River Island

13 Pages   |   3,330 Words
Introduction
River Island is known as an affordable brand of fashion serving the UK and the international community. It produces stylish accessories amongst clothing and done so since its inception in 1948 (Scott, 2015) . The focus for River Island is on producing cutting edge designs that follow the fashion trends that are prevalent. Innovation and creativity drives the river island brand and has been responsible for the successes enjoyed by the brand (Walker, 2012). River Island trades its shares privately while its closest competitors choose to publicly offer their shares. To have a longstanding business like River Island, it is important to understand the customers changing demands before the competition, a quality possessed by River Island.
To fully understand the nature of River Islands business, a look at the important figures and trends associated with River Island are looked at in detail with emphasis on both the financial side as well as the non-financial aspect of the company.
To start with, the general industry performance in fashion and apparel is analyzed to understand the environment the apparel store is operating in and the kind of innovations that are coming about. Then, an analysis of River Islands past performance is conducted with the help of a trend analysis conducted for both the income statement and the balance sheet. Through this key patterns and changes in the financial makeup of the company is understood and interpreted. The use of financial ratios of liquidity, profitability and solvency is made to be able to pin down the direction of movement of the company. Forecasting methodology discusses the key use of the cost of sales methodology undertaken to estimate the potential values pertinent to the income statement and the balance sheet. Then the valuation of the company is conducted through the Discounted Cash flows technique using the W.A.A.C followed by multiple valuation method used as a comparison (Lin & Chen, 2005).
 

Yes, We Can Help!

We promise to deliver high quality papers on time which will improve your grades. Get help now!

SAMPLES PLACE ORDER OUR SERVICES
Plagiarism Free Work
Best Price Guarantee
100% Money Back Guarantee
Top Quality Work
Industry performance
The fashion industry, known for its high end, high priced products, is leaning towards discounted and economy retailers in 2014 (Wagner, 2012). 2014 saw a reliance on affordable wear, with preference on smart casual rather than formal. The changing trends through time in the industry affects the different clothing brands in a multitude of ways. To gain a crucial advantage in the industry, cost cutting has dominated with a larger increase in sales due to the age-old method (Hoovers, 2014). While trends are changing, there is a necessary task of having key stores operating to exert presence and brand name. Internet retailing may be on the rise, but the shopping outlet serves the key function of being an internet shoppers browsing catalogue. While there is a surge in internet retailing, studies suggests that the impact of quality and service in the internet market is the most important factor in the success of the internet business (Lin & Liao, 2007). Another trend is analyzed in a study suggesting variety and price to have significant effects on impulse buying and utilitarian buying in general from the internet. It is important in this context to recognize the need for a wide range of apparel on the websites offering deals and discounts (Smith, 2004).
 
 
River Island Trend analysis
In this section, analysis on the historical performance of the firm in terms of the income statement and the balance sheet is done (Walker, 2009). Graphs are drawn to indicate the comparative strengths and weaknesses for the firm throughout the years. The income statement analysis is done below
Income Statement
The graph below indicates the levels of the key figures used to analyze performance of the firm.  Three metrics, namely, sales, cost of sales and final profit are used to understand the swings in the firms key financial figures (Walker, 2009).
                                                           

The revenue for the firm when looked at in isolation from the cost of sales and other expenses displays a positive trend of increments. Though the increases in revenues are not substantial, it is still encouraging to see a line of revenue that is being sustained as the years go by.  Cost of sales pertains to the expenses that are relevant to make the goods available for sale. Although the revenues are increasing, cost of sales has kept up with them. There seems to be a proportionate relationship between the cost of sales and the revenues. Perhaps the most important figure over here is that of retained profit. Retained profit for the years 2009 and 2010 was negative while the following three years it was more or less constant. Recently, in 2014, the company made more losses which indicate the changing atmosphere of demand.
 
Balance sheet
The balance sheet presents the composition of the company in terms of assets and liabilities. It also gives a good idea of the kind of financing done in the company and the level of operations that can be sustained in the long run. Below is the balance sheet for River Island.
 
