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Table of Contents
Executive Summary 1
Business Overview and Industry Analysis 10
Business Overview 10
Industry Overview (Paper Packaging) 11
Five Forces Model 12
Rivalry Among Existing Firms 13
Industry Growth 13
Concentration and Balance of Competitors 14
Degree of Differentiation and Switching Costs 15
Economies of Scale 16
Learning Economies 16
Excess Capacity and Exit Barriers 17
Conclusion 17
Threat of New Entrants 18
First Mover Advantage 18
Economies of Scale 19
Legal Barriers 19
Access to Distribution Channels and Relationships 20
Conclusion 20
Threat of Substitute Products 22
Technological Advances 22
Similar Products 23
Relative Pricing 23
Conclusion 23
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Bargaining Power of Buyers 23
Price Sensitivity 24
Conclusion 25
Relative Bargaining Power 25
Conclusion 26
Bargaining Power of Suppliers 26
Conclusion 27
Industry Analysis 27
Industry Overview (Building Products) 27
Five Forces Model 28
Rivalry Among Existing Firms 29
Industry Growth 30
Concentration and Balance of Competitors 31
Degree of Differentiation and Switching Costs 31
Economies of Scale 32
Learning Economies 32
Excess Capacity and Exit Barriers 33
Conclusion 33
Threat of New Entrants 33
First Mover Advantage 34
Economies of Scale 34
Legal Barriers 35
Access to Distribution Channels and Relationships 35
Conclusion 35
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Threat of Substitute Products 36
Technological Advances 37
Similar Products 37
Relative Pricing 37
Conclusion 38
Bargaining Power of Buyers 38
Price Sensitivity 39
Conclusion 40
Relative Bargaining Power 40
Conclusion 40
Bargaining Power of Suppliers 41
Conclusion 41
Value Creation Analysis 42
Paper Packaging 42
Economies of Scale and Scope 42
Efficient Production 43
Lower Input Costs 43
Low-Cost Distribution 44
Little Research and Development or Brand Advertising 44
Tight Cost Control System 44
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Value Creation Analysis 45
Building Products 45
Economies of Scale and Scope 45
Efficient Production 46
Lower Input Costs 46
Low-Cost Distribution 46
Little Research and Development or Brand Advertising 47
Tight Cost Control System 47
Combined Industry Value Creation Conclusion 47
Firm Competitive Advantage Analysis 49
Economies of Scale and Scope 49
Efficient Production 50
Lower Input Costs 51
Low Cost Distribution 51
Tight Cost Control 54
Conclusion 55
Formal Accounting Analysis 56
Key Accounting Policies 56
Type 1 Key Accounting Policies 57
Conclusion 60
Type 2 Key Accounting Policies 61
Goodwill 61
Operating Leases 63
Pension Liabilities 64
Commodity Contracts 67
Debt Rating 68
Conclusion 69
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Accounting Flexibility 69
Goodwill 70
Operating Leases 71
Pension Liabilities 72
Commodity Contracts 76
Debt Rating 76
Conclusion 77
Evaluate Accounting Strategy 78
Goodwill 78
Operating Leases 80
Pension Plans 81
Commodity Contracts 83
Debt Rating 83
Conclusion 83
Quality of Disclosure 85
Goodwill 86
Operating Leases 87
Pension Plans 87
Commodity Contracts 88
Debt Rating 88
Conclusion 89
Quantitative Analysis 90
Sales Manipulation Diagnostic 90
Net Sales/Cash from Sales 91
Net Sales/Accounts Receivable 92
Net Sales/Inventory 95
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Core Expense Manipulation Diagnostic 96
Asset Turnover 96
CFFO/OI 98
CFFO/NOA 100
Total Accruals/Sales 102
Conclusion 104
Potential Red Flags 105
Financial Analysis, Forecasting Financials, and Cost of Capital Estimation 105
Financial Analysis 106
Liquidity Ratio Analysis 106
Current Ratio 107
Quick Ratio 109
Working Capital Turnover 111
A/R Turnover Ratio 113
Day’s Sales Outstanding 114
Inventory Turnover 116
Day’s Supply of Inventory 118
Cash to Cash Cycle 119
Conclusion 120
Profitability Analysis 121
Gross Profit Margin 122
Operating Expense Ratio 123
Operating Profit Margin 125
Net Profit Margin 127
Asset Turnover 128
Return on Assets 130
Return on Equity 132
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Firm Growth Rate Ratios 134
Internal Growth Rate 134
Sustainable Growth Rate 136
Conclusion 138
Capital Structure Ratios 140
Debt to Equity 140
Times Interest Earned 142
Debt Service Margin 143
Z-Score 145
Conclusion 147
Estimating Cost of Capital 147
Cost of Equity 148
Alternative Cost of Equity 153
Cost of Debt 154
Weighted Average Cost of Capital 157
Financial Statement Forecasting 159
Income Statement 159
Balance Sheet 167
Statement of Cash Flows 172
Conclusion 174
Valuation Analysis 175
Method of Comparables 175
Price to Earnings Trailing 175
Price to Earnings Forward 176
Price to Book 177
Dividends to Price 178
Price to Free Cash Flow 179
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Price Earnings Growth 180
Price to EBITDA 181
EV to EBITDA 182
Conclusion 183
Intrinsic Valuation Models 184
Discount Dividends Model 184
Discounted Cash Flows Model 186
Residual Income Growth Model 190
Abnormal Earnings Growth Model 192
Long Run Residual Income Model 196
Appendices 198
Sales Manipulation Ratios 198
Net Sales/Cash from Sales 198
Net Sales/Accounts Receivable 198
Net Sales/Inventory 198
Core Expense Manipulation Ratios 199
Asset Turnover 199
CFFO/OI 199
CFFO/NOA 200
Total Accruals/Sales 200
Liquidity Ratio 201
Current Ratio 201
Quick Ratio 201
Working Capital Turnover 202
A/R Turnover Ratio 202
Day’s Sales Outstanding 202
Inventory Turnover 203
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Day’s Supply of Inventory 203
Cash to Cash Cycle 203
Profitability Ratios 204
Gross Profit Margin 204
Operating Expense Ratio 204
Operating Profit Margin 205
Net Profit Margin 205
Asset Turnover 206
Return on Assets 206
Return on Equity 207
Firm Growth Rate Ratios 207
Internal Growth Rate 207
Sustainable Growth Rate 208
Capital Structure Ratios 208
Debt to Equity 208
Times Interest Earned 208
Debt Service Margin 209
Z-Score 209
Cost of Capital 209
Weighted Average Cost of Debt 209
Weighted Average Cost of Capital 210
Cost of Equity Regression Analysis 210
3 month 211
2 year 212
5 year 213
7 year 214
10 year 215
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Method of Comparables 216
Price to Earnings Trailing 216
Price to Earnings Forward 216
Price to Book 216
Price Earnings Growth 217
Price to EBITDA 217
EV to EBITDA 218
Price to Free Cash Flow 218
Dividends to Price 219
Intrinsic Valuation Models 220
Discount Dividends Model 220
Discounted Cash Flows Model 220
Residual Income Growth Model 221
Abnormal Earnings Growth Model 222
Long Run Residual Income Model 223
References 224
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Executive Summary
Investment Recommendation: Overvalued Sell
As of November 3rd, 2008
TIN – NYSE (11/3/2008) $5.6152 Week Range: $ 2.34 - $ 47.83
Revenue: $ 3.85 Billion
Market Capitalization: $ 596.19 Million
Shares Outstanding: 106,274,170
Book Value Per Share: $ 7.18
Return on Equity: 59.62%
Return on Assets: 6.37%
Cost of Capital Estimated R-Squared Beta Ke
2 – Year .0640 1.40 15.19%
3 – Year .0977 1.49 15.93%
4 – Year .1371 1.69 17.50%
5 – Year .1627 1.70 17.59%
6 – year .2128 1.69 17.53%
Back Door Ke: 11.26%
Published Beta: 2.6
Cost of Debt: 4.73%
WACC (BT): 6.06%
Altman Z-Scores
2002 2003 2004 2005 2006 2007
4.12
4.39
4.40
4.47
2.99
4.66
Financial Based Ratios
Current Market Share Price $ 5.61
Trailing P/E: $ 197.54
Forward P/E: $ 0.99
Dividends to Price: $ 6.74
Price to Book: $ 10.35
P.E.G. ratio: N/A
Price to EBITDA: $ 9.96
Enterprise Value/EBITDA: $ 33.03
Price to Free Cash Flows: N/A
Intrinsic ValuationsDiscounted Dividends: $ 3.12
Free Cash Flows: $ 22.04
Residual Income: $ 3.89
Long Run Residual Income: $ 5. 10
Abnormal Growth Rate: $ 3.26
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Industry Analysis
To understand the value of a firm, the industry the firm is in must be
understood. In the paper packaging industry, there are 3 major competitors next to
Temple-Inland. These 3 are Smurfit Stone Container Corporation (SSCC), International
Paper (IP) and Packaging Corporation of America (PKG). The paper packaging industry
is a commodity based industry and therefore must rely on their low-cost production,
quality and service. This raises a high degree of competition in the paper packaging
industry. Temple-Inland does a good job of keeping their costs down and providing
customers with diligent and excellent service and a quality product. Temple-Inland does
this by being a regional company, meaning they sell only to people who are around
their actual workplace, and pushing to provide their customer with the best service by
committing to improve. They have a great opportunity to continue to be successful and
grow if they continue to do these things and find new ways to perfect them. The
industry has also has an advantage since they have bargaining power over buyers. This
is too large of an industry for buyers to be a significant hit on a company who might
lose a customer. Unfortunately, Temple-Inland has no real advantage over any other
competitor.
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There are other factors when looking at the paper packaging industry such as
the threat of new entrants and technological advances. In this industry, as in ever
commodity industry, these factors do not come in to play as much. It is extremely
difficult to enter into this industry as there are not many areas to find a customer basis
and it is extremely expensive to even start a business. With technological advances, it is
difficult to find a better way to process paper packaging products.
Temple-Inland also is involved in the business product industry. This is very
much like the paper packaging industry by the fact that it is also a commodity industry.
Therefore cost allocation is a very large factor. The competitors we analyzed were Plum
Creek Corporation (PLC) and USG. As stated before, Temple-Inland does a good job of
keeping their costs down and providing customers with diligent and excellent service
and a quality product. Temple-Inland does this by being a regional company, meaning
they sell only to people who are around their actual workplace, and pushing to provide
their customer with the best service by committing to improve. They have a great
opportunity to continue to be successful and grow if they continue to do these things
and find new ways to perfect them. The industry has also has an advantage since they
have bargaining power over buyers. This is too large of an industry for buyers to be a
significant hit on a company who might lose a customer. Unfortunately, Temple-Inland
has no real advantage over any other competitor.
Once again, the threat of new entrants into this industry is small due to large
amount of finances and small available customer basis. Unlike the paper packaging
industry, technological advances in the building products industry can be very
significant. This is due to the industry being vertically integrated and able to improve
Accounting Analysis
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When analyzing companies the accounting analysis is an important analysis to
perform. The believability of the Temple-Inland’s financial statements will be assessed
along with the application of some forensic accounting ratios. It is important to look at
the financial statements of Temple-Inland because the numbers being reported will be
compared to its competition it is important to understand whether or not a Temple-
Inland is being more aggressive and inflating net income. With the help of ratios we can
see strange changes such as sales/inventory. If the ratio increases drastically Temple-
Inland may be attempting to recognize sales prematurely, or Temple-Inland might be
changing its inventory procedures. Companies have information with which they choose
whether or not to disclose to the public. Companies that do choose to disclose
information to the public are subject to red flags if the information does not make
sense.
There are two types of key accounting policies used in analyzing Temple-Inland.
Type one key accounting policies are policies related to the key business strategies we
found earlier, Temple-Inland’s industry requires cost leadership strategies so disclosure
of cost of goods sold is important. Temple-Inland’s disclosure of cost of goods sold was
very bad. A gross profit had to be calculated by the analyst. Cost of goods sold and
expenses are separated into business units, however cost and expenses are combined,
to calculate gross profit margin for each segment you need to take out the extra
expenses. A gross profit margin had to be calculated for the entire company, not
business segments. Temple-Inland should have disclosed the prices of timber they paid,
they consistently had a low gross profit compared to the industry average yet they
never disclosed the prices paid for raw materials. They say they pay market prices. Also
Temple-Inland discloses the % increase paid for raw materials every year, this only
helpful if you can understand the exact market prices paid, average prices paid implies
Temple-Inland takes the average of the yearly prices paid and compares the average
prices from last year.
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The type two key accounting policies are goodwill, operating leases, pension
plans, commodity contracts, and debt rating. Pension plans are the most important the
type two key accounting policies. They are so important in fact that the SFAS No. 158
law was implemented to set the minimum amount of information to disclose and
regulate the flexibility that managers have when disclosing information regarding
pension plans. Temple-Inland does a good job adhering to this law and have exceeded
the minimum expectations set forth by SFAS No. 158 in relation to pension plans.
Temple-Inland does not exceed the expectations set by GAAP. There is enough
information provided by most of the key accounting policies to explain any changes that
have risen. The disclosure of the financials is sufficient.
Financial Analysis, Forecasting Financials, and Cost of Capital Estimation
To predict a current stock price we must analyze the past performance using
financial ratios, attempt to predict future financial performance, and estimate the costs
of capital. The information gathered in this portion of the analysis allows us to later
apply evaluation techniques to get a reasonable cost of equity.
The first portion of the financial analysis is to find liquidity ratios for Temple-
Inland and compare these ratios to its competition. By using these ratios, we were able
to compare and contrast Temple Inland’s liquidity to the rest of the industry.
Liquidity Ratio Performance Trend
Current Ratio Over-performed Decreasing Trend
Quick Ratio Under-performed Stable
Working Capital Turnover Over-performed Increasing Trend
A/R Turnover Under-performed Decreasing Trend
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Inventory Turnover Under-performed Decreasing Trend
Cash to Cash Cycle Under-performed Decreasing Trend
Overall Average Decreasing Trend
After observing Temple-Inland’s liquidity ratios it is important to point out both
the performance and the trend. We felt the most important liquidity ratio pertaining to
the industry was the cash to cash cycle. The ability to increase the turn over of your
cash flows is a big advantage in a cost leadership style of industry. Temple-Inland
needs to drastically improve this aspect of their business.
The second portion of the financial analysis is the profitability ratios, these ratios
give an analyst an idea of how well Temple-Inland generates profit compared to its
competition.
Profitability Ratio Performance Trend
Gross Profit Margin Under-performed Stable
Operating Expense Ratio Average Stable
Operating Profit Margin Average Stable
Net Profit Margin Over-performed Decreasing Trend
Asset Turnover Under-performed Stable
ROA Average Increasing Trend
ROE Average Increasing Trend
IGR Average Stable
SGR Over-performed Decreasing Trend
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Overall Average Stable
It is interesting Temple-Inland has a large net profit margin compared to its
gross profit margin. This implies Temple-Inland is generating net income other than
beating its competition with cost leadership strategies such as low cost of goods sold.
The next and final portion of the financial analysis is the capital structure ratio’s
which give us insight into how Temple-Inland is being financed.
Capital Structure Ratio Performance Trend
Debt to Equity Highly Leveraged Decreasing Trend (positive)
Times Interest Earned Average Stable
Debt Service Margin Average Stable
Z - score Average Increasing Trend
Overall Average Increasing Trend (positive)
Temple-Inland has the highest debt to equity ratio in the industry but has an
average debt service margin. This implies Temple-Inland has the ability to cover more
debt with its cash flows from operations than anyone else in the industry.
The next step in the process is to find our cost of capital. Specifically our cost of
equity, cost of debt, and our weighted cost of capital. We accomplish this using a
number of equations including CAMP and the back door method which utilizes the
market to book equation. The cost of debt is estimated using a weighted average of the
firm’s interest rates to arrive at a comprehensive estimation of the firm’s total cost of
debt. The two debt and equity costs are combined in the WACC equation. These costs
of capital are used later on in the analysis in models used to predict a reasonable stock
price.
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The last step in the process of gathering information to input into our evaluation
models is predicting the future financial statements for Temple-Inland. For our models
we chose to forecast our financial statements for 10 years. To forecast an income
statement, balance sheet, and statement of cash flows financial ratios and common
sized statements are utilized. The most important line item to forecast is revenues
because a firm exists to generate net income from its revenue stream. To help predict
revenues we observed how Temple-Inland’s ratios changed the past 5 years and drew
assumptions accordingly. A great example of this is our forecast of how Temple-Inland
will react to a recession. We believe Temple-Inland will experience a negative growth in
revenue for two years then have an extreme growth rate followed by a manageable
revenue growth rate for the remainder of our forecast. We were conservative in our
estimates because we believe it is better to error on conservative side rather than
overestimate our future net income.
After our forecasting our financial statements we then combine our costs of
capital and future earnings to value Temple-Inlands share price as of November 3rd
2008.
Analyst’s Opinion
The goal of a firm valuation is to determine true value of a firm and conclude
whether or not the firm is overvalued. There are two ways to go about estimating a
firm’s value: one way is to compare financial ratios of the firm to the industry’s average,
this is known as the method of comparables, the second way is to apply valuation
models that asses the intrinsic value of the firm. Both methods were used in an
attempt to determine Temple-Inland’s value.
When applying the method of comparables, a total of eight ratios were used and
of the eight, two were not applicable. The remaining six ratios yielded prices as high as
$197.54 and as low as $0.99. This lack of consistency is due to the fact that financial
ratios alone lack financial theory. Another major problem with the method of
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comparables is the use of industry averages. Another problem with this method is that
all prices are assessed according to an industry average so for this method to work, one
must assume that all firms in an industry gravitate towards that industry’s average, this
is rarely the case. The last critical flaw with the method of comparables is that it
doesn’t account for unique and nonrecurring events. Due to these flaws, the method of
comparables has the lowest level of explanatory power out of all the valuation methods.
