Myer Holding Ltd Forecasting Assumptions - Case Study Example

Myer Holding Ltd. Myer Holding Ltd. Introduction Myer Holdings Ltd. operates a leading chain of retailstores in Australia. The company has 65 stores under the brand of “Myer”. The retail stores of the company sell all types of household, food, clothing, and accessories item. The company’s stock symbol is MYR.AX that is listed on the Australian Stock Exchange 200 (ASX 200). In the last one year, the company’s stock price has fallen from $2.22 to $1.56 (as of May 15, 2015). It peaked at $2.50 with a low of $1.29. In this report, two different methods of stock valuation are implemented to determine the intrinsic value per share. These methods include Dividend Growth Model (DGM) and Discounted Cash Flow (DCF). In order to carry out the analysis, the company’s financial statements including balance sheet and income statement are collected from 2010 to 2014 and reformatted to calculate relevant financial figures to assist with the analysis. Figure 1: Stock Price Movement of Myer Holdings Ltd. (1-year) Stock Valuation Analysts use different valuation models to determine the intrinsic value of stocks before suggesting investment in or investment retraction from the company’s stocks. These methods are implemented in this report to determine the intrinsic value per share of Myers Holding Limited. Furthermore, an average of both values is calculated and compared with the current price of the company’s stock to make recommendation for stock holding. Forecasting Assumptions The company plans to open up new retail stores in 100 different locations nationally by the year 2020. It is expected to increase the company’s revenues. However, it has not indicated that how many stores will be opened in the next year. There is tough competition from other retails and department stores that could affect the company’s expansion plan. The degree of rivalry between competitors in Australia is becoming strong as they compete on low cost strategies to offer products to customers at low prices. It could have a negative effect on the company’s earnings. The increase in online shopping trend can have a positive effect on the company’s earnings as it has also improved it e-retailing system and inventory management. The company has taken initiatives such shrinkage reduction, reduction in markdown, and improved merchandise mix that could have positive effect on the company’s profitability. The increase in the company’s profitability will have a positive impact on the company’s free cash flows and also it could have better dividend payout ratio as compared to the historical data. Dividend Growth Model The dividend growth model is used to determine the intrinsic value of a company’ stock based on the series of dividends paid by the company in the last few periods to determine the growth rate of future dividend. The model assumes a constant growth in the value of dividend to be paid by the company in the next period. The stock value is determined using the following formula: P1 = D1/(K-g) = D0(1+g)/(K-g) P1 = Price (Intrinsic Value) D1 = Dividend at t+1 D0 = Dividend at t g = Constant growth rate (perpertual) K = Cost of equity. The following table provides the working of dividend growth model implemented for determined the price of Myer Holdings Ltd. stock in the next period. The current price of MYR.AX is $1.56. The company paid dividends every year. However, the growth rate of dividends was negative i.e. -10.40% in the last five years. The forecasted dividend for the next period is determined to be 0.14 per share (Appendix I). However, considering the forecasting assumptions including expansion of retail network, ability to compete with its others and other initiatives that the company has undertaken to improve its inventory management and sales. It could be suggested that the company will have better response from the market and therefore, an improved growth rate of dividends is estimated for the valuation purpose. Instead of the negative growth rate of 10.40% the valuation of the company’s stock is based on a better yet negative growth rate that is -5%. The cost of equity is determined by using the CAPM equation as follows. K = rf + β (rm – rf) K = Cost of equity rf = Risk free rate (rm – rf) = Market risk premium β = Beta of stock The risk free rate is determined at the rate on 10-year Australian government bond. The return on market is calculated by determining return on ASX 200 index based on its values in the last one-year period. The beta of the company’s stock is 2.13 that implies that the company’s stock price is high volatile and for one basis point change in the value of the index the stock price of Myer Holdings Ltd. changes by 2.13 basis point. It is quite significant and investors expect high returns from their holding in such stocks. However, it has not been the case for Myers’ Holding Ltd as it could be noted that the YoY% change in its stock price is approximately – 30%. It is suggestive of ‘Sell’ strategy for the investors. The intrinsic value is determined to be $0.94 per share that is less than the company’s current price of $1.56. In the case of the intrinsic value being less than the current price, it is likely that the stock price movement will be negative in the future unless the company takes positive strategic steps. It implies that the company’s stock is overpriced and investors must sell their holdings before they incur capital loss. Discounted Cash Flow Discounted cash flow method of valuation considers a series of free cash flows of the company and use the growth rate to project future cash flows. Free cash flows of Myers Holdings Ltd have been calculated from 2010 to 2014. For this purpose, three years projections have been made using the estimate growth rate of negative 5% and the terminal value of the final cash flow is determined using the following formula. Terminal Value = Last Cash Flow (1+g) / (WACC-g) Last cash flow is the reported free cash flow of the company for the year ended 2014. g = perpetual growth rate WACC = Cost of capital