The Principles of Analysing and Evaluating Equity - Essay Example

Table of Contents Table of Contents 1 PART 1: VALUATION AND VALUATION REPORT FOR GRAINCORP LIMITED 2 Company overview 2 Industry sector overview 2 Key risks and adjustments 3 Market risk 3 Pricing pressure 4 Compliance risk 4 Strategic risks 4 Valuation Methodology 4 How each individual items of pro-forma financial statement will be forecasted? 5 Pro forma income statement 5 Pro from balance sheet 6 Pro Forma Current Assets 6 Valuation 8 Pro-forma income statement 8 Assumption; 8 Pro-forma balance sheet 9 Assumption; 9 Pro-forma free cash flow to equity (FCFE) and firm (FCFF) 11 FCFF = NI + NCC + [Int x (1-tax rate)] – FCInv – WCInv 12 Valuation of firm’s shares in accordance with FCFE 13 Valuation of firm’s shares in accordance with FCFF 13 Recommendation 14 PART B; SELECTION OF STOCKS FOR PORTFOLIO BASED ON P/E RATIOS 15 Bibliography 17 PART 1: VALUATION AND VALUATION REPORT FOR GRAINCORP LIMITED Company overview Graincorp limited is an Australian public company listed on ASX. The company’s main business activities entails the receives and store of grains and associated commodities. It as well provides the supply and marketing of these products. The company operates widely with network of rail-ranked storage across Australia. Graincorp limited experienced a sharp decline in its share price nearly to2.5%, as much it closes at a high industry sector overview. This is because; the company released its result for the half year to 31st march 2016. The period is experienced with high slide in profits unlike the market anticipations. The company blamed low grain production for pulling the net profit down by 0.4 to 30.2$ million. Industry sector overview The company has both local and international suppliers. This is due to strong networking and associations that provide the company with professional services and competitive pricing to worldwide suppliers, access of main European, Middle East and Asian markets. The company facing stern competition from Archer Daniel Midland who is the Australian grains handlers. The co0mpany is facing a takeover worth a$2.8 billion from this company due to aggressive competition that might cost the expense for farmers but hit the earnings at the nation’s biggest listed agribusiness. The low cost might as aid the Australia, the global second biggest wheat exporter to fend off the challenges from the upcoming company that produces at low cost such as the united states in its main Asian market inclusive of Indonesia, south Korea and Japan (Alastair, 2000). Key risks and adjustments Financial forecast aids in controlling the finance of a company. They are the future anticipation of the business finances in relation to the statement, which provides the information concerning the actual outcome or progress. Forecasting the future financial situation of a company is intricate, more specifically where external and internal factors are hard to ascertain. Nevertheless, forecasting and making adjustment will lead to provision of accurate forecast for decision making. The following are some of the external factors that will affect our forecast and thus are deem risk factors that need adjustment in our forecast (Albrecht, 2007). Market risk This is the risk of change in price due to change in forces of demand and supply as result of the effect of inflation. Inflation is anon controllable factor and will this affect the market performance, in order to ensure that the forecast is sufficient and reliable; we must include the effect of inflation in our forecast in order to be 95% confident that our result will be reliable for decision making concerning the company future performance (Ernst & Young , 2011). Pricing pressure The pricing pressure is uncontrollable factor within the business and consequently will depict an impact in our future forecast. To adjust for this, we intend to ensure that a certain tolerable rate say +5% or-5% tolerable rate in pricing movement shall be incorporated in our forecast in order to ensure that the fluctuation in price in the market will depict small impact in order forecast (Evans, 2002). Compliance risk The compliance risk entails the change in law which might depict an impact in the company’s forecasted business performance. To