1

FINANCIAL

ANALYSIS McLean Limited

ABSTRACT This report is an analysis of McLean Ltd.’s overall

performance and financial position over the last 5

years with focus on significant key ratios and

recommendations for future success.

Sara Young Accounting for Managers MBA 5404

McLean Ltd.

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Executive Summary

This report will cover the financial history over the past 5 years for McLean Limited (Ltd.). Key

ratios in Profitability, Liquidity, Gearing, Activity/Efficiency and Shareholder Equity over the last

5 years will be analyzed with consideration given to economic, environmental and social factors

and their impact on the business with recommendations for future success. In the appendix, the

detailed financial statements of McLean over the past 5 years- the income statement, statement

of financial position and cash flow statement- can be reviewed, along with a chart of all ratios

being discussed. Key areas of focus are McLean’s sales growth of over 2% in 2012 and 2013 which

is in line with the expectation of market growth throughout the world in the vitamin and

supplement industry. McLean has steadily seen a decrease in working capital ratio- down to 2.88

in 2013- as it has worked to make its assets work harder as well as a higher than industry average

quick ratio of 2.15. Asset turnover, a key driver of return on equity as discussed in the DuPont

analysis, has been undesirably low since 2009, with only a slight improvement in 2012. Gearing

in McLean has steadily increased to 38% in 2013 but still lags behind the industry average by

almost 10% showing McLean’s apparent past aversion to risk. Dividend yield has seen a decent

increase since 2011 for McLean, now up to 4.6% and has maintained a higher than industry

average- 40% vs 20%, respectively- in Dividend Payout ratio.

.

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cLean Limited (Ltd.) has been

helping people achieve greater

health since the mid-2000s in

the vitamin and dietary supplement industry

(VSI). Not simply a Health Food and

Supplement Retail Store, McLean Ltd. is

focused on improving the quality of life of its

clients and employees. Developed from a

small store in downtown Melbourne,

McLean Ltd. has grown to 350 retail stores

spanning from Victoria to Queensland along

with an increasingly strong online presence.

McLean products are currently available

throughout Australia and exports to New

Zealand. Customers enjoy the highest

quality of products while knowing they were

sourced ethically and with the greatest

amount of consideration for the continued

sustainability of the environment. Mclean

has obtained a certified Fair Trade and

organic quality assessment.

Founders

The CEO and Co-Founder Benjamin Smith

along with CFO and Co-Founder Samuel

Jones have extensive experience in the

Health Food and Supplement Industry. Mr.

Smith studied health sciences and medicine

as well as natural therapies from Columbia

University in

America and

has his MBA

from

Melbourne University. Mr. Jones has his

Finance degree and Masters of Finance from

Monash University and is the spokesperson

of McLean. Mr. Jones has successfully

competed in over 15 marathons in his

lifetime and sits on the board of the Run for

Life Charity.

Market History

‘The industry as a whole came under fire in

2010 after a review of complementary

medicine products by the Department of

Health and Ageing found that as many as

90% of those company’s examined did not

comply with regulations, including labelling

breaches which it said might “mislead”

customers’ (Rourke 2013). Women

represent the largest group of purchasers,

according to a survey by the Roy Morgan

group in 2012. It reported that 73% of first-

time mothers-to-be had bought vitamins in

the previous six months, as had 62% of

expectant mothers, 44% of women in

general and 31% of men (Roy Morgan

Research 2012). McLean’s ability to maintain

M

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sales growth in 2010 shows it did a better job

in regard to market reaction to its product

over the bigger players in the industry which

was in large part due to McLean’s

transparency reporting and ethical sourcing

company standards. In March 2013, 7.4

million (42%) Australians aged 18+ bought

vitamins within a 6 months period as

reported by Roy Morgan Research (2013).

Market Expectations

The Vitamins and dietary supplements

market grew by 9% in 2012, reaching sales of

$1.8 billion. The popularity of vitamin and

supplement products in Australia has

provided a high penetration rate amongst

consumers. The vitamins and dietary

supplements category expected to see

constant value sales rise at a 3% CAGR (or

year-over-year growth rate of an investment

over a specified period of time) over the

forecast period of 2013. Consumers

continued to value their health over this

period, which led to continued product

purchases (Euromonitor 2013).

