Ratio Analysis and Company Valuation - Newcrest Mining Ltd - Assignment Example

Ratio analysis and company Valuation Name Lecturer Course Date Outline Ratio Analysis Liquidity Ratio Leverage Ratio Efficiency Ratio Profitability Ratio Valuation Free Cash Flow Model Earnings Multiplier Approach Summary of valuations Conclusion and recommendation References Ratio Analysis Financial analysis is the process of evaluating businesses, projects, budgets and other finance-related documents to determine their suitability for investment. Basically, a comprehensive financial analysis is done on an institution’s financial statements to establish if an entity is stable, solvent, liquid, or profitable enough to be invested in. When looking at a specific company, financial analyst will often focus on statements of income, statement of financial position, cash flow statement and statement of changes in equities. Ratio analysis is a key technique for financial analysis. While inferring the current performance into the future, time value of money is taken into consideration. This section will analyze financial statements of Newcrest Mining Ltd using ratio analysis for the year 2008 to 2011 as compared to Magna Mining. Liquidity Ratio- Liquidity ratios are those which basically come from the Balance sheet which helps in knowing the liquidity of the particular company. This ratio is considered to be the important one in which its helps in knowing whether the company is able to match with its long term and short term obligations. The liquidity ratios show the ability of the company to maintain positive cash flow while satisfying immediate obligations, that is, the availability of cash to pay debt. The computation of these ratios will be based on the cash flows or liquid assets. They define liquid asset as those tradable in an active market and thus can be quickly converted to cash at the going market price. The most common ratios used to analyze liquidity are current and quick ratio (Eugene and Michael, 2009). Table below gives a summarized computation of the ratios. 2008 2009 2010 2011 Magna Mining Current ratio 2.722 3.374 4.315 1.887 1.24 Quick ratio 1.848 2.523 3.498 1.042 1.1 (Bloomberg BusinessWeek, 2012) From the table above, the company quick ratio 1.042 in 2011 which was lower than Magna Mining of 1.1:1. This means that Newcrest Mining Ltd covers all it current liabilities although it is lower the competitor. The current ratio for the company shows the same results although it is higher than the competitor. This determines whether the company has sufficient current assets to meet its short term current liabilities if the business is not able to generate enough cash by liquidating its current assets. The following id the trend graph of the two ratios; Leverage Ratio- The debt utilization ratio is such that which shows the exact debt of the company in relating to its assets. In this it gives an overall view of how the company actually faces with its risk in terms of debt. The following table shows the debt ratios; 2008 2009 2010 2011 Magna Mining Debt-to-total assets ratio 24.79% 22.39% 20.90% 19.71% 78.8% Debt to equity 25.24% 21.50% 19.90% 18.67% 254.5% (Bloomberg BusinessWeek, 2012) In this the debt to total assets of the company is reducing at a slow rate from 2008-20011 which shows the assets of the company is basically being financed through the equity and not through the debt but when looking on to the industry norm it is slowly increasing from 2008-2011 in which it will be facing a higher risk especially when the interest rate is increasing in the market. Debt to equity also shows the same trend and it is lower than the Magna Mining ratio in the year 2011. The following graph shows the trend for the two ratios; Efficiency Ratio- The Asset Utilization Ratios helps in knowing how good the company is able to hold on to its assets. The following table shows the debt ratios; 2008 2009 2010 2011 Magna Mining average trade receivable 4.523 3.626 4.568 3.551 Fixed asset turnover ratio 0.238 0.197 0.250 0.108 0.5 Total asset turnover ratio 0.200 0.159 0.195 0.098 0.0 average inventory 13.634 6.653 5.813 5.013 (Bloomberg BusinessWeek, 2012) The table shows that Newcrest Mining Ltd’s average trade receivable was the highest in 2010, which indicates successful efforts by management to improve efficiency. A simple reading of the average inventory turnover it shows that shows that company outperformed