Laurence Fricker – Class Group 10

Mothercare plc: Performance Report

Laurence Fricker
201706103
Class Group 10
Laurence Fricker – Class Group 10

Introduction to the Company

Mothercare plc has experienced turbulent times between 2010 and 2017. Between 2010
and 2011 the firm made a healthy profit and return on equity was on-par with industry
standard. However, a collapse of gross margin in 2012 and a spike in operating expenses
saw Mothercare lose profitability, net assets also plunged during this time. However, since
2014 Mothercare has been able to make a recover to the point they have returned to
profitability and industry standard return on equity and operating margin.

Performance in the early years and problem years including causes of problems

Performance in the very early years (2010 – 2011) was generally strong although nothing
spectacular. Profitability was high although we cannot compare this to industry standard. We
can instead look at return on equity which was industry standard, nothing to be concerned
about. Operating margin was slightly below industry average even in Mothercare’s strongest
period. 2012 saw a drastic decline in profitability and the company didn’t return to
profitability until 2016.

2009 – 2011 was a period of relative strength, net assets were strong as was the firms income,
however even in 2011 we can see forewarnings of decline, net cash flow fell quite
significantly in 2011, in large part due to cashflow from operating activities. Cashflow from
operating activities, fell even further between 2012 and 2015. Indicating this as a cause of
some of the firms problems. Financial leverage was at its lowest in 2009, however
Mothercare’s financial leverage was still above the ideal level1.

One of the largest changes seen in 2012 is the increase in the differential between gross profit
and operating profit. This is indicative of a large spike in operating expenses, we also see this
reflected in the operating margin graph where Mothercare’s operating margin feel even
further from the industry average and into negative territory. We also see net assets have
fallen in the years of decline as liabilities (in particular, short term liabilities) have risen
sharply while total assets have also declined. In particular, we see a fall in total non-current
assets. While the exact reasons for this fall are unknown, it could potentially be attributed to
depreciation of equipment or buildings. Sales revenue actually increased in 2012 when
profitability collapsed and although cost of sales did rise, leading to a decline in gross profit,
this alone cannot be identified as the main problem. In fact, while the decline in operating
margin is likely the main source of issues for Mothercare, the issue is a complex one because
the firm experienced diminishing health in numerous areas for example, declining of net
assets as mentioned above.

Another concerning ratio of Mothercare is the drastic decline of interest coverage, initially
starting at a healthy level2 of 106.002, this dropped significantly from 2009 to 2012 when it
reached a low of -79.15, although it recovered after 2012 it still remained at below ideal (and
sustainable) levels. Another cause of the problems for Mothercare.

It is clear given the industry comparison graphs that this decline has been quite specific to
Mothercare. Nonetheless, the graphs of Mothercare and its competitors do show an industry

1
https://www.investopedia.com/articles/investing/080113/understanding-leverage-ratios.asp
2
https://www.investopedia.com/ask/answers/121814/what-good-interest-coverage-ratio.asp
Laurence Fricker – Class Group 10

wide decline (falling ROE and operating margins) however, none of the competitors
experienced the same level of turbulence as Mothercare.

Road to recovery

Mothercare’s recovery can be attributed to changes implemented by Mothercare between

2012 and 2015 these changes were financed in numerous ways, one of which was leveraging
the firm to raise cash, this is reflected in the sharp increase in the financial leverage of the
firm. Moreover, total liabilities also increased during the recovery period, likely because
Mothercare has taken out loans to fund its recovery and implement changes which is why the
financial leverage of the firm has increased from 1.93 to 19.74.

Moreover, there is a drop in total assets because of a selloff by Mothercare, this could have
taken place for two reasons: either they were selling unprofitable parts of the business to help
return to profitability or they were selling parts of the business to raise cash in order to make
the necessary changes to the business. Given the increasing use of online services in the retail
industry and the appointment of a new CEO in 2014, potentially this selloff has been to
prioritise the online business and significant investment was needed to shift the business in a
new direction.

Mothercare’s recovery started, on some levels, in 2012. Operating margin recovered in part
in 2013 and hence we saw a drastic improvement in Profit / Loss for the Year from -91.8 to -
22. However, the more extensive changes did not come into effect until a few years later.

Investors will not have reacted well to many of the changes especially the increase in risk
taken by the company when leveraging up the firm, as it puts share capital at much higher
risk from even small downturns. While this figure is still above ideal levels in 2017 investors
will be relieved to find out that the changes implemented and the risk undertaken by the firm
seem to have paid off in the short run although there are still problems faced by Mothercare
which are discussed below.

Future problems

One future problem that Mothercare is potentially at risk to its high financial leverage,
although in 2017 it has recovered from 19.74 in 2014 to 4.26, this still represents a
significant risk to the investors in the business and so the business is exposed to industry
and economic wide downturns should they materialise at some point in the future.

Secondly, we have seen slowly deteriorating efficiency ratios, these will need to be
improved if Mothercare is to remain profitable and challenge competitors in the market. For
example, Days inventory has increased from 47.26 in 2009 to 61.1 in 2017 not only does this
represent higher operating costs in the form of warehousing fees but it is also indicative of a
more serious problem: loss of sales revenue. Despite improvements in profitability, sales
revenue has fallen from 766.4 to 667 hence although Mothercare has been able to recover
its operating margin to industry standard it still needs to improve sales revenue as the
current trend is alarming.

In addition, very little cash was held in 2016 and 2017, this lack of liquidity represents
numerous problems moving forward including worsening credit ratings which are important
Laurence Fricker – Class Group 10

if Mothercare needs to borrow further cash at a future date. Moreover, liquidity issues feed
through to the competitive advantage of the firms as they may be restricted and unable to
implement strategies to improve the business if they are short on cash.