Competitors

Australia’s market is dominated by a few big

players, including the long-time industry

leader, Blackmores, accounting for 17% of

sales in 2012 and was the leading brand in

Australian vitamins and dietary

supplements. Blackmore Ltd.’s offerings

have broad retail distribution across the

country and throughout the world

(Euromonitor 2013). With a well-respected

and trusted brand name, Blackmores was

voted Australia’s most trusted vitamins and

dietary supplements brand for the last 5

years according to Reader’s Digest (2013).

GNC and Vitamin Shoppe Inc. are two of

McLean’s direct competitors with McLean

coming close to matching in terms of size

and sales. Other competitors are

PharmaCare, which owns a number of

brands including Nature’s Way, and Swisse,

and which in 2013 spent around $50m (or

approximately 30% of its revenue) on

marketing and in-

store promotions,

showing growth in

advertising in the

vitamins and

supplements category

(Rourke 2013).

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Profitability

Sales Growth

Trends in health and wellness in Australian

society and consumers seeking to pre-emptively

avoid illness are two factors impacting Australian

diets’ turn to supplementation. Strong sales up

$80m from 2012 and $140m from 2011 have

provided a growth rate in sales of 2.7% and 2%,

respectively. In 2012, the vitamin market grew

9.6 per cent over 2011 figures. Profitability took

a small but significant hit in 2011 due to the company’s preparation for sales growth in 2012 and

coming years.

Operating Margin and Overhead to Sales

Operating Margin can be affected by several

things (for example, material or labor costs), but

because these items are a part of the day-to-day

decisions managers make, operating margin can

also be seen as an evaluation or measure of

managerial flexibility and competency,

particularly during tough economic times, as

McLean experienced in late 2000s. Operating

Margin was affected by a high increase in Overhead to Sales in 2011 up 4.1% from 2010. This was

due to an increase in advertising expense as the company competed for market share as growth

for the industry was predicted at 9% in 2012. Overhead to sales increased 4 out of the last 5 years

with 2013 being the first year to not see an increase. McLean is starting to get a hold on its

overhead expenses as the opening of new stores becomes more standardized. In the future this

could be an issue if the company decides to pursue international expansion, meaning it will have

to have a more dynamic approach and consider a larger number of factors.

7.0% 6.6%

9.2%

11.3%

2010 2011 2012 2013

Sales Growth

18.4% 18.0%

12.9%

16.8%

22.1%

2009 2010 2011 2012 2013

Operating Margin

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Gross Margin

Gross Margin has remained considerably high, albeit slightly reduced from 78% to 75% in the

past 5 years. This figure is outstanding in the industry- 49.5% in 2013 down from 54.7% in 2010-

due to McLean’s ability to keep cost of sales at an ultimate minimum through building its strong

relationship with suppliers with long-term supply agreements while focus has been on driving

sales volume. Gross Margin must be high enough to cover the company's expenses plus allow for

a reasonable amount of profit, which McLean has shown quite capable of managing.

Return on Investment (ROI)

ROI improved for the past 2 years from 4.8% to

7.6% from 2012 to 2013, respectively. The return

of ROI to the same figure in 2012 as in 2010,

demonstrates how a poor year in sales with

increasing costs can deteriorate profitably based

on how a company employs its equity. The

comeback was due to higher increase in sales

while cost of sales remained consistent from the previous year and operating costs increased

only slightly. This improvement comes as a relief from the dissatisfactory result in 2011 of 2.5%.

This proved that McLean needs to work on employing a strategy for maintaining earnings when

forecasting a year of low sales growth, preparing for expansion or facing increased industry costs.

Return on Capital Employed (ROCE)

ROCE paints a clear picture of the improved efficiency and profitability of McLean’s capital

investments. With an ROCE of 10.5%- up from 5.8% in 2011- McLean is creating value whereas in

2011, value was clearly destroyed. McLean’s recent increased profitability, specifically in 2012

and 2013, can be partly attributed to the heightened demand of supplement products as

preventative methods to avoid illness and the move to focus on health and wellness as the baby

boomer generation ages. In recent years there has also been an overall cultural focus on health,

wellness and fitness. NPBIT’s increase of $84m to $174.5m from 2011 to 2013, respectively,

shows the improved generation of return by each dollar of operating income.