the competitor although it was it shows that is has been declining at a faster rate from 2008-2011. This implies that the company is facing improper sale of their commodity and also controlling its cost of production. In the fixed asset turnover the company is having a low ratio of sales to fixed assets which means it has over invested in its fixed assets. A low fixed asset turnover indicates the company has more fund tied up with the fixed assets for each dollar of sales revenue. Finally, it comes to the total asset turnover is seen where the Newcrest Mining Ltd is compared with the competitor. In this Newcrest Mining Ltd is having a low total asset turnover. This indicates that Newcrest Mining Ltd uses more assets which are being used for its sales. However the company does not utilize the assets well. The following is the trend graph for the ratios Profitability Ratio- The following table shows the Profitability ratios; 2008 2009 2010 2011 Magna Mining Profit Margin: 18.901% 31.597% 48.013% 56.790% -5,579.88% Return on total assets 3.785% 5.023% 9.346% 5.590% -70.54% Return on owner's equity 5.034% 6.473% 11.816% 6.962% -735.63% (Bloomberg BusinessWeek, 2012) We should first take the profitability of the Newcrest Mining Ltd and it position with the average of the competitor. In this it mainly shows that how the company can allocate its resources and whether it is able use its resources in the right way. In the beginning of the year it shows the profit margin is 18.9% and as the years pass on it shows that the profit margin keeps on increasing. The competitors show a negative figure for the year 2011. In the return on assets for the year 2011 it shows that the competitor -70.54% (Bloomberg BusinessWeek, 2012) which is lower because the company has 5.590%. In all the years the company shows a positive figure. In the return of equity it is basically done in order to check the percentage change in the income of the shareholders equity. Except for the year 2010 where there is a higher return on equity for the Newcrest Mining Ltd the while the other years are lower. This shows that a higher return on equity is basically due to the proper utilization of the debt and also due to the strong economy. But while comparing with the competitor it performed well. When saying with the Du point analysis when there is a higher asset turnover it eventually results in the increase of the return on equity. In this the Newcrest Mining Ltd has exceeded the asset turnover when comparing to the industry norm. Valuation The intrinsic value of Newcrest Mining Ltd’s share is calculated using the free cash flow model and this is supplemented by the earnings multiplier approach. Free Cash Flow Model- This valuation method is based on making estimations of the future free cash flow expected from the business operations and then using an appropriate rate for discounting them back to the present value. In this way, the company’s intrinsic value can be determined per share. If the intrinsic value is more than the stock price of the company then it is implied that investors must pull their investments out of that company’s stock as it is expected to decline in the near future(Brealey, Myers and Marcus, 2007). On the other hand, if the intrinsic value is more than the stock price of the company then it may be attractive for the investors to buy that company’s stock as the stock price is likely to increase to its intrinsic value. Moreover, if intrinsic value matches with the stock price then hold option should be exercised by investors. The formula for calculating intrinsic value based on discounted cash flow model of valuation used in this report is given as: FCFE=CFO + FClnv + Net Borrowing + Net Debt Repayment Where: CFO = cash flow from operating activities = NI + NCC – WClnv FClnv = Capital Expenditure NI = Net Income or Net Profit After Tax (NPAT) NCC = Non Cash Changes (Depreciation and Amortization) WCInv = Working Capital Changes FCF1 = FCF*(1+g) Intrinsic Value = FCF1/(WACC-g) Basis for Analysis- For determining the intrinsic value financial statements for the year June 2007- 2011 have been used for drawing figures for different financial elements required for discounted cash flow method of valuation. Free cash flows have been prepared using the six driver of valuation as shown. The figures have been estimated using the 2007-2011 historical financial statement Growth rate 25.7% Operating profit % 