11/2/2018 Nattawoot Koowattanatianchai 1 Investment Analysis & - PowerPoint PPT Presentation

11/2/2018 Nattawoot Koowattanatianchai 1

Investment Analysis & Portfolio Management Assistant Professor Nattawoot Koowattanatianchai, DBA, CFA 11/2/2018 Nattawoot Koowattanatianchai 2

 Em Email: :  fbusn snwk@k wk@ku. u.ac. c.th th  Homepag age: e:  http:// tp://fin. in.bu bus. s.ku. ku.ac. c.th/nattaw h/nattawoot.h oot.htm tm  Ph Phone:  02 02-942 4287 8777 77 Ext. t. 1212  Mobile le: :  087 087- 5393525 5393525  Of Offic fice: e: th floor,  9 th r, KBS Building 4 11/2/2018 Nattawoot Koowattanatianchai 3

Lecture 3 Stock Valuation: Free Cash Flow Model 11/2/2018 Nattawoot Koowattanatianchai 4

Discussion topics  Reviewing dividend discount models  free cash flow valuation models 11/2/2018 Nattawoot Koowattanatianchai 5

Readings  CFA Program Curriculum 2015 - Level II – Volume 4: Equity.  Readings 33-34 11/2/2018 Nattawoot Koowattanatianchai 6

Stock valuation  Selecting the appropriate valuation model  Absolute valuation model  specifies an asset’s intrinsic value using present value models.  Dividend Discount Model  Free ee Cas ash h Flow w Model del  Residual Income model  Relative valuation model  estimates an asset’s value relative to that of another asset.  Price multiples  Enterprise value multiples 11/2/2018 Nattawoot Koowattanatianchai 7

Free cash flows (FCFs)  Differences between FCF and dividends  Whereas dividends are the cash flows actually paid to stockholders, FCFs are the cash flows available for distribution to shareholders.  Free cash flow to the firm: FCFF  The cash flow available to the company’s suppliers of capital after all operating expenses (including taxes) have been paid and necessary investments in working capital (e.g., inventory) and fixed capital (e.g., equipment) have been made. 11/2/2018 Nattawoot Koowattanatianchai 8

Free cash flows (FCFs)  Free cash flow to equity: FCFE  The cash flow available to the company’s holders of common equity after all operating expenses, interest, and principal payments have been paid and necessary investments in working and fixed capital have been made.  FCFE is the cash flow from operations minus capital expenditures minus payments to (and plus receipts from) debtholders. 11/2/2018 Nattawoot Koowattanatianchai 9

Free cash flows (FCFs)  Common equity valuation  Common equity can be valued directly by using FCFE or indirectly by first using a FCFF model to estimate the value of the firm and then subtracting the value of non-common-stock capital (usually debt) from FCFF to arrive at an estimate of the value of equity. 11/2/2018 Nattawoot Koowattanatianchai 10

Free cash flows (FCFs)  Analysts like to use FCF as the return (either FCFF or FCFE) whenever one or more of the following conditions is present:  The company does not pay dividends.  The company pays dividends but the dividends paid differ significantly from the company’s capacity to pay dividends. 11/2/2018 Nattawoot Koowattanatianchai 11

Free cash flows (FCFs)  Analysts like to use FCF as the return (either FCFF or FCFE) whenever one or more of the following conditions is present:  FCFs align with profitability within a reasonable forecast period with which the analyst is comfortable.  The investor takes a “control” perspective. If an investor can take control of the company (or expects another investor to do so), dividends may be changed substantially. 11/2/2018 Nattawoot Koowattanatianchai 12

Present value of FCF  11/2/2018 Nattawoot Koowattanatianchai 13

Present value of FCF  11/2/2018 Nattawoot Koowattanatianchai 14

Single-stage FCF models  Constant-growth FCFF valuation model  Firm value = FCFF 1 /(WACC – g)  Firm value = [FCFF 0 (1+g)]/(WACC – g) The model assumes that FCFF grows at a constant rate, g, such that  FCFF in any period is equal to FCFF in the previous period multiplied by (1+g).  Constant-growth FCFE valuation model  Equity value = FCFE 1 /(r – g)  Firm value = [FCFE 0 (1+g)]/(r – g) The model assumes that FCFE grows at a constant rate, g. FCFE in  any period is equal to FCFE in the preceding period multiplied by (1+g). 11/2/2018 Nattawoot Koowattanatianchai 15

Single-stage FCF models  Example 1  Cagiati Enterprices has FCFF of 700 million Swiss frans (CHF) and FCFE of CHF620 million. Cagiati’s before-tax cost of debt is 5.7%, and its required rate of return for equity is 11.8%. The company expects a target capital structure consisting of 20% debt financing and 80% equity financing. The tax rate is 33.33%, and FCFF is expected to grow forever at 5%. Cagiati Enterprises has debt outstanding with a market value of CHF 2.2 billion and has 200 million outstanding common shares. 11/2/2018 Nattawoot Koowattanatianchai 16