4.5% 4.8%

2.5%

4.8%

7.6%

2009 2010 2011 2012 2013

ROI

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Liquidity

Quick Ratio (Acid Test)

With a quick ratio of 2.09 in 2013, the lowest

figure in the 5 year analysis period, McLean

has experienced no difficulty in meeting its

current financial obligations with its

available quick funds at hand. Quick Ratio or

Acid Test shows how fast the short term

asset can be to cover or pay back short term

liability if needed. Although McLean has

reduced from previous years, meaning

assets are working harder, they are still well above industry average and need to work on

collecting accounts receivable to be able to make use of that money in a profitable investment.

Working Capital

Working Capital has followed a similar trend as the quick ratio in that it has decreased from a

startling 4.12 in 2009 to 2.79 in 2013. Working Capital ratio is useful in telling us whether the

business can support itself with its current assets despite its current liabilities. The improvement

in Working Capital demonstrates that McLean is utilizing its assets more effectively than 5 years

ago but there are indeed opportunities to capitalize future benefits with further improvement.

McLean is still quite above the industry average of 1.6 in 2013. However, with increasing sales

and costs, McLean will need to employ assets to work harder than previous years and particularly

remain cautious of cash in the bank.

412% 432%

361%395%

279%328% 339%

291%322%

209%

2009 2010 2011 2012 2013

Working Capital & Acid Test

Working Capital Acid Test

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Gearing

McLean’s overall increase in gearing for the

last 5 years- 32.9% to 37.6%- demonstrates

that the company is increasing its financial

leverage thus risk, albeit slowly. The highest

increase in long term debt occurred from

2012 to 2013 when McLean invested in new

retail outlet leases and a distribution center,

showing the company’s confidence in

sustaining increasing sales growth, with

control over costs, and ability to cover its debt. With the increase in direct online sales, McLean’s

decision to open more retail stores signals a possible plan to increase its gearing in order to take

on new projects or future expansion. Thus, McLean faces the decision of increasing their

borrowing in preparation for a market move. Such increase in risk could create hesitation from

investors and lenders who were comfortable with McLean’s risk aversion.

Interest Cover

McLean’s current interest cover of 279% means it has the profitability to sufficiently cover over

2 and a half times the amount of its current finance cost. A drop in 2011 to 1.68 was a warning

sign as PBIT was reduced due to low sales growth and increased costs- both in sales and

overhead- and long term debt increased with forecasted growth in the coming years led to new

building leases of 5 years with the option to renew the lease for two additional 5-year terms.

32.9%32.2%

34.2% 34.1%

37.6%

2009 2010 2011 2012 2013

Gearing

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Activity/Efficiency

Total Asset Turnover

McLean’s asset turnover ratio is lower than industry standard and has not increased much- 38%

to 43% from 2009 to 2012, respectively. This ratio indicates how efficiently all the company’s

assets, both current and non-current, generate revenue by measuring how quickly a company

turns over its asset through sales (Collier 2013). Although the company’s total assets has

increased over the past 5 years, so has their sales. However, the company has increased the

amount of money tied up in fixed assets for each unit of sales compared to previous years.

McLean saw its first reduction in current assets, a big drop in cash, from 2011 to 2012 and an

increase in non-current assets for the same period, with a big increase in plant, property and

equipment. There is room and need for improvement in this area which can be accomplished

through more effective management in current assets, especially cash and inventory, and non-

current assets, ensuring that the money invested in fixed assets such as plant, property and

equipment is in line with the company’s growth strategy and being used to their full capacity.

