valuation is an art

8/22/2019 Valuation is an Art

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Equity Valuation in the context of Bangladesh

Ali Imam

AnalystBRAC EPL Stock Brokerage Ltd.

June 30, 2012


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Valuation

Is an art

Is always biased- find the direction and extent

Is a forward looking exercise

Value is what you get (price is what you pay)

Does not indicate when it will be realized


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Basic Principles

Both buyer and seller wants to win

Everything has an opportunity cost for everyone

Cash is the king

Relative perspective

Tools

Macro-economic Data

Industry Data Financial Statement


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Rights of different stakeholders of a company

Lenders lend fund to earn interest income on investment Government provides public services to collect tax revenue from corporations

Shareholders invest in current share price to earn future dividend and capital gain

Enterprise value is the operating value of the entity (market cap excluding cash &

investments) Market Cap of Equity = No of Shares x Current Share Price

Market Cap of Debt = Book Value of Debt

Enterprise Value = Market cap of Equity + Market Cap of Debt Cash & Investment

Stakeholders Contribution of Stakeholders Payoff to Stakeholders

Customer Revenues Product/ services

Supplier Raw material Cost of Sales

Employees Human resource Wage & salaries

Lenders Interest debt Interest payment

Government Public facilities Tax

Sponsors Financial & entrepreneurial capital Net profit and dividend

Minority Shareholders Share price Net profit and dividend


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Understanding the Income Statement

Personal Income Statement

Salary

- Food

- House Rent

- Conveyance- Allocation of Fixed asset cost

- Interest Expense

+ Income from Assets

Taxable Income

- Income Tax

Savings

Summary of revenue and expenses for a particular period

Think about your personal accounts-


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Personal Income Statement

Salary

- Food

- House Rent

- Conveyance- Allocation of Fixed asset cost

- Interest Expense


Taxable Income

- Income Tax

Savings

Corporate Income Statement

Revenue

- Raw material cost

- Labor cost

- Overhead- Allocation of Fixed asset cost (Depreciation)

- Interest Expense


Taxable Income

- Tax Exp

Net Income

Understanding the Income Statement

Summary of revenue and expenses for a particular period

Revenue and expense recognition is governed by accounting standards and assumptions


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Personal Balance Sheet

+ House-hold Assets

+ Jewelery

+ Bank deposit

+ Cash

Total Assets

- Bank Loan

Net Worth

Understanding the Balance Sheet

List of assets and liabilities on a particular date- a snapshot


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Personal Balance Sheet

+ House-hold Assets

+ Jewelery

+ Bank deposit

+ Cash

Total Assets

- Bank Loan

Net Worth

Corporate Balance Sheet

Plant, Property & Equipment

Account Receivables

Investments

Cash

Total Assets

- Payables

- Interest Bearing Debt

Shareholders Equity

Understanding the Balance Sheet

List of assets and liabilities on a particular date- a snapshot

Liabilities and Shareholders Equity represent Sources of Capital while Assets represent

Utilization of Capital Assets and liabilities are recognized at historical cost value

Shareholders Equity = Share Capital + Net Profit for the year Cash Dividend for the year


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What drives value- think of an asset that never offers cash-returns


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So, cash-flow is the main value driver


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Cash-flow Statement

+ Cash Revenue

- Cash Expenses

Net Cash-flow from Operation

+ Asset Sales Proceed- Asset Purchase

Net Investing Cash-flows

- Debt Repayment

- Dividend Payment

Financing Cash-flows

So, cash-flow is the main value driver


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Cash-flow Statement

+ Cash Revenue

- Cash Expenses




- Debt Repayment

- Dividend Payment


So, cash-flow is the main value driver But which type of cash-flows?


