Case study 3: Predicting Tesco's 2009/2010 Earnings

On April 21, 2009, UK-based retailer Tesco plc presented its preliminary financial statements for the fiscal year ending on March 31, 2009. See attached Excel worksheets containing tables showing a selection of Tesco's financial figures for the fiscal years 2007/2008 and 2008/2009 (i.e., the fiscal years ending on March 31, 2008 and 2009, respectively).

In addition to disclosing the financial statements, Tesco's management also provided guidance about future investment plans, financing strategies, and performance expectations. In particular, the following information became available to investors and analysts on the publication date:

? In 2008/2009, Tesco opened 9 million square feet of new store space. The retailer plans to open 8 million square feet of new store space in 2009/2010.

? Revenues in 2008/2009 were the revenues of 53 weeks. The fiscal year 2009/2010 will include 52 weeks.

? Group capital expenditure during 2008/2009 was GBP 4.7 billion, a little more than planned (GBP 4.5b) due to currency movements. Tesco's management indicates that capital expenditures in 2009/2010 will be around GBP 3.5 billion. One reason for why capital expenditures can be reduced is that in the current economic downturn, Tesco can buy more new store space for less.

? Tesco's effective tax rate in 2008/2009 was 26.7 percent versus 24.0 percent in 2007/ 2008. The increase in tax rate was primarily the result of one-time tax benefits in 2007/ 2008. Management expects the effective tax rate for 2009/2010 to be around 27 percent.

? In 2008/2009, Tesco was able to realize cost saving of close to GBP 550 million through its Step-Change program. Management expects these cost savings to persist.

? In 2008/2009, Tesco's net finance cost, including the company's return on pension assets, was GBP 284 million. The underlying interest charge was GBP 309 million, up from GBP 159 million in 2007/2008. The weighted average coupon rate of Tesco's debt was 5.6 percent.

? Tesco's debt rose substantially during 2008/2009 as a result of:

1. Increased capital expenditures.

2 .An increased pension deficit (GBP 0.65 billion increase).

3. The significant depreciation in the sterling-dollar/euro exchange rates (with a debt impact of approximately GBP 1 billion).

If exchange rates remain stable, management intends to bring down debt by approximately GBP 1 billion during 2009/2010. Further, management disclosed the following information about realized and planned store openings (see worksheet "Store Space" in attached Excel file)

Consider the following questions:

1. Predict Tesco's 2009/2010 sales using the information about the company's store space and revenues (per geographical segment).

2. Predict the 2009/2010 book values of Tesco's non-current assets and working capital using the information about the company's investment plans. Make simplifying assumptions where necessary.

Notes for this case study

1. For answering the above questions, you need to make some assumptions. Please note that the assumptions are free of consideration as long as they are reasonably justified.

2. Please do not submit Excel workouts only. Word documents with excel results pasted are welcomed. Showing the procedure by which you achieve each item will help to maximise your mark.

3. For Question 1, the sales driver for Tesco is square feet store space.

4. Calculation of Tesco's realised store productivity in 2008/2009 is helpful to estimate sales revenue for 2009/2010, i.e. sales per square feet store space.

5. For Question 1, it's better to assume new openings, extensions, adjustments, disposals, and acquisitions contribute half a year of sales, on average. And it is also assumed that store productivity remains constant in 2009/2010 and new openings, extensions, adjustments, disposals, and acquisitions contribute half a year of sales.

6. For Question 2, in the absence of detailed information about future investments in working capital, non-current intangible assets and non-interest bearing liabilities, you need to assume that the book values of these items follow sales growth:

7. To solve Question 2, three steps are recommended:

i. Estimate the initial cost of non-current tangible assets that Tesco will dispose of during 2009/2010;

ii. Calculate the ending value of non-current tangible assets at cost;

iii. Estimate 2009/2010 depreciation and the ending value of accumulated depreciation on non-current tangible assets (ignoring the effect of accumulated depreciation on disposals for simplicity.