Days Sales Outstanding

McLean has significantly improved its days sales outstanding (DSO) from 70 to 55 days from 2009

to 2013, respectively which puts it right in line with the industry average of 55, considering 30-

day trading terms. The average collection period is a variation of receivables turnover and is can

be used to evaluate the effectiveness of the company's credit and collection policies as well as

minimizing bad debts (Collier 2013). There is a high cost in carrying receivables. With an interest

rate of 10%, McLean is paying $1.762K in interest expense per day on total annual receivables

compared to that of $2.215k per day in 2011. The reduction in expense payment is due to

McLean’s ability to cut down on annual receivables by looking into the credit approval process

and by being more cautious of who they extend credit. To further reduce DSO, which will improve

cash flow, McLean should look into their receivables management process regarding invoicing

and collections as the company saw an increase in provisions in 2013, likely due to an inability to

collect debt or of customers’ inability to pay their debts.

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Inventory Turnover

McLean’s efficiency in turning its inventory has improved over the past 5 years from 2.1 to 2.8

with days inventory of 129 for 2013. The industry average is 4-5 times per year so McLean could

improve their inventory turnover by developing better relationships with key suppliers. Since

McLean purchases products directly from suppliers at high volume and low cost, a solution could

be to buy more frequently and in smaller quantities and to negotiate to pay the same cost.

Further, if McLean can differentiate between its fast moving and slow moving products it could

work with suppliers to forecast and plan necessary order requirements. Creating supplier

relationships could also help McLean in the future to possibly share costs with suppliers or gain

their support in product development ideas, Research and Development (R&D) or even

marketing ideas on new products.

Days Purchase Outstanding

McLean has worked to pay its suppliers more quickly, which is important to the business-supplier

relationship, by having strong accounts payable management. Longer Days Purchase Outstanding

(or DPO) could be more beneficial as the lag time in DPO is good for working capital and free cash

flow, however, it should not come at the risk of upsetting suppliers. Thus, the number of days

has reduced from 122 to 92 over the past 5 years which still is beneficial for the company

financially but also has the added benefit of making suppliers happy which helps strengthen the

key business-supplier relationship, potentially helping in future business transactions.

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Four areas impacting cash flow:

1. Cash flow from operating activities

There was a $41.45m increase in cash flow from operating activities from 2012 to

2013, the biggest increase over the past 5 years. This increase was the result of a

significant increase in cash receipts and receivables.

2. Cash flow from investing activities

In 2011, McLean made a careful investment of $66m in new stores. The

investment was successful. Therefore, there was an additional investment of

$231.3m in 2013 for new store leases which was in preparation for expansion for

a higher expected sales growth based on increased consumer spending trends in

health and nutrition.

3. Cash flow from financing activities

McLean increased its long term debt borrowing by $175m over the 5 year period

due to the expected growth. Within the next 2 years, McLean should expect the

new stores to begin to turn a profit and contribute to the repayment of the

financing. Dividend payout increased in 2013 three times the amount paid in 2011

due to the high increase in profit. However, in 2011, dividends paid was

significantly lower due to investments in preparation for growth and expansion

which was recovered in 2012 and surpass the dividends paid in 2010.

4. Net Cash Flow

McLean had positive net cash flow until 2013, significantly reducing cash, which

was due to an increase in gearing.

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Shareholder Returns

Shareholder Return Ratios- 5 years

2013 2012 2011 2010 2009

Dividend per share $ 0.057 $ 0.035 $ 0.017 $ 0.033 $ 0.030

Dividend payout ratio 40.0% 40.0% 40.0% 40.0% 40.0%

Dividend yield 4.6% 2.9% 2.0% 4.1% 4.7%

EPS $ 0.143 $ 0.087 $ 0.043 $ 0.082 $ 0.076

P/E Ratio 8.8 13.8 19.6 9.7 8.6

Analysis:

Issued capital remained consistent over the 5 year period at 550,000 shares per year. McLean’s

commitment to shareholders has shown in the decision to maintain the dividend payout ratio

constant at 40% over the 5 years, which has been possible due to the overall increase in profits.

Dividend per share increased from $.03 to $.057 from 2009 to 2013, with a slightly negative

variation in 2011, for reasons previously mentioned. The market value per share doubled from

2009 while the dividend yield fluctuated and actually saw a decrease in 2011, only returning to

almost the same yield in 2013 as 2009.