The graph above is a reflection of the solvency of the company. The levels of total current assets and total current liabilities indicate that having more current assets than liabilities, the company is performing well in terms of its liquidity needs. With each passing year, with the exception of 2010, the gap is substantial. Total net assets account for the firm’s long term and short term liabilities in addition to all types of assets. The movement seen is confounding, an initial increase, followed by a decrease and so on. It is however, encouraging to see the total levels of net assets to be higher than before. The company is thriving and sustaining its growth through increased net assets.
Ratio analysis
To measure the company against certain qualities like profitability, solvency and liquidity, a ratio analysis is used. The ratios for the historical years are then plotted on the graphs to be able to deduce a trend of the company and its qualities (Uechi & Akutsu, 2015). Below are the ratios pertaining to profitability of the company;

 
The return on assets, have consistently decreased throughout the years, although the rate of decrease has declined to almost zero. Earlier it was found that net assets were on the rise. However in terms of profitability, these assets are proving to be counterproductive. The return on equity as well indicates a decrease in the return on investments in the company. After good years earlier on the rate of return took a hit and has been struggling ever since. While it is encouraging to see, the ratios having positive levels the general trend shows a significant reduction in profitability values. If a company’s profitability is on a decline it is indicative of two things. A decline in demand for the company’s product or an increase in the costs associated with production (Carrera, 2015).  
Liquidity ratios
The liquidity ratios indicate the company and its abilities to be a safe investment for creditors. The ability to be able to finance short term loans through cash and other current assets is an indication of the financial stability of the company (Barth, 2014)

The position pertaining to liquidity for the company is a positive indication of successful financial management. The usual benchmark in terms of stable liquidity for a company is 2:1, however any figure above 1 means that there is an excess of assets over liabilities for the firm. The levels of acid test in 2013 are one of the highest in the firm’s history and current ratio indicates the rising strength of the firm in terms of current assets of the firm.

 
A firm like River Island is in the business of selling merchandise. The rate of turnover related to their inventory is a good indicator of the stock in demand. If inventory turnover is on a rise, there is indication of a growing demand for the company’s products. Through the years, inventory turnover for the firm has increased but is on a consistent decline in the past few years. Add to this the asset turnover ratio has decreased meaning the value of the firm is on a decline. The company is losing customers fast and it needs to address this issue as quickly as they can. There needs to be a revamping of design and products to gain back the competitive advantage in the business.
Other than the liquidity figures’ indicating a positive outlook for the company, the firm on the whole is in a slump. Based on the metrics utilized above, there seems to be a decrease in demand for River Islands apparel. With declining demand, the company is ill managing the costs associated with increased revenues meaning inefficient production.
Forecast methodology
When forecasting values, there needs to be a measure that ensures proportionality, rather than an average increase in all measures across the board. The cost of sales method is considered an appropriate method of forecasting as it gives varying growth rates for each item in the company’s financials. In order to calculate the revenue figure, an average growth rate using historical data is obtained. There is an exogenous addition of one percentage in the growth rate figure to incorporate expectations of a rise in demand for apparel worldwide. This one percent also is added due to the positive news of a rise in demand for UK brands abroad.
 
WAAC Calculation
The WAAC calculation consists of two components, the cost of equity and the cost of debt. Cost of debt is taken to be ten percent. As for cost of equity, the most reliable and suitable method for its calculation is through the usage of the CAPM. The CAPM is used as it holds superiority over the various other measures of equity rate calculations.
The table below shows the necessary calculations and values relevant to the CAPM
 
 
CAPM calculation    
Risk free rate   0.0212
Market premium   0.05
beta   0.79
CAPM   6%
 
The long term government GILT’s rate for 15 years is taken as the risk free rate. Beta calculations are done by taking the provided betas of the many companies in the apparel industry and aggregated to arrive at 0.79.
The figures for the WACC are obtained to discount the free cash flows obtained for the five years shown. the Waac comes out to be 6.09 percent. This is the discount rate to be used for the calculation of the present value of the company.
 
WACC CALCULATION            
    2014 2015 2016 2017 2018
Shareholders Equity   222.212 228.8783 235.7447 242.817 250.1015
Long Term Liabilities   1.121026 1.154657 1.189296 1.224975 1.261725
Shareholders Equity + Long Term Liabilities   223.333 230.033 236.934 244.042 251.3633
WACC   6.09% 6.09% 6.09% 6.09% 6.09%
 
 
Discounted Cash Flows
The discounted cash flows method uses projections of varying items, discounts them at the WACC and adds together the present values of the company in the years calculated. There Is a final step to the calculation of the DCF method. The use of the terminal value is made with the perpetuity formula and rate taken to calculate the value (Dividend monk, 2014).
 
To calculate the terminal rate, the rate of 0.2 percent is utilized. It is assumed that this rate is fitting for the cause. To calculate the free cash flows, the formula utilized is stated below. It consists of profit before tax, depreciation, and change in net working capital and capital expenditure.
 
