Sky-City - Sales Growth and Cost of Debt, Gross Profit Margin, Asset Turnover, Residual Operating Income - Example

Table of Contents Table of Contents 1 Introduction 3 About the company 3 Motivate your choice 4 Industrial and Company Background 4 Gross profit Margin 5 Asset turnover 5 Residual Operating Income Model 6 Discounted Dividend Model 7 Discounted free cash flow model 7 Residual Income model (Abnormal Earnings Valuation Model) 9 Industry and company background 10 Share price forecast for 2016 10 A multiples valuation 12 The price earnings ratios 12 Value based on balance sheet value 14 Debt RATIO 14 Based on the company profitability and liquidity risk analysis, Sky city is considered a viable investment due to the fact that the company depict a low debt ratio as depicted by the ratio of debt to asset. Moreover, the profitability ratio is enhancing annually which implies that the business is going concern and thus the rate of stock turnover and profit is very high. The implication as a result is that the venture alternative in stock city would lead to profit creation. The trend in price earnings ratio and earning per share depict a growing tendency which is an implication that the business performance of stock city limited is enhanced annually which a strong indication of going concern assumption. 14 Aapplication 14 What may impact the forecast of the company valuation 15 Conclusion 16 Appendices 18 References 25 Introduction The research focus on developing a detailed appraisal of the sky=city limited. The valuation will employ some of the forecasting tool which is deem significant for ideal valuation of sky-city. The appraisal of stock valuation for the company is deem appropriate due to the fact that it creates a proof in valuing the performance of the company over the past and creating an opportunity to anticipate the prospect state of business situation for sky-city limited. The result of the forecast will help in develop a conclusion on the state of the company performance and the recommendation of investing in the company or not. A venture that is considered investing for the sky-city limited is more risky but might take into consideration and also venturing in the company must as a result guarantee the venture risk is minimal. The likelihood of having an investment diversification on security to ensure reduced venture risk will be advisable to an investor since it will ensure that the returns and risk on diverse securities will not be same and thus savers and investors from risk of losses in having a single period investment alternatives. About the company Sky City Entertainment Group is an Australian registered corporation in gaming and entertainment industry. The business was registered in 1996 and currently has an employment capacity of 6150 across Australia and New Zealand. The focus of the business is entertainment and casinos business. Moreover, the business comprise of Hotel, bars and conference halls. Motivate your choice The appropriate financial assessment and valuation such as the use of free cash flows, discounted divided model will be considered in appraising the performance and valuation of sky city entertainment limited. The prospective analysis of sky-city has been appraised and recommendation reached on the basis of the financial statement of the company. Some of the valuation tool used in the research are the free cash flow model, the residual income approach and also the determining the asset discounted dividend cash flow model. There are some of the important tool in appraising as well as comprehending the business performance of sky city limited. Industrial and Company Background The assumption of forecast is that the sales growth will growth at a steady rate of 8.5% as well as the cost of debt will grow at 10% per annum from 2015 to 2016. Whilst the dividend payout will be upheld at 12% for sells. Goods and expense, we predict it to be 8.5% of sales since in the past the SG%A has been roughly 8.5% from the year 2011 to 2015. The short term spur mentioned in the research which might impact the sales. Goods and expense is the least wage growth. If the least wage were to grow, then sky city may depict a growth in sells. Goods and expense. So we concluded on upholding sells. Goods and expense at past percentage of sales. For tax, we employed the past year tax rate applicable at 39%. We cannot comprehend the existing political situation of Harriman and thus we cannot just assume that tax will be fixed. Gross profit Margin The gross profit margin predicted to grow from 53% to 54%. This slight growth is because of sky city progressively shifts the product mix to adjust for the growth in demand for more services from the company. As a result sky city is focusing on shifting the product mix to a higher margin. Asset turnover The asset turnover of sky city limited is assumed to increase by 10.3% for the next 10 years because of growth in the level of sales. Asset turnover= (Net operating Asset/ sales) Year 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Asset Turnover 174.900 