Earnings per share was at its highest for McLean in 2013 over the 5 year period at $.143 which

means that for every $1 invested, McLean is returning $.143 per share as profits.

Since earnings took a hit in growth in 2011, price to earnings (P/E) ratio more than doubled- to

19.6. However, as earnings grew in 2012, P/E reduced to 13.9 and further to 8.8 in 2013 even as

the market share price increased. Competitors had a P/E ratio between 15-20 as of 2013. This

means McLean is relatively cheap for the sector, which could attract some investors who are

interested to see a return, given the expected further growth of the Australian supplement

market.

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Recommendations to the Board of Directors

The following recommendations should be considered by McLean’s Board of Directors to ensure

sustainability and growth for the company:

Focus should be on employing assets to work harder in alignment with company growth

strategy. Accounts receivable needs to be analyzed to increase collection more quickly to

be able to capitalize on re-investment.

Growth focus in Southeast Asia as the emerging Asian middle class could exploit offshore

operations possibilities.

As demand increases for bigger discounts and cheaper prices which lead to lower profit

margins, focus needs to shift to supplier relationships to increase inventory turnover and

potentially help to share costs in the future.

To support international expansion, McLean would benefit by having a more dynamic

management structure focused on exploiting growth potential which would result in

further value creation and ROI for shareholders.

With expansion into the Asian pacific market, franchising could be a potential opportunity

for increasing profits and market share.

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Final Remarks

The trends of health and nutrition are driving consumer spending resulting in increasing demand.

Future growth and profitability depend on McLean’s adaptation of business strategy and on

product innovation, effective merchandising, and competitive pricing. The benefits of increasing

in scale could be to gain advantages in purchasing, distribution, finance, and marketing. However,

focus should remain on providing superior customer service, offering unique products, serving a

local market, and further leveraging online sales. McLean will need to adapt to lower margins in

the future, and should review its cost structure to protect its current margins which are currently

better than industry average. However, with continuous pressure on the Australian dollar and

the increasing cost in goods, McLean will have to prepare a future of lean operations to continue

increasing its sales growth and market share to compete as the industry loses its borders.

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Reference

Collier, P. M. 2012, Accounting for Managers: Interpreting accounting information for decision-making. 4th edition. Chichester: John Wiley.

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Bibliography

Euromonitor International 2013, Vitamins and Dietary Supplements in Australia, Country Report, viewed 3 April 2014, http://www.euromonitor.com/vitamins-and-dietary-supplements-in-australia/report

Reader’s Digest 2013, Australia’s Most Trusted Brands 2009-2013, viewed 3 April 2014, http://www.readersdigest.com.au/australias-most-trusted-brands

Roy Morgan 2012, Vitamin market in Australia looking healthy with 7 million customers,

Roy Morgan Research, Press Release, viewed 3 April 2014, http://www.roymorgan.com/findings/finding-1738-201304290027

Rourke, Alison 2013, Vitamins Take Australia, The Guardian, viewed 3 April 2014, http://www.theguardian.com/world/2013/jun/11/vitamins-take-australia-hollywood-names

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INCOME STATEMENT

2013 2012 2011 2010 2009

Sales 790,000 710,000 650,000 610,000 570,000

Cost of sales 25.0% 24.0% 24.0% 23.0% 22.0%

Cost of sales 197,500

170,400

156,000

140,300

125,400

Gross profit 592,500

539,600

494,000

469,700

444,600

Selling & admin expenses 418,000

420,000

410,000

360,000

340,000

Net Profit before interest & tax 174,500

119,600

84,000

109,700

104,600

Interest expense 62,500

51,106

50,000

45,000

45,000

Net profit before tax 112,000

68,494

34,000

64,700

59,600

Less income tax 33,600

20,548

10,200

19,410

17,880

Net profit after tax 78,400

47,946

23,800

45,290

41,720

Less dividend paid 31,360

19,178

9,520

18,116

16,688

Retained profits 47,040

28,767

14,280

27,174

25,032

McLean Ltd.