curb this impact, the financial analyst needs to be up to date the law and regulation of the country and ensure that the new laws are incorporated in the forecast to minimize the compliance risk on the forecast results. Strategic risks This is the risk that the company’s strategy will turn to be less efficient and makes the company struggles to attain its objectives. It might be as a result of technological transformation, strong competitors entering the market, change in customer preference, and spike in cost of raw materials or any whichever large scale transformation outside the business. Valuation Methodology We intend to use the pro forma statement which an ideal valuation methodology that is applicable to the procedure of presenting the financial forecast for a specified time in a standardized structure. The importance of pro forma statement is that it aid in making investment decision in planning and controlling as well as for external reporting to shareholders of the company and the creditors. Pro forma statement might employed as a basis for comparing and analyzing the financial situation of the company in order to provide the management, venture analyst as well as the credit personal with a view of a specific situation of the company financial structure under many situations (Jerry, 2009). How each individual items of pro-forma financial statement will be forecasted? Pro forma income statement Pro forma Gross profit It is assumed that the anticipated sales will grow by 10% next year. In this regards, sales for this year will be multiplied by 110% and hence, it is assumed that the there shall ne growth in the cost of each item that is being sold. Pro forma Cost of good sold The cost of goods sold will be multiplied by 110% since; it is assumed that there shall be no growth in cost of every time sold, and then there is need to increase the item of sales by 110% in order to attain the sales target. Pro forma total expense The total expense is assumed that salaries and wages will grow by 5% and thus it shall be multiplied by current salaries value and expense by 105%. The pro forma total expense shall be added with the pro forma salaries and wages (Shim, 2009). Pro Forma Profit before Taxes Pro forma profit before taxes will be arrived at by deducting the pro forma expense from pro forma gross profits for pro forma profit before tax. Pro Forma Taxes Pro forma taxes will be worked out by deducting the tax at 30% and multiplying it by the pro forma profit before tax. Pro from balance sheet Pro Forma Current Assets Pro forma cash: This will worked out by adding the cash flows to the forecasted cash flow at present and the pro forma period. Pro forma accounts receivable In estimating the account receivable, we will consider the average collection period of debtors and the sales forecast for the past period. Pro forma total current assets: This is worked out by adding the pro forma cash and pro forma account receivables. Pro Forma Long-Term Assets Pro forma land: Land doesn’t depreciate and thus it will depict similar value. We will just enter the value of the land as it is in the balance sheet. Pro forma buildings: The building will be subject to depreciation and will assume that the building will have a 30 year depreciation which will be reflected in the accumulated depreciation. Pro forma vehicles: Vehicles are subject to depreciate. The take short time before they lose value unlike the building. Pro forma total long-term assets: Total asset will be worked out by summing upon the pro forma holdings. Pro Forma Total Assets Pro forma total assets will be worked out by summing up the pro forma total current and the long term assets. Pro Forma Current Liabilities Pro forma accounts payable: The Pro forma accounts payable is worked out by identifying how much to spent on suppliers and time it takes to pay them. Pro forma notes payable: The Pro forma notes payable entails the notes on account payable for a year, Pro forma total current liabilities: Ti get the pro forma total liabilities, we will sum up the account payable, accrued salary AND WAGES accruing for a period of one year. Pro Forma Total Liabilities Pro forma total liabilities are established by summing the current; liabilities Valuation Pro-forma income statement Assumption; The