Corporate Valuation - Woolworth Limited - Assignment Example

Corporate valuation - Woolworth Limited Student Name Student ID E-mail address Supervisor Name Academic Year Semester October 18, 2012 Outline Introduction Woolworth capital structure Beta: Risk free rate and market risk premium: Cost of equity: Enterprise value: Valuation using constant growth FCFF: Two stage FCFF model P/E Valuation A P/BV valuation P/BV valuation = Current share price/ current book value Summary of valuations Conclusion Introduction Continued from last assessment we basically attempt to develop and provide a range of estimates of the value of the publicly-listed company which is Woolworth. Woolworth Company is basically a retail company that is famed for setting trends world over. It is also believed to be one of the successful international stores, creating what other modern retail stores follow in a bid to stay ahead in the market. Woolworth ltd’s success depends on its ability to connect with customers by providing them a wide variety of products that meet their desires, and also on the ability of the company to execute the will of its customers effectively. This paper covers some of the developed data that would assist in the investment decisions of the firm or clients. A lot of consideration has been done before coming up with most of the information covered. For instance, When carrying out valuation report we adopt methods that analysis of the firm’s capital structure, valuation using free cash flow to the firm (FCFF), constant growth and multistage growth model, Price to earnings, price to book ratios …etc. which enable us to come up with clear picture on the financial status of the organization. It goes further to show a broad knowledge of business valuation, both practice and theory, through some of the developed estimates of the value of the firm. This paper critically analyses Woolworths. Woolworth capital structure The company two forms of capital debt and equity, it does not have preference share capital. This capital be determined by two ratios Debt ratio and Equity ratio. The Debt Ratio shows us the proportion of assets that are financed through debt and is an indicator of the riskiness of the business as well as the borrowing capacity. A high debt ratio also means that the company is paying a sufficient amount of interest to pay for their loans. These ratios are calculated as follows; Debt ratio = Debt/Equity ratio = From the appendix (excel document the rations for this company are; 2011 2010 2008 2008 Debt ratio 60.46% 54.97% 56.78% 62.06% Equity ratio 42.22% 46.06% 38.58% 56.17% From the results above, it is clear that Woolworth has no optimal capital structure as the structure is fluctuating from year to year. The company should strive to reduce its debt to total assets to rate below 50%. Lower debt ratio can be considered as a good sign for any company especially in this industry as some of the risks related to debt like interest rate risk, timing risk are reduced significantly. Beta: Beta is a measure of risk if a stock or portfolio as relative to the market. The beta of the company to be used in this case is 0.34(Reuters, 2012). This beta indicates that is less risk than the overall market. A higher beta implies a higher expected rate of return but at the same time posing more risk. As a beta greater than 1 indicates that the security's price will be more volatile than the market. Higher return on market portfolio is simply higher benefit accrued to investors from diversified portfolios. The effectiveness of beta as a measure of risk and returns is good but it is limited in the sense that it incorporates only the changes in the stock price but not the risk that can be understood only from reading the financial statements from a fundamental viewpoint. Beta is one of the important indicators though of the risk and return relationship of stocks when you are just concerned with trading them and not holding them for an indefinite period of time. The CAPM method at least allows investors some degree of measurement on how to value their investments or potential investments and assist in decision making but it should not be treated as the absolute measure of value and allocation decisions. Risk free rate and market risk premium: The risk free rate and market premium utilized in this case is 3.09%. Risk free rate is considered as the yield to maturity on long term government bond. Market risk premium is equals to expected return of the market minus the risk free rate, in this case we consider is as 6.3% according to ‘Re-examination of the historical equity risk premium in Australia’ (Appendix) Cost of equity: CAPM can be used to find out the cost of equity of Woolworth