To assess Temple-Inland’s intrinsic value, five different models were used. The
first two models used were the discounted dividend model and the discounted cash
flows model. While better than the method of comparables, these models are the
weakest of the intrinsic valuation models. The discounted dividends model, which
indicated that the firm is overvalued, fails to take the entire firm into account and
assumes stocks are bought and sold merely for their dividends. The discounted cash
flows model, which indicated that the firm is undervalued, puts too much emphasis on
future dividends making it overly dependent on assumed growth rates. Both of these
two models have a relatively low level of explanatory power. Among the models with a
high level explanatory power are the residual income model, long-run residual income
model and abnormal earnings model. These three models are deeply rooted in financial
theory, require few assumptions and are insensitive to growth rates. The residual
income model and the abnormal earnings growth model indicated that the firm is
overvalued, while the long-run residual income model indicated the firm is fairly valued.
Based on the results of the five intrinsic valuation models we think Temple-Inland is
overvalued and our opinion is to sell.
Valuation Summary Discounted Dividends Overvalued Discounted Cash Flows UndervaluedResidual Income Overvalued Long‐run Residual Income Fairly valued
Abnormal Earnings Growth Overvalued
Analyst’s Opinion Overvalued
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Business Overview and Industry Analysis
Business Overview
Temple-Inland Inc. began when two companies merged in 1983. Time Inc.
bought out Temple Industries in 1973 and merged it with Eastex Pulp and Paper Firm
forming Temple-Eastex Inc. Temple Industries began as a small lumber firm in Texas
which grew in acreage by 640% before being bought out. Then in 1978, Time Inc.
bought Inland Container Firm which began in 1925 making ventilated corrugated boxes.
Finally, in 1983, Time Inc. deciding to combine Temple-Eastex Inc. and Inland
Container Firm to create the firm now know as Temple-Inland.
Temple-Inland has two focuses in production. The first and major product for
Temple-Inland is corrugated packaging. This operation line is driven by the production
of containerboard “which makes up the largest segment of the paper market”
(http://www.templeinland.com ). The second product for Temple-Inland is building
products. This production line “manufactures a tailored portfolio of products for
residential and commercial construction markets and industrial panels for furniture,
cabinets and fixtures” (http://www.templeinland.com). A smaller focus for Temple-
Inland is the selling of the currently owned timber and timberland across the United
States and Mexico.
Although Temple-Inland has both production lines, corrugated packaging
outweighs building products significantly in revenue for the firm. Corrugated packaging
brought in 77.5% of revenues for Temple-Inland in 2007 while building products only
brought in 20.5% of revenue (Temple-Inland 10-K). The other 2% accordingly went to
the selling of timber and timberland (Temple-Inland 10-K).
The corrugated packaging industry is a very competitive market. A few of
Temple-Inland’s competitors are Packaging Corporation of America, Smurfit-Stone
Container Corporation and International Paper. These are only three of the many
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companies that compete with Temple-Inland. Temple-Inland accounted for 12.5% of
total industry shipments in 2007, which places them as “the third largest producer of
corrugated packaging in the United States” (Temple-Inland 10-K).
Industry Overview (Paper Packaging)
The industry overview gives us an idea of why the industry exists, what the
industry does and who the customers are. The paper packaging industry started in the
1870’s when corrugated products where first used as packaging for kerosene lamp
chimneys. From that point on, other products began using corrugated products for
packaging. Paper packaging grew in popularity as it became more customizable with
the invention of rubber printing plates. The industry provides its customer base with
corrugated products and other paper products used for packaging purposes.
Most large firms own their own lumber mills which provide their containerboard
mills with raw materials. The container board mills then produce a variety of container
board ranging in quality which the firm manufactures into a variety of corrugated
products. Some firms in the industry have the ability to produce more corrugated
products than their internal supply of container board allows, so they turn to the
external container board market for additional supply. In the United States there are
645 companies producing corrugated products. The industry is a combination of large
vertically integrated conglomerates and smaller companies with a regional presence.
Firms have a regional presence because of the high costs of delivering corrugated
products. Corrugated products are considered a commodity and companies have not
been able to differentiate their product from their competition. Because of the high
costs of shipment and the inability of producers to differentiate their product the
industry has been segmented into regional accounts. Large customers with multi-plant
integrated companies deal with large multi-plant producers and smaller local producers
attempt to differentiate themselves through pricing, quality, service, and design and
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product innovation (PKG 10K). Firms attempt to cut costs by using efficient energy
strategies.
Porter’s Five Forces Model (Paper Packaging)
The five forces model developed my Michael Porter is used to examine the
concentration of competition within an industry and thus the attractiveness of firms
within that industry. Knowing the level of competition will allow us to have a better
understanding of the industry, determine the profitability of firms within that industry
and allow us to make wise investment decisions. We will be using the five forces model
for our qualitative analyses of the industries that Temple-Inland is involved and Temple-
Inland itself because we feel that the five forces model provides an in depth analysis.
The five competitive forces we will look at are the rivalry among existing firms, the
threat of new entrants in the industry, the threat of substitute products, the bargaining
power of buyers, and the bargaining power of suppliers. The following tables
summarize the level of competition that each competitive force produced through our
analysis.
Competitive Force Degree of Competition
Rivalary Among Existing Firms High
Threat of New Entrants Low
Threat of Substitute Products Low
Bargaining Power of Buyer Moderate
Bargaining Power of Supplier Moderate
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Rivalry Among Existing Firms
In many industries the rivalry among existing firms has a moderate effect on the
average level of profitability. In some perfectly competitive industries this rivalry makes
is necessary for firms to drop their prices to gain or merely hold their market share. In
others there is no need to compete directly on prices, because they focus on
differentiating themselves through branding and innovation.
Rivalry among existing firms is the first of the five forces and is a key
determinate of the degree of actual competition. This force includes five components:
the industry growth rate, concentrated and balance of competitors, the degree of
differentiation and switching costs, scale and learning economies and the ratio of fixed
to variable costs, and excess capacity and exit barriers.
Industry Growth
When industries experience growth, it creates an opportunity for all firms in the
industry to grow and obtain market share. When the industry’s growth slows and
begins to stagnate, however, the only option for firms to continue to grow is by taking
market share from each other. This is important to know when dealing with industries
with strong competitors. In these industries, it can be substantially more difficult for a
firm to remain profitable when the growth in the industry has slowed. In the paper
packaging industry the growth for the past five years has averaged 2.52%. Although
the industry has seen some enormous growth rates in the past, we expect for the
growth to decline due to economic conditions throughout the nation.
“The level of competition in a given market may be affected by economic factor,
including interest rates, housing starts… strength of the dollar, and other market factors
such as supply and demand for these products…” (TIN 10-K). Due to forecasted
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slowing industry and its highly competitive nature, pricing will be an important factor in
the success of this firm.
Percent Change in Sales
2003 2004 2005 2006 2007
TIN 3.76% 5.88% 3.67% 8.90% -6.19%
PKG -.02% 8.91% 5.48% 9.70% 5.90%
IP 2.14% 11.99% -5.49% 7.79% 8.54%
SSCC 6.82% 24.25% -17.84% 5.06% 3.67%
Industry 3.175% 12.76% -14.18% 7.86% 2.98%
Concentration and Balance of Competitors
Market structures that are monopolistic and oligopolistic would be examples of
highly concentrated industries. Highly concentrated industries are those that have few
businesses operating. An industry with a lower concentration would be one with many
competitors and lean toward a perfectly market structure. There are 645 direct U.S.
competitors in the corrugated paper manufacturing industry, but thousands of indirect
paper manufacturing competitors which could mean that the degree of concentration is
quite low and extremely price competitive. Temple-Inland’s corrugated products plants
accounted for 12.5% of the total industry shipments in 2007 and makes them the third
largest producer of corrugated packaging in the U.S. (TIN 10-K Pg 6).
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The table below is a list of competitors and their percent of total sales. Total
sales was calculated by adding all four firm’s revenues.
(Dollars in millions)
2003 2004 2005 2006 2007
TIN 12.4% 12.4% 13.5% 12% 12.5%
PKG 7.83% 8.16% 9.04% 8.09% 8.51%
IP 30.5% 32.24% 32% 28.16% 33.93%
SSCC 30.49% 35.79% 30.88% 26.48% 30.48%
Total
Sales
$21,881 $23,169 $22,062 $27,028 $24,341
Degree of Differentiation and Switching Costs
Differentiation of a firm’s product helps keep that firm from losing market share
based solely on price. Firms that aren’t able to differentiate themselves in industries
with a low degree of concentration do not become as profitable as those that can
differentiate themselves in industries. Corrugated materials are difficult to differentiate
from one another, and are treated as a commodity, which makes the switching costs
low for customers. Companies differentiate themselves and their products through
innovation, brand image, and quality and service; however these differentiation
strategies are easily imitated. This, combined with the fact that the commodity like
products that firms within this industry produce are very difficult to differentiate from
one another, means that the costs for the customer to switch from one firm’s product
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to another are very low and makes the business in the paper packaging industry
extremely price competitive.
Economies of Scale
Economies of Scale are an occurrence when large firms with high fixed costs are
able to lower their marginal cost by producing more products. This means that they are
able to spread the fixed costs over more units of production, thus making the firm more
profitable. However if everyone drives the price down by utilizing economies of scale
the profit margin will shrink.
Property Plant and Equipment (in millions)
2003 2004 2005 2006 2007
TIN $1,843 $1,738 $1,632 $1,628 $1,632
PKG $1,373 $1,345 $1,321 $1,252 $1,215
IP $14,275 $12,216 $11,801 $8,993 $10,141
SSCC $3,561 $4,638 $4,245 $3,731 $3,454
From the figures above we feel confident that Temple-Inland and its competitors
comprise enough fixed assets to experience economies of scale.
Learning Economies
The learning curve measures the ability to improve efficiency by doing a task
over and over again. When firms have steep learning curves and high fixed costs, it
allows them to lower their prices and increase production to obtain a larger market
share.
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In a manufacturing industry like that of Temple-Inland’s, the learning curves
tend to be quite steep which gives firms an incentive to compete to gain market share
and grow. Temple-Inland has a sufficiently steep learning curve, and that they are able
to become more efficient because of it.
Excess Capacity and Exit Barriers
When an industry’s capacity to supply is larger than the demand of the
customer, there is a need to close the gap by lowering prices on products that the
industry produces. It becomes difficult to fill excess capacity when there are barriers to
exit the industry. This means that a firm may have invested in specialized assets that
are not very liquid or may be heavily regulated and subsequently caused high direct or
indirect costs. This is important for us to know because exit barriers can keep firms
who are interested in pursuing more profitable opportunities in other industries from
doing so. In manufacturing industries, exit barriers are high due to the need to invest
in assets that are highly specialized and designed for the manufacture of one product.
Another reason exit barriers are so high in this industry is due to the amount of
environmental regulation that is placed on manufacturing facilities. These exit barriers
make it difficult for firms in the paper packaging industry to fill excess capacity.
Conclusion
Rivalry among existing firms is a key determinant in the five forces model and
crucial to the analysis of this industry. From the analysis we have come to the
conclusion that firms will become more competitive on price, and need to gain market
share from one another in order to expand. We also realized that economies of scale,
the lack of differentiation, and the exit barriers that are present in this industry could
make it difficult for the firm to profit because future industry growth seems bleak.
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Threat of New Entrants
Competition is found in every aspect of the business world. This raises a serious
question about the threat that new competitors bring into an industry. Companies
obviously do not wish to see new entrants in their market because new entrants take
market share and, more importantly, profits from existing firms. There are certain
factors to be judged when analyzing the threat of new entrants, such as first mover
advantages, economies of scale, legal barriers and distribution channels and
relationships. There are always ways to get into the paper and more specifically,
packaging industry, but to do so and succeed is extremely hard to do. The threat of
new entrants to this industry is tremendously small due to the massive amount of paper
mills and packaging companies across the United States and the fact that the entire
world is becoming more aware of the environment and moving more and more into a
paperless world.
First Mover Advantage
When an industry begins, the first companies to succeed can often take control
over the industry with what is called the first mover advantage. These first companies
can usually set the standards for the industry as a whole and never have to change a
thing. Since the paper and packaging industry has been around for so long, there are
almost no advantages anymore when considering a first mover. This can be seen by the
fact that when a customer is looking at which firm to buy from, or if they are looking to
switch to a different firm, there is really no cost to switch to that firm due to the very
triteness of paper. This is also shown by how the world is currently moving towards a
paperless environment. With an industry that is actually seeing a decline in demand due
to technology, it is hard for not only existing companies to continue their business, but
it is much more difficult for a new firm to enter this industry and even come close to
succeeding.
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Economies of Scale
To have an economy of scale, there must be high fixed costs along with constant
marginal costs. Therefore entering into the paper and packaging industry would end up
costing a lot of money, early, just to try to get a product on the market. A large portion
of the economies of scale in the paper and packaging industry is the cost to begin to
produce a competitive product. New entrants would end up paying an excruciating
amount to either invest in their own timberlands or to purchase materials off of other
pre-existing companies. For the most part these new entrants would also have to buy
the timberlands off of those same pre-existing companies which would give the pre-
existing companies an extremely high bargaining power that would end up keeping the
new entrants out of entering the industry. A new entrant into this industry would have
to be able to undergo a large sum of debt before seeing a single penny of profit if they
were to continue in this industry. Although this is inevitable with the beginning of any
firm in any industry, a new firm in the paper and packaging industry would experience
this debt for a more extended period of time than in other industries. Ultimately a new
entrant into this industry would not be able to compete with existing companies due to
the economies of scale in the paper and packaging industries.
Legal Barriers
Certain industries have legal barriers such as copyrights or licensing to be able to
produce their product. In the paper and packaging industry there are really very few
advantages or disadvantages when it comes to such things. All paper industries must
comply with governmental regulations. This means that the paper industry must follow
rules on the way they discard waste materials, the air and water omissions created by
producing their manufactured goods at the firm’s plant and other factors that contribute
to the environment. While the federal regulations are the same for all paper companies,
31
state and local governments can also enforce certain regulations. Although this can
have an impact on the output of companies in different regions of the United States,
this impact is not large enough to make a difference since federal regulations tend to
cover most of the rules that the paper industry follows (www.corrugated.org). Overall,
the legal barriers involved with the paper and packaging industry is not a large factor
when accounting for the threat of new entrants.
Access to Distribution Channels and Relationships
The paper and packaging industry’s most controlling aspect is the access to
distribution channels and relationships. As stated, the cost to begin a firm in this
industry will be extremely high. Another factor to this large amount of expenses is the
limited capacity of distribution channels or trying to create new channels. With the
current paper and packaging industry covering all fifty states in the United States, the
distribution channels have almost been completely filled. Even if a new entrant into the
industry were to find a certain channel that could be used at a low cost, the pre-existing
companies would be able to buy out that channel from the new entrant due to the large
amount of capital that these companies have already obtained. Also, even though it is
easy for a consumer of paper and packaging to switch between companies, the fact
that the price a new firm would have to charge for their product would consistently be
higher than what a pre-existing firm would charge puts new companies at a severe
disadvantage. This would then allow pre-existing companies to maintain their marker
share leaving none for new companies.
Conclusion
The paper and packaging industry is a tremendously difficult industry to
compete in as a new entrant into the industry. There are too many large, competitive
companies who have already taken a considerable amount of control in the industry for
a new firm to emerge and be successful in any way.
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Since there are almost no advantages when it comes to first movers, and there is
a sole disadvantage of a slowly declining demand for paper products, it can be seen
that there is really no room for anymore companies to surface and find a way to
succeed.
There are far too many beginning areas to finance to start a business in the
paper and packaging industry that a firm could not compete with the pre-existing
companies and the land and other assets that they control. The length of time it would
take for a firm to overcome the beginning debt incurred and to start making profits
would be far too long of a time for any firm to bear. The following chart gives an
example of the large amount to of capital to have just to be successful in this industry.
Just as the first mover advantage is almost non-existent, the legal barriers that a
new firm would incur would be exactly the same as a pre-existing firm. This is one
factor that does not hinder a new entrant into the paper and packaging industry.
Total Assets
2003 2004 2005 2006 2007
Temple-Inland $21,367 $20,144 $21,630 $20,474 $5,942
PKG $1,985 $2,082 $1,973 $1,986 $2,035
Smurfit-Stone $10,684 $9,583 $9,114 $7,776 $7,387
International
Paper
$35,525 $34,217 $28,771 $24,034 $24,159
*in millions (from all listed firm’s 10-K)
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A new firm in the paper and packaging industry trying to begin and have any
type of distribution channel or customer relationship would not have much success with
the other companies that are already in place. There are too many strong companies
that already have control of this industry.
Overall, the paper and packaging industry is not threatened by new entrants due
factors such as the first mover advantage, economies of scale, legal barriers and
distribution channels and relationships.
Threat of Substitute Products
The treat of substitute products to an industry is extremely important to
consider, because a product may become obsolete due to advances in technology. The
type writer is not as popular as it once was before the invention of the computer. If
two goods are performing the same function, consumers may consider them to be
substitutable goods. If this is the case, a product may price itself out of a market due
to economic conditions and relative prices of substitute products. In economic terms
the consumer’s preferences are changed by relative price changes in similar products.
If consumers consider two goods substitute products and one increases’ in relative price
the consumer buys more of the other good and less of the more expensive good.
Technological Advances
The paper products industry is an industry which is subject to technological
advances. Advances in the production of materials and advances in the use of
materials greatly effects how the industry creates value. The current technology
available has allowed firms to grow into massive conglomerates, becoming vertically
integrated. Because firms are vertically integrated advances in technologies in specific
portions of their supply line will only improve the costs of producing their product. The
real threat to firms in the corrugated products industry advances in technologies to
other forms of packaging material. Currently the treat of plastic completely replacing
corrugated products seems minute.
