.70
$
14,720.30
(Source: Annual Reports of each company)