as: Expected return on stock = risk-free interest rate + (beta x market risk premium) R = r f + B (r m –r f) which is 3.09% + 0.33 (6.3%) = 5.23% Enterprise value: The valuation method uses total market capitalization and total debt of the company to calculate the value. The amount of debt used in this report base on the book value while market capitalization is measured base on the market value. The company has a market capitalization of $35.76billion and the book value for Woolworths’ Ltd debt is $3374 million as recorded by Thomson One Banker report. Thus, the current enterprise value is (3374+35760) million $39134 million. Thus the weight of equity is: WE = Equity/Enterprise Value = 35760/39134 = 0.914 (or 91.4%) Hence, the current company weight of debt (WD) is 0.086 (or 8.6%). Cost of debt: Cost of debt is cost of paying the debt taken and it is in a form of interest. The effective cost of debt is that cost is after tax and is calculated as (1 – Tc) rD. The before tax rate is 6.42% and does not have preference stock. Weighted Average Cost of Capital (WACC): The cost of debt (rD) for Company is 6.42%, Corporate tax (Tc) rate is 28.84%, the cost of equity (rE) is = 6.23% Therefore: WACC = 5.03% as shown in the appendix (excel file). The weighted average cost of capital for company was worked out at 5.03%. Valuation using constant growth FCFF: 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. 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: The formula for calculating FCFF is as follow: FCFF = EBIT (1 – TC) + Depreciation – CAPEX – NWC or FCFF = EBIT – Cash Tax + Depreciation – CAPEX – NWC FCFF = EBIT (1 – TC) + Depreciation – CAPEX – NWC Earnings before interest and tax (EBIT) EBIT for year 2012 is 3386.3 million from Thomson corporate snapshot report. Depreciation Depreciation is 883.7 million in year 2012 derived from Thomson Financial Full Company Report Capital expenditure (CAPEX) CAPEX is 2134.50 million in year 2012 from Thomson Financial Full Company Report Net Working Capital Working capital is equal to enterprise’s current total assets minus current total liability In year 2012: current total asset is 20936.40, liability is 12490.10 In year 2011: current total asset is 20584.10, liability is 12738.30 For 2012: NWC= (20936.40 – 12490.10) – (20584.10 – 12738.30) = 600.5 Calculating FCFF For 2012: FCFF = 3386.3 * (1-0.2884) + 883.7 -2134.5 – 600.5 = 558.39 For 2009, 2010, 2011, FCFF are calculated as 266.84, 432.03, 1050.18, 558.39 respectly (refer to excel spreadsheet) Growth rate Competitors’ growth rate: Observed from Thomson data, competitors earnings per share (EPS) 5 year average was 6.28%. Constant growth rate: g = b × ROE = 27.334% × (1 – 84.75%) = 4.168% (Appendix) Constant growth FCFF model Using competitors’ growth rate: Value = Current FCFF × (1 + growth rate) / (WACC – growth rate) = 558.39 × (1 + 6.28%) / (5.089% - 6.28%) = - 49828.45 Using constant growth rate: Value = Current FCFF × (1 + growth rate) / (WACC – growth rate) = 558.39 × (1 + 4.168%) / (5.089% - 4.168%) = 67918.4 Woolworth’s current enterprise value is 34257.2 million, market value is 35993 million, compared to the calculated enterprise value, the estimated value is 49828.45 million using competitors’ growth rate and 67918.4 using constant growth rate, significantly lower than the current enterprise value and it shows that Woolworth currently is undervalued. Valuation with two-stage FCFF model Valuation using 2 stages FCFF model through 4 years, year 2009, 2010, 2011 and 2012, at the beginning of the first 3 years it growth rapidly and then in the fourth year, the growth became stable. As showed below: Using the data calculated previously, the free cash flow for year 2009, 2010, 2011, 2012 are 266.84 million, 432.035 million, 1050.18 million, 558.39 million. WACC is 5.089% and g is using constant growth rate 4.168%. Using these data calculate firm value is 51260.6 million which is also exceed the current enterprise value. Indicate that Woolworth is undervalued now. P/E Valuation P/E valuation is a measure of the current share price divided by the earning per share. P/E valuation is one of the important financial ratios that can reflect company’s capital structure. The Price Earnings Ratio (PER or P / E) denotes an indicator used in market analysis. The PER is calculated by dividing the market capitalization by net income. The PER should be used to compare companies with similar business lines; and when two competitors have different PER but comparable growth, this means that one of these companies is over-valued (or the other is undervalued) (Damodaran, 2012). In practice, this ratio varies between 5 and 40, depending on the type of business (business growth , defensive , cyclical , a crisis, declining ... ), the upward or downward phases of the award , the "stock modes" for such activity or that type of society (which can lead to a speculative bubble ), the economic cycle , the listing market , etc. In sum, many interpretations are possible and there is no ideal theoretical value (Thomsett, 1998). The P/E valuation model can be calculated as P/E valuation = The ease of use of the PER should not overshadow its limitations: PER does not account for the debt, or the cash; its calculation is based on net income, which can be "manipulated" (examples: the impact of exceptional items, influence of depreciation and provisions) (Damodaran, 2010). The PER varies depending on the number of listed securities, profits, and the change in share price, all subject to random difficult to predict the long term. In this case we using the forward P/E ratio because it with forward looking for the company. Expected EPS = Current EPS × (1+ growth rate) = 1.49 × (1+ 22.59%) = 1.826 Forward P/E = share price/ expected EPS = 29.09 /1.826 = 15.93 The formula of P/E ratio: P/E ratio=Current share price/ Expected earnings per share The Share price and Expected earnings per share From the research our group found that Woolworth company current share price is $29.09,and the expected earnings per share is equal to Current EPS times 1 plus the growth rate. As mentioned, the growth rate is 22.59%, the earnings per share is $15.93. So the expected earnings per share of Woolworth is 1.826. The P/E multiple of the company and industry While, it is not helpful the investors to analysis the Woolworth corporate if they only use P/E ratio of Woolworth. The ratio must compare to other companies in the same industry. Therefore the P/E ratio referred as the multiple, it will shows how much investors are willing to pay per dollar of earning. P/E multiple is Equals to current share price divide expected earnings per share, the data shows Woolworth current share price is $29.09 and the expected earnings per share has been calculated which is 16.7, therefore the P/E multiple of Woolworth is 15.93 The industry P/E multiple can be calculate as a mean P/E of the picked large competitors. The comparison of P/E valuation As the above calculation result shows, the P/E multiple of Woolworth is Lower/Higher than average P/E of competitors in the same industry, this is means the Woolworth share price has been overvalued/undervalued. A P/BV valuation A P/BV valuation model used to compare a stock's market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share. A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. This ratio can vary by industry. This ratio also gives some idea of whether you're paying too much for what would be left if the company went bankrupt immediately. P/BV valuation = Current share price/ current book value The company current share price is $29.09 The company current book value per share is $16.71 Then the P/BV valuation = 29.09/16.71 = 1.74 which is lower than the industry average. The P/BV ratio of the industry is 1.97. This means the company is undervalued. 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) $27.77 Free Cash Flow Model $124.92 Earnings Multiplier Approach $15.93 P/BV 1.74 CAPM 7.43% Conclusion The WACC for company is 5.03% interest for each $100 it borrows from the market, which is a reasonable amount. This also means that company can easily get finance from the market, as investor confidence is positive about the company.. This indicates that company is a financially viable and attractive company for investors. The company is experiencing positive growth in its revenue and net income over the last four years of analysis and therefore a positive average growth rate has been obtained. Based on the calculations provided in this report the intrinsic value of the company per share issued is higher than the price of the company’s stock therefore it can be suggested that investors will benefit from holding the stock. . Reference List: Damodaran, A., 2012. Investment Valuation. New York: John Wiley & Sons. Damodaran, A., 2010. The Dark Side of Valuation. New York: FT Press. Finance yahoo, 2012. Woolworths Limited (WOW.AX) Gaughan, P. A., 2010. Mergers, Acquisitions, and Corporate Restructurings. New York: John Wiley & Sons. Thomsett, M. C.,1998. Mastering Fundamental Analysis. Kaplan Publishing. Reuters, 2012. Woolworths Limited . www.reuters.com/finance/stocks/overview?symbol=WOW.AX Thomson ONE 2012, “Woolworths Limited,” Thomson Financials, Viewed 08 October 2012, Titman S, and Martin J, 2011, Valuation: The Art and Science of Corporate Investment Decisions, 2nd edn., United States of America: Prentice Hall/Pearson. Read More