169.000 172.500 177.500 195.700 215.800 237.070 243.400 249.900 256.600 The following model was employed to carry out the above prediction in apprising the sky city using the stock as well as the worth of the company. The outcome of the forecast is depicted in the appendices below. Residual Operating Income Model The model creates positive and negative result in making a comparison to constantly used dividend discounting model. The approach uses the data from the financial statement of the company hence the residual income look at the business viability rather than the accounting profitability of the company. Discounted Dividend Model The model depict the process of appraising the value of the stock using the forecasted dividend and discounting them in the current year. The idea is that the value obtained from the dividend discounting model is higher in ration to what the share are currently trading, then the stock will be undervalued. The shares of the company will be undervalued according to the trend in the current present value of the stock for the company as depicted in the data below. This is an indication that the stock price for stock city isn’t the best due to its undervaluation and consequently they will not be bought in the stock market. The outcome of the model implies that stock city portrays the value of dividend that is less as compared to the stock value in the market. As a result, it means therefore that stock city stock is undervalued hence the security is declining in worth. The implication is that an investor should invest in the company stocks since they are decline in value. Discounted free cash flow model The model of valuation is a price method with significant venture with skills in using it to value the worth of a stock. Exponents of this valuation argued that an investor can achieve a correct image of the company’s precise valuation only whether he estimates the current and future cash flows. FCF= (operating cash flow-capital expenditure} FCF= (230,773- 166,623=$64150 From the above calculation, it can be observed that stock city depict a positive free cash flow of $64,150 which is an implication that the company has enough cash which may be employed in the future venture opportunities. The detailed free cash flows for the 10 years provides an implication that the capital of the sky city limited is less and it may be due to high capital venture that leads to negative capital to the business or the business may be liquidity risk. This isn’t the case for sky city since, the company depict a positive and high capital expenditure which makes the company to realize negative capital. The implication is that the stock price of sky city is declining as well as an investor will incur losses on venture due to undervaluation of stock by company in raising more finance for business operation. Year 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Free Cash Flow(Sky city) 147 166 156 140 139 102 76 113 58 158 159 Residual Income model (Abnormal Earnings Valuation Model) The Model focus on transforming the future earnings of the company, to remunerate for the cost of equity as well as placing the correct value of the firm. Although the return to equity holders of the company isn’t an official requirement for the return to stakeholders, I so far as drawing investors to the company must remunerate them for venture risk. The main workings in residual income is to add equity charge which is just the company’s total equity growth by the required rate of return of equity. The formulae below depict the equity charge equation used for the base year. The detailed valuation of sky city for 10 year period assessment using the residual income is provided in the appendices below. Equity charge= {Equity capital*cost of capital} Equity charge= {773,886*10%} =77,388.6 Residual income= (equity charge-Net income) Residual income= {77,388.6- 84,916) =-7536.5 From the above workings, it can be observed that using the residual income valuing method provides a positive value of sky city limited. The model provide a detailed estimates of the intrinsic value of the company hence the assumption provided is that the forecasted income will increase every year at 5 to 10% rate with net income growing at 5-9% per annum. The net working capital, the fixed asset turnover and also the net operating asset to equity ratio will be similar to the 2015 financial year. Using the cost of equity for sky city will give {5%+1.3*8%=14.5% The value of equity is -0.3 which implies that there is a decline in worth of the equity per share hence venturing in sky city is risky due to the fact that the returns on capital employed isn’t enough. An investor must value the prospect performance of sky city in anticipating the extent to which one can venture in the company since, the assessment comprise of 10 year past trend as well as the model forestall the future performance of sky city limited which is not known Industry and company background Share price forecast for 2016 Stock price October 2016 $4.23 change 7% 1.68%. Closing at $118 Stock price (Sky city) $4.23 Change 1.68% ($6.87) Market trend (ASX) $117 (SAP 500) $188 The above stock valuation for sky city depict a variation in stock price. This is due to the fact that the economic situation as well as external factors such as effect of competition and political factors may contribute to speculators change in stock venture in sky city, since investment in stock price is based on speculation and assumption which makes the price for sky city to be different as observed above. The market stock price for Sky-city Limited is as per the ASX provide a value of 117 (Sap 500) while the company’s stock price is $ 6.87 at a closing price of $118. It therefore implies that the stock price for sky city is undervalued and this an investor should not buy the company’s stock since they are going to fall. An investor should consider buying overvalued stock price in order to capitalize on the proceeds from returns since, it is anticipated that an overvalued stock is going to fall when they vying available for sell in the stock exchange. The above analysis was concluded after considering the business situation and making forecast ion the anticipated company’s performance, care should be taken in making an investment decision since external factors might affect the stock price in the near future. The prospective analysis of sky-city has been appraised and recommendation reached on the basis of the financial statement of the company. Some of the valuation tool used in the research are the free cash flow model, the residual income approach and also the determining the asset discounted dividend cash flow model. There are some of the important tool in appraising as well as comprehending the business performance of sky city limited. A multiples valuation The company used for comparison is Nine Entertainment Co which is Australia largest media and Entrainment Company. The company asset entails the Nine Network, Mi9 as well as the 50 stake in subscription video. The price earnings ratios The company’s equity share was forecasted using the price earning method (P/E) in order to get an understanding of the company’s historic present as well as forecasting the company’s future performance. The forecasting tool is an ideal investment forecasting method adopted by many business but care should be taken since the tool do not consider other external factors that might affect the forecasted result such as the effect of inflation and the competitors. The data for analysis was collected from Sky city limited financial statement in the company website and thus the result can be relied in making an informed investment decision. P/E= {Earning per share/current stock price} Year 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Price earnings ratio (Sky city) 0.22 0.2 0.09 0.17 0.14 0.16 0.19 0.19 0.16 0.19 0.22 Price earnings ratio (Nine Entertainment Co) 0.59 0.66 0.79 1.04 1.07 1.03 1.07 1.13 1.25 1.28 1.32 The company (Nine Entertainment Co limited) is depicting a significant increase price earnings ratio which implies therefore that the company made the highest turnover during the year 2015/16. For sky-city limited, the profitability ratio is improving but quite small unlike those of the Nine Entertainment Co limited. It can as well as be observed that there is a declining trend in return on equity for sky city limited which is an indication that the turnover for the company is quite low. This is an indication that the stock price for stock city isn’t the best due to its undervaluation and consequently they will not be bought in the stock market. The outcome of the model implies that stock city portrays the value of dividend that is less as compared to the stock value in the market. As a result, it means therefore that stock city stock is undervalued hence the security is declining in worth. The implication is that an investor should invest in the company stocks since they are decline in value. Value based on balance sheet value Debt RATIO Based on the company profitability and liquidity risk analysis, Sky city is considered a viable investment due to the fact that the company depict a low debt ratio as depicted by the ratio of debt to asset. Moreover, the profitability ratio is enhancing annually which implies that the business is going concern and thus the rate of stock turnover and profit is very high. The implication as a result is that the venture alternative in stock city would lead to profit creation. The trend in price earnings ratio and earning per share depict a growing tendency which is an implication that the business performance of stock city limited is enhanced annually which a strong indication of going concern assumption. Aapplication Amongst the quantitative strength, is the company’s constant growth in revenue due to high operating income? The company is having an 8.5% growth rate which strong as well as steady growth which depict a strong as well as constant growth to the business performance. It is assumed that the sales for the company grow at 8.5% for the 10 years. The assumption made is approximated on the basis