Sainsburys valuation analysis using the models of dividend growth and cash flow - Essay Example

?Topic: Evaluate Sainsbury grocery retailers using two valuation models: The purpose of this report is to Sainsbury's valuation analysis using the models of dividend growth and cash flow. This information is taken from the annual report of the Sainsbury grocery retailer. Sainsbury plc is the parent company of Sainsbury's Supermarkets Ltd, generally known as Sainsbury's, the third biggest chain of supermarkets in the U.K with a share of 16.5 per cent in the UK supermarket division. The group's headquarter is in the Sainsbury's Store Supporting Centre in Holborn Circus, City of London. The company also has interests in banking and property. A.First valuation model is: Forecast dividend growth using financial statement information to arrive at the forecast or to adjust and validate a forecast based on historical trend data. A dividend is a payment of part of the company’s profit to shareholders. The Board of directors have agreed to pay its shareholders a final dividend of 10.8 percent per share (2009/10: 10.2 pence), which was paid on 15 July 2011 to shareholders on the Register of Members at the close of business. The dividend is covered by the underlying earnings. Dividend will increase only if the shares are high. Sainsbury’s has increased its market share in a crucial economic environment. The grocery has concentrated more on the supermarket sale. Net profit is increasing which means there is higher sale through good sales forecaste without increasing the cost. From the financial statement it is clear that the business is able to maintain a dividend payment and the dividend per share is increasing yearly from 7.8 %- 8%. This shows that the dividend paying by the company to its shareholders is increasing. The earning per share has also increased tremendously. The business can take a good place in the market by increasing the shares. The company’s profit and sale is increasing without increase in the cost. The share price also shown a good figure which shows that they can pay the dividend without any risk. There was a 6.3 % change in the full year dividend per share when compared the years 2009 & 2010. The dividend per share was 14.2p in 2009-2010, whereas in 2010-2011, it increases to 15.1p. (Note: The above informations are gathered from the financial statement of the company) Dividend       2011 2010 Amounts recognized as distributions to equity holders in the year: 10.2 9.6 Final dividend of prior financial year 4.3 4 Interim dividend of current financial year 14.5 13.6 After the balance sheet date, a final dividend of 10.80 pence per share (2010: 10.20 pence per share) was proposed by the Directors in respect of the 52 weeks to 19 March 2011, resulting in a total final proposed dividend of ?201 million (2010: ?189 million). The proposed final dividend has not been included as a liability at 19 March. Return to shareholders underpinning performance in the year was a 2.3 per cent rise in like-for-like sales (including VAT and excluding fuel). This is the sixth consecutive year of growth which has enabled the Company to maintain a good level of shareholder returns. The recommended full year dividend of 15.1p is 6.3 per cent higher than the previous year. http://annualreport2011.j-sainsbury.co.uk/downloads/pdf/sainsburys_ar11_note_10_dividend.pdf The business needs the following: Accurate and timely dividend information enhanced by option market prices A dividend staff steeped in option experience Empirical studies of the forecasting effectiveness The dividend-price ratio changes over time due to deviation in expected returns and in forecasts of dividend growth. The company needs to change the dividend-price ratio to cut off the fluctuations that are due to variation in expected returns from those of varying forecasts of dividend growth. The company has to propose a simple process for expected returns and an even simpler, yet reasonable, for investor forecasts of dividend growth rates. Once again, it has been a challenging but successful year for Sainsbury’s. Among a tough consumer environment and a highly competitive market place, the Company has delivered another year of strong performance, increasing both its customer base and market share. Under the qualified leadership team, sustained growth across a range of key financial indicators has been achieved. B. Second valuation model: Forecast free cash flow: Cash flows record the movement of cash into and out of the business. This is a valid method to understand the value of money and it helps to record the cash most efficiently. For this, both operating and investing activity are involved. A cash flow forecast, in order to be useful as a management and control tool, must be based on real data and actual commitment. Historical data on which to support a cash flow forecast will be useful, but must be considered in combination with information from your business strategy and your budget in order to project a reasonable picture of what to expect in terms of future cash flows as you move further.  A cash flow forecast should be considered as an essential part of an overall financial planning. And there should be equality between historical financial reports and budgets and forecasts. The financial presentations will be comparable, and used to describe, evaluate and manage the operation of business. Cash Flow Forecasting is a relatively easy technique for checking the feasibility of a project. These are good techniques for taking decisions involving relatively small amounts of money. Where large sums are involved, project evaluation can become an extremely complex and sophisticated art, which uses more formal techniques. The Cash Flow Forecast is the most significant part of accounts preparation, be it Cash Flow Forecast & Management Accounts, the accounts organized by a company for internal management utilize, or accounts arranged for a lender, for instance a bank to assess how you will be able to repay the funding. Where the Profit & Loss Account