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Similar Products
Corrugated materials have been used for packaging materials for some time and
are preferred by customers to other forms of building materials. This customer
preference is important when analyzing threats to the industry. To illustrate the point
imagine plastic containers exclusively holding peaches at your local grocery store. This
scenario, or something, similar is hard to imagine.
Relative Pricing
The third threat a substitute product could create is the threat of relative pricing.
Corrugated packaging is important to the packaging industry, however if new legislation
made the production of wood product substantially more costly the consumer may look
at another packaging material. The threat of a relatively cheaper substitute product
immerging on the market place seems minute since corrugated products are currently
the most cost efficient forms of packaging products.
Conclusion
Because corrugated products have been a staple of the building products
industry it is unlikely a new substitute product will completely replace them. The only
real threat the industry could encounter is the threat of relative pricing of other
materials. If trees become more expensive through government regulation the industry
will lose market share to another industry specializing in the production industry. The
industry has no direct substitutes because of the relative pricing of other packaging
products. The threat of substitute products is low.
Bargaining Power of Buyers
Understanding the extent to which an industry’s buyers control the prices of the
industry is crucial to understanding the industry as a whole. In industries where
innovation is key, buyers have little power over the companies they buy from because
the firm’s product is one-of-a-kind and if the buyers want the product, they’ll pay. In
35
commodity industries, buyers have more power because the products produced by the
companies in these industries are almost directly substitutable with one another. Paper
packaging is a commodity industry, and its buyers are consumer good producers. Some
of Temple-Inlands buyers are Nabisco and other food suppliers, with other buyers such
as Coors in the adult beverage industry. While factors like quality, innovation and
service play a part in differentiation, a box is a box, and price is the main source of
competitive advantages for competing companies. To better understand this power,
one must look at the two components that contribute to it: price sensitivity and relative
bargaining power.
Price Sensitivity
According to the text Business Analysis and Valuation Tools by Krishna Palepu
and Paul Healy, price sensitivity is defined as “the extent to which buyers care to
bargain on price” (Palepu & Healy). A more sensitive buyer is more likely to shop
around for the best price and a less sensitive buyer is less likely to shop around and
more willing to pay a given asking price. A buyer’s price sensitivity depends on two
things, how differentiated the product is and how important the product is to the
buyer’s operation.
As stated earlier the corrugated packaging industry is commodity based. A box is
a box, and this leaves little room for product differentiation. This factor increases the
price sensitivity of the industry’s buyers. The switching costs associated with switching
from one packaging supplier to another are relatively low, if not non-existent, because
the product of one firm is identical to the product of another. This gives buyer little
reason to tolerate a firm whose prices exceed that of the market. This factor tends to
increase buyer’s price sensitivity.
The other factor that affects buyers’ price sensitivity is relative importance of the
product being purchased when compared to the buyers’ overall cost. With the
exception of companies that actually sell boxes like U-Haul and UPS, paper packaging is
36
not a part of its buyer’s product; it’s merely a transport tool. This makes paper
packaging a relatively unimportant necessity in terms of its buyers’ cost structure. As
Palepu and Healy would put it, paper packaging to its buyers is like windshield wipers to
car manufactures; they both represent a minute fraction of the buyers’ costs. This
factor tends to reduce buyers price sensitivity. Because packaging represents a
relatively small expenditure for buyers, the buyers are far less likely to be phased by
price fluctuations.
Conclusion
All things considered, the buyers in the paper packaging industry are price
sensitive. This sensitivity stems form industry’s commodity like nature and the low
switching costs that come with it. However, the sensitivity is hedged, but not
eliminated, by the fact that packaging represents a small portion of its buyers’ costs
thus making price fluctuations more tolerable.
Relative Bargaining Power
The second major component to buyers’ power is the buyer’s relative bargaining
power. According to Papelu and Healy, bargaining power is affected by a number of
factors, the most important of which (in terms of the paper packaging industry) are the
cost the buyers incur when switching from one product to another and the volume of
the buyers’ purchases.
As stated above, the paper packaging is a commodity based industry and as
such, the cost of switching between companies’ products is low. This adds to the
buyers relative buying power because the financial consequences of switching suppliers
is negligible thus providing no incentive to continue to do business with a firm whose
products are overpriced.
On the other hand, there are far more buyers than suppliers in the industry. As
a result, the volume of each buyer’s purchase represents a small percentage of the
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firm’s total sales volume. This being the case, the loss of any individual buyer is of little
concern to the firm. This reduces the buyers’ relative bargaining power to the point of
eliminating it because a buyer’s threat to “take their business elsewhere” carries little or
no weight in this industry. According to Temple-Inland “We have no single customer to
which sales equal ten percent or more of consolidated revenues” (Temple-Inland 10-K).
Conclusion
Buyers in the paper packaging industry have a degree of power that is kept in
check by free market forces. Individual buyers have the power to switch between
packaging suppliers to meet their price sensitive needs at no cost to themselves.
However this power is limited by the fact individual buyers have little, if any, bargaining
power because as individuals, these buyers aren’t responsible for a large enough
percentage of their supplier’s sales to exercise any control over there suppliers.
Bargaining Power of Suppliers
Understanding the bargaining power of an industry’s suppliers is a lot like
understanding the bargaining power of its buyers. They both deal with price sensitivity
and relative bargaining power the only difference is that now the industry is the buyer
(not the supplier). In the case of the corrugated packaging industry however, there is a
major difference between the two: in this industry, companies are there own supplier
which makes the bargaining power of suppliers a moot issue. The corrugated
packaging industry is a highly integrated one and the major players in this industry
produce everything from the timber to the linerboards and the containerboards (which
they turn into the corrugated medium themselves). While the companies in this
industry produce their own inputs, they often buy and sell these inputs amongst
themselves. In these transactions, the suppliers have little or no power because the
purchasing firm will often have the resources and capacity to produce the input
themselves if they’re unhappy with the price.
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Conclusion
Thus, when companies in the corrugated packaging industry purchase inputs
they are do so at market prices, with neither the purchaser nor buyer having the power.
The question that is better asked in these situations is “who hedges costs in these open
market transactions?” In the case of the firm to firm transactions in the paper
packaging industry, the supplier does, and this hedging puts the supplier at a
disadvantage. This disadvantage is eliminated however, because any given firm in the
industry acts as both the buyer and supplier of various inputs, which offsets this
disadvantage.
Industry Overview (Building Products)
The industry overview gives us an idea of why the industry exists, what the
industry does and who the customers are. The building products industry is as old as
civilization itself; the modern industry can trace it roots to the great lumber mills and
mines of the 19th century. Once extraction of materials became efficient building
materials became less expensive. We are interested in looking at the portion of the
industry dedicated to the production of building materials. We are specifically looking
at firms producing gypsum wallboard and lumber products.
Firms either harvest their own resources such as gypsum and lumber or buy the
raw materials on the open market, often firms produce a portion of the total amount
used and purchase the remaining amount. Owning resources such as timberland adds
additional opportunities for revenue and expenses. “The timber industry, which
consists primarily of timberland owners, provides raw material and conducts resource
management activities for the paper and forest products industry, including the
planting, fertilizing, thinning, and harvesting of trees and the marketing of logs.” (PKC
10K) However by making the choice to manage your resource extraction your firm
gains the benefits associated with land appreciation.
39
Firms then manufacture the raw materials in an assortment of plants. Firms
often build their factories near sources of raw materials in an attempt to keep
transportation costs as low as possible. The products are then sent through some sort
of inventory pipeline. Plum Creek Timber Firm has established nationwide distribution
points owned by customers or independent warehouses. In the case of some
manufactured products, they are combined to produce a finished product which is then
sold on the open market.
In the building products industry it is not uncommon for the firm to be vertically
integrated and function on different levels of the business.
Temple-Inland Inc. is primarily concerned with the production of corrugated
products and is a vertically integrated firm. It also has a presence in building products.
The Plum Creek Timber Firm is the largest timberland owner in the United States. Plum
Creek has a presence in the building product manufactured segment as well as the
timber industry. USG Corporation mines its own gypsum and produces a variety of
gypsum products. USG owns several paper mills and therefore is able to buy only 1%
of its paper supply from outside users (USG 10-K).
Porter’s Five Forces Model (Building Products)
The five forces model developed my Michael Porter is used to examine the
concentration of competition within an industry and thus the attractiveness of firms
within that industry. Knowing the level of competition will allow us to have a better
understanding of the industry, determine the profitability of firms within that industry
and allow us to make wise investment decisions. We will be using the five forces model
for our qualitative analyses of the industries that Temple-Inland is involved and Temple-
Inland itself because we feel that the five forces model provides an in depth analysis.
The five competitive forces we will look at are the rivalry among existing firms, the
40
threat of new entrants in the industry, the threat of substitute products, the bargaining
power of buyers, and the bargaining power of suppliers. The following tables
summarize the level of competition that each competitive force produced through our
analysis.
Competitive Force Degree of Competition
Rivalary Among Existing Firms High
Threat of New Entrants Low
Threat of Substitute Products Low
Bargaining Power of Buyer Moderate
Bargaining Power of Supplier Moderate
Rivalry Among Existing Firms
In many industries the rivalry among existing firms has a moderate effect on the
average level of profitability. In some perfectly competitive industries this rivalry makes
it necessary for firms to drop their prices to gain or merely hold their market share. In
others there is no need to compete directly on prices, because they focus on
differentiating themselves through branding and innovation.
Rivalry among existing firms is the first of the five forces and is a key
determinate of the degree of actual competition. This force includes five components:
the industry growth rate, concentrated and balance of competitors, the degree of
differentiation and switching costs, scale/learning economies and the ratio of fixed to
variable costs, and excess capacity and exit barriers.
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Industry Growth Rate
When industries experience growth, it creates an opportunity for all firms in the
industry to grow and obtain market share. When the industry’s growth slows and
begins to stagnate, however, the only option for firms to continue to grow is by taking
market share from each other. This is important to know because with strong
competitors, it could be substantially more difficult for a firm to be as profitable when
the growth in the industry has slowed. In the building products industry the growth for
the past five years has averaged 5.78%. Although the industry has seen some
enormous growth rates in the past, we expect for the growth to decline due to
economic conditions throughout the nation. Chairman and Chief Executive Doyle R.
Simons expects that market to "remain very difficult" for the rest of the year as the firm
is "determined to control costs and minimize losses." ’ (WSJ, Temple-Inland 2Q Net
Dives 88% Amid Housing Slump) Due to forecasted slowing industry and its highly
competitive nature, pricing will be an important factor in the success of this firm.
Percent Change in Sales
2003 2004 2005 2006 2007
TIN 3.76% 5.89% 3.67% 8.90% -6.19%
USG 5.71% 23% 13.97% 13.06% -10.46%
PCL 4.20% 30.48% -2.7% -2.18% -4.46%
Industry 4.56% 19.79% 4.98% 6.59% -7.04%
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Concentration and Balance of Competitors
Market structures that are monopolistic and oligopolistic would be examples of
highly concentrated industries. Highly concentrated industries are those that have few
businesses operating. An industry with a lower concentration would be one with many
competitors and lean toward a perfectly market structure. There are thousands of U.S.
competitors in the building materials manufacturing industry which could mean that the
degree of concentration is quite low and extremely price competitive. Temple-Inland
believes its market share to be small. “Many of our competitors are substantially larger
and have greater resources in the manufacturing of building products” (TIN 10-K Pg 9).
USG accounted for approximately 30% of gypsum wallboard sales in 2007. The
building products industry is not highly concentrated leading to a greater level of
competition.
Degree of Differentiation and Switching Costs
Differentiation of a firm’s product helps keep that firm from losing market share
based solely on price. Firms that aren’t able to differentiate themselves in industries
with a low degree of concentration do not become as profitable as those that are.
Building materials are difficult to differentiate from one another, and are treated as a
commodity, which makes the switching costs low for customers. The fact that the
commodity like products that firms within this industry produce are very difficult to
differentiate from one another, means that the costs for the customer to switch from
one firm’s product to another are very low and makes the business in the building
materials industry extremely price competitive.
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Scale Economies
Economies of Scale are an occurrence when large firms with high fixed costs are
able to lower their marginal cost by producing more products. This means that they are
able to spread the fixed costs over more units of production, thus making the firm more
profitable.
Property Plant and Equipment (in millions)
2003 2004 2005 2006 2007
TIN $1,843 $1,738 $1,632 $1,628 $1,632
USG $1,818 $1,853 $1,946 $2,210 $2,596
PCL $303 $248 $234 $216 $202
From the figures above we feel confident that Temple-Inland and its competitors
comprise enough fixed assets to experience economies of scale.
Learning Economies
The learning curve measures the ability to improve efficiency by doing a task
over and over again. When firms have steep learning curves and high fixed costs, it
allows them to lower their prices and increase production to obtain a larger market
share.
In a manufacturing industry, like that of the building products industry, the
learning curves tend to be quite steep which gives firms a reason to compete in order
to gain market share and grow. We feel that the industry has a sufficiently steep
learning curve, and that they are able to become more efficient because of it.
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Excess Capacity and Exit Barriers
There are three exit barriers in any industry leading to high exit barriers: Filling
excess capacity, high investment in illiquid assets, and high environmental regulation.
When an industry’s capacity to supply is larger than the demand of the customer, there
is a need to fill that capacity by lowering prices on products that the industry produces.
It becomes difficult to fill excess capacity when there are barriers to exit the industry.
This means that a firm may have invested in specialized assets that are not very liquid
or may be heavily regulated and subsequently caused high direct or indirect costs. In
manufacturing industries, such as the one that Temple-Inland is involved, exit barriers
are high due to the need to invest in assets that are highly specialized and designed for
the manufacture of one product. When there are stringent environmental regulations it
becomes difficult to exit the industry. Manufacturing industries are highly regulated.
These exit barriers make it difficult for firms in the building products industry to fill
excess capacity.
Conclusion
Rivalry among existing firms is a key determinant in the five forces model and
crucial to the analysis of Temple-Inland and its industry. From the analysis, it can be
concluded that firms will become more competitive on price, and need to gain market
share from one another in order to expand due to the current economic outlook.
Economies of scale, the lack of differentiation and the exit barriers that are present in
this industry leads to high rivalry among existing firms.
Threat of New Entrants
Competition is found in every aspect of the business world. This raises a serious
question about the threat that new competitors bring into an industry. Companies
obviously do not wish to see new entrants in their market since the new entrants would
45
take market share and more importantly profits away from existing firms. There are
certain factors to be judged when analyzing the threat of new entrants, such as first
mover advantages, economies of scale, legal barriers and distribution channels and
relationships. The building products industry has a small threat of new entrants in the
United States with a larger threat from companies in Canada and other countries.
First Mover Advantage
When an industry begins, the first companies to succeed can often take control
over the industry with what is called the first mover advantage. These first companies
can usually set the standards for the industry as a whole and never have to change a
thing. In the building products industry, the first mover advantage is almost obsolete.
One advantage in this industry that could associate with the first mover advantage
theory is the technology used to when collecting and distributing goods. If a firm can
find a better technology to cut prices when it comes to collecting and distributing the
timber and wood products, they will have a large advantage over the rest of the
competition.
Economies of Scale
To have an economy of scale, there must be high fixed costs along with constant
marginal costs. New entrants generally don’t experience economies of scales, therefore
entering into the building products industry would end up costing a lot of money early
just to try to get a product on the market. There is a large price advantage for current
companies in the building products industry due to the large amount of timberland
already owned. New companies must decide whether or not to spend a lot of money
trying to buy their own timberland or purchasing the raw materials needed from
companies such as Plum Creek Timber Firm who owns 8 million acres of timberland in
18 states (Plum Creek 10-K). This would make it difficult for new companies as they
continually struggle to even break even each year.
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Legal Barriers
Certain industries have legal barriers such as copyrights, licensing and
environmental regulations that affect the way companies in these industries do
business. The most prolific legal barrier encountered in the building products industry is
the government’s regulations on environmental use. The building products industry is
built upon the timber used to manufacture goods. Governmental regulations are not
only put on how to discard waste and the air and water omissions, but there is also a
limit to how much timber can be cut down and how much harvesting can be done.
These regulations take a large amount of preparation and money to comply with which
can make if difficult for new entrants to survive in the industry.
Access to Distribution Channels and Relationships
The access to distribution channels and relationships has a significant impact on
whether a firm succeeds or fails. As already stated, the building products industry has a
considerable amount of companies who own a large part of the available timberland in
the United States. A new firm would be at an extreme disadvantage trying to find a way
to not only get the materials needed to make a product but also to find a customer
base to sell to. Successful companies in this industry often have most of their customers
near to their shipping plants. This has to do with the cost of shipping timber and
building products to the customer. A customer will not pay the large amount of
excessive shipping for a product from a great firm when they can spend less on
shipping on a lesser valued product. This does not leave very much room for a new firm
to sell a product and still make a decent profit.
Conclusion
In conclusion, the building products industry has a very minimal threat of new
entrants into the industry. With the current companies and the assets owned by these
47
companies, it is no extremely difficult for a new firm to compete or break even in this
industry.
Unless a new firm has a brand new technology that can collect and distribute
timber and building products at a cost that is exceptionally lower than the rest of the
market, a first mover advantage will not be a factor in this industry.
With a difficult economy of scale in this industry, the price to be paid when
entering into the building products industry is too steep for a new firm to handle. Debt
would likely outlast the longevity of a firm due to the competitors already in the market.
To begin a new firm in the building products industry and follow all federal, state
and local regulations would be a feat that is not easily done. The cost to actually
comply with these regulations and still bring in a profit while manufacturing a product
would be almost unbearable for a new firm.
A firm must have a way to manufacture their goods and get them to customers if
they are to succeed. The access to distribution channels and relationships in the
building products industry presents a very small window of opportunity for a new firm.
