Fundamental Analysis Hennes & Mauritz Limite

Executive Summary

H & M Hennes & Mauritz AB is a public limited company headquartered in Stockholm Sweden. The Company business model involves the design, production and retail of apparel and shoes for all ages. The company’s revenues have registered increases in the last few years in a majority of the regions it operates. It is therefore necessary to analyse its profitability from a fundamental point of view to ascertain whether it is really in a good financial position and also to identify the strategic activities performed by its managements and their likely impact on the company’s profitability. Although the merit of the analysis is limited by the assumptions of ratio analysis and the comparability of the financial statements the company’s profitability can be said to be strong but declining. The management has adopted many ambitious programs to improve the company’s profitability. The strategic analysis of the company and its environment shows that there are more opportunities than threats and the future prospects of the company looks good.

Table of Contents

Introduction. 1

Sales performance. 2

Sales Including VAT. 2

Sales Excluding VAT. 2

Profitability. 3

Operating Profit 3

Operating Margin. 4

Profit after Financial Costs. 4

Profit after Tax. 5

Return on Capital Employed. 6

Cost control 6

Operating and Net Profit Growths. 6

Depreciation. 7

Gearing. 8

Stock Market Analysis. 9

Return on Equity. 9

Key strategic issue. 9

Future prospects. 11

Conclusion. 12

References. 13

Introduction

H & M Hennes & Mauritz AB is a public limited company headquartered in Stockholm Sweden. The Company business model involves the design, production and retail of apparel and shoes for all ages. The company has also invested in the production of its own branded cosmetics. The company produces its products through contracted manufacturers a majority of which are in Asia. It does not own any production facility. The company currently has operations in nearly 40 countries in the world but a significant part of its operations are in Western Europe. It operates its own outlets in all the countries it has a presence through fully owned subsidiaries. For its customers in Europe the company has provided them with additional shopping channels through the internet and delivery systems. The company’s revenues have registered increases in the last few years in a majority of the regions it operates. The company also registered increases in its profitability over the same period. It is therefore necessary to analyse its profitability from a fundamental point of view to ascertain whether it is really in a good financial position and also to identify the strategic activities performed by its managements and their likely impact on the company’s profitability.

The analysis is based on the audited financial information of the last four years i.e from 2006 to 2009. The analysis will also look at the strategic information in the managements discussion included in the annual reports. The analysis is ratio based focusing on the trend of the major aspects of the financial information related to profitability. A conclusion will be made at the end of each aspect of analysis. The final conclusion brings together all the sub conclusions to form an overall view of the company’s profitability and future prospects.

Sales performance

Sales Including VAT

The sale performance including VAT of a company is closely related to its profitability. Increasing sales revenues are most of the times accompanied by increasing profits. However in special circumstances profits might not increase as the sales increase. The most possible explanation being falling profit margins.

As the table shows H&M has increased its sales revenues before VAT form year to year in the last four years. This is a very strong indicator of good prospects for the company. It is observable that the company was able to increase its sales revenues even during the years that the world economy experienced a recession. The company has very strong sales teams and the outlets are obviously efficient in making sales.

Sales Excluding VAT

Sales excluding VAT of a company, when compared with sales including VAT show the actual trend in the sales that contribute to profit generation by a company. When the two sales figures have a different trend the implication is that the company is either moving into products that are highly taxed or into products that are lowly taxed? Tax affects the elasticity of demands of goods and as a consequence the margins that a company is capable of charging and therefore its profitability.

H&M sales excluding VAT have grown at a slightly higher rate than sales including VAT in the last two years. This indicates that the company is moving into less taxed goods. This implies that the sales of the company are slightly less elastic and the company can charge higher margins. This is a favorable thing to the profitability of the company.

Profitability

Operating Profit

Operating Profit of a company shows the efficiency of a company in the use of the resources at its disposal and the power it has in its market segment. Growing profits indicates that the company has some power over competitors and the market share is either increasing or the margins are increasing (Wild and Halsey, 2007).

Although the growth rate of the operating profits has declined the company has managed to maintain a positive growth over the four years. The growth in operating profits can be attributed to the growing sales although it can also result from increasing margins. The company is doing well which is an indication that the prospects for continued profitability are good. The decline in the growth rate can be attributed to increasing competition and the world economic crises. It is notable too that the growth in operating profits is less than the growth in sales excluding VAT in the last two years. This can be explained by the profit margins.

