Join our community of smart investors

How to check out a company's revenues

Understanding a company's revenues is one of the most important parts of researching a business. Here we look at what you can learn by taking a closer look
April 30, 2020

Companies generate revenues (or sales) from selling goods and services and don’t survive and prosper without them. But not all revenues are the same. Being able to understand the nature of revenues is a very important part of researching a company. Here we will take a look at the things you need to pay attention to and what you can learn from them.

 

Revenues are all important

Without revenues a company cannot make a profit. If a company cannot grow its revenues – and profits – then it is unlikely to be able to  grow in value and be of much interest to investors looking to increase the value of their savings.

How a company generates and grows its revenues is very important. Some sources of revenue growth are more valuable than others. Being able to identify the make-up and trends in a company’s revenue is a vital part of the process of identifying good companies and staying away from bad ones.

 

Start with the basics

You should always try to keep things as simple as you can. When it comes to revenues start with looking at where a company gets its revenues from. Is it reliant on one product or service or from one particular country? Some companies are very simple in that they sell the same products in one country. Others have lots of different revenue sources in different countries.

If you can, look at how the mix of a company’s revenues has changed over time. Look to see if it is stable, or whether one line of business has become more significant. Changes in mix can be a good way to spot changes in business quality. It can show you the impact that the growth or decline of a revenue source has had on the company as a whole.

For example, the rapid growth of Microsoft’s cloud computing business has seen it become a very significant part of its total revenues in the past few years. This is currently seen as a good thing, but if something came along that was better than cloud computing then having such a large chunk of revenues coming from one source might be viewed as a problem.

Take time to understand what form the revenues take. Are they based on subscriptions or contracts, which makes them more secure and predictable. Or do they come from single purchases, which can be put off when the economy turns down. Also try to work out whether the goods and services are necessities or luxuries, and whether they cost small or large amounts of money. This can have a big impact on how resilient revenues will be in a downturn.

For example, people tend to buy essential, inexpensive items such as food and drink items very frequently, but more expensive and less essential things such as a holiday or a new kitchen much less often. This makes the revenues of food producers and supermarkets more resilient than a travel agent or kitchen seller.

Another important thing to consider is who the paying customers are. For example, is a good or service bought by a particular type of consumer or business or even governments?  Some products are sold primarily to younger or older people, or may be a branded good that has lots of customer loyalty. Governments may be the main buyers, which may limit the chance of bad debts.

 

Organic or like-for-like sales

The best and most valuable form of revenues are when they come from a company’s existing assets. Selling more from what it already has means that the company generally does not have to spend a lot more money to make more money.

Many companies tell you how they are doing on this basis by reporting organic sales or like-for-like (LFL) sales.

A company that can consistently generate LFL sales or organic sales growth is usually a sign that it has high quality and robust revenues. This measure of revenue performance is closely watched by investors and share prices can move significantly on the back of changing trends in it. One company that has been very good at generating LFL sales growth over the past decade is Howden Joinery (HWDN), which sells kitchens in the UK.

 

LFL sales fell in the 2008-09 recession, which shows that the business is sensitive to the ups and downs of the economy, as people tend not to buy kitchens when times get tougher. Since then, the company has grown its LFL sales every year.

 

LFL sales and the maturation effect

Consistent growth in LFL sales is usually seen as being a good thing, but you do need to be a little bit careful in interpreting it nonetheless. This is due to something known as a sales maturation effect, which explains that new stores can grow for quite a long time – sometimes many years – before they reach their potential level of revenues.

Definitions of LFL sales vary, but they commonly exclude stores that have been open for less than a year. Howden excludes new depots open in a current and previous year when disclosing its LFL sales.

Howdens’ depots (the business trades under the name Howdens) can take seven years to mature, which means that a new one will not be included in LFL sales in its first year, but might contribute to rising LFL sales for the following five or so years as it goes through its maturation phase. 

Don’t get me wrong, there’s nothing wrong with this as rising sales tend to be good news for investors, but there is a difference between comparing a business with rising LFL sales and a strong maturation effect with one where there isn’t.

When you come across a business where a maturation effect exists you might want to look at other measures of sales effectiveness, such as sales per store (or depot in Howden Joinery’s case) or sales per square foot of selling space.

We can see the significant number of new depots that Howdens has been opening up over the years, which have been maturing and boosting LFL sales. What’s encouraging to see is that over the past few years, sales per depot has been going up after dropping for a while.

Estimating the sources of revenue growth

If a store or outlet-based business gives an LFL sales figure then it is possible to get an estimate (depending on how LFL sales are defined) of the actual contribution to the change in sales from year to year from LFL sales and net new openings (openings less closures). 

To do this, you first calculate the change in sales for the year. Then take last year’s revenue number and apply the LFL growth figure to it to get the contribution and then take this number away from the total change in revenues to get the contribution from net new openings.