The weighted average cost of capital of Myer Holdings Ltd. is calculated using the following formula. WACC = D/D+E * rd(1-T) + E/E+D * re D = Total Debt E = Total Equity rd = Cost of debt T = Average tax rate of 2013 and 2014 re = Cost of equity The calculation of intrinsic value based on discounted cash flow method is provided in Appendix II. The WACC of Myer Holdings Ltd. is 7.74% based on the calculated cost of debt 3.83% and cost of equity 9.59%. The PV of future cash flows is determined to be 906,336.43 that gives per share value $1.55. The intrinsic value is almost equal to the current price of the company’s stock that is $1.56. It suggests that the investors and analysts have already estimated that the company’s initiatives as highlighted under forecasting assumptions will have a positive impact on the company’s future earnings and growth rate. The following table provides the arithmetic average of share value of the company’s stock as $1.25, which is less than the current price. It reflects that the capital market and investors will have a negative view about the company’s performance and this could push its stock price further down unless the company works on improving its earnings and pay better dividends to its shareholders to maintain their holding in the company’s stock. Arithmetic Average of Share Value Dividend Growth Model $0.94 Discounted Cash Flow Method $1.17 Average Share Value $1.06 Current Share Price $1.56 Sensitivity Analysis The sensitivity analysis considers two scenarios. The first scenario considers a positive growth rate of 1% as opposed to the negative growth rate determined through the analysis. The results are provided in Appendix III that indicates that the PV of future cash flows estimated is 1,562,701.11 and the intrinsic value of the company’s stock will be $2.67 that is higher than the current price. The second scenario considers further deteriorated negative growth rate of 20% as opposed to the negative growth rate of 10.74% determined through the analysis. The results are provided in Appendix IV that indicates that the PV of future cash flows estimated is 1,562,701.11 and the intrinsic value of the company’s stock will be $1.00 that is below the current price. Recommendation From the analysis, it could be indicated that the stock valuation of Myer Holdings Ltd. Indicates low intrinsic value derived from both DGM and DCF methods. The average value of both values is lower than the current price. In the present situation, it is recommended that investors must sell their holding in the company’s stocks to avoid capital loss. In order to improve the value of the company’s stock, the company needs to undertake strategic decisions to improve its financial performance and generate better cash flows. List of References Australian Government Bonds 2015, viewed 18 May 2015, . Myer Holdings Ltd (MYR.AX) 2015, viewed 18 May 2015, . Appendix I: Dividend Growth Model Dividend Growth Model                       Price 1.56         Sales 18,169.30         Outstanding Number of Shares 586,000.00                     Company Paying Dividend                         2010 2011 2012 2013 2014 Dividends 0.220 0.225 0.190 0.180 0.145             g -10.40%         Revised growth rate, g1 -5.00%         Po 1.56         Do 0.15         D1 0.14         K 9.59%   Rf 2.89%   P1 D1/K-g   Rm 6.04%   P1 0.94   Beta 2.13   Sources: (Australian Government Bonds 2015; Myer Holdings Ltd (MYR.AX) 2015) Appendix II: Discounted Cash Flow Method Discounted Cash Flow                                   Interest Expense 22,931               Total Debt 422,030               Total Equity 893,413               Debt + Equity 1,315,443               Tax Rate 29.52% Two-Yr Avg             Cost of Debt 3.83%               Cost of Equity 9.59%                                             1 2 3     2011 2012 2013 2014 2015f 2016f 2017f Free Cash flow   171,899.70 146,945.80 133,471.50 109,134.20 103,677.49 98,493.62 93,568.93 Terminal Value               538,860.44     171,899.70 146,945.80 133,471.50 109,134.20 103,677.49 98,493.62 632,429.38 Discount Factor           0.9281 0.8614 0.7995 PV of FCF           96,226.12 84,844.78 505,635.53 Sum of PV of FCF 686,706.43               PV of FCF per Share 1.17                                 g -5.00%                                 WACC 7.74%               Appendix III: Sensitivity Analysis – Positive Growth Discounted Cash Flow                                   Interest Expense 22,931               Total Debt 422,030               Total Equity 893,413               Debt + Equity 1,315,443               Tax Rate 29.52% Two-Yr Avg             Cost of Debt 3.83%               Cost of Equity 9.59%                                     2011 2012 2013 2014 2015f 2016f 2017f Free Cash flow   171,899.70 146,945.80 133,471.50 109,134.20 110,225.54 111,327.80 112,441.08 Terminal Value               1,634,520.72     171,899.70 146,945.80 133,471.50 109,134.20 110,225.54 111,327.80 1,746,961.79 Discount Factor           0.9281 0.8614 0.7995 PV of FCF           102,303.56 95,900.45 1,396,718.73 Sum of PV of FCF 1,594,922.75               PV of FCF per Share 2.72               g 1.00% >>>Positive Growth                             WACC 7.74%               Discounted Cash Flow                                   Interest Expense 22,931               Total Debt 422,030               Total Equity 893,413               Debt + Equity 1,315,443               Tax Rate 29.52% Two-Yr Avg             Cost of Debt 3.83%               Cost of Equity 0.00%                                     2011 2012 2013 2014 2015f 2016f 2017f Free Cash flow   171,899.70 146,945.80 133,471.50 109,134.20 103,677.49 98,493.62 93,568.93 Terminal Value               411,271.99     171,899.70 146,945.80 133,471.50 109,134.20 103,677.49 98,493.62 504,840.93 Discount Factor           0.9281 0.8614 0.7995 PV of FCF           96,226.12 84,844.78 403,626.90 Sum of PV of FCF 584,697.80               PV of FCF per Share 1.00               g -20.00% >>>Worst Growth                             WACC 1.23%               Read More