Operating Margin

The operating margin shows the power wielded by a company in its markets. A company with a lot of power is against the consumers and competitors are able to charge considerably higher prices resulting in high operating margins than those with less power. This margin is sometimes referred to as the gross profit margin.

As expected the operating margin has been declining for H&M this explains the lower increase in operating profits compared to the increases in sales after VAT. The implication of this is that the company although it still holds some power in the market place this power is falling. The explanation can be competition and the reducing purchasing power as a result of the economic crises of 2007 to 2008. Apparel and cosmetics are highly sensitive to economic conditions as compared to foodstuffs.

Profit after Financial Costs

Profit after financial costs discloses the company’s ability to generate profits using borrowed funds. When the growth in profits after financial costs is higher than the overall profit growth the implication is that the company is able to leverage its profits using debt. When the growth is less than the overall growth in profits the company is not able to leverage its profits using debt which is an opportunity if the debt levels are still low.

In the last two years of operations H&M profit after financial costs has grown at a rate less than the growth in operating profits. This shows that the company is not able to utilize its debts to amplify profits well and the cost of debt is increasing relative to increase in operating profits. This is an area where the company can make improvements to outdo the competitors in profitability.

Profit after Tax

Profit after tax is the net profit that a company is left with after taking care of all the expenses. When compared with the operating profit growth the efficiency of the company in minimizing management sales and distribution costs can be determined.

H & M net profits after tax have grown at on average a higher rate than operating profits except for the last year under analysis. The implication of this is that H & M has been good at minimizing its management, sales and distribution expenses but this has changed. To remain profitable the company will have to strategies on high to raise its operating profits as the expense rise.

Return on Capital Employed

This measure the productivity of the investment the company holds. High return on capital employed indicates that the company is efficient in its use of the capital invested and its profitability prospects are good due to improved competitiveness (Wild and Halsey, 2007).

Although the ratio is decreasing the company has a very high return on capital employed. This might as a result of the outsourcing business model adopted by the company. The company does not won the production factories a fact that reduces the capital needed to operate the business.

Cost Control

Cost control is directly related to the profitability of a company. A company that is able to control its cost well becomes competitive and profits increase. The reverse is also true. In a company involved in design and production the cost control strategies have a significant impact on the profitability.

Operating and Net Profit Growths

As stated earlier in the profitability measures the difference between the growth in operating and net profits gives a lot of information on the managements cost control measures. A low net profit growth than operating profit growth indicates that the company is incurring more management, sales and distribution costs per unit of profit than in the previous year. This is not a favourable aspect to the company.

H & M has been doing well in controlling its overhead expenses but th trend has changed in the year 2009. The increase in overhead costs in relation to profitability can only be explained by new launches of products which require significant marketing costs or it may imply deteriorating methods of cost control. The strategic analysis shows that the company has launched new products in the last year which might be the cause of cost deterioration.

Depreciation

Depreciation is a very rich are in cost control. The trend in depreciation indicates the nature of cost control mechanism employed by the management. When the management avoids incurring costs in getting new machines and maintenance they end up incurring huge depreciation costs that eat into the profits.

H & M depreciation costs have grown year after year. This is very striking and unless it is backed by increasing investments in fixed assets it might a threat to the company’s profitability. The rate of expansion might also explain the investment in fixed assets and thus the increase in depreciation.

As the rate of expansion shows the company has expanded its operations at a rate that is lower than the increase in depreciation especially in the last two years. This implies that depreciation per store on average has increased posing a serious threat to the profitability of the company.

Gearing

This measure shows how much of the company is owned by outsiders. The higher the proportion of the company owned by outsiders the greater the profits magnification. However this comes with liquidity and solvency risks (Wild and Halsey, 2007). It is almost impossible to find a company that does not use debt to finance its assets and the level of debt used depends on the industry. Retailers generally maintain high levels of debt.

As the proportion of assets financed by equity shows the company has maintained a relatively low debt proportion over the years. The company has been increasing the amount of debt used until last year when the trend changed and more equity was used. The debt level indicates that the company prefers low risks as opposed to high profit amplification.

Stock Market Analysis

Stock market indicators have a bearing on the profitability of a company. Good stock market measures leads to popularity of the company in the stock markets and low cost of capital consequently leading to high profit margins. H & M is a listed company and its attractiveness in the stock markets has a capacity to influence other stakeholders like customers and suppliers leading to influence on its profits (Wild and Halsey, 2007).