 

Howden UK depots: Revenues from LFL growth and new openings

Year

Change in sales £m

Sales base £m

LFL %

LFL £m

New openings £m

2008

14.5

768.4

-3.1%

-23.8

38.3

2009

-26.5

782.9

-4.6%

-36.0

9.5

2010

38.7

756.4

3.6%

27.2

11.5

2011

43.6

795.1

3.1%

24.6

19.0

2012

33.8

838.7

1.9%

15.9

17.9

2013

68.2

872.5

5.6%

48.9

19.3

2014

134.8

940.7

10.8%

101.6

33.2

2015

128.3

1075.5

9.2%

98.9

29.4

2016

77.9

1203.8

4.2%

50.6

27.3

2017

90.3

1281.7

5.2%

66.6

23.7

2018

105.3

1372

6.3%

86.4

18.9

2019

73

1477.3

2.5%

36.9

36.1

Source: Howden Joinery/Investors Chronicle

 

This estimate will not work perfectly in Howdens’ case as new depots from the current and previous year are excluded from LFL sales. I have performed the exercise anyway just as an illustration as it is still possible to get a feel for what might be going on.

We can see that in recent years most of Howdens’ sales growth has come from LFL sales. New openings have contributed a much lower amount.

 

When LFL sales go bad – sales cannibalisation

A slowdown in the rate of LFL sales growth is often the sign of trouble ahead. Sometimes it is just due to the maturation of a business that has reached its natural limit of sales. It can also be a sign of a company that has overreached itself and has started competing against itself.

This often occurs in retailing when a company opens up lots of new stores too close to some of its existing ones. What then happens is that the new stores take sales away from the existing ones in a process known as sales cannibalisation.

This is what has been happening at Domino’s Pizza (DOM) in recent years. In order to try to keep on selling more pizza ingredients (where Domino’s makes most of its money) it has been attempting to get its franchisees to open new stores close to existing ones in a strategy called splitting territories. What this means is that where there was previously one or two Domino’s Pizza stores there are now two or three or more.

 

Effect of splitting territories on Domino’s Pizza UK LFL sales

UK System Sales (£m)

2019

2018

2017

2016

2015

Previous year

1091.5

1019.3

938.7

825

706.4

Mature Stores

36.9

37

38

79.1

81.1

New Stores

8.5

19.1

32

26

19

Immature stores

23.5

39.1

32

27.7

19.3

Effect of Splits

-16.6

-23

-21.4

-18.3

0

Closed Stores

0

0

0

-0.7

-0.8

Total System Sales

1143.8

1091.5

1019.3

938.8

825

LFL ex splits %

3.7

4.6

4.8

9.8

11.7

LFL incl Splits %

1.9

1.4

1.8

7.4

11.7

Source: Domino’s Pizza UK/Investors Chronicle

 

The effect of these splits has been to reduce the company’s LFL sales growth by a significant amount.

 

Spotting incremental changes in LFL sales

A really interesting and valuable way to analyse LFL sales is to track the incremental changes in it. Companies tend to give trading updates throughout the year and disclose the LFL sales for a period of time, such as the first 10 weeks or from weeks 36 to 47, as well as at half-year and full-year results.

You can use these numbers to get extra information as to the current rate of LFL growth between reporting dates and to see if the trend is rising or falling. Let’s take a closer look at Howden Joinery to show you what I mean.

 

Calculating Howdens’ incremental LFL sales

Trading update

Reported LFL %

Wks x LFL %

Incremental LFL %

8   weeks

2.4

19.2

2.4

16 weeks

3.9

62.4

5.4

24 weeks (Half Year)

3.4

81.6

2.4

Weeks 24-44

2.0

40

2

44 weeks

2.8

121.6

 

52 weeks Full year)

2.5

130

1.1

Source: Howden Joinery/Investors Chronicle

 

In 2019, the company gave trading updates for its first eight and 16 trading weeks and then for 24 weeks at its half-year results. It then gave an update for the period between weeks 24 and 44 (but not a year-to-date figure) and then at its full-year results.

For the first eight weeks we multiply the weeks by the LFL sales (8 x 2.4) to get 19.2. At 16 weeks we do the same (3.9 x 16). However we can work out what was happening to LFL sales between weeks eight and 16 by taking 19.6 from 62.4 to get 42.8 and then dividing by eight. This shows an acceleration in growth to 5.4 per cent. We then get the half-year results, which show that the next eight weeks saw a slowdown to 2.4 per cent growth.

Then it gets a little bit trickier as the company then gave a trading update for the next 20 weeks from the half-year with LFL sales growth of 2 per cent. This is an incremental growth rate and shows the business continuing to slow. To get the year-to-date growth we add the cumulative growth (2 x 20=40) to the half-year and get 121.6, which we then divide by 44 to get year-to-date LFL growth of 2.8 per cent.

The full-year results allow us to calculate the LFL sales growth for the past eight weeks, which showed growth of just 1.1 per cent, representing a further slowdown and probably some cause for concern.

 

The relationship between volumes and price

Company revenues are the sum of how much they sell (volume) and the price they sell it for. Sales growth therefore comes from selling more, increasing prices or a combination of the two.