A detailed calculation of the valuation performed through the DCF technique is provided below

 
Years 2014 2015 2016 2017 2018
Projected Revenues 833.785 858.7986 884.5625 911.0994 938.4324
Operating cost 718.904 740.4712 762.6853 785.5658 809.1328
Tax Amount 15.09166 13.22638 11.59163 10.15894 8.903328
Capital expenditure 0.481055 0.482979 0.484911 0.486851 0.5
Depreciation 33.51863 34.52419 35.55992 36.62671 37.72552
           
Change in WC -27.5 0.04 0.04 0.04 0.04
FCF 93.28962 70.05385 74.20076 78.22103 82.1307
PV OF CASH FLOWS 87.93298 66.03139 69.94019 73.72961 77.41479
Terminal Value         1389.69
PV of TV         1311.895
Total Value of the company       1686.944
 
 
Using the total value of the company, and dividing it by the total number of shares outstanding the bid price of the company is calculated
Total Shares 34
Price per share 49.616
 


Multiple Valuation
Perhaps a less desirable method is made use of now to serve as a comparison tool for the value calculated of the company by the discounted cash flow method. The relative comparison method utilizes a price divided by sales method to reach a value of the total industry. The mean is then calculated and the figure obtained.
Below is a list of companies that form part of the industry of apparel. The table shows the calculations carried out for the answer value of 14.9
 
 
Company Name Turnover price/sales RI P/S
  Next PLC   3740 0.0287 23.23265
  Marks and Spencer Group PLC   10309.7 0.0075 6.07125
  Burberry PLC   2329.8 0.033 26.7135
  ASOS PLC   975.47 0.025 20.2375
  Brown (N) Group PLC   834.9 0.0146 11.8187
  Ted Baker PLC   321.92 0.031 25.0945
  Mulberry Group PLC   163.46 0.0307 24.85165
  Mothercare PLC   724.9 0.003 2.4285
  Moss Bros Group PLC   109.14 0.0076 6.1522
  French Connection Group PLC   189.4 0.0031 2.50945
        Mean 14.91099
 
 
Sensitivity analysis
The robustness of the values for the bid price and the overall valuation of the company are tested through the sensitivity analysis. It is essentially a ‘what if’ scenario. It is performed to test what net effects will changes in the key assumptions of the model make. Testing the range of values different assumptions are able to withstand, a clear idea is gauged about the potential swings of values that run through the model. The calculations made to test the sensitivity of the model are of the growth rate of revenues, the terminal growth rate and the risk free rate.
Growth rate of revenues
The average change in the historic growth rate is calculated to arrive at a growth rate figure. This figure, however, carries with itself the pitfalls of being rooted in static conditions. Growth rate for a company is a dynamic entity, one that changes with time and trends. A surge in fashion apparel for women may push sales and revenues to rise faster than the industry rates and vice versa. The following calculations establish a range of possible growth rates and the consequent effect it has on the price of shares in the market
 
Growth RATE 1% 2% 3% 4% 5%
Bid price 8.167 26.93 46.24 66.09 86.5
 
 
It is noticed that with a one percent increase in growth rate of revenues, the share price for the firm increases significantly. A small change of one percent changes the bid price by around 20 dollars.
 
Risk free rate
The risk free rate considered in the calculations below is of the 15 year GILTS measure. A change in the risk free rate affects the economy in a multitude of ways. If the government were to decide on an expansionary monetary policy it may increase the interest rate and the money supply. It, therefore, becomes necessary to assess the amount of exposure the company financials have on changing risk free rates. Below is a table that assesses these risks through a range of different interest rates
Risk Free Rate 2 3 4 5 6
Bid Price 46.2 46.1 46 45.9 45.8
 
 
With changes in the risk-free rate, it is observed that the change in the share prices is low. This presents a situation where the relative risk associated with the company's stock is greatly reduced.
 
Terminal Rate
The terminal rate as discussed above is the rate used to value the growth of the free cash flows over the long run. The rate used is 0.2 percent. Changing of this rate displays patterns of insignificant change of the bid price.
 
Terminal Growth Rate 0.04 0.06 0.08 0.1 0.5
Bid Price 46.36 46.48 46.6 46.7 49.38
 
 
 
Once again, the rigidity of the model and the cash flows are displayed. When changes in the values take place, the bid price displays a constant trend.
 