of economic factors that is ideal to growth of the company’s business performance. Sky city limited anticipate that the inflation rate will be constant for the year 2015-2024 and thus, it is a good stand for sky city to take advantage of the sales growth for the time period. The best customer services together with the company’s product that adheres to expectation of the customer by way of unique product branding, quality product as well as steady pricing are the factors that at present makes the customers to buy more from the company. This is a good standing to make a valuation on the future growth rate in sales. On the basis of forecasted cash flows, it can be observed that the sky city is a going to realize returns from venture since the working capital is enough to fund the daily operation of the company. The worth of sky city is high and thus the liquidity situation of the company isn’t a threat to the business operation for sky city limited. What may impact the forecast of the company valuation The effect of inflation makes the economy stunted and makes the company to face financial risk. The forecasted estimates will not be achieved as well as there will be big variation between the budgeted figures and the actual value. The adverse threat of competition will lead to poor result due to their competition. The appraisal of stock valuation for the company is deem appropriate due to the fact that it creates a proof in valuing the performance of the company over the past and creating an opportunity to anticipate the prospect state of business situation for sky-city limited. The result of the forecast will help in develop a conclusion on the state of the company performance and the recommendation of investing in the company or not. A venture that is considered investing for the sky-city limited is more risky but might take into consideration and also venturing in the company must as a result guarantee the venture risk is minimal. The likelihood of having an investment diversification on security to ensure reduced venture risk will be advisable to an investor since it will ensure that the returns and risk on diverse securities will not be same and thus savers and investors from risk of losses in having a single period investment alternatives. Conclusion It can therefore be concluded that from the above valuation analysis for sky city limited, an investors should consider making an investment option in sky city limited due to the fact that the company business situation is favorable in terms of capital as well as finance existing for venture. In ascertaining the financing situation of sky city limited employing the free cash flow approach depict a per share value of $0.65 as observed in the assessment. The implication is that for every one share of investor, there is $0.65 discounted free cash flow which is good sign that the performance of sky city limited doesn’t depict any financial intricacies despite the fact that the business is having a heavy capital on research and development. The future business situation of sky city limited is certain for sky city limited hence the positive free cash flow implies that the prospect business situation will be impacted by the sufficiency of capital finance its business operation. The worth of stock valuation for sky city is undervalued which is an implication that the stock purchase will lead to overvaluation thus turning to be worthless. An investor will loss from an investment. The sky city business situation is steady as well as depict the venture chances of prospect business situation. In an intention to venture in sky city limited, a detailed valuation and basement of the business situation is taken into consideration so as to get rid of doubt that is depicted in the historic performance and cash flow sufficiency of sky city limited. The company is having strong financial situation as observed by the size of asset and market capitalization. As a result, the business viable for venture due to the fact that it portray growth in asset capital and the sales. Sky city limited is depicting a huge investment on capital in order to realize enhanced returns in the prospect. It can be depicted by the free cash flow appraisal of sky city financial statement in which the appraisal depict that the net income worth is reducing which is an indication that sky city limited will cater for stakeholders wealth maximization and also the safety of investor will be at risk. This is because, the business situation for sky city limited doesn’t provide assurance returns on investment according to the above trend assessment. In this regards, a detailed appraisal of business performance for sky city limited need to be undertaken before venturing on the company. The intricacies arises from negative appraisal result such as the frequent reduction in reported net profit and also as depicted the intricacies that sky city limited is undergoing through in terms of financial constraints as well as taking into consideration the requirement of investors returns inform of dividend in order to capitalize