Ideally, you want a combination of the two. A company that is just growing from increasing prices can be a sign of a business that has run out of growth and the higher prices could attract competition.

Many companies won’t tell you how much of their sales growth was driven by volume and price, but some do and this is very useful information. One company that does is consumer goods giant Unilever (ULVR).

 

Unilever sales growth: price vs volume

Unilever sales growth %

Volume

Price

Total

2019

1.2

1.6

2.8

2018

2.1

1

3.1

2017

1

2.4

3.4

2016

0.9

2.8

3.7

2015

1.9

2.9

4.8

Source: Unilever

 

We can see here that over the past few years most of Unilever’s underlying sales growth has come from putting up prices rather than selling more stuff. Some might say that it is good to see that the company has some ability to put up prices. Others might say that it is a business with weak volume growth because its prices are too high.

 

Seasonality of revenues

Many businesses have peaks and troughs in revenues throughout the year and the differences between them can be quite big. For example, many retailers will see a large proportion of their annual revenues at Christmas. Travel companies will see the bulk of their revenues between March and September and pubs tend to sell more drinks in the summer.

A good or bad seasonal sales performance can therefore have a big impact on the company’s performance for the year as a whole and it’s important to be aware of this.

 

Seasonal revenues

£m

H1

H2

Total

H1 %

H2 %

Dart Group

2247

896

3143

71%

29%

Howden Joinery

653

931

1584

41%

59%

Hotel Chocolat

81

52

133

61%

39%

Morrisons

8831

8705

17536

50%

50%

National Express

1334

1410

2744

49%

51%

Source: Company Reports/Investors Chronicle

 

We can see here that Dart Group (DTG), Howden Joinery and Hotel Chocolat (HOTC) have a significant seasonal bias to their revenues, whereas Morrisons (MRW) and National Express (NEX) have a more even split between the first and second halves of their financial years.

 

Growing revenues by investing more

As well as growing revenues from existing assets, a company can invest in new ones – such as opening more stores and entering new markets – or buy revenues by buying other companies. 

This can be a good thing if the extra revenues bring in a healthy amount of extra profits compared to the money invested. One of the best ways to look at the effectiveness of investment on revenues is to compare revenues with the amount of money invested in the business (or capital employed. We do this by calculating a company’s capital turnover ratio:

This ratio tells us the amount of revenue a company generates for each £1 invested in the business.

We can see here that Howden is not as good as it was at generating revenues from its investments. Back in 2010, £1 of investment generated around £3.40 in revenues. In 2019, it only generated around £2.30. There can be valid reasons for this such as lots of depots that are still maturing or it might be a sign that investment is more costly and not as effective as it once was. If the revenues generated are producing higher profit margins (which they are in Howden’s case) then the company can still make very good returns on investment.

 

Selling goods and services on credit

Many companies offer credit to their customers in order to generate revenues. There is nothing wrong with this as long as the company doesn’t offer too much credit to customers who can’t pay it back. 

Trade receivables on a company’s balance sheet tell you the amount of a company’s revenues that have not been paid at the balance sheet date. By comparing this number with total revenues you can see how reliant on credit a business is and see how it has changed over time.

Howden typically offers its customers eight weeks’ credit on their bills. However, its ratio of trade receivables to revenues has been remarkably steady over the past decade, which is a good sign.

Buried in the notes to Howden’s financial statements there is a detailed disclosure on its trade receivables. In particular you can see the amount of them that have been written off as bad debts and also how many of them are overdue.

We can see here that bad debts are low as a percentage of gross receivables and around half of what they peaked at in the last recession in 2009. The absolute level of bad debt has also been very stable, which is good to see.

 

Howden Joinery: bad debts and overdue debts

£m

Gross receivables

Bad debts

Trade receivables net

o/due receivables

Bad debts %

o/due %

2019

159.7

11.4

148.3

27.7

7.1%

18.7%

2018

156.5

11.3

145.2

25.8

7.2%

17.8%

2017

113.7

9.9

103.8

24.1

8.7%

23.2%

2016

107.9

8.7

99.2

18.9

8.1%

19.1%

2015

105.4

8.3

97.1

19.4

7.9%

20.0%

2014

110.2

7.3

102.9

16.5

6.6%

16.0%

2013

103.1

6.8

96.3

13

6.6%

13.5%

2012

79.3

8.1

71.2

13.6

10.2%

19.1%

2011

81.7

8.7

73

14.2

10.6%

19.5%

2010

78.1

9.2

68.9

15.1

11.8%

21.9%

2009

76.3

10.9

65.4

17.9

14.3%

27.4%

2008

87.8

10.2

77.6

21.6

11.6%

27.8%

2007

121.9

18.2

103.7

18.2

14.9%

17.6%

Source: Annual Reports/Investors Chronicle

 

What’s interesting is that the amount of overdue receivables has been increasing. In 2017, they were close to levels seen in the last recession as a percentage of net receivables and had increased significantly. They have since come down. Looking at how overdue receivables are tells us that just under half (£13.2m) were less than 30 days overdue. The longer receivables are overdue, the more likely that they are to turn into bad debts.