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STATEMENT OF FINANCIAL POSITION 2013 2012 2011 2010 2009

Current Assets

Cash 91,032

166,147

142,120

139,216

126,322

Receivables 118,000

120,000

120,000

115,000

110,000

Inventories 70,000

65,000

63,000

70,000

60,000

Total current assets 279,032

351,147

325,120

324,216

296,322

Non-Current Assets

Property, plant & equipment 1,262,261

1,113,166

1,095,366

1,016,990

1,004,710

Intangibles 300,000

200,000

200,000

200,000

200,000

Total non-current assets 1,562,261

1,313,166

1,295,366

1,216,990

1,204,710

Total assets 1,841,293

1,664,313

1,620,486

1,541,206

1,501,032

Current Liabilities

Payables 50,000

49,000

50,000

45,000

42,000

Provisions 50,000

40,000

40,000

30,000

30,000

Total current liabilities 100,000

89,000

90,000

75,000

72,000

Non-current liabilities

Long-term debt 625,000

511,060

500,000

450,000

450,000

Provisions 80,000

75,000

70,000

70,000

60,000

Total non-current liabilities 705,000

586,060

570,000

520,000

510,000

Total liabilities 805,000

675,060

660,000

595,000

582,000

Net assets 1,036,293

989,253

960,486

946,206

919,032

McLean Ltd.

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Equity 2013 2012 2011 2010 2009

Issued capital (550,000 @ $1) 550,000

550,000

550,000

550,000

550,000

Retained earnings 486,293

439,253

410,486

396,206

369,032

Total equity 1,036,293

989,253

960,486

946,206

919,032

Number of shares 550,000

550,000

550,000

550,000

550,000

Market value per share $1.25

$1.20

$0.85

$0.80

$0.65

McLean Ltd.

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STATEMENT OF CASH FLOWS 2013 2012 2011 2010

Cash flow from operating activities

Cash receipts 792,000

710,000

645,000

605,000

Cash payments - 604,500 - 588,400 - 544,000 - 497,300

Interest paid - 62,500 - 51,106 - 50,000 - 45,000

Income tax paid - 33,600 - 20,548 - 10,200 - 19,410

Net cash from operating activities 91,400

49,946

40,800

43,290

Cash flow from investing activities

Payments for property, plant & equipment - 249,095 - 17,800 - 78,376 - 12,280

Net cash used in investing activities - 249,095 - 17,800 - 78,376 - 12,280

Cash flow from financing activities

Proceeds from borrowings 113,940 11,060 50,000 -

Dividends paid - 31,360 - 19,178 - 9,520 - 18,116

Net cash from/used in financing activities 82,580 - 8,118 40,480 - 18,116

Net increase/(decrease) in cash - 75,115 24,027

2,904

12,894

Cash at beginning of year 166,147

142,120

139,216

126,322

Cash at end of year 91,032

166,147

142,120

139,216

McLean Ltd.

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RATIOS 2013 2012 2011 2010 2009

ROI 7.6% 4.8% 2.5% 4.8% 4.5%

ROCE 10.5% 8.0% 5.8% 7.9% 7.6%

Operating margin 22.1% 16.8% 12.9% 18.0% 18.4%

Gross margin 75.0% 76.0% 76.0% 77.0% 78.0%

Overhead to sales 52.9% 59.2% 63.1% 59.0% 59.6%

Sales Growth 11.3% 9.2% 6.6% 7.0%

Working capital 279% 395% 361% 432% 412%

Acid test 209% 322% 291% 339% 328%

Gearing 37.6% 34.1% 34.2% 32.2% 32.9%

Interest cover 279% 234% 168% 244% 232%

Asset turnover 43% 43% 40% 40% 38%

Days sales outstanding

55

62

67

69

70

Inventory turn

2.8

2.6

2.5

2.0

2.1

Days purchases outstanding

92

105

117

117

122

Dividend per share

$0.057 $0.035

$0.017

$0.033

$0.030

Dividend payout ratio 40.0% 40.0% 40.0% 40.0% 40.0%

Dividend yield 4.6% 2.9% 2.0% 4.1% 4.7%

EPS

$0.143

$0.087

$0.043

$0.082

$0.076

P/E Ratio 8.8 13.8 19.6 9.7 8.6

McLean Ltd.