30.7% Tax on operating profits 13.2% Fixed asset investment % of sales growth 13.6% Working capital investment % of sales growth 8.1% Cost of capital 6.9% The cash flows from the excel output are shown below Year 0 1 2 3 4 5 6 2011 2012 2013 2014 2015 2016 2017 Sales 4,102.00 5,155.36 6,479.22 8,143.03 10,234.10 12,862.14 16,165.03 Op profit 1,583.54 1,990.17 2,501.24 3,143.53 3,950.77 4,965.30 Tax 209.28 263.02 330.56 415.44 522.13 656.21 Fixed assets 698.65 878.06 1,103.54 1,386.92 1,743.07 2,190.68 Working capital 418.70 526.22 661.35 831.19 1044.63 1312.88 cash flow 2910.17 3657.48 4596.69 5777.09 7260.60 9125.06 Discount factor 1.0000 0.9356 0.8753 0.8189 0.7661 0.7168 0.6706 Planning horizon 2722.66 3201.33 3764.16 4425.95 5204.09 6119.03 Cost of Equity: The required rate of return on equity is estimated via the capital asset pricing model (CAPM). Each investor is assumed to diversify their portfolio; therefore, only systematic risk is rewarded(Brigham and Houston, 2009). The CAPM equation can be written: E(Ri) = Rf + βi (E(Rm) – Rf) where E(Ri) = the expected return on the asset i; E(Rm) = the expected return on the market; Rf = the risk-free rate of return; βi = systematic risk relative to the market. Risk free market is considered to be 3.75%. The market premium can be estimated to be 8% and beta of 0.46. E(Ri) = 3.75% + 0.46(8%) Cost of equity = 7.43% Cost debt Cost debt is estimated using Cost debt= Kd (1- tax rate) In this case the cost of debt is estimated to be 8% Cost debt= 8% (1- 0.132) Effective cost of debt = 6.94% Weighted average cost of capital Cost of capital Long - term debt 8% 684 equity 7.430% 13,875 14,559.00 Market value debt ratio Cost of debt 6.94% Cost of equity 7.43% Tax rate   Weighted     Weights Costs After-tax cost of debt 6.94% 4.70% 0.33% Cost of equity 7.43% 95.30% 7.08% WACC 7.41% Valuation of Free Cash Flow Model Summary Sum of planning horizon PVs 19,009.87 PV of perpetuity, discounted 5 years 80,239.67 Corporate value 99,249.53 Long-term debt 684.00 Shareholder value $ 98,565.53 No. of shares (00000) 718 Share price based on calculation $ 137.26 share price in 1 July 2011 $ 37.73 share price in 13 th May, 2012 $ 25.65 Based on the calculations performed in this report it can be indicated that the company operations has a negative growth rate therefore it is not deducted from WACC in the above given formula. The intrinsic value obtained is well above the group’s stock price therefore it can be suggested that the company’s stocks are under price and investors should buy this stock for earning higher returns in the future or hold for those who hold Earnings Multiplier Approach The other way to value the share price of a company is the use is the earnings multiplier approach. To calculate the earnings multiplier, we multiply the estimated earnings per share (EPS) by estimated P/E ratio. In the case of company; to calculate whether the share price is overvalued or undervalued we have to calculate the intrinsic value. Therefore; EPS / Discount rate 2011 2010 2009 2008 2008 Average basic earnings per share 147.3 160.5 103.2 113.2 21.5 109.1 diluted earnings per share 147.1 160.1 103.0 112.9 21.5 108.9 Newcrest Mining limited (2012) WACC = 7.41% (From above) Intrinsic Value = (1.091) / 0.0741 Therefore; Intrinsic Value = 14.72 The share or market price of Newcrest Mining Ltd is 37.73 and thereby is higher than its intrinsic value and therefore the stock is overvalued and therefore comprises a higher risk to the investors and shareholders. Summary of valuations Below is a summary of the share price valuation: Valuation Method (Estimated) Share Price Actual Share Price (as of 1 July 2011) $37.73 Free Cash Flow Model $137.26 Earnings Multiplier Approach $14.72 CAPM 7.43% Finance yahoo(2012). Conclusion and recommendation The intrinsic and market values of the stock are not same one model suggests the holding or buying the share while Earnings Multiplier Approach suggest sell the share. References Bloomberg BusinessWeek, (2012). Magna mining ltd (MAN:ASX). Retrieved May 15, 2012, from Brealey, R, Myers, S & Marcus, A. (2007). Fundamentals of Corporate Finance. Sydney : McGraw-hill,. Brigham, E. F., & Houston, J. F. (2009). Fundamentals of financial management. Mason: CENGAGE Learning Finance yahoo(2012). Newcrest Mining Ltd. Retrieved May 15, 2012, from Newcrest Mining limited (2012). Newcrest Mining Annual Reports. Retrieved May 15, 2012, from Read More