Single-stage FCF models  Example 1  Computing WACC  WACC = .20(5.7%)(1-.3333) + .80(11.8%) = 10.2%  Computing equity value using FCFF  Firm value = [700(1.05)]/(.102 - .05) = CHF14,134.6 million  Equity value = 14,134.6 – 2,200 = CHF11,934.6 million  Computing equity value per share  V 0 = CHF11,934.6/200 = CHF59.67 11/2/2018 Nattawoot Koowattanatianchai 17

Computing FCFF from net income  FCFF = NI + NCC + Int × (1 – Tax rate) – FCInv - WCInv  NI = Net income available to common shareholders  NCC = Net noncash charges  Int = Interest expense  FCInv = Investment in fixed capital  WCInv = Investment in working capital 11/2/2018 Nattawoot Koowattanatianchai 18

Computing FCFF from net income  Example 2  Calculate the FCFF for Cane Distribution, Inc. Cane ne Distribu ribution, ion, Inc. Inc ncom ome Stat atem ement ent (in n Thou ousand nds) Year ar Ending ding 31 Decem embe ber 2010 2011 2012 EBITDA $200.00 $220.00 $242.00 Deprec preciat iation ion expe pens nse 45.00 49.50 54.45 Oper erat ating ing income 155.00 170.50 187.55 Int nter eres est expen pense (at at 7%) 15.68 17.25 18.97 Inc ncom ome bef efor ore e tax axes es 139.32 153.25 168.58 Inc ncom ome tax axes (at at 30%) %) 41.80 45.97 50.58 Net inc ncom ome $97.52 $107.28 $118.00 11/2/2018 Nattawoot Koowattanatianchai 19

Computing FCFF from net income Cane ne Distribu ribution, ion, Inc. Balanc lance e Sheet eet (in n Thous ousan ands ds) Year ar Ending ding 31 Decem embe ber 2009 2010 2011 2012 Cash $0.00 $108.92 $228.74 $360.54 Account unts receiv ivable ble 0.00 100.00 110.00 121.00 Inv nven entory ry 60.00 66.00 72.60 79.86 Curr urren ent asset ets 60.00 274.92 411.34 561.40 Fixed ed assets 500.00 500.00 550.00 605.00 Les ess: Accum umulat lated ed deprec eprecia iatio ion 0.00 45.00 94.50 148.95 Tot otal l asset ets $560.00 $729.92 $866.84 $1,017.4 5 Account unts payab able le $0.00 $50.00 $55.00 $60.50 Curren rrent port ortio ion n of long ng-ter erm debt bt 0.00 0.00 0.00 0.00 Curr urren ent liabilit abilitie ies 0.00 50.00 55.00 60.50 Long ng-ter erm debt bt 224.00 246.40 271.04 298.14 Common n stoc ock 336.00 336.00 336.00 336.00 Retain ained ed earn rning ings 0.00 97.52 204.80 332.80 Tot otal l liabilit abilities ies and nd equit uity $556.00 $729.92 $866.84 $1,017.4 5 11/2/2018 Nattawoot Koowattanatianchai 20

Computing FCFF from net income Cane ne Distribu ribution, ion, Inc. Work rking ing Capit ital al (in n Thou ousand nds) Year ar Ending ding 31 Decem embe ber 2009 2010 2011 2012 Curren rrent asset ets exclu luding ding cas ash Account unts receiv ivable ble $0.00 $100.00 $110.00 $121.00 Inv nven entory ry 60.00 66.00 72.60 79.86 Tot otal l curre urrent nt assets exclu ludin ding g cash 60.00 166.00 182.60 200.86 Curren rrent liabilit abilities ies exclud luding ing short hort-term rm debt bt Account unts payab able le 0.00 50.00 $55.00 $60.50 Work rkin ing g capit pital al $60.00 $116.00 $127.60 $140.36 Inc ncre reas ase e in work rkin ing g capit pital al $56.00 $11.60 $12.76 11/2/2018 Nattawoot Koowattanatianchai 21

Computing FCFF from net income Cane ne Distribu ribution, ion, Inc. FCFF (in n Thou ousand nds) Year ar Ending ding 31 Decem embe ber 2010 2011 2012 Net inc ncom ome $97.52 $107.28 $118.00 Noncas ncash h char arge ges - Depre precia iatio ion 45.00 49.50 54.45 Intere rest expe pens nse e × (1 (1-Tax rat ate) e) 10.98 12.08 13.28 Investment nt in fixed ed capit apital al (0.00) (50.00) (55.00) Investment nt in work rking ing capit apital (56.00) (11.60) (12.76) FCFF FCFF $97.50 $107.26 $117.87 11/2/2018 Nattawoot Koowattanatianchai 22

Computing FCFF from CFO  FCFF = CFO + Int × (1 – Tax rate) – FCInv  CFO = Cash flow from operations  Int = Interest expense  FCInv = Investment in fixed capital  Example 3  Calculate Cane Distribution’s FCFF from the statement of cash flows 11/2/2018 Nattawoot Koowattanatianchai 23