Overall, the threat of new entrants to the building products industry is minimal, if
any at all. With companies such as Temple-Inland, Plum Creek Timber Firm and USG
Corporation who own a considerable amount of timberland and have a large customer
base already built, a new entrant into this industry has almost no way of entering the
industry and being successful.
Threat of Substitute Products
The treat of substitute products to an industry is extremely important to
consider, because a product may become obsolete due to advances in technology. The
type writer is not as popular as it once was before the invention of the computer. If
two goods are performing the same function, consumers may consider them to be
substitutable goods. If this is the case, a product may price itself out of a market due
48
to economic conditions and relative prices of substitute products. In economic terms
the consumer’s preferences are changed by relative price changes in similar products.
If consumers consider two goods substitute products and one increases’ in relative price
the consumer buys more of the other good and less of the more expensive good.
Technological Advances
The building materials industry is an industry which is subject to changing
technological advances. Advances in the production of materials and advances in the
use of materials greatly effects how the industry creates value. The current technology
available has allowed firms to grow into massive conglomerates, becoming vertically
integrated. Because firms are vertically integrated advances in technologies in specific
portions of their supply line will only improve the costs of producing their product. The
real threat to firms in the lumber and gypsum products portion of the building materials
industry is advances in technologies to other forms of building material. Currently the
treat of Steel completely replacing wood and gypsum as building materials seems
minute.
Similar Products
Wood and gypsum have been used for building materials for some time and are
preferred by customers to other forms of building materials. This customer preference
is important when analyzing threats to the industry. To illustrate the point imagine
bricks became more popular than wood and gypsum products because a famous
architect only builds with brick. The demand for wood and gypsum would drop.
However this scenario, or something, similar is hard to imagine.
Relative Pricing
The third threat a substitute product could create is the threat of relative pricing.
Wood and gypsum products are extremely important to the construction industry,
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however if new legislation made the production of either product substantially more
costly the consumer may look at another building material. Currently firms in the
industry is more concerned with the price of raw materials because they sell a
commodity type of product and compete with a large volume of firms. “The cost and
availability of raw materials and energy are critical to our operations.” (USG 10-K) The
threat of a relatively cheaper substitute product immerging on the market place seems
minute since wood and gypsum products are currently the most cost efficient forms of
building products. Have you ever seen a house framed in steel?
Conclusion
Because wood and gypsum products have been a staple of the building products
industry it is unlikely a new substitute product will completely replace them. The only
real threat the industry could encounter is the threat of relative pricing of other
materials. If trees and gypsum minerals become more expensive the industry will loose
market share and profit margins will shrink adversely affecting the amount of firms in
the industry. The industry has no direct substitutes, barring steel becomes substantially
less expensive and another form of building material begins to dominate the interior of
modern buildings. The threat of substitute products is low.
Bargaining Power of Buyers
Understanding the extent to which an industry’s buyers control the prices of the
industry is crucial to understanding the industry as a whole. In industries where
innovation is key, the buyers have little power over the companies because the firm’s
product is a one of a kind and if the buyers want the product enough, they’ll pay. In
commodity industries, it is the buyer’s who have the power because products produced
by the companies in these industries are almost directly substitutable with one another.
Like paper packaging, building product industry is also a commodity industry. Temple-
Inland’s buyers in the building product industry are from a wide variety of companies.
All of their revenue comes from selling products to individual construction sites, like
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Cleveland Construction who recently built the basketball stadium for the Memphis
Grizzlies. While factors like quality, innovation and service play a part in differentiation,
the basic output from all of the industries competitors is the same, making price the
main source of competitive advantages for competing companies. To better understand
the power the buyers posses, one must look at the two components that contribute to
it: price sensitivity and relative bargaining power.
Price Sensitivity
Price sensitivity is defined as “the extent to which buyers care to bargain on
price” (Palepu & Healy). A more sensitive buyer is more likely to shop around for the
best price, and a less sensitive buyer is less likely to shop around and more willing to
pay a given asking price. A buyers price sensitivity depends on two things, how
differentiated the product is and how important the product is to their operation.
The building product industry is commodity based; this leaves little room for
product differentiation. This factor has the profound impact of increasing the price
sensitivity of the industry’s buyers. The switching costs associated with switching from
one packaging supplier to another are relatively low, if not non-existent, because the
product of one firm is comparable if not identical to the product of another. This gives
buyer little reason to tolerate a firm whose prices exceed that of the market.
The other factor that effects buyers price sensitivity is relative importance of the
product being purchased to the buyers overall cost structure and end product. Building
products like gypsum, lumber and drywall play a vital role in the construction of new
house, and the remodeling of existing ones. This makes building products relatively
important in terms of its buyers’ cost structure. This factor also increases buyer’s price
sensitivity. Because building products often constitute a large portion of their buyers
total costs, the buyers are far less likely to tolerate price fluctuations.
All things considered, the buyers in the building products industry are price
sensitive. This sensitivity stems form industry’s commodity like nature and the low
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switching costs that come with it and the relative importance of the building products to
its buyers. This price sensitivity adds to the buyers’ power.
Relative Bargaining Power
The second major component to buyers’ power is the buyers’ relative bargaining
power. According to Palepu and Healy bargaining power is effected by a number of
factors the most important of which, in terms of the building products industry, are the
cost the buyers incur when switching from one product to another, and the volume of
the buyers’ purchases (Palepu & Healy).
As stated above, the building products are commodities and as such, the cost of
switching between product suppliers is low. This adds to the buyers relative buying
power because the financial consequences of switching suppliers is negligible thus
providing no incentive to continue to do business with a firm whose products are
overpriced.
On the other hand, there are far more buyers than suppliers in the industry. As
a result, the volume of each buyer’s purchase represents a small percentage of the
firm’s total sales volume. This being the case, the loss of any individual buyer is of little
concern to the firm. This reduces the buyers’ relative bargaining power to the point of
eliminating it because a buyer’s threat to “take their business elsewhere” carries little or
no weight in this industry.
Conclusion
Buyers in the building products industry have power that is kept in check by free
market forces. Individual buyers have the power to switch between packaging
suppliers that meet their price sensitive needs at no cost to themselves. However this
power is limited by the fact individual buyers have little, if any, bargaining power
because as individuals, these buyers aren’t responsible for a large enough percentage
of their supplier’s sales to exercise any control over there suppliers.
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Bargaining Power of Suppliers
Understanding the bargaining power of an industry’s suppliers is a lot like
understanding the bargaining power of its buyers. They both deal with price sensitivity
and relative bargaining power the only difference is that now the industry is the buyer
(not the supplier). In the case of the building products industry however, there is a
major difference between the two: in this industry, companies are there own supplier
which makes the bargaining power of suppliers a moot issue. The building products
industry is a highly integrated one and the major players in this industry produce
everything from the timber to the gypsum. While the companies in this industry
produce their own inputs, they often buy and sell these inputs amongst themselves.
50% of Temple-Inland’s virgin wood fiber requirements will come from individual timber
owners and producers of wood products such as Louisiana Pacific (TIN 10-K). In these
transactions, the suppliers have little or no power because the purchasing firm will often
have the resources and capacity to produce the input themselves if they’re unhappy
with the price.
Conclusion
Thus, when companies in the building products industry purchase inputs they are
do so at market prices, with the suppliers having no particular power of the buyer. The
question that is better asked in these situations is “who hedges costs in these open
market transactions?” In the case of the firm to firm transactions in the building
products industry, the supplier does, and this hedging puts the supplier at a
disadvantage. This disadvantage is eliminated however, because companies in this
industry act as both the buyers and suppliers of various inputs, which offsets this
disadvantage.
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Value Creation Analysis
Paper Packaging
With the large amount of competitive companies in the paper and packaging
industry, certain advantages must be used in order to be successful. The main
competitors in this industry are Temple-Inland Inc., Smurfit-Stone Container
Corporation and International Paper, and Packaging Corporation of America. In this
industry a cost leadership advantage is the key way to gain an advantage. Some of
these advantages are economies of scale and scope, efficient production, lower input
costs, low-cost distribution, little research and development and a tight control system.
Since the paper and packaging industry is a commodity based industry, these certain
cost leadership strategies lead to a distinct competitive advantage for any firm who can
use these strategies to the fullest.
Economies of Scale and Scope
In the paper and packaging industry, the economies of scale and scope factor
lead to a competitive advantage to those companies who can successfully use this
factor. To have an economy of scale, there must be high fixed costs along with
constant marginal costs. The paper and packaging industry is “capital intensive, which
leads to high fixed costs and generally results in continued production as long as prices
are sufficient to cover marginal costs. These conditions have contributed to substantial
price competition and volatility in these industries, even when demand is strong”
(Temple-Inland 10-K). With the amount of capital that current competitors in this
industry, such as with the amount of timberland owned, the economies of scale,
referred to here, is very competitive. There is also an economy of scope due to the fact
that companies in the paper and packaging industry use their timber or pulpwood to
produce more than one product and to also sell as a product. This economy of scope is
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also a competitive advantage because it allows the firm who can turn their wood into
more products will be most successful. Therefore if a firm in this industry can handle
this competitive economy of scale, they can be very successful.
Efficient Production
Efficient production can be defined as a competitive advantage experienced
when a firm takes its resources and make a product quickly and at a low cost. In the
paper and packaging industry, to successfully use this as a competitive advantage,
companies use energy allocation to do so. Certain companies such as Temple-Inland
Inc. and Packaging Corporation of America use their own product waste and wood fiber
to fulfill most of their electricity and steam requirements (Temple-Inland 10-K, PKG 10-
K). By using materials already owned by a firm to internally produce energy, efficient
production can be successfully employed as a competitive advantage.
Lower Input Costs
Input costs are costs of direct material, direct labor and other overhead items
that lead to the making of a product (www.answers.com). A firm in the paper and
packaging industry that can have lower input costs can have a firm competitive
advantage. Certain companies in this industry lower the cost for input by producing
their own material, using only a partial amount of it for their own products, and then
profiting off the sale of the rest of the materials. Packaging Corporation of America
shares were at an “all time high after the container board firm reported robust second-
quarter earnings growth due to greater demand, higher pricing and lower mill
maintenance costs” (WSJ, Packaging Corp. reaches all-time high on improved pricing).
With companies such as PKG lowering input costs, a competitive advantage can be
reached while cutting costs on all levels.
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Low-cost distribution
In the paper packaging products industry low-cost distribution is an important
factor used to create value. The industry is said to be highly competitive with a great
emphasis placed on distribution channels. According to Temple-Inland “We serve over
9,500 corrugated packaging customers with 17,000 shipping destinations.” (TIN 10K).
Because of the costs of shipping product to customers firms have created regional
presences among their customer base. According to Packaging Corporation of
America’s 10-K competitors in the industry engage in trading container board to help
keep transportation costs low. “These agreements minimize transportation cost by
allowing each party's containerboard mills to ship containerboard to the other party's
closest corrugated products plant.” (PKG’s 10K) The main competitors in this industry
are Temple-Inland Inc, Smurfit-Stone, International Paper, Rock-Tenn Firm, and
Packaging Corporation of America. Each of these competitors focus on having low-cost
distribution systems because of the cost advantages associated with them.
Little research and development or brand advertising
In the paper packaging products industry research and development and brand
advertising are not competitive advantages because of the commodity nature of the
products. In the paper packaging industry firms have research and development
departments working on new applications of their products however the expenditures
are minimal. In fact these expenditures are not itemized on the income statement of
one of the multi-billion dollar companies.
Tight cost control system
In the paper packaging products industry tight cost control systems are very
important. Since the nature of the industry is providing a low cost commodity type
product cost control systems are utilized. An example of a tight cost control system
found in the industry is the presence of the low cost distribution center.
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Value Creation Analysis
Building Products
With the large amount of competitive companies in the building products
industry, certain advantages must be used in order to be successful. Some of the main
competing companies in this industry are Temple-Inland Inc., Plum Creek Timber Firm
and USG. In this industry a cost leadership advantage is the key way to gain an
advantage. Some of these advantages are economies of scale and scope, efficient
production, lower input costs, low-cost distribution, little research and development and
a tight control system. These certain cost leadership strategies lead to a distinct
competitive advantage for any firm who can use these strategies at an optimal amount
of use.
Economies of Scale and Scope
In the building products industry, the economies of scale and scope factor leave
a competitive advantage to those companies who can successfully use this factor. To
have an economy of scale, there must be high fixed costs along with constant marginal
costs. “Competition in our lumber markets is based on price and quality and, to a lesser
extent, the ability to meet delivery requirements on a consistent long-term basis and to
provide specialized customer service” (Plum Creek 10-K). With the prices needed to
compete in the building products industry, a business needs to try to have a lower fixed
cost and lower marginal costs. This makes the economies of scale, referred to here,
very competitive. There is also an economy of scope by the fact that companies in the
building products industry use their timber to produce more than one product and also
to sale as a product. This turns this economy of scope into a competitive advantage
since the firm who can turn their wood into more products will be most successful.
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Therefore if a firm in this industry can handle this competitive economy of scale and
scope, they can be very successful.
Efficient Production
Efficient production can be defined by a competitive advantage for a firm who
can take their resources and make a product quickly and at a low cost. In the building
products industry, to successfully use this as a competitive advantage, companies use
energy allocation to do so. Certain companies such as Temple-Inland Inc. use their own
product waste or wood fiber to fulfill most of their electricity and steam requirements
(Temple-Inland 10-K). Just by allocating energy usage from materials already owned by
a firm, efficient production can be successfully used as a competitive advantage.
Lower Input Costs
Input costs are costs of direct material, direct labor and other overhead items
that lead to the making of a product (www.answers.com). A firm in the building
products industry that can have lower input costs can have a firm competitive
advantage. Certain companies in this industry lower the cost for input by producing
their own material, using only a partial amount of it for their own products, and then
profiting off the sale of the rest of the materials. This gives businesses a competitive
advantage in an industry that is constantly trying to cut costs on all levels of production.
Low-cost distribution
In the building products manufacturing industry low-cost distribution is an
extremely important factor used to create value. The industry is said to be highly
competitive with a great emphasis placed on distribution channels. According to the
USG corporation 10-K “Our gypsum products are distributed through our wholly owned
subsidiary, L&W Supply Corporation, and its subsidiaries, or L&W Supply, other
specialty wallboard distributors, building materials dealers, home improvement centers
and other retailers, and contractors.” (USG 10K). Because of the costs of shipping
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product to customers firms have expanded into the distribution portion, becoming
vertically integrated. The Plum-Creek Timber Firm also has a presence in the actual
delivery of product to its customer base. “The Manufactured Products Segment also has
established a network of nation-wide field inventory points where inventory is held for
customers at either independent public warehouses or on consignment at customer
distribution centers and facilities.” (PLC 10K)
Little research and development or brand advertising
In the building products industry research and development and brand
advertising are not competitive advantages as they are in newer industries such as
computer software development. In the building products industry firms have research
and development departments working on new applications of their products however
the expenditures are minuet. In fact these expenditures are not itemized on the
income statements of Plum-Creek Timber Firm, USG Corporation, or Temple-Inland Inc.
Each of these competitors has a research and development and marketing
departments, however they account for a minute amount of the total expenses of
business operations.
Tight cost control system
In the building products industry tight cost control systems are very important.
Since the nature of the industry is providing a low cost commodity type product any of
tight cost control system is utilized. The major industry competitors are all vertically
integrated from the harvest or mining of raw materials to the distribution of products to
their customer bases.
Combined Industry Value Creation Conclusion
The strategies for creating value above for both the building products industry
and the paper packaging industry are identical and share similar risk factors. Both
industries are adversely effected the volatility of the housing market and general
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economic factors such as changes in interest rates. Temple-Inland, USG Corporation,
and Plum Creek Timber Firm, Inc. each represent the building products industry.
Temple-Inland, Packaging Corporation of America, International Paper Firm, and
Smurfit Stone Container Corp are all major players in the paper packaging industry.
To create value in the industry firms must have economies of scale and scope,
efficient production, lower input costs, low-cost distribution, little research and
development and a tight control system. These six qualities are exhibited by firms that
practice cost leadership strategies. The firm that is able to produce a satisfactory
product for the lowest cost will become the industry cost leader.
As in any industry there are specific economic risks associated with a particular
industry. The building products and paper packaging products industries success is
highly correlated to the success of the housing markets. In recent months one firm in
the industry was forced to cut jobs and sell a portion of its paper packaging operations
to a competitor. ” Weyerhaeuser Co. said it would cut about 1,500 employees, or 6.3%
of its global work force, as the firm swung to a second-quarter loss amid slumping new-
home demand and rising input costs.” (WSJ. Weyerhaeuser Posts Loss, Plans to Cut
1,500 Jobs). The housing market does not seem to be improving as the Wall Street
Journal is reporting “the inventory of houses sitting on the market waiting for a buyer.
Those numbers have been near record highs. The law of supply and demand suggests
that doesn't bode well for the future direction of home prices.” (WSJ. Struggling To Fill
Vacant Homes). The news is not all overly pessimistic. Also in a news release by USG
Corporation the firm seemed optimistic about the stabilization of the construction
market but conceded the market is likely to remain weak into 2009 as the inventory of
unsold homes remains at historically high levels. (Market Watch. USG Corp. sees signs
of stabilization in construction market)
If a firm is going to survive in this competitive environment the firm must
become the cost leader in the industry or industries in which it operates.
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Firm Competitive Advantage Analysis
The firm competitive advantage analysis is one of the many ways to analyze a
firm’s strategy for creating value. Two of the most popular ways to gain a competitive
advantage are through Cost Leadership and Differentiation. We have determined
through our research that Temple-Inland’s strategy to create value is cost leadership
based. We believe that Temple-Inland follows six different strategies to achieve a cost
leadership advantage in its industries. These being, economies of scale and scope,
efficient production, lower input costs, low-cost distribution, little research and
development or brand advertising, and implementing a tight cost control system.