revenue will grow by 10% Cost of revenue will increase by 10% Sales, General and administrative and other operating expense will grow by 5% Operating income and interest expense will grow by 6% Provision for income tax will grow by 5% Net income from continuing operation will grow by 10% GRAINCORP LTD CLASS A (GNC) INCOME STATEMENT Fiscal year ends in September. AUD in millions except per share data. 2015 2016 2017 2018 Revenue $ 4,074.00 $ 4,481.40 $ 4,929.54 $ 5,422.49 Cost of revenue $ 3,293.00 $ 3,622.30 $ 3,984.53 $ 4,382.98 Gross profit $ 781.00 $ 859.10 $ 945.01 $ 1,039.51 Operating expenses Research and development Sales, General and administrative $ 361.00 $ 379.05 $ 398.00 $ 417.90 Other operating expenses $ 324.00 $ 340.20 $ 357.21 $ 375.07 Total operating expenses $ 685.00 $ 719.25 $ 755.21 $ 792.97 Operating income $ 96.00 $ 5.76 $ 0.35 $ 0.02 Interest Expense $ 43.00 $ 2.58 $ 0.15 $ 0.01 Net Cost $ 824.00 $ 727.59 $ 755.71 $ 793.00 Income before taxes $ (43.00) $ 131.51 $ 189.30 $ 246.51 Provision for income taxes $ 12.00 $ 12.60 $ 13.23 $ 13.89 Net income from continuing operations $ 32.00 $ 35.20 $ 38.72 $ 42.59 Net income $ 32.00 $ 154.11 $ 214.79 $ 275.21 Pro-forma balance sheet Assumption; Cash and cash equivalents Short-term investments will grow by 10% Receivables, Prepaid expenses Other current assets will grow by 5% Inventory will grow by 10% Gross property, plant and equipment will grow by 10% Accumulated Depreciation will increase by 5% Short-term debt Capital leases Accounts payable Deferred income taxes Other current liabilities will increase by 5% Long-term debt will grow by 5% Capital leases will grow by 2% Common stock Retained earnings Accumulated other comprehensive income is anticipated to grow by 10% GRAINCORP LTD CLASS A (GNC) BALANCE SHEET Fiscal year ends in September. AUD in millions except per share data. 2015-09 Assets 2015 2016 2017 2018 Current assets Cash Cash and cash equivalents $ 374.00 $ 411.40 $ 452.54 $ 497.79 Short-term investments $ 92.00 $ 101.20 $ 111.32 $ 122.45 Total cash $ 466.00 $ 512.60 $ 563.86 $ 620.25 Receivables $ 440.00 $ 462.00 $ 485.10 $ 509.36 Inventories $ 555.00 $ 610.50 $ 671.55 $ 738.71 Prepaid expenses $ 34.00 $ 35.70 $ 37.49 $ 39.36 Other current assets $ 3.00 $ 3.15 $ 3.31 $ 3.47 Total current assets $ 1,498.00 $ 1,623.95 $ 1,761.30 $ 1,911.14 Non-current assets Property, plant and equipment Gross property, plant and equipment $ 2,300.00 $ 2,530.00 $ 2,783.00 $ 3,061.30 Accumulated Depreciation $ (925.00) $ (971.25) $ (1,019.81) $ (1,070.80) Net property, plant and equipment $ 1,376.00 $ 1,558.75 $ 1,763.19 $ 1,990.50 Equity and other investments $ 191.00 $ 200.55 $ 210.58 $ 221.11 Goodwill $ 446.00 $ 446.00 $ 446.00 $ 446.00 Intangible assets $ 100.00 $ 102.00 $ 104.04 $ 106.12 Deferred income taxes $ 64.00 $ 70.40 $ 77.44 $ 85.18 Total non-current assets $ 2,176.00 $ 2,377.70 $ 2,601.25 $ 2,848.91 Total assets $ 3,674.00 $ 4,001.65 $ 4,362.55 $ 4,760.05 Liabilities and stockholders' equity Liabilities Current liabilities Short-term debt $ 329.00 $ 345.45 $ 362.72 $ 380.86 Capital leases $ 1.00 $ 1.05 $ 1.10 $ 1.16 Accounts payable $ 180.00 $ 189.00 $ 198.45 $ 208.37 Deferred income taxes $ 8.00 $ 8.40 $ 8.82 $ 9.26 Other current liabilities $ 354.00 $ 371.70 $ 390.29 $ 409.80 Total current liabilities $ 871.00 $ 915.60 $ 961.38 $ 1,009.45 Non-current liabilities Long-term debt $ 780.00 $ 819.00 $ 859.95 $ 902.95 Capital leases $ 9.00 $ 9.27 $ 9.55 $ 9.83 Deferred taxes liabilities $ 78.00 $ 78.00 $ 78.00 $ 78.00 Other long-term liabilities $ 114.00 $ 114.00 $ 114.00 $ 114.00 Total non-current liabilities $ 981.00 $ 1,020.27 $ 1,061.50 $ 1,104.78 Total liabilities $ 1,852.00 $ 1,935.87 $ 2,022.88 $ 2,114.23 Stockholders' equity Common stock $ 1,346.00 $ 1,480.60 $ 1,628.66 $ 1,791.53 Retained earnings $ 359.00 $ 394.90 $ 434.39 $ 477.83 Accumulated other comprehensive income $ 117.00 $ 128.70 $ 141.57 $ 155.73 Total stockholders' equity $ 1,822.00 $ 2,004.20 $ 2,204.62 $ 2,425.08 Total liabilities and stockholders' equity $ 3,674.00 $ 3,940.07 $ 4,227.50 $ 4,539.31 Pro-forma free cash flow to equity (FCFE) and firm (FCFF)           2015 2016 2017 2018 Net Income $ 32.00 $ 154.11 $ 214.79 $ 275.21 Net capital Expenditure $ 789.00 $ 828.27 $ 869.50 $ 912.78 Change