Are we valuing stocks correctly? AIA Seminar Riding the stock market roller coaster March 2016 This document has been prepared by Aurora Funds Management Limited (ACN 092 626 885, AFSL 22221). The information contained in this document is for information purposes only and has been prepared based on the information available to it at the time of preparation, from sources believed to be reliable and subject to the qualifications in this document. The information contained in this document is an overview and does not contain all information necessary to make an investment decision. No representation or warranty express or implied, is made as to the fairness, accuracy, adequacy, validity, correctness or completeness of the information contained in this document. Aurora strongly suggests that investors consult a financial advisor prior to making an investment decision. Aurora Funds Management Limited ABN 69 092 626 885 AFSL No. 222110
Transcript
Are we valuing stocks correctly?
AIA Seminar Riding the stock market roller coaster
March 2016
This document has been prepared by Aurora Funds Management Limited (ACN 092 626 885, AFSL 22221). The information contained in this document is for information purposes only and has been prepared based on the information available to it at the time of preparation, from
sources believed to be reliable and subject to the qualifications in this document. The information contained in this document is an overview and does not contain all information necessary to make an investment decision. No representation or warranty express or implied, is made as to the fairness, accuracy, adequacy, validity, correctness or completeness of the information contained in this document. Aurora strongly
suggests that investors consult a financial advisor prior to making an investment decision.
Aurora Funds Management Limited ABN 69 092 626 885
AFSL No. 222110
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Introduction:- Valuation
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Source: Alamy
! Valuations from the sell side Investment Banks
! Key components in valuing a company
! Strengths and weaknesses of valuation methods
! How valuations change overt time
! Impact of low interest rates on company valuation
Source: dailylendingnews
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Background
Team Member Background Years in financial industry
Hugh Dive
• Currently Fund Manager Aurora Dividend Income Trust and Aurora Property Buy-Write Income Trust.
• Lead Sell side analyst Citigroup covering Basic Materials (building materials, steel and chemicals).
• In the 2011 Reuters StarMine Equity Analyst Awards, he was rated 5th overall in Australia for stock picking
• Fund Manager and analyst Philo Capital, Investors Mutual and CC&L Investment Management in Vancouver (C$60B FUM)
• Education: B.Ec, LLB, CFA, Canadian Securities Course (Honours)
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Background
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Valuations from the Investment Banks
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Source: dailylendingnews
! Behind Stockbroker investment research
! Historic Role of security analysis
! Inherent conflicts
! 2003 Global Analyst Research Settlements and Structural Reforms
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Valuations from the Investment Banks
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Source: dailylendingnews
! Declining Commissions
! Increasing reliance on investment banking deals
! Flaws in the research model
! How to use stockbroker research
Key components in valuing a company
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! Why Value a company? ! Strengths ! Limitations – garbage in garbage out!
! Earnings forecasts ! Discount rates
! Margin of Safety
Valuing a company: Multiples Method
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! Price-to-Earning Multiples
! EBITDA Multiples ! Other Multiples
Valuing a company: Comparable Transactions
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! Comparable Transactions or sum of parts looks to value a company based on what it would cost to replace their long life assets on the open market.
! Relates asset values to open market transactions and can identify
undervalued or overvalued assets
Replacement Cost Valuation of Company AssetsFertil izers Units Capacity Replacement Cost /t Value SourcePhosphate Rock Reserves MT ($/t P2O5) MT 103 6.73 693 MOS/Mitsui purchase Bayovar 2010DAP Plant Phosphate Hill KT/per annum 975 1.53 1492 Fertecon estimates ex depositNitrogen (ammonia/urea complex) KT/per annum 405 1.25 506 Fertecon estimates (integrated nitrogen facil ity)Urea St Helens USA KT/per annum 182 2.44 444Perdamon 20 year marketing contract 131 NPV 20 year contract
ExplosivesUS Capacity KT/per annum 1036 3.00 3108 Moranbah less US deflatorMoranbah KT/per annum 330 3.26 1076 Moranbah construction cost estimatesQNP (50% share) KT/per annum 107.5 3.26 350 Moranbah construction cost estimatesLess Net debt -‐1,821TOTAL 5980Shares on Issues 1,687
Replacement Cost per Share (A$) 3.54$
Valuing a company: Discounted Cash Flow Analysis
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Source: Scott Adams/UFS
Valuing a company: Discount Rate
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Valuing a company: Discount Rate
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Company details Cost of capital (linear -‐ equity risk at spot year)
Incitec Pivot Tax rate assumed 30.00%Current share price 2.90$ Market capitalisation ($m) 4884 Cost of equity 11.58%Enterprise value ($m) 6058 Cost of debt 6.00%
Assumed leverage 30%Macro assumptions WACC 9.9%Terminal growth rate 3.00%Risk free rate (10 year government bond) 4.00%Equity risk premium 6.1%Implied market return 10.1%BETA 1.15Cost of equity 11.6%
! Key inputs to determine a stock’s (IPL.ASX) Weighted Average Cost Of Capital or WACC.
! This is then used to discount back IPL’s future expected cash flows.
EBIT 463 519 606 579 808 878 933 975 1,020 7.7%tax rate on EBIT (cur + def) 25.1% 19.2% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%Adjusted taxes (116) (100) (119) (108) (162) (179) (196) (244) (255)NOPLAT 347 419 488 471 647 699 737 732 767 790 7.2%Depreciation and amortisation 244 223 244 272 299 291 319 327 335 344 3.0%Capital Expenditures (net) (428) (498) (481) (498) (256) (253) (245) (256) (263) (269) -‐8.7%Net change in working capital 141 (123) 15 24 11 2 0 0 0 0 Disposals / (acquisitions) 15 0 0 0 0 0 0 0 0 0FCFF 318 22 266 269 701 739 812 803 839 11,434Discount factor (mid-‐year convention) 0.954 0.868 0.790 0.718 0.654 0.541 0.408Discounted FCFF 257 608 584 583 525 454 4,661Valuation ($m) p/share Present value of forecast period 3,011 $1.78 Estimated fair value per share ($) 3.47$ Present value of terminal value 4,661 $2.76 Current share price 2.91$ Total present value of CF 7,672 $4.55 Implied equity upside / (downside) 19.4%
Estimated enterprise value 7,672 $4.55Non-‐operating assets / investments 0 $0.00Net debt (1,821) -‐$1.08Cash from option discounted for taxEstimated net equity value 5,852 $3.47Shares (m) 1,687