and the Balance Sheet are mainly prepared for the ‘actual’ yearend figures for submission to industries House, the Cash Flow Forecast desires to be, some say, pessimistic as to the sales figure and costs. The direct method of cash flow forecasting schedules the industries and disbursements (R&D) and cash receipts. Receipts are chiefly the collection of accounts receivable from current sales, other than also contain proceeds of financing, sales of other assets etc. Disbursements include payroll, dividends and interest on debt, payment of accounts payable from current purchases. This direct R&D process is best suited to the short-term forecasting horizon of 30 days or so for the reason that this is the phase for which actual, rather than projected, data is obtainable. The three indirect methods are founded on the company’s projected balance sheets and income statements. The adjusted net income method creates with operating income and subtracts or adds changes in balance sheet accounts for instance payables, receivables and inventories to project cash flow. The pro-forma balance sheet system looks directly at the projected book cash account; if every the additional balance sheet accounts have been properly forecast, cash will be accurate, too. The cash flows of the company can be classified into the following: Cash flows from operating activities includes Cash generated from operations, Interest paid, Corporation tax paid Cash flows from investing activities includes Purchase of property, plant and equipment, Purchase of intangible assets, Proceeds from disposal of property, plant and equipment, Acquisition of and investment in subsidiaries, net of cash acquired, Investment in joint ventures, Investment in financial assets, Interest and Dividend received. Cash flows from financing activities includes Proceeds from issuance of ordinary shares, Repayment of short-term borrowings, Proceeds from long-term borrowings, Repayment of long-term borrowings, Repayment of capital element of obligation under finance lease payments, Interest elements of obligations under finance lease payments and dividends paid. Sainsbury’s cash flows show a year-on-year increase. This increase was driven primarily by the accelerated estate development, partially funded by sale and leasebacks, and the increase in working capital. Working capital increased, mainly due to increased inventories, with higher levels of non-food stock to support sales growth and an increase in the level of goods-in-transit, driven by increased direct sourcing operations. A Forecaste of cash flows Summary of cash flow statement for the year 2012 PARTICULARS RS. Operating cash flow before changes in   working capital 1300 (Increase)/decrease in working capital 85 Cash generated from operations 1385 Interest paid -110 Corporation tax paid -140 Net cash from operating activities 1135 Net cash used in investing activities -890 Proceeds from issue of shares 200 Proceeds from borrowings 32 Repayment of borrowings -75 Dividends paid -245 (Decrease)/increase in cash and   cash equivalents 157 Increase/(decrease) in debt 85 Fair value and other non-cash movements -3 Movement in net debt 239 With the implementation of more grocery items and good forecast of sales, Sainsbury can excel in the market. The company is poised to experience large, permanent cash flow increases after four years of cash flow, which tends to boost their dividends before their cash flow jumps. These firms also have a high frequency of relatively large dividend increases proceeding to the cash flow. Investors appear to interpret the dividend changes as signals about future profitability: Firms that penetratingly increase their dividends earn large market-adjusted stock returns in the year before their cash flow rises. This direct link between positive cash flow shocks, dividend decisions, and dividend changes signal positive information about permanent future cash flow levels. Sainsbury's currently operates 872 hypermarkets, supermarkets and convenience stores. It also operates Sainsbury’s Bank which sells financial services, and is a joint venture with Lloyds Banking Group; Sainsbury's Online internet shopping services; and has a property portfolio worth ?8.6 billion (as of March 2007). Sainsbury's now has more than 1000 stores across the UK. It is the third largest supermarket chain in the UK (since 2009), and places an emphasis on a higher quality grocery offering compared to its other large rivals. Sainsbury's market share was 16.4% compared to Tesco's 31.5%, Asda's 16.7% and Morrison's 11.4%. This shows that the company can pay the dividend at the right time to the shareholders as there is an increase in the sales and can plan the cash flows without any risk. Part B: compare the valuations with the actual market value of the company: Dividend growth method and forecast free cash flow are the important validations. Dividend growth is a method of calculating the cost of common stock equity that signifies the rate of return that ordinary shareholders suppose to earn in the form of dividends on an organization’s common stock. It is necessary so as to utilize the dividend discount model, which is a safe pricing model that supposes that a stock's price is influenced by the predictable future dividends, discounted by the excess of internal increase over the firm's probable dividend growth rate. It is an imbursement of division of the company’s profit to shareholders. The Board of directors have decided to pay its shareholders a final dividend of 10.8%, which was paid on 15 July 2011 to shareholders on the Register of Members at the close of business. In the case of Sainsbury grocery retailers, dividend increased its market share in a crucial financial environment. The Directors advised the payment of a closing dividend of 10.8%, making a total dividend for the year of 15.1%, a raise of 6.3% over the previous year. Subject to shareholders approving this recommendation at the Annual General Meeting, the dividend will be paid on 15 July 2011 to investors on the register at the close of