Economies of Scale and Scope
As we have mentioned before an economy of scale occurs when companies that
have a high amount of fixed costs is able to decrease the marginal cost by producing
more of their product. An adverse effect of a firm growing large is diseconomies of
scale, which means that the money the firm saves by increasing production is offset by
the costs associated with expansion. Economies of scale are important because firms
can profit greatly from them, but it is imperative to be aware as to not grow large
enough to experience a diseconomy of scale.
Property Plant and Equipment (in millions)
2003 2004 2005 2006 2007
TIN $1,843 $1,738 $1,632 $1,628 $1,632
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With over $1.5 billion in property and equipment alone and accounting for 12.5%
of industry shipments of corrugated packaging we believe that Temple-Inland is large
enough to experience some economies of scale in both industries in which it is involved.
Temple-Inland this past year sold their strategic timberland, and entered into a long
term supply agreement with the buyer. Since the sell of the timberland, Temple-
Inland’s total assets fell from 20 billion to 6 billion. This affected the amount of costs
associated with the timber harvesting operations and the forest management
operations. We feel that discontinuing the timber harvesting operations could have
prevented the firm from experiencing diseconomies of scale considering that only 2% of
Temple-Inland’s income came from timber.
Because Temple-Inland is vertically integrated it has the ability to produce more
than a single product. It has the ability to produce more container board, or gypsum
paper sidings if the external market values these inputs. Because of their ability to
produce multiple products from the same production lines they can take advantage of
changing market conditions. Thus Temple-Inland has economies of scope.
Efficient Production
Efficient production is one of the most important competitive advantages a firm
could implement to reduce costs associated with production. This is true because it
allows a manufacturer to produce more products at a lower cost than its competitors.
Fuel costs are a major expense in manufacturing firms due to the amount of energy it
takes to power all of the machinery involved in the manufacturing process. “Alexei
Miller, chief executive of Russia's gas giant OAO predicted oil would shoot up to $250 a
barrel in the near future” (WSJ, Oil Hits $145 As Supply Fears Push Up Prices). To help
keep from being subject to oil and other energy prices, Temple-Inland uses byproducts
from items that they produce for energy purposes. In doing this they were able to
generate 84% of their energy requirements at several of their mills (TIN 10-K Pg 3).
Temple-Inland has also practices efficient production by producing different types of
products in the same facilities. They have started using byproducts from a coal burning
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power plant to make synthetic gypsum and located their manufacturing facility adjacent
to the Tennessee Valley Authority plant in Cumberland City, Tennessee. Temple-Inland
has implemented several different strategies to produce their goods more efficiently,
and we believe that these strategies will help reduce costs thus making Temple-Inland
more profitable.
Lower Input Costs
Input costs are costs of direct material, direct labor, and other overhead items
that lead to a finished product (www.answers.com). Lowering a firm’s input costs can
have an immense effect on profitability and is crucial for Temple-Inland to implement
their cost leadership strategy for a competitive advantage. In both industries Temple-
Inland is able to vertically integrate their production process which leads to lower costs.
In the paper packaging industry Temple is able to produce corrugating medium and
linerboard (TIN 10-K Pg 3), the two main components of boxboard, preventing them
from having to pay other firms to supply them with materials. In the building materials
industry, some of the gypsum that Temple-Inland uses is synthetic gypsum that is
purchased from the Tennessee Valley Authority, which saves the firm money from
having to quarry it. The ways that Temple-Inland implements the efficient production
strategy leads us to believe that this could give the firm a competitive advantage in its
industries.
Low Cost Distribution
Low cost distribution is a strategy that aims to keep the costs associated with
transporting and distributing a firm’s goods as low as possible in order to help minimize
total costs. In both the paper packaging and the building industries Temple-Inland
excels at cutting costs through distribution. This has been achieved by acquiring a
number of production factories and warehouses that are strategically spread throughout
the United States, Mexico and Puerto Rico. The paper packaging division in particular
puts an emphasis on keeping its end products close to its demand by maintaining 64
63
converting facilities that convert corrugated medium and linerboard into cardboard.
Listed below are the converting facility locations used by the paper packaging division
of Temple-Inland:
Converting Facilities*
CorrugatLocation Size
Phoenix, Arizona 98″ Fort Smith, Arkansas 87″ Fort Smith, Arkansas(1)*** NoneBell, California 98″ Buena Park, California(1) 85″ El Centro, California(1) 87″ Gilroy, California(1) 87″ Gilroy, California(1)*** 98″ Ontario, California 87″ Santa Fe Springs, California 98″ Santa Fe Springs, California(1)** 87″ and
Santa Fe Springs, California(1)*** NoneTracy, California 110″ Union City, California(1)*** NoneWheat Ridge, Colorado 87″ Orlando, Florida 98″ Tampa, Florida(1) 78″ Rome, Georgia 98″ Carol Stream, Illinois 87″ Chicago, Illinois 87″
Chicago, Illinois(1)*** NoneElgin, Illinois 78″ Elgin, Illinois*** NoneCrawfordsville, Indiana 98″ Evansville, Indiana 98″ Indianapolis, Indiana 87″ Indianapolis, Indiana*** NoneSt. Anthony, Indiana*** NoneTipton, Indiana*** 110″ Garden City, Kansas 98″ Kansas City, Kansas 87″ Bogalusa, Louisiana 98″ Minden, Louisiana 98″
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Minneapolis, Minnesota 87″ St. Louis, Missouri 87″ St. Louis, Missouri*** 98″ Milltown, New Jersey(1)*** NoneSpotswood, New Jersey 98″ Binghamton, New York 87″ Buffalo, New York*** NoneScotia, New York*** NoneUtica, New York*** NoneWarren County, North Carolina 98″ Madison, Ohio*** NoneMarion, Ohio 87″ Middletown, Ohio 98″ Streetsboro, Ohio 98″ Biglerville, Pennsylvania 98″ Hazleton, Pennsylvania 98″ Littlestown, Pennsylvania*** NoneScranton, Pennsylvania 68″ Vega Alta, Puerto Rico 87″ Lexington, South Carolina 98″ Ashland City, Tennessee(1)*** NoneElizabethton, Tennessee(1)*** NoneDallas, Texas 98″ Edinburg, Texas 87″ San Antonio, Texas 98″ San Antonio, Texas*** 98″ Petersburg, Virginia 87″ San Jose Iturbide, Mexico 98″ Monterrey, Mexico 87″ Los Mochis, Sinaloa, Mexico 87″ Guadalajara, Mexico(1)*** None
This impressive collection of converting facilities is supplied by five container
board mills (located in California, Georgia, Kentucky, Louisiana and Texas), one
corrugating medium mill (located in Tennessee) and one combination corrugating
medium/containerboard mill (located in Indiana).
While much smaller, the building products division has adopted the same
strategy with five lumber mills (located in Texas, Georgia and Louisiana), four gypsum
wallboard factories (located in Arkansas, Oklahoma, Tennessee and Texas), five
fiberboard factories (located in Alabama, Arkansas, Georgia, Pennsylvania, and Texas),
and a particle board factory (in Texas).
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In paper packaging division as well as in building products division, Temple-
Inland’s facilities are placed in a manner that allows the firm to minimize the
transportation costs associated with shipping their bulky products by minimizing the
distance between production facilities and the demand source. The only difference
between the strategies used by the two divisions is that the larger paper packaging
division is spread throughout the United States Mexico and Puerto Rico, while the
building products division, which deals mainly with the southern United States, has is
facilities spread throughout this region only.
Tight Cost Control
Tight cost control strategies focus on cutting costs without detracting form the
quality of the end product by using resources as efficiently as possible. This strategy
allows companies to deliver quality products that meet the needs of the consumer at
the lowest price possible. Temple-Inland has taken a multi-step approach to its tight
cost control strategy in both its building products division as well as its paper packaging
division. In both divisions, Temple-Inland functions as a highly integrated firm thus
making the firm its own biggest supplier. Temple-Inland has its hands in every step of
the production process and when it’s cheaper to buy an input from an outside source,
they do so. This cuts costs because it allows Temple-Inland to acquire most of its
inputs for below market price because they don’t have to pay the mark-up that other
companies would charge.
The second step to Temple-Inland’s tight cost control strategy is their energy
production. To help minimize the effects of fluctuating energy prices, Temple-Inland
has turned to producing some of its own energy, 84% to be exact. This energy
producing process uses “natural gas, fuel oil, coal, petroleum coke, tire derived fuel,
wood bark, and other waste products resulting from the manufacturing process” (TIN
10-K). This internal energy helps to keep costs low by sheltering Temple for the
record-high oil prices.
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The third main contributor to Temple-Inland’s tight cost control strategy is
Temple’s low cost distribution. Both building products and corrugated packaging are
bulky making both expensive to transport. Temple-Inland has minimized this costly
expense by spreading its operations throughout the country thus minimizing the
distance from factory to customer.
With the clever application of integrated business units, internally produced
energy, and low cost distribution channels, Temple-Inland has been able to maintain an
effect tight cost control strategy. This strategy has helped to make their paper
packaging division the third largest firm in a competitive industry, and helped their
relatively small building product division thrive in an industry with much larger
competitors.
Conclusion
Using an effective combination of low cost techniques, Temple-Inland succeeds
at keeping their necessary costs under control while avoiding unnecessary expenditures.
This cost cutting strategy helps keep Temple-Inland’s operation in line with the value
drivers of the industry, and in doing so, they have made themselves a prominent force
in the paper packaging industry.
The same cost controlling techniques have been employed by Temple-Inland’s
building products division but cost leadership is only part of the reason this division is
poised to out perform its industry. According to Temple-Inland’s 10-K the success of
their building products industry is directly related to the demand for new homes.
Luckily for Temple, their building products division derives the majority of its sales
comes from the southern United States (TIN 10-K), the area least affected by the
housing crisis. According to figures from U.S. Census Bureau News cited in the Wall
Street Journal, as of July 2008, the south has been responsible for 180 of the 328
houses sold in the U.S. during 2008, with the west coast coming in as the second best
selling region with 78. By dealing mainly in the south, Temple-Inland has been able to
67
allay some of the costs associated with the housing crisis, unlike its larger competitors
in the building supply industry. While this relative advantage may not allow for growth,
it should help to level the playing field for the smaller, but less affected, Temple-Inland.
Accounting Analysis
Accounting analysis is a tool used to understand accounting policies and their
effects on the overall quality of the financial statements. “The purpose of accounting
analysis is to evaluate the degree to which a firm’s accounting captures the underlying
business reality.” (Palepu & Healy). The better quality of accounting analysis a firm has
the better the quality of an equity analysis because it improves the reliability of
conclusions drawn. The accounting analysis we will be using is a six step process, each
step building on the other. First we identify the key accounting policies given the
business activities which we identified earlier as adding value in this industry. The next
step is to evaluate the degree of flexibility available to managers, given the accounting
rules and conventions (Palepu & Healy). This step is very important because the greater
the potential distortion the less valuable the financial data becomes. The third step we
evaluate how managers exercise their accounting flexibility and the likely motivations
behind managers’ accounting strategy (Palepu & Healy). For example management
might attempt to recognize revenue without recognizing the proper expenses. The
forth step involves assessing the quality of discloser (Palepu & Healy). The next step
involves identifying potential red flags, which we will investigate further. The sixth and
final step in the accounting analysis is to restate accounting numbers to remove any
noise and bias introduced by the accounting rules and management decisions (Palepu &
Healy).
Key Accounting Policies
As identified earlier in the business strategy analysis, a firm’s industry
characteristics and its own competitive strategy determine its key success factors
(Palepu & Healy). These factors drive value in the industry and are important aspects
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to pay attention to when evaluating a firm’s value. There is an incentive for firm’s to
misrepresent specific portions of their financial statements to try and gain an upper
hand on their competition. By misrepresenting financial statements stock prices will be
inflated. Therefore it is imperative we evaluate how well these success factors are being
managed by the firm.
Temple-Inland’s key success factors, economies of scale, economies of scope,
efficient production, lower input costs, low cost distribution, and tight cost control are
all related to cost leadership. We believe a well managed firm has six characteristics.
It has economies of scope, efficient production, lower input costs, low cost distribution,
little research and development costs and tight cost control. By identifying disclosures
of costs of goods sold, gross profit, and operating expense we attempt to evaluate
these type one key accounting policies.
Because these factors are important to the industry line items in the financial
documents associated with these success factors is likely where any distortions will be
discovered.
After looking at the disclosures of type one key accounting policies we will direct
our attention toward type two key accounting policies. The type two key accounting
policies include goodwill, operating leases, pension plans, commodity contracts and
debt rating. Because GAAP allows flexibility in reporting in an attempt to give the best
possible economic picture of business activities and allows a minimal level of discloser
there is an opportunity for distortion. An effort should be made to look for distortions.
Type 1 Key Accounting Policies
Economies of scale are important because a firm has to be able to produce a
large amount of product at low profit margins in order to compete in both the
corrugated product and building product industries. The amount of total assets each
company has is a good indication of how large the firm is and thus how it can take
advantage of its economies of scale. The disclosure of the types of production facilities
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and the primary operations of these facilities are very good and can be found in the
properties section of Temple-Inland’s 10-K.
Temple-Inland also has a section about acquisitions where Temple-Inland has
been active the past few years. Since 2005 they have expanded their holdings of
Standard Gypsum LP among other joint ventures. It appears Temple-Inland is
attempting to expand its building products sector while eliminating businesses
segments such as their timberland they sold in 2007. International Paper for example
still owns its own timber operations.
Economies of scope occur when firms are able to use the same raw material, or
pieces of a raw material, used primarily to produce a product on another secondary
product. Economies of scope allow a firm to use material it would have discarded.
Temple-Inland and many of its competitors use waste from wood products to produce
electricity for their facilities. Also Temple-Inland purchases multiple raw materials but
do not disclose the price of these materials or amount of these materials they use in the
products they produce. This keeps investors from a clear understanding of the cost of
goods sold. Under the business segments section of the 2007 this is evident. “We
manufacture linerboard and corrugating medium that we convert into corrugated
packaging and sell in the open market.” (TIN 10-K)
Efficient production allows a firm to produce more products at a lower cost than
its competitors. Everyone in the industry claims to have efficient production however it
is evident looking at revenues and cost of goods sold. Since the industry sells a
commodity type of product and finding customers willing to pay premiums for
something they can get on the market for cheaper is difficult to do, therefore, the firm
with the highest revenues and lowest cost of goods sold would be the most efficient
producer.
The level of disclosure regarding cost of goods sold is disappointing for Temple-
Inland. The amount of cost of goods sold is shown on its annual balance sheet,
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however it is not separated into products anywhere in the 10-K. The best Temple-
Inland managed to do was separate revenues and costs for building products from its
corrugated manufacturing operating segment. The chart falls short of explaining the
amount of revenues and costs and expenses for each product in the segments.
Temple-Inland does not disclose the average price of its inputs nor does it
disclose the amount of raw materials it actually uses. It does provide a chart explaining
increases and decreases in significant expenses inputs.
Without the separation of cost of goods sold from other expenses it is difficult to
draw conclusions on how efficient Temple-Inland is in comparison to its competition.
They may be extremely efficient in one producing one product and horribly efficient in
the other, disclosing more information about the cost of goods sold and revenues would
shed light on the situation.
The chart gives some insight into the operations of Temple-Inland. Again
however It does not answer the question how much more material was used to produce
products. For example the chart points out wood fiber and recycled fiber expense
increased $8 million and $77 million dollars in 2007; the revenue of Temple-Inland’s
corrugated increased $47 million dollars. From this chart you might be able to say
Temple-Inland has become less efficient producing its products than last year.
Temple-Inland does not disclose the average price of its inputs nor does it
disclose the amount of raw materials it actually uses. It does provide a chart explaining
increases and decreases in significant expenses inputs.
As a disclaimer Temple-Inland explains “The costs of our wood and recycled
fiber, energy, and freight fluctuate based on the market prices we pay for these
commodities. It is likely that these costs will fluctuate in 2008.” (TIN 10-K) Temple-
Inland therefore has no advantage over competitors in this area. A supply agreement to
buy timber at market prices exists but this would only be an advantage if the
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competition wanted to enter Temple-Inland’s manufacturing region and attempt to use
its supplier.
Low cost distribution is important because it helps keep the costs of products
low. Temple-Inland discloses its distribution centers size and location in the 10-K.
In the industries in which Temple-Inland operates regional distribution centers
are common. Temple-Inland does a good job of disclosing information about their
distribution center, going so far as to show which are leased and which are owned.
Temple-Inland also discloses the amount of increases or decreases spent on
freight for each of its operating segments.
Since shipping commodity products over long distances are expensive Temple-
Inland must keep these costs to a minimum.
Tight cost control focus on cutting costs without detracting from the quality of
the end product to enlarge their gross profit. Temple-Inland’s disclosure on product
quality is limited to a few sentences about the importance of delivering quality products
at the lowest costs possible. While they do post what their gross profit is in numbers,
they do not disclose how they keep these costs down to enlarge their gross profit.
Conclusion
Overall, the disclosure of these key accounting policies are minimal. While they
did excel in disclosing most of their expenses, they lacked in areas of how they cut
costs and where their cost of goods sold is distributed. The small amount of disclosure
over these factors would lead investors to believe there might be some problems in the
accounting policies.
The disclosure specifically related to operating expenses and gross profit left
something to be desired. Temple-Inland had very bad disclosure pertaining to low cost
business strategies. No proof was given Temple-Inland has achieved their stated goal of
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becoming the low cost industry leader. Disclosure of cost of goods sold and operating
expenses must be better in the future.
Type 2 Key Accounting Policies
Goodwill
When purchasing other firm, firms will often pay more than fair market value for
the firm they purchase. When this happens, the difference between the purchase price
and the fair market value is capitalized as an asset known as goodwill. In addition to
balancing the books goodwill allows managers to paint a more optimistic picture for
their shareholders by capitalizing the amount they overpaid instead of expensing it.