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Cash-flow Statement

+ Cash Revenue

- Cash Expenses




- Debt Repayment

- Dividend Payment



Operating cash-flow is the primary

value driver

Investments are the most importantusage of operating cash-flows

Residual is available for distribution

among the investors of corporation


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Cash-flow Statement

+ Cash Revenue

- Cash Expenses




- Debt Repayment

- Dividend Payment



Operating cash-flow is the primary

value driver

Investments are the most importantusage of operating cash-flows

Residual is available for distribution

among the investors of corporation

Free CF= Operating CF Investments = Distributable CF to investors


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Discounted Cash Flow (DCF) valuation

Cash Flow Cash Flow Cash Flow Cash Flow Continuing Value

Discounted at opportunity cost

Enterprise Value

Net Debt

Equity Value


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Discounted Cash Flow (DCF) valuation

Cash Flow Cash Flow Cash Flow Cash Flow Continuing Value

Discounted at opportunity cost

Enterprise Value

Net Debt

Equity Value

Present Value =

Fair Value Estimate =


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Relative Valuation

Return/ Yield

Output/Input Ratio

The higher, the better for investors

Example: Interest Rate, Dividend Yield

Trading Multiple

Input/Output Ratio

The lower, the better for investors

Example: PE Ratio, P/ BV Ratio

Comparing valuation ratios of Company X with- Its own historical average

Valuation ratios of company Y

Valuation ratios of the sector where X belongs

Valuation ratios of the broader market


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Who is entitled to what?

Income Statement Investors' Claim Investors' Investment

Multiple

/Yield

Revenue FCF for all stakeholders Total Value of the FIrm P/S

- Raw material cost

- Other Direct Cost

Gross Profit

- Admin Exp

- Selling Exp

EBITDA FCF for Lender, Govt & Shareholders Enterprise Value EV/ EBITDA-Depn & Amort

EBIT FCF for Lender, Govt & Shareholders Enterprise Value EV/ EBIT

- Interest Expense


EBT FCF for Govt

- Tax Exp

Net Income FCF for Shareholders Market Capitalization of Equity P/EEPS FCF for Individual Shareholder Share Price P/E


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Price to Earning Ratio (P/E)

Definition:

Trailing P/E= Current Share price/Trailing 12 months earnings per share Forward P/E= Current Share price/Next 12 months earnings per share

Meaning and implication:

It indicates number of years will it take for return OF capital (not return ON capital)

Generally, the lower the P/E, the cheaper the stock

Companies with better earnings growth outlook should have higher P/E multiple

Pros & Cons:

Intuitive measure, readily available across stocks, practically applicable

Cant capture effect of earnings growth

Weak indicator when earnings quality is poor and unsustainable

Analytical Challenges:

Use fully-diluted earnings per share after record date

Adjust earnings for non-recurring items

Dont use P/E for evaluating asset-based companies (banks, MF etc.)


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Price to Book Value (P/BV)

Definition:

P/BV= Current Share price/Book Value Per Share Book value per share= (Total Assets- Total Debt)/ Number of outstanding shares


It indicates how market values an asset relative to its accounting value

Generally, the lower the P/BV, the cheaper the asset

Companies that can generate higher ROE should have higher P/BV

Pros & Cons:

Book value does not consider important assets like human resource, brand value, etc.

Should be used for companies which has significant marketable assets on balance sheet such

as banks


Assess the quality of asset revaluation

Assess implications of off-balance sheet assets & debt


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Enterprise Value to EBITDA (EV/EBITDA)

Definition:

EV/EBITDA= (MCAP of Equity + MCAP of Debt Cash & Investments)/ EBITDA EBITDA= Net Profit + Tax + Interest Expenses + Depn & Amort


It indicates number of years it will take to recoup investments done by all investor-groups

Generally, lower EV/EBITDA indicates cheap valuation

Generally, companies with better revenue growth, higher EBITDA margin and lower debt

have higher EV/EBITDA

Pros & Cons:

EBITDA is a better proxy of cash flow

Good indicator for investment intensive industries

Auto-adjusts for differential tax status, depreciation policy and capital structure

Analytical Challenges: Difficult to calculate- more information need


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Dividend Yield (D/P)

Definition:

Dividend Yield= Cash Dividend Per Share/ Current Share price


It indicates the rate of return based on the dividend income only

Generally, investors prefer high dividend yield specially during economic downturn

High dividend yield also means lack of growth opportunity

Pros & Cons: Practically applicable, simple and intuitive

Captures only one source of return- dividend, does not consider capital gain


Stock dividend is effectively no dividend

High dividend yield investments may not be positively viewed specially when growth outlook

is weak


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Sample Valuation Case

Valuation of ABC Corp 2012E 2013E 2014E 2015E

Pretax Earning 41,469 43,901 47,953

+ Depreciation & Amortization 15,718 17,352 19,183

+ Net Financial Expenses 309 825 182

- Cash Income Tax Paid (19,768) (16,824) (17,916)- Working Capital Investments 1,317 1,115 2,403

CFO 39,046 46,369 51,804

- Capex (22,068) (15,700) (16,887)

+ Divestment of Other Assets - - -

CFI (22,068) (15,700) (16,887)

Free Cash Flow 16,978 30,669 34,917

Normalized CF 39,826

Terminal Value 384,564

PV of FCF 14,693 23,202 277,473

Enterprise Value 315,368

+ Cash & Investments 22,225

- Interest Bearing Debt 20,221

Equity Value 317,372

Number of Share 1,000Per Share Value 317

Weighted Avg Cost of Capital 15.6 15.0% 14.8%

EV/ EBITDA 5.5 x 5.1 x 4.7 x

P/E 12.8 x 11.9 x 10.8 x

P/B 8.1 x 7.4 x 6.7 x

Yield 7.0% 7.5% 8.4%


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CompaniesP/E P/BV EV/EBITDA Dividend Yield ROE Earnings Growth

2011A 2012E 2011A 2012E 2011A 2012E 2011A 2012E 2011A 2012E 2011A 2012E

Cement

A Cement 20.2 16.1 3.1 2.2 13.1 9.1 2.1% 2.5% 16% 14% -17% -4%

Consumer

B Cons Co Ltd 21.6 16.2 5.0 3.4 15.9 10.2 3.2% 3.7% 26% 22% 0% 3%

ABC Instant Food 14.5 11.3 6.3 5.5 6.4 5.4 6.7% 8.4% 42% 51% -11% 25%

Fuel & Power

Electricity Dist Co 13.5 10.9 4.4 3.5 8.6 6.7 5.7% 7.3% 34% 33% 6% 8%

Gas Dist Co 8.2 8.2 2.7 1.9 5.1 4.2 3.7% 5.3% 37% 25% 25% -17%

Pharmaceuticals

R&D Pharma 16.7 9.0 1.4 0.9 9.2 5.5 N/A 2.6% 9% 11% 36% 35%

Gnenric Pharma 15.4 12.1 3.3 2.6 9.2 7.8 1.4% 1.7% 24% 24% 31% 29%

Telecom

Dhaka Telecom 12.5 14.2 6.0 6.7 5.0 5.1 12.5% 9.1% 43% 48% 72% 3%

Tannery

Leather Footwear 15.5 10.9 4.9 2.9 7.6 4.6 1.4% 1.7% 31% 30% 8% 10%

Brand Footwear 13.0 9.2 4.7 3.2 8.7 6.0 5.0% 7.3% 41% 38% 17% 13%

Valuation Multiple Comparisons


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Current Valuation of the Market

Valuations become attractive after 44%

market correction from the peak

Current market PE is 13.0x against the

long-term average PE of 17.2x

Current market dividend yield is 3.7%,

more than long term average of 3.3%

On average, earnings of listed

companies grew by more than 20%

annually during last 10 years0.00%

1.50%

3.00%

4.50%

6.00%

7.50%

9.00%

0.00x

6.00x

12.00x

18.00x

24.00x

30.00x

36.00x

DividendYield

MarketP/E

Market P/E Yield

Source: DSE, BRAC EPL Research


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Thanks

valuation is an art

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