business. The dividend yield is the connection among the dividend and the share price. This method is more suitable to customers of minority stakes in an organization because minorities obtain dividends and have no admission to earnings. Once more, one would observe the dividend yields of listed industries and discard those that were out of line. Here, Sainsbury might be considered as being uncharacteristic of supermarkets usually. If that is lost the average dividend yield of this sector looks to be about 4%. Therefore: Dividend *100 divided by the Share value = 4% 50,000 *100 divided by the Share value = 4% Share value = 50,000 * 100/4 = $1,250,000. Once more, this would be an opening position for negotiation, and thought would require to be given to the consistency of future dividends. The share value $1,250,000 would have to be decreased for two effects: • Minority holdings are fewer attractive than majority holdings. • Unquoted industries are less attractive to shareholders than quoted organizations. Free cash flow is the cash that runs through a company throughout a quarter or a year once every cash values have been taken out. Free cash flow signifies the real amount of cash that an industry has left from its procedures that could be used to follow opportunities that develop shareholder value, for instance, increasing new products, paying dividends to shareholders or doing share buybacks. A quantify of financial performance computed as operating cash flow less capital expenditures. It represents the cash that an organization is able to make after laying out the money necessary to keep or expand its asset base. Free cash flow is significant for the reason that it permits a company to follow opportunities that develop shareholder value. With no cash, it's tough to increase new products, pay dividends, make acquisitions and decrease debt. FCF is calculated as: EBIT + Amortization & Depreciation - Change in Net Working Capital - Capital expenses. Sainsbury’s cash flows show a year-on-year raise and this increase was driven chiefly by the accelerated estate growth, moderately funded by leasebacks and sale, and the increase in working capital. Working capital increased, mostly due to improved inventories, with high levels of non-food stock to sustain sales growth and a raise in the level of goods-in-transit, driven by increased in direct sourcing process. The dividend valuation model suggests that the market value of a share is supported by the present value of future dividends. Statistics of the company valued: Dividend divided by share just paid = 12c Historical dividend growth rate = 5% divided by the year. This is estimated to be insisted in the future. Statistics of a appropriate listed company’s Share price = $2.40 and Dividend just paid = 22c. So the historical dividend growth rate = 10% divided by the year. This is estimated to be maintained in the future. Part c: Advantages and disadvantages of each of the two Methods: 1. The cash flow-based approaches calculate the expected distribution of wealth by the business to its investors. In contrast, dividend growth method provides the cost of common stock equity that signifies the rate of return that ordinary shareholders suppose to earn in the form of dividends on an organization’s common stock. 2. The dividend growth model shows that the approximation of intrinsic value can be divided into net assets in place and super earnings. Expectations of future abnormal earnings have to be driven by attitudes regarding the nature and likely life span of the company’s competitive advantage. Therefore, this model gives a mechanism for the straight integration of attitudes about competitive advantage. In contrast to cash flow models, the RIM treats savings as part of book value and states that investments make zero residual incomes and therefore have no effect on value computed. Additionally, residual income is not influenced by dividends; share repurchases and share issues, so utilizing the RIM yields evaluations that are not sensitive to these value irrelevant dealings with investors when there are no market imperfections. 3. The cash flow-based models can lead to inaccurate estimates of intrinsic value, since they are wholly dependent upon forecasts that are uncertain. In contrast, because a significant proportion of the estimate of the fundamental value given by the RI model is embedded within the observable accounting book value, this approach is only partially dependent upon forecasts. Thus, there is less scope for error in the estimate arising from error in the forecasts. 4. Unlike the cash flow methods that do not calculate value added in the short-run, the residual income model utilizes accrual accounting which captures value earlier than cash flows and equal value added to value given up. Additionally, it can be utilized with a broad mixture of accounting values as long as income is calculated on a comprehensive basis. The purpose of forecast based models is inclined to rely upon explicit forecasts able to a medium-term horizon, in addition an estimation of the cost of the post-horizon flows, which symbolizes the main part of the inherent value estimate. These methods are very responsive to terminal values, which frequently account for excess of 50% of the valuation of Sainsbury. In contrast, the percentage of the intrinsic value approximation that relies on forecasts is lesser for the dividend growth model than for cash flow models due to the addition of book value Conclusion: The dividend growth method is by no means the end-all and be-all for valuation. It is said that learning regarding the dividend growth method does encourage thinking. It forces shareholders to assess different assumptions concerning development and future prospects. If nothing else, the dividend growth method demonstrates the fundamental principle that the industry is worth the sum of its discounted future cash flows. The challenge is to create the model as appropriate to reality as probable, which means using the most dependable assumption that is accessible. Read More