on their wealth. The cash flows control is the main verdict that the manager for sky city limited must consider since an efficient cash flow management implies that sky city limited will be depicting an effective working capital control which implies that the company is a going concern. Appendices Data Analysis and Assessment 1. Discounted dividend model Input for the 10 years projection Inputs from current financials   Net Income = $127,000 Book Value of Equity = $1.36 Current Earnings per share = $0.13 Current Dividends per share = $3.56     Inputs for Discount Rate   Beta of the stock = 0.96 Risk free rate= 1.90% Risk Premium= 5.50%     Inputs for High Growth Period   Length of high growth period 10 years Output of the result for 10 years (2015-2025)     Cost of Equity = 6.05% Net Income = $98,900 Earnings per Share = $0.19 Growth rate in EPS = 16.32% Payout Ratio for high growth phase 118.9 The dividend for high growth for 2015-2025 2016 2017 2018 2019 2020 2021 2022 2023 2024 Expected Growth Rate 16% 17% 17% 17% 17% 14% 11% 8% 5% Earnings per share 512% 483% 567% 665% 780% 891% 991% 1071% 1125% Payout ratio 41% 41% 41% 41% 41% 49% 53% 63% 73% Dividends per share 274% 304% 340% 381% 430% 568% 721% 881% 1035% Cost of Equity 8% 8% 8% 8% 8% 9% 8% 8% 8% Cumulative Cost of Equity 109% 117% 126% 135% 152% 162% 172% 183% 184% Present Value 262% 278% 294% 313% 333% 408% 483% 551% 507% 1. Residual income Model 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Forecasted earnings $825,000.000 $850,000.000 $875,000.000 $900,000.000 $925,000.000 $950,000.000 $975,000.000 $1,000,000.000 $1,025,000.000 $1,050,000.000 Beginning book value $4,299,750.000 $5,025,750.000 $5,773,750.000 $6,543,750.000 $7,335,750.000 $8,149,750.000 $8,985,750.000 $9,843,750.000 $10,723,750.000 $11,625,750.000 + Forecasted earnings $825,000.000 $850,000.000 $875,000.000 $900,000.000 $925,000.000 $950,000.000 $975,000.000 $1,000,000.000 $1,025,000.000 $1,050,000.000 - Forecasted dividends ($99,000.000) ($102,000.000) ($105,000.000) ($108,000.000) ($111,000.000) ($114,000.000) ($117,000.000) ($120,000.000) ($123,000.000) ($126,000.000) Ending book value $5,223,750.000 $5,977,750.000 $6,753,750.000 $7,551,750.000 $8,371,750.000 $9,213,750.000 ########### $10,963,750.000 $11,871,750.000 $12,801,750.000 Forecasted earnings (from above) $825,000.000 $850,000.000 $875,000.000 $900,000.000 $925,000.000 $950,000.000 $975,000.000 $1,000,000.000 $1,025,000.000 $1,050,000.000 - Normal earnings ($429,975.000) ($502,575.000) ($577,375.000) ($654,375.000) ($733,575.000) ($814,975.000) ($898,575.000) ($984,375.000) ($1,072,375.000) ($1,162,575.000) Abnormal earnings $395,025.000 $347,425.000 $297,625.000 $245,625.000 $191,425.000 $135,025.000 $76,425.000 $15,625.000 ($47,375.000) ($112,575.000) x Discount factor $0.683 $0.621 $0.565 $0.513 $0.467 $0.424 $0.386 $0.351 $0.319 $0.290 Present value of abnormal earnings $269,802.08 $215,716.18 $168,009.31 $126,054.75 $89,299.76 $57,264.10 $29,461.84 $5,476.56 ($15,093.68) ($32,612.98) Initial book value $4,299,750 PV of abnormal earnings over 10 years 913,379 Estimated value of equity $5,213,129 Number of shares (millions) 307 Predicted share price $16,980.88 Actual high $64.00 Actual low $56.00 3. Residual Operating Income Model（RoIM） ReOI = NOPATt – (Cost of Equity Capital * Net Operating Assetst-1) 2016 2017 2018 2019 2020 2021 2022 2023 2024 2015 Cost of equity 0.0604 0.08 0.11 0.15604 0.16 0.18 0.2 0.21 0.22 0.25 Net operating Asset 1831000 1950000 2,050,000 2150500 2255000 235000 2450000 2650000 270500 285000 110592.4 156000 225500 335564 360800 42300 490000 556500 59510 71250 NOPAT 99780.8 101646.4 103646.4 110592.4 120564 123450 124500 126500 128000 130500 REOI -10812 -54354 -121854 -224972 -240236 81150 -365500 -430000 68490 59250 4. Discounted free cash flow Model Initial Cash Flow: $820,000         Years: 5-Jan 10-Jun Growth Rate: 6.80% 10%       Terminal Growth Rate: 1%         Shares Outstanding: 738,000   Debt Level: $528,000             Year Flows Growth Value 2015 822,000.00 7% $713,045.0 2016 861,000.00 7% $650,285.0 2017 853,000.00 7% $560,204.0 2018 813,000.00 7% $459,128.0 2019 810,500.00 7% $397,991.0 2020 789,450.00 10% $341,324.0 2021 743,400.00 10% $279,519.0 2022 756,000.00 10% $245,177.0 2023 722,500.00 10% $202,527.0 2024 746,800.00 10% $184,250.0 2025 746,540.00 12.5 $208,530.0                 Terminal Year $753,358.0         PV of Year 1-10 Cash Flows: $4,033,434.0     Terminal Value: $1,329,967.0     Total PV of Cash Flows: $5,363,480.0     Number of Shares: $748,000.0     Intrinsic Value (IV): $6.6 Margin of Safety IV: $4.6 References Damodaran, A., 2007. Valuation Approaches and Metrics: A Survey of the Theory. Gabehart, S., 2002. The Business Valuation. Gedde, R., 2002. Valuation and Investment Appraisal - Page 75. Henschke, S., 2009. Towards a more accurate equity valuation: An empirical. Parkinson, A., 2012. Managerial Finance - Page 175. Pereiro, L.E., 2012. Valuation of Companies in Emerging Markets: A Practical. Stowe, J.D., 2007. Equity Asset Valuation - Page 60. Read More