Case Analysis - Carrefour S.a.

CASE ANALYSIS - CARREFOUR, S.A. BACKGROUND: Carrefour was in the Retail Business and opened their first store in France in the summer of 1960. The concept of one-stop shop with discount prices proved to be very successful in France as retail distribution at that time was highly fragmented and product lines in individual stores were very narrow. Visits to up to four separate shops were required in order to purchase all retail food item and merchandise. Carrefour facilitated the process of buying food items by creating a store where the consumer could find almost every food product he needs. Non-food products were later added to Carrefour line of products. In 1963 Carrefour opened its first hypermarket in France outside Paris, selling food and non-food products at discount prices, and providing parking for 450 cars. The high degree of consumer acceptance can be attributed to convenience and price. The hypermarket strategy proved to be very successful and from 1965 and 1971 sales grew in excess of 50% and nonfood items accounted for 40% of total volume. In 1970 new stores were opened with selling area as large as 25,000 sq m. Carrefour’s strategy was to build its store outside of towns in location where highways provided easy access and land could be acquired very inexpensively. The combination of low-cost land and inexpensive construction gave Carrefour a total investment per square meter of selling space equal to about one third of traditional supermarkets. Another strategy was a decentralized management. Each store manager had high decision-making power to operate their stores, which make decisions faster, more dynamic, and the daily store management more efficient. Plus, manager could customize its store to suit local needs better. The decentralized operations were a key success factor underlying Carrefour’s national achievements. As a rapidly growing company, Carrefour had great opportunities to be accepted by its customers as a convenient and one-stop shopping center with its cheaper price compare to other available stores. This lead to a number of 40% of other small retail shops or approximately 80,000 stores had closed down in 1971. In order to solve this issue, French Government 1

to some extend decided to make tighter regulations to slowdown the significant enlargement of hypermarket, such as Carrefour by limiting the number of new opening store each year (maximum of two stores per year). However that solution was not enough to keep small retailers in business, so in 1972 legislation was passed to tax retail stores in order to provide pensions for small shopkeepers who were unable to continue in business. All these factors were obstacles for Carrefour growth, nonetheless Carrefour managed to get two new construction permits each year from 1960 and early 1970s. However, in order to achieve a more rapid expansion Carrefour did joint ventures and franchises agreements, which it offered to share its retailing know-how, trademark, and consumer goodwill with potential partners both in France and elsewhere in Europe. Carrefour offered its expertise in exchange for either an ownership interest in stores under construction or franchise fees. Carrefour was very successful in adding selling area under the Carrefour name using this strategy. The combination of those partnerships and low construction costs made Carrefour ability to grow 50% a year without going for massive funding through equity selling or debt financing. Carrefour was facing an increased competition in France and the future growth was beginning to look limited. Although Carrefour was the leader in the French market other firms were becoming big competitors. It was estimated that 50% of market saturation had already been taken. Furthermore, it was expected in the next few years, the market for hypermarket stores would be completely saturated at current growth rates. Therefore, Carrefour considered expanding their strategy by investing in others countries. As a result, Carrefour needed to observe several possible ways to set up stores outside France. KEY ISSUES

OF THE

FIRM:

The Exhibit 2 of the case reveals that Carrefour had been maintaining a negative net working capital which was growing over the years from 1965 to 1971. Negative Working Capital is good as long as the firm has the cash adequacy to meet the liabilities. In case of Carrefour, the firm may not be able to pay the long-term and short-term debts through its current assets including cash, accounts receivable and inventory if there is a temporary 2

recession. The statement of Free Cash Flow of Carrefour as shown in the following table indicates that the Company was not generating enough cash to meet its liabilities. TABLE 1: FREE CASH FLOW

OF

CARREFOUR

Working capital represents operating liquidity available to a business. The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses. Cash flow in operating working capital could be measured by Cash Conversion Cycle (“CCC”). CCC measures how quickly a company can convert its products into cash through sales. The shorter the cycle, the less time capital is tied up in the business process, and thus the better for the company's bottom line. Maintaining a short CCC was therefore a good thing for Carrefour. However, Carrefour had generated cash so quickly they actually have a negative working capital. This is not uncommon on retailer business. This happens because customers pay upfront and that to so rapidly, that the business has no problems raising cash. In these companies, products are delivered and sold to the customer before the company even pays for them. However in a long run that is a risky strategy because a delaying payment to suppliers may lead to the loss of cash discounts and other price breaks. Further, as a part of its Capital Management strategy, Carrefour created two types of businesses besides its wholly owned stores - one in form of joint ventures and the other were in a franchise type of businesses. Each type of business generated different net income in which joint ventures gave Carrefour a profit between 10-50% of the ownership, while franchises provided a fee of 0.2% of total store sales. The main concern of Carrefour was to create maximum returns and minimize risks as low as possible by combining these three types of businesses. However, the risk seems to be not fully mitigated as the Debt-to-Equity (D/E) ratio showed 3

an increasing number over a period of time and it was relatively higher than other competitors. A higher debt-to-equity ratio means that the more debt that is used thereby imposing higher risk. Carrefour financed its capital mostly by using a non-interest bearing Trade Notes. Consequently, Carrefour indeed should find a way to make a slightly higher net working capital and reduce its debt-to-equity ratio. WHY THE NEGATIVE WORKING CAPITAL CARREFOUR?

NOT

A

GOOD STRATEGY

FOR

Exhibit 2 shows that the composition between investment activities and financing activities. The composition between these two activities was mismatching. Carrefour’s fund was more than enough to support their operating activity. Mostly its fund was covered by short-term debt from external parties. Ideally, a short-term investment should be supported by a short-term debt and a long-term investment through a long-term debt. However, the Balance Sheet indicates that Carrefour kept increasing its Net Fixed Asset (“NFA”) through investments in land and buildings. The investment in building such NFA was financed mostly through non-interest bearing Trade Notes which is a type of short-term debt. Net fixed asset is again categorized as a long-term investment. Therefore Carrefour had been funding long-term investment through short-term financing which is evident from the firm’s growing negative working capital. TROUBLE

WITH

DEBT-EQUITY RATIO

Another major problem with Carrefour investment strategy was that the Debt-Equity ratio kept increasing and it showed a 4.6 ratio at the end of 1971. The debt was 4.6 times its equity. However, the composition of the debt mostly consisted of short-term debt as explained above. This could cause a problem for Carrefour since its equity would not cover its debt in case of debt maturity. Hence the result of a negative working capital would also be futile for Carrefour in this respect. CONCLUSION: Based on the analysis above, it has been observed that the following two main factors have raised several issues in Carrefour working capital management: 1. Maintaining a negative net working capital 4

2.

High Debt-to-Equity Ratio

These two conditions are considered as a risky financial management. Negative net working capital could be a sign for a company facing a bankruptcy or serious financial problem. This is due to the higher current liabilities compare to its current assets. If Carrefour in case of any temporary recession cannot generate enough cash, it will end up with having higher amount of debt that cannot be covered by its equity. Carrefour therefore should adjust its negative net working capital by reducing its current liabilities.

SUBMITTED BY: Shubhayu Sanyal – MP13056 Ankan Mitra – MP13012 V Satish – MP13066 Kunal Ranjam – MP13027 Jasbir Singh – MP 13032

5