As an asset, goodwill is considered an intangible but unlike most intangible
assets, goodwill isn’t amortized, it’s impaired because it has an indefinite useful life. In
2001, the Financial Accounting Standards Board issued SFAS No. 142 which requires
publicly traded corporations to annually test their good will for impairment (FASB.org).
This test involves estimating the fair value of the goodwill, checking for impairment,
and estimating the amount of the impairment (FASB.org). While the annual test for
impairment is mandatory, the actual impairment is not. If, according to the managers’
estimation, the fair value has not changed there may be not impairment for the year. If
any impairment is found, the estimated amount of the impairment is then expensed and
the book value of goodwill is reduced accordingly.
The fact that goodwill is subject to this impairment process is an important
distinction to make because amortization involves a constant and systematic reduction
in the book value of an intangible asset but the impairment process, on the other hand,
involves marking down the asset based on estimations (estimations that are subject to
managers’ discretion). Because it’s discretionary, goodwill impairment can be used by
managers as a way to inflate and deflate assets and expenses as they see fit.
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The following are tables containing the annual recorded goodwill of key
competitors in both the paper packaging and building product industry:
Paper Packaging (in millions)
Goodwill
Company 2007 2006 2005 2004 2003 2002
TIN 365.00 365.00 395.00 382.00 384.00 397.00
PKG 37.16 37.20 34.19 3.69 0 0
RKT 364.5 356.60 350.90 297.06 291.80 260.39
IP 3,650 2,929 5,043 4,994 5,341 5,307
USG 226 154 64 43 39 30
SSCC 2,727 2,873 3,309 3301.00 3,117 3023
Percentage of long-term assets
Company 2002 2003 2004 2005 2006 2007
TIN 7.82% 1.88% 4.35% 5.11% 6.07% 8.11%
PKG 2.85% 2.78% 2.41% 0.26% 0.00% 0.00%
RKT 27.90% 27.46% 26.26% 33.07% 31.44% 30.60%
IP 20.95% 19.02% 23.61% 23.09% 20.39% 20.37%
USG 6.71% 5.79% 1.61% 1.73% 1.69% 1.33%
SSCC 42.71% 41.94% 41.73% 39.68% 44.88% 42.89%
Based on the data presented above one can clearly see that the goodwill of
Temple-Inland and its competitors fails to display the steady decline from year to year
that the impairment process should yield. While there could be a number of rational
explanations for this phenomenon, investors should see this as a potential point of
concern. Upon taking a closer look at Temple-Inland’s 10-k one will discover that in
addition to the constant goodwill attributed to the paper packaging division, Temple-
Inland carried 145 to $160 million in goodwill for its financial services from 2002 to
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2005. In 2006, the goodwill from the financial services division was taken off the books
with the discontinuation of the division, but in this same year, the firm added another
$129 million in goodwill it gained form the acquisition of its joint venture Standard
Gypsum.
Percent Change in Goodwill from 2002 to 2007
Division 2007 2002% Change
Goodwill from Core Operations 236 249 5.51%
Total Goodwill 365 397 8.77%
Even thought goodwill accounts for a rather small portion of Temple-Inland’s
long-term assets, the firm’s failure to impair the goodwill they carry for their paper
packaging services is suspect. In addition, the fact that the firm conveniently replaced
the goodwill lost from its discontinuation of the fitnancial services division with the
goodwill from the gain of a joint venture buy-out is another point of concern. These
actions may be the result of manager manipulation which may lead to a slight
overvaluation of the firm.
Operating leases
A firm’s financial statements are key to investor’s decisions with the money they
want to invest in a firm. When it comes to operating and capital leases, a firm’s
financial statements can be changed to an extreme. Capital leases are usually the most
reliable leases on financial statements, due to the fact that they are recorded as both
an asset and a liability, because of the lease payments, and also accumulate
depreciation and interest. Capital leases are also amortized over the life of the lease. All
of the factors of a capital lease are shown on the balance sheet and are thoroughly
available for investors to observe and make judgments on these items. Operating leases
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are almost the exact opposite of capital leases. They are not included on the balance
sheet which would reduce the liabilities of the firm and therefore making their debt
ratios much lower. Along with taking away from liabilities, operating leases also leave
depreciation and interest expenses out of the equation which obviously understates
expenses leaving the net income and equity of a firm overstated.
Temple-Inland has very few capital leases and a majority of operating leases.
This is the trend for most firms, not only in the paper packaging industry and building
supply industry, but also in most industries. When taking a closer look at Temple-Inland
to see if the operating leases owned by the firm really change the face of the firm’s
financial statements, it can be seen that there is not really a large change since
operating leases only carry 4.7% of long term liabilities. Thus there is really no harm
done to the financial statements of Temple-Inland leaving investors at ease to continue
their judgment of the firm elsewhere.
Pension liabilities
Pension liabilities can come in two forms. Defined Benefit plans and employee
contribution plans. A Defined Benefit plan compensates the employee for years of
service by promising a lifestyle upon retirement. Essentially the firm must grow an
asset today to cover a future liability. Estimates are used to guess the future cost of
these plans. Employee contribution plans are different because the individual not the
firm has the responsibility to grow their own assets to a level which they choose. Firms
typically match employee contributions to retirement plans. Firms like Temple-Inland
have Defined Benefit plans which give them the ability to overstate or understand a
significant portion of their liabilities and or expenses. Temple-Inland also has a 401 (K)
matching plan.
The following is a table describing the Defined Benefit obligations for Temple-
Inland from 2003 to 2007.
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Temple-Inland Pension Expense
2003 2004 2005 2006 2007
401 (k) 28 26 22 16 17
Defined benefit 43 50 50 46 35
Postretirement medical 12 10 8 9 8
Total 83 86 80 71 60
Temple-Inland’s pension expenses have remained relatively stable; the drop in
postretirement medical expenses can be explained by a new health care plan. “Effective
January 2005, we implemented a new Consumer Driven Health Plan option for our
employees. About 41 percent of our employees elected this option. We believe
implementing this option will help mitigate our rising health care costs.” (TIN 10-K) It
appears the plan has worked. The drop in expenses from 2006 to 2007 can be
explained by Temple-Inlands sell of 2 operating segments; Guaranty Bank and Forestar
Real Estate Group Inc. Their total employment shrunk from 16,000 employees in 2005
to 12,000 employees in 2007.
Temple-Inland also recognizes its pension liabilities with an estimated discount
rate. These liabilities can become large burdens to firms over time, therefore discloser
of accounting policies used with pension liabilities are very important. According to
Temple-Inland “We used the 1994 Group Annuity Mortality Tables to determine benefit
obligations and annual defined benefit obligations” (TIN 10-K) To determine a growth
rate Temple-Inland and its competition assumes a rate correlated with long term bonds.
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The following chart shows Temple-Inland’s estimates compared to its
competition in both industries in which it operates.
Pension Plan Discount Rates
2003 2004 2005 2006 2007
PKG 6.25% 6.00% 5.50% 5.75% 6.00%
RKT 6.50% 6.00% 5.50% 5.875% 6.25%
IP 6.50% 6.00% 5.75% 5.50% 5.75%
USG 6.00% 5.75% 5.75% 5.90% 6.55%
PCL 6.25% 5.75% 5.75% 5.90% 6.75%
TIN 6.75% 6.375% 6.00% 6.00% 6.125%
The smaller the discount rate the larger the long term liability. At any time over
the past five years each of these firms are within 100 basis points of each other, this
however can mean the difference of millions of dollars of liability so it is important to
investigate reasoning behind each rate. PCL’s jump from 5.90% to 6.75% is alarming,
Temple-Inland has no such increase or decrease in discount rates. These smooth
transitions can be explained by similar movements among its competition, PKG for
example starts its discount rate in 2003 at 6.25% and ends up in 2007 at 6.00%, in
every year staying within 50 basis points of Temple-Inland’s discount rate. Temple-
Inland has decreased its discount rate over the years; this conservative approach was
also adopted by its competitors in the paper packaging industry. The building products
sector however has increased their discount rates, a more aggressive approach, by
doing so in a short time period they have assumed less long term liabilities. The
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differences in the discount rates between USG, PCL, and Temple-Inland are about 50
basis points.
Temple-Inland assumes an asset growth rate similar to that of its liabilities. “In
selecting that rate, currently 6.875 percent, particular consideration is given to our
asset allocation because approximately 80 percent of our plan assets are debt related
with a duration that closely matches that of our benefit obligation.” These assumptions
seem logical and are in line with the rest of the industry.
In our opinion the amount of disclosure Temple-Inland has provided is
substantial. They have made an effort to explain everything from how they estimate
future liabilities, expenses, and value of current assets to explaining drops in medical
expenses. Because the industries in which Temple-Inland operates are dominated by
cost leadership strategies it is imperative Temple-Inland keep its cost structure low,
every advantage matters. By having great disclosure Temple-Inland’s current reduction
in liabilities and expenses has some legitimacy. Without the explanations in their 10-K’s
outside observers could potentially concluded there is some distortion.
Commodity Contracts
Commodity risk is the risk associated with the price of commodities. When
commodity prices rise, the costs of raw materials that a firm uses increase. The most
popular way to reduce commodity risk is through hedging. To hedge, a firm simply
enters into a contract with a supplier to buy a commodity at a specified price at a
certain point in time. Temple-Inland uses both virgin wood fiber and recycled fiber in
the paper packaging business and also in some of their building products business.
After selling their strategic timberland in the fall of 2007, TIN will be especially
vulnerable to commodity risk because they rely entirely on the price competitive timber
market to supply their wood fiber requirements. Temple-Inland chooses not to hedge
their costs associated with raw materials, because “The wood fiber market is difficult to
predict and there can be no assurance of the future direction of future prices for virgin
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wood or recycled fiber.” (TIN 10-K Pg. 10) They have, however, entered into long-term
supply agreements with the buyers of their strategic timberland and will be guaranteed
a certain amount of timber that will account for about half of their wood fiber
requirements. Temple-Inland has no long term supply agreements to acquire recycled
fiber which represents a substantial amount of their raw materials needs. The timber
market, as is the case with other commodities, is cyclical in nature and can create
hardship for the firm. Therefore, we feel that it is wise of TIN not to hedge their raw
materials costs due to the volatility of the prices of timber.
Debt Rating
Given the obvious impact of the current financial crisis the credit ratings of firms
have become extremely important both for borrowing from banks or raising money in
equity or debt markets. Currently Temple-Inland’s bonds are rated “BBB-“, the lowest
investment grade. At this rating large hedge funds and institutions are able to still own
bonds in Temple-Inland, however if the firm where to slip into the speculative bond
ratings the amount of interest they would pay for the same amount of debt would
increase dramatically. In a recent article Standard & Poor’s Rating Services expressed
concern over the outlook of Temple-Inland due to the housing slump, “we would
consider a one-notch downgrade if building products market conditions become worse
than we currently expect," credit analyst Pamela Rice said in a statement.” (New York
AP)
Management has a large incentive to keep Temple-Inland within the investment
grade ranks. The ability of management to alter accounting documents to represent
higher profits for a struggling quarter or longer should be taken into consideration.
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Conclusion
The key accounting policies that we looked at were leases, pension liabilities,
goodwill, and contracts concerning commodities. The key accounting policies we
observed are important because of the effects they can have on the financial
statements of Temple-Inland. Specifically accounting for pension plans, good will, and
operating leases can have a large impact on Temple-Inland’s financial statements.
Accounting Flexibility
Introduction
Accounting flexibility refers to the elasticity that managers possess when
choosing accounting policies and estimates. When managers have a large amount of
flexibility in accounting, they are more easily able to reveal the true value of their firm
and portray their financial statements to be more informative. The problem that arises
when managers have a considerable amount of flexibility in accounting is that it gives
managers the ability to show their estimates and figures on financial statements in a
more attractive manner. When managers misrepresent their financial statements to
cause the firm to look more profitable, investors are mislead into purchasing shares of
the firm at a price that is different than the firm’s true value. In this section we will be
checking for the managers’ flexibility in the key accounting policies.
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Goodwill
Given the provisions of SFAS No. 142, which dictates the manner in which
goodwill is to be impaired, Temple-Inland has a significant amount of wiggle room
when it comes to writing off its good will. In June of 2001, the Financial Accounting
Standards Board issued SFAS No. 142 which required the annual impairment testing of
goodwill, with the hopes that these tests would lead to a more realistic valuation of
goodwill; this however, has not been the case. While under this rule annual impairment
tests are mandatory, the provisions for how the goodwill is to be tested allows for a
great deal of managerial estimation. Each step of the two-step impairment tests calls
for the comparison of estimates which can be manipulated at the managers will. In the
years since its implementation, firms have taken advantage of SFAS No. 142 by keeping
their goodwill intact on their books while saving themselves the expense of impairing
the asset.
In accordance with the provision of SFAS No. 142 that calls for the annual testing
of good will, Temple-Inland performs its “annual impairment measurement as of the
beginning of the fourth quarter of each year” (TIN 10-k). While these tests have
occurred annually since 2002 (the year in which SFAS No. 142 was put into effect) the
only significant goodwill impairments took place between 2002 and 2004 and reduced
the amount of the goodwill associated with the Temple-Inlands core operations; these
impairments where off-set by subsequent increases in the goodwill associated with the
firms financial services department. Upon the discontinuation of the financial services
department, the goodwill associated with the department was taken off the books and
replaced by the goodwill associated with the purchase Standard Gypsum (which was
previously a joint-venture). The result of all these adjustments: since 2002 there have
only been two periods in which an actual impairment took place, and the last six years
Temple-Inland’s goodwill has experienced a total decrease of less than 10%.
Percent Change in Goodwill from 2002 to 2007
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Division 2007 2002% Change
Goodwill from Core Operations 236 249 5.51%
Total Goodwill 365 397 8.77%
Due to the provisions set forth in FASB’s SFAS No. 142, which was designed to
foster a more aggressive impairment process, firms are now legally allowed to keep
their goodwill on the books for years at a time with little or no impairment. Temple-
Inland has taken full advantage of this loop-hole by juggling its goodwill between its
departments while keeping their total goodwill fairly constant. This may have the effect
of overstating the firm’s assets. Because Temple-Inland is within its legal right to
manage its goodwill in this manner, it is safe to say that Temple-Inland has a great deal
of accounting flexibility as it pertains to goodwill.
Operating Leases
With all firms there is a choice to be made when it comes to leases: using capital
or operating leases. Like sated before, a firm records a capital lease on the balance
sheet as an asset and a liability. These types of leases also incur interest expense and
depreciation expense throughout the leases lifetime. The other side of leases includes
operating leases. While the operating leases are recorded as operating expenses on the
income statement, they do not have to be recorded on the balance sheet. This can give
a firm an advantage by allowing them to understate their expenses while overstating
both there net income and their retained earnings. This of course would give investors
a false sense of prosperity that a firm might or might not have.
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Temple-Inland Inc. uses both of these types of leases. While most of them are
operating leases, this decision by Temple-Inland Inc. does not influence much of their
financial statements. Only 4.7% of long term liabilities are operating leases and if they
were to capitalize all of the operating leases, the effect it would have on their reports
would be minute if anything. With the small proportion of operating lease, Temple-
Inland has a large amount of flexibility when it comes to choosing either an operating
lease or a capital lease.
Pension Liabilities
Pension liabilities are key account policies for both industries in which Temple-
Inland operates. There can be significant flexibility in regard to how the firms estimate
the amount of long term liabilities in the pension plans. This amount of flexibility is
evident when you compare the discount rates chosen by management of the building
products industry and the paper packaging industry. The discount rate is adjusted to
represent the growth of the liabilities over a long period of time, ultimately for the
purpose of finding the present value of a future obligation. The larger the discount
rates the smaller the present value of the future obligation. If an overly large discount
rate is chosen the firm will overstate liabilities, overstate expenses, understate net
income and thus overstate equity. The inverse is true for an overly small discount rate.
Under GAAP managers are charged with the task of choosing accounting policies
that best describe the underlying business transactions of a firm. Laws such as the one
which created the minimum pension liability in 1988, limited the amount of flexibility
that management had when estimating the value of the pension plans. New legislation
has been implemented to further impede the flexibility available to management.
Temple-Inland in 2006 adopted “Statement of Financial Accounting Standards (SFAS)
No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement
Plans, requiring the funded status of defined benefit plans be shown on the balance
sheet.” (TIN 10K) In 2007 they transitioned into a year in date to value the plans
assets. They also had to adjust for the new accounting date, prior to the rule being
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implemented Temple-Inland used September 30th as a yearly evaluation of the pension
liabilities, this was changed to December 31st.
Prior to this move Temple-Inland and the rest of the public corporations didn’t
have to recognize whether or not their pension fund was over or under funded. In
Temple-Inland’s 2008 10-K they address the issue of under or overfunding by showing
the value of their assets attributed to the pension plan. FASB Statement No. 158 says
an employer must recognize the over or underfunded status of a defined benefit
postretirement plan as an asset or liability in its statement of financial position and to
recognize changes in that funded status in the year in which the changes occur through
comprehensive income. (fasb.org) The rule also requires an employer to recognize all
transactions and events affecting the overfunded or underfunded status of a defined
benefit plan in comprehensive income in the year in which they occur. (fasb.org)
This rule was implemented because the board felt previous rules allowed firms to
delay recognition of economic events that affected the costs of providing postretirement
benefits. The statement improves the financial reporting because information is more
timely and complete. (fasb.org)
Inside Temple-Inland’s 2008 10-K there is a table summarizing the changes to
the financial statements as a result of SFAS No. 158. As a result of SFAS No. 158 total
liabilities increased by 41 million dollars.
• In Millions Before Application
Adjustments
After Application
Prepaid expenses and other 76 (16) 60
Deferred tax liability 279 (35) 244
Liability for pension benefits 156 73 229
Liability for postretirement benefits 119 3 122
Total Liabilities 18,244 41 18,285
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Accumulated other comprehensive loss
134 57 191
Total shareholders’ equity 2,246 (57) 2,189
SFAS No. 158 effectively reduces the flexibility available for management to use
their judgment but provides more transparency.