 
Analysis of the methodologies
The methodologies applied in the report stands on considerable backing and theoretical soundness. The ways of calculating the valuation of the company amongst other things have been the standard method of evaluation. Revenue forecasting in particular applied a simplistic yet highly effective technique. The past revenue figures use generated the average growth of revenues and this growth rate is then applied to predict movements in future revenues. The crux of the forecasts made is based on the cost of sales method. The items in the income and the balance sheet are used to estimate the relative percentage of sales value these figures are. Using the different figures calculated, the aggregate of the score is taken to be used to estimate future figures. The discounted cash flows method essentially uses the wacc to discount cash that the company is able to produce. It measures the worth of the company in real terms. Multiple valuation on the other hand lacks in validity and often cannot be used to rate companies due to the variation in the industry. The problem arises in multiple valuations when the company in question performs on a significantly different level of the other companies. The sensitivity analysis is performed to gauge the variance of the bid price that exists when the assumption the model rests on fail (Scott, 2015)

Conclusion
To get an accurate estimate for the appropriate bid price to be offered, the DCF and the multiple valuation calculation can be made use of. The DCF method produces a bid price of 49. The sensitivity analysis indicates a range of 25-85 for the bid price in certain circumstances. The values deduced from using the multiple valuation methods of 19 dollars can be ignored as the method is wrought with inaccuracies and drawbacks. The analysis conducted above shows the ease of bid price movements in either direction. The likelihood of each change is, however, subject to many factors. The bid price calculated by the DCF has always been and is the most authentic measure of the company’s true share price and one which shall be used
 

Bibliography

Armond, L., 2014. How to Forecast Sales. [Online]
Available at: http://www.iplanner.net/business-financial/online/how-to-articles.aspx?article_id=forecasting-sales
[Accessed 3 April 2015].
Barth, A., 2014. Optimal risk and liquidity management with costly refinancing opportunities. Insurance: Mathematics and Economics, Volume 57, pp. 31-45.
Bearne, S., 2015. River Island looks to tap into next wave of tech entrepreneurs. [Online]
Available at: http://www.retail-week.com/sectors/fashion/river-island-looks-to-tap-into-next-wave-of-tech-entrepreneurs/5071457.article
[Accessed 3 April 2015].
Buttonwood, 2014. The new risk-free rate?. [Online]
Available at: http://www.economist.com/blogs/buttonwood/2014/03/investing
[Accessed 3 April 2015].
Carrera, A., 2015. Studies in profit and capital formation: An alternative theory of distribution. Cuadernos de Economía, 38(106), pp. 1-10.
Dividend monk, 2014. Disciplined Dividend stock research. [Online]
Available at: http://dividendmonk.com/earnings-multilple-approach-to-valuation/
[Accessed 3 April 2015].
Faull, J., 2015. River Island moving IT ‘out of the back room’ with tech hub collaboration. [Online]
Available at: http://www.thedrum.com/news/2015/02/10/river-island-moving-it-out-back-room-tech-hub-collaboration
[Accessed 4 April 2015].
Hoovers, 2014. Clothing Stores Industry Overview. [Online]
Available at: http://www.hoovers.com/industry-facts.clothing-stores.1519.html
[Accessed 11 April 2015].
Lin, H.-W. & Chen, M. S., 2005. Valuation by using a fuzzy discounted cash flow model. Expert Systems with Applications, 28(2), pp. 209-222.
Lin, T.-H. & Liao, C., 2007. Shopping motivations on Internet: A study based on utilitarian and hedonic value. Technovation, 27(12), pp. 774-787.
Merritt, C., 2014. What Does the Company's Asset Turnover Ratio Mean?. [Online]
Available at: http://smallbusiness.chron.com/companys-asset-turnover-ratio-mean-60811.html
[Accessed 3 April 2015].
Scott, M. &., 2015. River Island. [Online]
Available at: http://mellorandscott.com/portfolio/river-island/
[Accessed 13 April 2015].
Smith, D. N., 2004. Flow and Internet shopping behavior: A conceptual model and research propositions. Journal of Business Research, 57(10), pp. 1119-1208.
Uechi, L. & Akutsu, T., 2015. Sector dominance ratio analysis of financial markets. Physica A: Statistical Mechanics and its Applications, Volume 421, pp. 488-509.
Wagner, N., 2012. Analysis of the Retail Apparel Industry. [Online]
Available at: http://smallbusiness.chron.com/analysis-retail-apparel-industry-70514.html
[Accessed 12 April 2015].
Walker, H., 2012. River Island heads across the pond. [Online]
Available at: http://www.independent.co.uk/life-style/fashion/features/river-island-heads-across-the-pond-8036648.html
[Accessed 13 April 2015].
Walker, J., 2009. Chapter 2 – The Income Statement (Profit and Loss Account). In: Accounting in a Nutshell (Third Edition). s.l.:s.n., pp. 25-40.
Woodard, R., 2015. Uk textile and clothing industry poised for growth?. [Online]
Available at: http://www.just-style.com/analysis/uk-textile-and-clothing-industry-poised-for-growth_id124343.aspx
[Accessed 3 April 2015].

Download Full Answer

Order Now