in working capital $ 517.00 $ 603.68 $ 699.80 $ 806.36 New Debt $ 114.00 $ 114.00 $ 114.00 $ 114.00 Debt Repayment 141 167 236 248 FCFE $ (1,301.00) $ (1,330.84) $ (1,476.52) $ (1,577.93) FCFF = NI + NCC + [Int x (1-tax rate)] – FCInv – WCInv Where: NI = Net Income NCC = Non-cash Charges (depreciation and amortization) Int = Interest Expense FCInv = Fixed Capital Investment (total capital expenditures) WCInv = Working Capital Investments 15-Dec 16-Jan 16-Feb 16-Mar Net Income $ 32.00 $ 154.11 $ 214.79 $ 275.21 Non-cash charges (Depreciation) $ (925.00) $ (971.25) $ (1,019.81) $ (1,070.80) Interest expense $ 43.00 $ 2.58 $ 0.15 $ 0.01 Fixed capital investment $ 789.00 $ 828.27 $ 869.50 $ 912.78 Working capital Investment $ 517.00 $ 603.68 $ 699.80 $ 806.36 FCFF $ (2,168.90) $ (2,247.28) $ (2,374.22) $ (2,514.73) Valuation of firm’s shares in accordance with FCFE 2015 2016 2017 2018 Free cash flow to equity $ (653.00) $ (669.57) $ (843.02) $ (913.15) Discount rate 0.9090909 0.8264463 0.7513148 0.6830135 Terminal Value and formula PVTV $ (593.64) $ (553.36) $ (633.37) $ (623.69) Total Present Value of Equity $ (707.64) $ (667.36) $ (747.37) $ (737.69) Number of shares (m) 3 15 21 28 Price per share $ (221.14) $ (43.30) $ (34.80) $ (26.80) Assumption 10% WACC 4% Growth rate Valuation of firm’s shares in accordance with FCFF 2015 2016 2017 2018 Free cash flow to equity $ 320.00 $ 154.11 $ 214.79 $ 275.21 Discount rate 0.9090909 0.8264463 0.7513148 0.6830135 Terminal Value and formula PVTV $ 290.91 $ 127.36 $ 161.37 $ 187.97 Total Present Value of Equity $ 290.91 $ 127.36 $ 161.37 $ 187.97 Number of shares (m) 3 15 21 28 Price per share $ 90.91 $ 8.26 $ 7.51 $ 6.83 Assumption WACC 10% Growth rate 4% Recommendation From the above analysis, it is apparent that the price per share of Graincorp limited is closing at 90.91 while the market price according to ASX is closing at $88.6. It since, FCFE is more than the market price; the company is financed with debt or current capital. The current capital entails the retained earning for the previous financial period. It can therefore be advice that an investor should not buy shares in this company. Since, shares are going to fall which would lead to a loss. In using the FCFF, it is apparent that the free cash flow is negative which is an implication that the earning for the company is declining. As results, the future share price will decline as well and thus it is advice that an investor should buy the shares in this company since, it will decline in the future. PART B; SELECTION OF STOCKS FOR PORTFOLIO BASED ON P/E RATIOS XMJ - MATERIALS Best Investment Option Share prices delayed by 20 minutes Stock P/E Ratio ASX Code Last Price % Move 52wk High 52wk Low P/E Market Cap               ABC 5.37 -0.19 5.58 4 16.78 3,488,642,512 AMC 16.32 1.87 16.47 12.06 21.16 18,900,865,624 AWC 1.38 -1.78 1.807 0.97 32.55 3,974,184,027 AWC 32.55 XNJ - INDUSTRIALS Share prices delayed by 20 minutes ASX Code Last Price % Move 52wk High 52wk Low P/E Market Cap               AIO 8.85 0 9.14 6.33 23.29 8,632,163,126 AIO 23.29 ALQ 4.21 -0.94 6.273 2.93 -9.54 2,122,744,733 ASB 1.425 1.06 2.56 0.98 11.59 496,460,665 PJ - A-REIT Share prices delayed by 20 minutes ASX Code Last Price % Move 52wk High 52wk Low P/E Market Cap ABP 3.23 -0.31 3.41 2.78 11.96 1,797,743,381 ABP 11.96 BWP 3.59 0 3.67 2.95 7.21 2,306,157,853 CHC 5.27 -0.75 5.475 4.14 9.32 2,175,022,817 SJ - CONSUMER STAPLES Share prices delayed by 20 minutes ASX Code Last Price % Move 52wk High 52wk Low P/E Market Cap               AAC 1.5 -0.66 1.552 1.12 10.95 799,404,346 AHY 1.975 -4.13 2.1 1.45 15.67 1,110,902,398 BAL 10.23 -4.84 16.5 3.39 50.15 988,794,941 BAL 50.15 XTJ - TELECOMMUNICATIONS Share prices delayed by 20 minutes ASX Code Last Price % Move 52wk High 52wk Low P/E Market Cap SPK 3.41 -0.29 3.485 2.35 18.43 6,239,601,554 TLS 5.64 -1.4 6.53 4.98 16.21 68,952,698,915 TPM 11.57 -0.69 11.9 8.45 29.44 9,816,833,975 TPM 29.44 XUJ - UTILITIES Share prices delayed by 20 minutes ASX Code Last Price % Move 52wk High 52wk Low P/E Market Cap AGL 18.45 -0.32 19.65 15.02 -22.56 12,448,443,374 APA 8.98 -0.11 9.39 8.01 110.18 10,006,480,174 APA 110 AST 1.57 -2.79 1.695 1.222 11.25 5,554,087,186 Bibliography Alastair, G. 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