Pension plan discount rates are another way management can affect the value of
pension funds long term liabilities. As mentioned before there exists an inverse
relationship between the discount rate and the present value of the future liability.
That is if the discount rate is large, liabilities are small. Temple-Inland’s industries
stand in contrast to one another. The paper packaging industry uses rates hovering
around 6.00% while the building product industry decided to jump at least 50 basis
points last year to well above 6.00%. Temple-Inland follows the trend of the paper
packaging industry while interesting enough consistently staying above the 6.00%
barrier most of the industry is reluctant to cross. Thus Temple-Inland has a greater
discount rate than the paper packaging industry benchmark firms yet has a smaller
discount rate than its competitors in the building products industry. Bellow is the
discount rates for Temple-Inland and competitors.
Pension Plan Discount Rates
2003 2004 2005 2006 2007
PKG 6.25% 6.00% 5.50% 5.75% 6.00%
RKT 6.50% 6.00% 5.50% 5.875% 6.25%
IP 6.50% 6.00% 5.75% 5.50% 5.75%
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USG 6.00% 5.75% 5.75% 5.90% 6.55%
PCL 6.25% 5.75% 5.75% 5.90% 6.75%
TIN 6.75% 6.375% 6.00% 6.00% 6.125%
Temple-Inland’s management seems content to keep their discount rate steady
around 6.00% while the rest of the building products industry makes a major jump.
The liabilities of USG and PCL have both decreased as a result of the increased discount
rate. Interesting enough this jump in discount rates, which lead to decreased liabilities,
also coincides with the adoption of SFAS No. 158 which increased USG’s liabilities by
102 million dollars or approximately 200 basis points. After the adoption of SFAS No.
158 Temple-Inland also increased its liabilities by 41 million dollars, or approximately 2
tenths of a basis point. There seems to be a correlation across both industries between
an increase in discount rates and the implementation of the SFAS No. 158. One
movement decreases the liability while the other increases the liability.
The amount of flexibility Temple-Inland enjoys with their asset allocation is
substantial, however most of the assets placed in investment grade bonds. Currently
80% of pension plan assets are placed in the long term debt market with the additional
20% being placed in the relistate and equity markets. These allocations seem
reasonable and are in line with the rest of the industry. Many firms’ use a similar 70+
percentage of allocation in the debt markets for their pension assets.
In conclusion Temple-Inland and the rest of its industry are in the midst of great
change as they grapple with the implementation of SFAS No. 158 and extra liabilities
placed on their books. It appears management has decided to increase the discount
rates temporarily to absorb the impact of new mandatory liabilities present on the
balance sheet.
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Commodity Contracts
Accounting flexibility does not apply to Temple-Inland’s commodity price risk due
to the fact that the firm does not currently use derivatives to hedge either its raw
materials nor its energy costs. The 20 year pulpwood supply agreement does not offer
TIN much flexibility in accounting either. The price set forth by the supply agreement
has been pre-determined and cannot be changed. TIN determines the volume to be
purchased on November 1 for the following year. We feel that the lack of flexibility in
accounting for commodities is a good thing because it doesn’t allow managers to
manipulate figures on the financial statements.
Debt Rating
The amount of flexibility Temple-Inland has in acquiring a debt rating of
investment grade is zero. As this article illustrates from October 2007, the industry
outlook often determines a downgrade in credit rating. This downgrade prompted
Temple-Inland’s sell of its timberland, according to the article. “On Friday, however,
S&P affirmed the firm as investment grade, with a stable outlook, stating that in spite of
reduced cash flows from the reorganization, and less diversification of earnings,
Temple-Inland's profile remains investment grade.” (US Credit – Temple-Inland’s)
The flexibility of management to inflate cash flows and earnings while following
account standards is substantial however if the overall outlook of the industry is poor a
rising credit rating could be a sign of account manipulation. One example would be
increasing collections of accounts receivable in relation to amount of sales, thus
increasing your cash flows. However if this trend continues an annalist would have to
consider both how Temple-Inland has increased its collection of debt and where the
extra sales are coming from.
Essentially if fundamental changes in accounting strategy undertaken by
management during a credit crisis should be monitored. Temple-Inland is restructuring
the firm and changing its operations so any positive change in credit rating should be
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attributed to a positive business model rather than simply sales or earnings
manipulation.
No earnings or expense manipulations where found using our ratios.
Conclusion
The overall flexibility of management to inflate earnings using GAAP has always
been a great concern for the SEC. However, as discussed previously the ability of
management to represent the economic impacts of business offsets the costs
potentially brought by more strict guidelines.
Temple-Inland and its competition enjoy the same amount of flexibility as others
in business; as shown previously Temple-Inland’s ability to affect the balance sheet by
tampering with good will can be substantial. Good will represents over 10% of the total
long term assets, since good will is what you paid – what its worth it should be written
off as quickly as possible. We will restate the financials to where we feel good will
should be recognized.
Currently Temple-Inland dose not have a substantial amount of operating leases
and the effects of capitalizing these leases would be minimal. Thus in the future
management has substantial flexibility when deciding between capital or operating
leases.
The amount of flexibility management has in account for pension liabilities have
substantially dropped with the adoption of SFAS No. 158 which gives more transparency
to accounting for pension plans. However management can still adversely affect the
amount of liabilities through adoptions of aggressive increases or decreases in the
discount rate. Until the SEC mandates a standard discount rate for pension plan
liabilities this flexibility across the industries will remain.
Commodity contracts and credit ratings both have no accounting flexibility in
respect to Temple-Inland. The amount and timing of future supply agreements have
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been set at market prices and the ability of management to change credit ratings lies
only in the ability to substantially alter earnings. If earnings are substantially altered
sales and expense manipulation diagnostics should show substantial changes.
Evaluate Actual Accounting Strategy
Introduction
Evaluating accounting strategy is a crucial step in the accounting analysis. This
is the case because when accounting flexibility is high; the manager’s have the choice
on how much information they disclose in their financial statements. When a firm has a
high level of disclosure, the firm tends to give more than ample amount of information
to investors to aid in the process of valuing the firm. When firms disclose just enough
information to meet SEC requirements, they don’t give investors near as much
information, which makes it much easier to distort the firm’s figures and mislead
investors by making the value of the firm look different than its true value. When
evaluating accounting strategies, analysts need to determine whether the firm practices
aggressive accounting procedures or conservative accounting procedures. Determining
whether a firm is aggressive or conservative on its accounting procedures is helpful to
know because a firm with an aggressive accounting procedure generally reports higher
earnings than a conservative firm.
Goodwill
To evaluate the accounting strategy Temple-Inland employs to account for its
goodwill, one must look at two things: the degree of disclosure and the degree of
conservatism.
Temple-Inland provides a moderate to low level of disclosure as it pertains to
goodwill. For a firm that now operates in two industries, Temple-Inland does a good
job as disaggregating its goodwill and apportioning the proper amounts of goodwill to
their respective divisions. From 2002 to 2005 Temple-Inland disclosed the amount of
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goodwill that could be attributed to its core operations as well as the goodwill that could
be attributed to it financial services department. Upon the selling off of its financial
services department and the acquiring of Standard Gypsum, Temple-Inland began to
distinguish between its core operations and building products goodwill. While helpful,
the disclosure of these details is off set by the lack of disclosure about the origin and
impairment of this goodwill.
Temple-Inland discloses the fact that they perform “the annual impairment
measurement as of the beginning of the fourth quarter of each year” (TIN 10-k), but
they fail to distinguish how they come up with the estimates used to “measure” their
goodwill for impairment. In addition, Temple-Inland fails to mention why they impair,
or fail to impair, there goodwill each year. Lastly, with the exception of the building
products division, Temple-Inland fails to disclose where their goodwill comes from and
when it was originally put on the books. This lack of information makes it difficult to
identify whether or not the firm’s assets are properly valued, and if they are not, it
difficult if not impossible to accurately tell the degree to which the improper valuation
effects the firm’s total assets.
All things considered, Temple-Inland is on the low side of the spectrum
(moderate at best) when it comes the degree of disclosure about the goodwill. While
the firm does a good job at disaggregating its goodwill, this only helps so much
because they do a poor job of disclosing the crucial details surrounding this goodwill.
As previously discussed, Temple-Inland has a great deal of flexibility when it
comes to accounting for their goodwill, and they put this flexibility to good use. Based
on the provisions set forth in FASB’s SFAS No. 142, Temple-Inland is required to test
their goodwill annually for impairment, but they are not required to reduce the book
value of their goodwill, and for the most part, they don’t. By not impairing their
goodwill, Temple-Inland is able to avoid the expenses that come with these
impairments, thus minimizing expenses and maximizing income. This maximization of
income can be characterized has an aggressive (or non-conservative) accounting policy
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on an absolute basis. Relative to its industry, however, Temple-Inland’s approach can
be considered fairly conservative. Temple-Inland has (since 2002) impaired its goodwill
more frequently than all of its competitors.
Percent of Goodwill impaired
Firm 2007 2006 2005 2004 2003TIN 0.00% 7.59% 0.00% 0.52% 3.27%PKG 0.11% 0.00% 0.00% 0.00% 0.00%RKT 0.00% 0.00% 0.00% 0.00% 0.00%IP 0.00% 41.92% 0.00% 6.50% 0.00%
All things considered, Temple-Inland has a multi-faceted strategy when it comes
to the accounting of its goodwill. This strategy involves a high level of disaggregation,
a low level of disclosure in terms of the goodwill’s details, and a aggressive accounting
strategy that appears rather conservative when compared to the industry’s standard.
Operating Leases
As stated in the paragraphs already mentioned over leases, a firm may choose to
use operating or capital leases. Of course, capital leases are placed on the balance
sheet as an asset and liability. Capital leases also have interest and depreciation
expenses. Operating leases are only used on the income statement without any
expenses and understates both assets and liabilities, avoiding any risk with their leases.
This would give a firm an aggressive accounting strategy.
Firms in the paper & packaging industry along with the building supply industry
do not often capitalize their leases. Most firms give the information needed for investors
to see the amount of payments to be made over the next 5 years, specifically, and then
a whole sum for the years after. The one thing that Temple-Inland did not state was
the discount rate. In fact, most firms in these industries do not give the discount rate
for their leases. Through calculations, we have found that Temple-Inland’s discount rate
on their leases is .01. This is with the fact we determined through Temple-Inland’s 10-K
that their leases are for the next 9 years. This shows that if Temple-Inland were to
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capitalize their operating leases, not much would change in their financial statements
and wouldn’t be enough of a change to persuade or dissuade investors. Therefore
Temple-Inland’s accounting strategy is not aggressive.
Pension Plans
The industries in which Temple-Inland operates all have defined benefit plans.
The new rules put forth by FASB pertaining to the accounting of pension funds and the
flexibility managers have of implementing discount rates to estimate the present value
of the future liabilities leads to an interesting questions regarding the level of disclosure
and levels of accounting conservatism.
The level of disclosure in the industry since the conception of SFAS No. 158 has
improved. Before the adoption firms would disclose the funded status of the liability in
the notes to the financial statements. This made it much more difficult to evaluate the
ability of the firm to service the liability in the future. Temple-Inland in the 2005 10-K
discusses its use of discount rates and its rate of return assumptions in the “Critical
Accounting Estimates”. It assumed a 5.50% discount rate for its liabilities and a 8.50%
expected return on its assets. (TIN 10-K) Since the implementation of SFAS No. 158
the disclosure has gotten dramatically better. USG also has a similar amount of
disclosure as dose PKG.
The level of accounting conservatism can undoubtedly be traced to the level of
disclosure about the chosen discount rate because the discount rate appears to be the
most flexible option left to management. Temple-Inland’s choice of discount rate
relative to its competitors in the paper packaging industry is relatively higher which
means it is assuming a smaller liability than its competition. The same can be said
about the building products industry until this year when both firms raised their rates
rapidly above Temple-Inland. Temple-Inland’s recent increase of 12.5 basis points
pales in comparison to the increases of its competition. After the implementation of
SFAS No. 158 liabilities were increased. The increase in liabilities recognized for pension
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plans was met with an increase in discount rates industry wide, which decreased the
liabilities for pension plans. We believe management is attempting to keep the liabilities
in check while they figure out how to deal with the extra burden by increasing the
discount rates of the future long term liabilities. Bellow is the discount rates for Temple-
Inland and competitors.
Pension Plan Discount Rates
2003 2004 2005 2006 2007
PKG 6.25% 6.00% 5.50% 5.75% 6.00%
RKT 6.50% 6.00% 5.50% 5.875% 6.25%
IP 6.50% 6.00% 5.75% 5.50% 5.75%
USG 6.00% 5.75% 5.75% 5.90% 6.55%
PCL 6.25% 5.75% 5.75% 5.90% 6.75%
TIN 6.75% 6.375% 6.00% 6.00% 6.125%
Temple-Inland has above average disclosure pertaining to its pension plan, since
the adoption of SFAS No. 158 the level of disclosure has improved dramatically across
the industry. If the latest flurry of discount rate increases is any indication of
accounting conservatism than Temple-Inland is also on the conservative side. The
paper packaging industry’s firms each increased their discount rates, Temple-Inlands
increase of 12.5 basis points was the smallest. Among the more aggressive building
product manufactures Temple-Inland’s increase of 12.5 basis points pales in comparison
to the 65 basis points and 85 basis point increases of USG and PCL respectively.
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Commodity Contracts
As we have mentioned before, Temple-Inland has chosen not to use derivatives
to hedge either their raw materials or their energy costs. For this reason, Temple does
not implement an accounting strategy for costs associated with commodities. We feel
that this is an advantage because it keeps TIN from devoting time and resources
toward the task of hedging through derivatives. “In 2008, we currently expect that we
will purchase at market prices approximately 50 percent of our wood fiber requirements
under our long-term fiber supply agreements, the most significant of which were
entered into in connection with our timberland sale.” (TIN 10-K Pg 3) Having long-term
supply agreements we feel is a good strategic move in that they are guaranteed a
certain amount of their raw material needs. Because the pulpwood supply contracts
have low amount of information disclosed, we are not able to determine whether the
firm implements an aggressive or conservative accounting policy regarding the risk from
commodities.
Debt Rating
The debt rating in any industry is important. Firm’s can not take aggressive
account strategies and hope to improve their ratings because they are designed to
compare the firm to the overall economy. Temple-Inland mentions the downgrade of
its credit rating in the 2007 10-K however nothing is mentioned in 2006. The amount
of disclosure about credit ratings is very poor. Temple-Inland is still of investment
grade, however to obtain this rating they streamlined their operations drastically last
year.
Conclusion
All things considered, Temple-Inland has a moderate level of disclosure. In
terms of its operating leases, they are a low disclosure, in terms of goodwill they are
low (moderate at best) and in terms of their pensions, they are high disclosure thanks
to SFAS No. 158. Taking all these factors into account, Temple-Inland can be
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considered to have a low or moderate level of disclosure, but in the industries in which
Temple-Inland competes, this level of disclosure is on par.
Asset Level of Disclosure
(L=low, H=high)
Operating Leases L
Goodwill L
Pension H
In addition to the moderate level of disclosure, Temple-Inland has used it
flexibility to create a moderate balance in terms of the conservatism it uses to record its
assets and liabilities. Because the use of operating leases instead of using capital
leases has a negligible effect on the firms balance sheet, this policy is neither
conservative nor aggressive. The same can be said about the firms hedging activities.
Because the market is no more likely to yield favorable prices than it is to yield
unfavorable prices, hedging against this risk is just as likely to be a liability as it is to be
an asset. This being the case, Temple-Inland avoids hedging all together, but because
this avoidance of hedging is not done with the hope of unreasonably increasing profits,
it can’t be considered aggressive. At the same time, this lack of hedging has no
negative affect on the reported earnings so it can’t be considered conservative. Temple-
Inland can however be considered aggressive in its accounting of its goodwill because it
has managed to avoid any significant impairments, thus inflating its reported earnings.
This aggression then offset by the firms accounting of its pension liabilities, by using a
consistent discount rate, Temple-Inland has taken a conservative approach given the
amount of volatility in other firms.
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Asset Conservative or Aggressive
Operating Leases C
Goodwill A
Pension C
Commodity Contracts N/A
All in all, Temple-Inland has a moderate accounting strategy that is neither
conservative nor aggressive. This is the strategy adopted by the main competitors with
which Temple-Inland competes.
Quality of Disclosure
Evaluating the quality of disclosure will make it easier for an analyst to finding the value
of a company. Under the generally accepted accounting policies, firms are required to
disclose a certain amount of information. Some firms disclose more information than
just the bare minimum which allows investors and shareholders alike in making better
judgments to the firm’s value. Though it seems ideal to have a firm disclose a lot of
information, there can be some potential drawbacks. Managers have a significant
amount of flexibility when disclosing information which could make it difficult for
investors and analysts to interpret, and cause individuals to make assumptions based
on the managers’ information. Though managers might reveal information that is
vague, GAAP does require managers to provide supplemental data when they
information they disclose is not clear. Another drawback to a company disclosing more
information is that their competitors are able to see the information that they publish.
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This could hurt the company because they could reveal their key success factors and
allow competitors to mimic their strategies. Evaluating the quality of disclosure will
make it easier for an analyst to find the true value of a company.
Goodwill
The quality of Temple-Inland’s disclosure about its goodwill is important because
it affects the quality of the share-holders understanding of the firm’s total assets.
Goodwill represents as much as 6% of Temple-Inland’s total assets, and as much as
8% of its long term assets. Being that goodwill represents a considerable portion of
Temple-Inland’s assets, share-holders and other interested parties can learn a great
deal about Temple-Inland though good disclosure provided about their goodwill. Bad
disclosure, on the other hand, can cloud the picture of the firm and give an inaccurate
estimation of the firm’s well being.