Return on Equity

Return on Equity is used by shareholders and other who want to be investors in the company to evaluate the appropriateness of the company stock as an investment. Increasing return on equity has a strong effect on the profitability of the company.

H & M has seen falling return on equity over the last two years. It is notable however that the rate is relatively high at close to 40 % the company has a high return to equity. This is a good figure in terms of profit prospects although the trend would have to be reversed.

Key Strategic Issue

The company’s management has adopted key strategic measures that can be traced to the profitability measures of the company. These measures will be analysed using the five forces model developed by Michel Porter (1998). There exist many models of strategic analysis of a company, the Porter’s model has however remained relevant as it captures the major issues and is easy to apply.

Buyer Power

The consumers have been becoming more and more informed and their demand for quality has increased (Worrell, 1998). At the same time their demand for reduced prices has risen. T counter this the company has adopted Celebrity marketing strategies and adopted quality control mechanisms. The company has also increased its outlets widening its geographic reach and online platforms (H&M, 2009). These are the most convincing explanation to the rising sale by the company.

Supplier Power

To reduce on the supplier power effect the company has maintained most of its production sources in Asia where the labor is relatively cheap compared to European and American markets. This explains the low capital requirements and the high return on capital employed. The lack of fixed investments in production facilities also enables the company to shift from one supplier to another without significant costs. This can be traced to the high operating profit margins. The company also has its own team of designers and production experts and does not have to incur huge evaluation costs of designers every time it needs to make a new design (H&M, 2009).

Competitive Rivalry

The apparel industry has very serious rivalry and the only way to beat the competition is by differentiating. The company has a dedicated team that is always coming up with new models. The company has considerable power in the market as the figures of profit margins shows. The company has also been able to beat the competition by having its won stores as well as production lines. The vertical integration makes the company lower the transaction costs and improve its profitability as the figures shows. However the competition is intensifying and the company will have to continue differentiating even more.

Threat of Entry

The apparel industry does not have mush barriers to entry. When a company does not invest in production much like H&M the cost of entry is significantly reduced. This poses a threat to the profitability of H&M. The only barrier to entry in the apparel industry is fast mover advantage enjoyed by those with recognized brands. It takes time for the customers to establish the attractiveness of a brand. H & M has established brands which might explain its resilient sales performance in the wake of a global recession.

Threat of Substitutes

Apparels do not have close substitutes. Cloths are worn regardless of the other economic factors as they are a basic need (Worrell, 1998). However in the markets targeted by H & M the customers are sensitive to prices and quality and can easily move to other types of cloths. The company has maintained a growing market share which indicates that it has been able to counter the threat of substitutes. The implication of this is that the prospects of the company’s profitability are good.

Future Prospects

The company faces various challenges and opportunities in its environment. In terms of opportunities the company has a very wide distribution of outlets making it possible for its newly introduced brands to move fast. The adoption of internet shopping platforms is also a significant opportunity facing the company. The trend is changing in all regions of the world towards internet shopping. The strong solvency position of the company and the high profits it has reported in the recent past also offers the company an opportunity to exploit up coming markets.

In terms of threats the company will have to handle its dependence on other retailers to sell its products. The quality will also have to be improved continuously to keep abreast with the competition and unpredictable consumption trends in the various regions of the world (Worrell, 1998). The recession of the world economy also threatens the company’s profits.

Conclusion

The financial analysis of H & M audited statements shows that the company has much strength in terms of profitability and economic prospects. These strengths however have shown stabilization and in some areas decline. The trend can be explained by the intense competition in its industry and lowered economic activity in the world economy. Although the merit of the analysis is limited by the assumptions of ratio analysis and the comparability of the financial statements the company’s profitability can be said to be strong but declining. The management has adopted many ambitious programs to improve the company’s profitability. The strategic analysis of the company and its environment shows that there are more opportunities than threats and the future prospects of the company looks good. There are no major threats except a few issue that require internal restructuring.

References

Hennes & Mauritz AB, (2010). “Annual Reports 2005-2010,” Available at http://www.hm.com/us/investorrelations/financialreports/annualreports__investorannualreports.nhtml

Porter, M.E. (1998). Competitive advantage: creating and sustaining superior performance. New York; London: Free Press

Wild, Subramanyan, and Halsey 2007, “Financial Statement Analysis”, 9^th edn, Irwin/McGraw-Hill.

Worrell, L. (1998). Strategic analysis: a scientific art. Wolverhampton: Wolverhampton Business School.