Temple-Inland provides a moderate to low level of disclosure as it pertains to goodwill.
For a firm that now operates in two industries, Temple-Inland does a good job as
disaggregating its goodwill and apportioning the proper amounts of goodwill to their
respective divisions. From 2002 to 2005 Temple-Inland disclosed the amount of
goodwill that could be attributed to its core operations as well as the goodwill that could
be attributed to it financial services department. Upon the selling off of its financial
services department and the acquisition of Standard Gypsum, Temple-Inland began to
distinguish between its core operations and building products goodwill. While helpful,
the disclosure of these details is set off by the lack of disclosure about the origin and
impairment of this goodwill.
Temple-Inland discloses the fact that they perform “the annual impairment
measurement as of the beginning of the fourth quarter of each year” (TIN 10-k), but
the fail to distinguish how they come up with the estimates used to “measure” their
goodwill for impairment. In addition, Temple-Inland fails to mention why they impair,
or fail to impair, there goodwill each year. Lastly, with the exception of the building
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products division, Temple-Inland fails to disclose where their goodwill comes from,
when it was originally put on the books. This lack of information makes it difficult to
identify whether or not the firm’s assets are properly valued, and if they are not, it’s
difficult if not impossible to tell the degree to which the improper valuation affects the
firm’s total assets.
All things considered, Temple-Inland’s quality of disclosure is poor, moderate at best.
Because the readers of Temple-Inland’s financial statements have no way of judging
how much the goodwill should be, they have no way of telling whether or not the
goodwill is overvalued. The only information provided is about how the goodwill is
allocated among Temple-Inland’s divisions. This information may help readers compare
Temple-Inland’s goodwill across firms but without knowing whether or not the goodwill
is overvalued, this information is limited in its usefulness.
Operating Leases
Temple-Inland is very similar to the rest of the industry when looking at the
disclosures of operating and capital leases. This would give Temple-Inland an average
disclosure rate. They include everything needed for an investor including the types of
leases and how much was being paid over the next 5 years and on. What they did not
include was the discount rate. Although, as we stated before, almost all firms in this
industry do not disclose a discount rate with their operating and capital leases. With this
average disclosure rate, Temple-Inland have legitimate leases.
Pension Plans
Temple-Inland has above average disclosure when compared to its competitors.
There is ample management discussion in the 10K regarding pension plans. Pensions
are discussed in Note 1. Temple-Inland also reacted the least to a change in accounting
policy therefore Temple-Inland’s accounting policies should be considered more
conservative than aggressive. Out of the four total firms in the paper packaging
industry Temple-Inland has the 2nd smallest discount rate, creating a larger liability.
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Out of the three building products firms it has the smallest discount rate. Temple-
Inland follows the paper packaging industry trend of keeping their discount rate around
6% while not over reacting to the new accounting policies of FASB, unlike its
competition in the building products industry.
Commodity Contracts
The level of disclosure provided by managers for commodity risk we feel is fairly
low. TIN briefly discusses the fact that the firm does not use derivatives to hedge. It
also touches on derivative instruments it had used in 2005 to hedge raw materials cost.
“We also have used, to a limited degree, derivative instruments to mitigate our
exposure to changes in anticipated cash flows from sale of products and manufacturing
costs. These derivative contracts had notional amounts that represent less than one
percent of our annual sales of linerboard and purchases of recycled fiber. These
instruments expired in 2005. Operating income increased $1 million in 2005 as a result
of linerboard and recycled fiber derivatives, and there was no material hedge
ineffectiveness.” (TIN 10-K Pg 72) In the pulpwood supply agreement, Temple has
elected to withhold detailed information regarding the prices of their virgin pulpwood.
Although they do not reveal much information from their long-term supply agreement,
we feel their intentions may be to keep confidential information from competitors rather
than mislead investors or shareholders.
Debt Rating
The disclosure of debt ratings is very poor. Management dose not address the
issue in the 10-K, opting instead to explain increases in expenses to decreases in long-
term debt ratings. “The interest rate on these notes was increased 25 basis points
during third quarter 2007 following a change in our long-term debt rating by Moody’s.”
(TIN 10-K) Others in the industry don’t do any better.
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Conclusion
Temple-Inland has above average disclosure when compared to its competitors.
There is ample management discussion in the 10K regarding pension plans; capital
leases vs. operating leases, goodwill, and commodity risk. In fact Temple-Inland has a
section in their 10-K called “Summary of Significant Accounting Policies”. The level of
discussion about changes in accounting for pension plans, goodwill, capital leases and
commodities is sufficient to explain most changes in the balance sheet. Whenever
Temple-Inland changes discount rates for pension liabilities management explains the
effects of changes on the balance sheet, and the effects errors will have on the
liabilities. A 1% change will adversely affect the overall value of the liability.
Since the sale of Guaranty Financial Group and Forestar Real Estate Group
Temple-Inland has eliminated two of its four operating sections. The two remaining
operations are not separated into two groups in the financial statements. Others in the
industry don’t separate their operating segments either.
Temple-Inland has good disclosure of capital and operating leases, lacking the
giving the discount rate. This is not something abnormal however, most firm’s do not.
We were able to find the discount rate through calculations.
The amount of disclosure for goodwill is low however. The amount of details on
goodwill leaves something to be desired.
Overall transparency of the financial documents is good. There is no reason we
have found to distrust anything management has put into the discussions or the actual
financial statements. More disclosure over the expenses of pension liabilities year to
year, greater details of operating leases, and greater details concerning goodwill
accounting. However the amount of information drawn from the 10-K’s allowed us to
complete our ratios.
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Quantitative Analysis
Introduction
The quantitative analysis is the analysis of the figures that a firm provides in its
financial statements. This analysis will provide information on how the financial
statements are linked together and whether or not these numbers were used to
improve or distort the value of a firm. As we have mentioned before, managers have a
varying amount of flexibility in choosing both the accounting procedures and the
amount of information disclosed in the firm’s financial statements. Since some
managers are offered supplemental compensation based on performance, it gives these
managers an incentive to distort the firm’s figures. When managers distort figures on a
firm’s financial statements, it can mislead investors and shareholders into believing that
the firm is more valuable. A quantitative analysis is a good place to put the firm and its
competitors’ numbers at work through ratios which will aid in identifying trends and
potential red flags. Two in depth analyses that we will perform are the sales
manipulation diagnostics and the core expense manipulation diagnostics.
Sales Manipulation Diagnostics
Introduction
To determine if any or the amount of manipulation that has occurred that might
have an effect on the value of Temple-Inland, we will run ratios on items from Temple-
Inland and its competitors’ financial statements. We look at the ratios of TIN and its
competitors to seek out trends over the industry. If anything is found that doesn’t
follow the industry trend we will be better able to identify potential red flags, and the
chart will help us more easily investigate the factors that caused the red flags. We will
be able to evaluate how the firm processes their sales by examining their cash flows
from sales, accounts receivable and inventory compared to the sales acquired.
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Net Sales / Cash from Sales
The ratio Net Sales / Cash from sales allow us to determine the amount of cash
the firm generates compared to total sales for a period. Out of the ratio’s we will run
for Temple-Inland we know for certainty this ratio should be around one. If the sales
and the compensation for those sales are dramatically different than the ratio will
demonstrate a jump from one to another number. A jump in this ratio will signify a “red
flag”. Either the firm has generated an exuberant amount of cash with a standard
amount of sales or have generated an exuberant amount of sales and did not receive,
or recognize payment. A “red flag” for example would be a ratio greater than 1.10 or
less than 0.90. To calculate Net Sales / Cash from sales we used the actual revenues
from manufacturing operations, taking into consideration the spinoff of the financial
sector. By adding or subtracting the difference in the accounts receivable, found in the
statement of cash flows, we were able to determine the amount of cash collected. To
find net sales and cash from sales we took only the building products and corrugated
product sectors from 10-K’s before the sell of Temple-Inland’s financial and real state.
On the following is the chart and graph for Temple-Inland and its competition.
2002 2003 2004 2005 2006 2007Temple‐Inland 0.99 1.00 1.01 1.00 1.01 1.00Packaging Corp. 1.00 1.01 1.01 1.00 1.02 1.01International Paper 1.00 1.00 1.01 1.00 1.00 1.01Plum Creek 1.00 1.00 1.00 1.00 1.00 1.00USG 1.00 1.01 1.02 1.01 1.00 0.98Rock‐Tenn 1.00 1.00 1.01 0.99 1.01 1.00Smurfit‐Stone 1.00 0.99 1.01 0.99 1.00 1.01
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The ratio is consistently around 1, which is where we would expect it to be.
Because the account receivables for the industry are not very big, less than 10% of
total revenue, the ability of a firm to grossly over state their cash flows through either
writing down account receivables or recognizing accounts before the service has been
preformed is minimal. One firm Plum Creek doesn’t even have a line item for changes
in account receivable in their statement of cash flows. USG is the only doesn’t exactly
follow the trend of up and down in the industry; they were under chapter 11 protection
in 2001 until June 2006. There are special circumstances involving recognizing liabilities
and by extension accounts receivable. Smurfit-Stone is currently the only firm
increasing its ratio; the firm has a program where they regularly sell their receivables.
The jump in the ratio can be explained by the interest gained on the sell of these
receivables. The cash received from these sales are not accounted for by their sales.
Net Sales / Accounts receivable
The net sales to accounts receivable ratio is a figure that measures how efficient
a firm is at collecting its receivables. To find this ratio, one must simply take a firm’s
net sales from its income statement in a given year and divide it by the firm’s net
receivables in that year. Ideally, this ratio should be 1 to 1 or higher, if this is the case,
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this means that the firm is efficient at collecting its receivables. If this ratio is low, this
means that the firm’s receivables are out pacing its sales, and the firm is failing to
collect on its receivables. Assuming a firm’s credit policy stays constant, the net sales
to accounts receivable can be used to test whether or not the firm is overstating its
sales. This can be done by observing the ratio over time. If sales are growing at a rate
consistently higher than that of the firm’s receivables, sales may be overstated because
the two should move together.
Below is a chart plotting the net sales/accounts receivable ratio for Temple-
Inland and its competitors:
As the graph above illustrates, this industries ratios are well grouped around the
average of 9. This high average implies that the industry as a whole is extends and
collects credit efficiently. Temple-Inland in particular is right on pace with the industry
maintaining the most stable ratio of the 5 firms measured. This stability means that
Temple-Inland is not only efficient at colleting its receivables, it is consistently efficient.
To get an idea of how this ratio can be used to check the reasonableness of the
firm’s sales figures, the changed form is used. To get the changed form version of this
ratio, the yearly change in net sales is divided by the yearly change in accounts
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receivable. Years in which this ratio is high are causes for concern because this means
that sales grew at a rate greater that of the accounts receivable. Below is a chart
plotting the changed form version of the net sales/accounts receivable ratio:
Although it is clear, given the above graph, that there is no industry trend when
it comes to the change form sales/account receivable ratio, it is clear Temple-Inland’s
ratio is far less volatile than its competitors. This lack of volatility, however, doesn’t
mean there are no questions to be asked. Although small relative to its competitors,
the peak in this ratio displayed in year 2003 is of some concern because the ratio in this
year is 18.1, 64% higher than the firm’s average. The reason for the increase in 2003’s
ratio is the mere 7 million dollar change in accounts receivable, which is far smaller
than the changes displayed previous and subsequent years. Because this small change
is not the result of a change in Temple-Inland’s accounting policy, it and the large
resulting ratio cannot be explained.
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Net Sales / Inventory
The net sales to inventory ratio is important because it shows how net sales are
supported by inventory. A high ratio means that it takes very little inventory to support
revenue. A firm with a high ratio would mean that the firm would be more liquid and
would reduce the costs to warehouse and manage its inventory. PCL is the building
products industry leader and SSCC is the corrugated products industry leader with ratios
above 14. Temple-Inland currently has a ratio of less than 10, which makes us the
worst performer in both industries with regards to the net sales to inventory ratio. In
both industries the trend seems to be flat which means that TIN will most likely
continue to be the worst performer. This means that TIN will continue to carry excess
inventory when compared to its competitors.
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Core Expense Manipulation Diagnostics
Introduction
The ratios we use in the expense manipulation diagnostics section will help us
more easily analyze trends between Temple-Inland and its competitors. The ratios will
include items derived from the statement of cash flows, the income statement, and the
balance sheet. Again, looking at these trends, we will be able to discover any potential
red flags and help us find the source of any red flags that are unrealized. These red
flags could be found in the way the company portrays its assets with goodwill or
whether or not they impair their PP&E or be found on their process of receivables.
These ratios are put up against the rest of the industry so they can be more easily
interpreted and to show the position of prosperity of the company compared to the rest
of the industry.
Asset Turnover ratio
Asset turnover is found by dividing net sales by total assets from the previous year. This
is done to show how sales were made compared to the assets the company had from the
beginning of the year. An ideal ratio would be 1:1 meaning every dollar from sales matches
every dollar of assets that the company had. A higher ratio would mean a company is either
exceeding the use of their assets or are understating their assets. This could mean the company
is not correctly writing off their goodwill or impairing their PP&E. A lower ratio would state that
a company could be overstating their assets to improve their balance sheet or are creating sales
without using their assets to their full potential. This could lead an investor away from the
company because the company could falter without using its assets and lead to a loss in the
company.
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According to the graph, only PKG and USG are reaching the goal of a 1:1 ratio. Also all
companies, excluding TIN, are increasing in at least the past 2 years. This shows that the
industry, in general, is using assets correctly and is growing. TIN could also be in good standing
and possibly moving more towards the goal of a 1:1 ratio. The reason for a growth from 2003
to 2004 leading to a significant drop in 2005 is due to the fact that in 2004 TIN had securities
brought to market which increased its assets that year. This also happened in 2005. In 2006
assets were increased due to the discontinuing of operations put on the balance sheet. Since
this ratio uses the previous year of assets, this made 2005-2007 significantly lower than 2003
and 2004. While this graph may show TIN not using their assets to their full potential, they will
most likely not have any more discontinuing operations or securities held to market in the next
few years. Therefore, you could expect TIN’s ratio to jump back up to .7 or .8 and possibly
grow closer to the 1:1 goal, thus showing investors that TIN does not need to be ruled out
immediately.
The change form for asset turnover is calculated by taking the change of total sales and
dividing it by the change in total assets. This shows the yearly change in the ratio.
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As you can see, every company except PKG stays right around 0. This is good for the
industry and TIN as it shows that the companies are not varying the way they handle their
assets whether the company is increasing or decreasing their sales.
CFFO / OI
Another way to look at a company’s earning in quantitative way is the ratio between the
firm cash flow and operating income. This relates the operating income from the income
statement and the operating cash flows from the statement of cash flows. Once again, the key
ratio is a 1:1 ratio. This would show that the company is getting their operating cash flows from
their earnings in operations. As you can see from the graph below, Temple-Inland stays around
this 1:1 ratio along with two other competitors. The other three competitors obviously have a
sporadic pattern with this ratio. A reason for this, such as in the case of PKG, is there can be a
drop in sales price with rising costs or the accounts receivable balance could be rising. We also
did not include Smurfit Stone or USG due to their extreme irregularities in this ratio.
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When looking at the change of this ratio from year to year, you can see that most of
companies in the paper and packaging industry and the building industry have an increasing
rate. This is due to the fact that most of these companies have done some restructuring with
the impairment of assets and the write-off of PP&E causing a drop in cash inflows. With this
ratio already below 1:1 due to a larger cash flow from operations than operating income, the
restructuring would bring the ratio of cash flows from operating activities to operating income
closer to a 1:1 ratio and then rise from there with a larger operating income than cash flow
from operations. We expect that the change would begin to drop since a continuing to rise from
the current point TIN is at would mean they were getting an extreme amount of cash from
operations and almost completely outweighing their actual operating income. Therefore, we
expect this ratio for TIN to begin to drop closer to a 1:1 ratio and that there are no immediate
red flags when looking at this ratio.
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CFFO/OI (CHANGE)
-2.0000-1.5000-1.0000-0.50000.00000.50001.00001.50002.00002.50003.00003.50004.00004.50005.0000
2003 2004 2005 2006 2007
TINIPPKGSSCCPLUMUSG
Cash Flow From Operations/Net Operating Assets
CFFO/NOA Raw
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The cash flow from operations to net operating assets ratio is important to
determine how well a firm uses its operating assets to create positive cash flows. When
the ratio is large, a firm is doing a better job at using its operating assets to create
cash. The inverse is true for a smaller ratio. For example a firm with a CFFO/NOA ratio
of .50, would mean that every dollar invested in operating assets would generate fifty
cents in cash. Operating assets are long-term tangible assets, more comprehensively
they include property, plant and equipment. We find here that Temple-Inland has
historically lead most of its competitors in generating cash from operating assets, but
the firms seem to be fairly close in their ratios and seem to follow the same trend. The
exception to the firms listed above would be United States Gypsum Company, who
experienced a large decrease in 2006 due to a lawsuit that the company is facing. We
feel that the main reason for the decrease in this ratio for the year 2007 was mainly
due to the sale of strategic timberland that TIN used for operating activities, which
caused a decrease in cash flows from operations.
CFFO/NOA Change
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The CFFO/NOA Change graph shows Temple-Inland and its competitors’ changes
in cash flows from operations over the changes in net operating assets. We see from
the graph above that Temple-Inland’s ratios over the past five years have been fairly
volatile. The volatility can be best explained by the amount of changes in cash flows
from operating activities. We also believe that the substantial drop in operating cash
flows caused the enormous drop in 2007.
Total Accruals / Net Sales
A firm’s accruals to net sales ratio is a diagnostic used to measure a firm’s credit
tolerance. To find this ratio, net income is subtracted from cash flow from operations
to find total accruals; this number is then divided by net sales. Ideally, this ratio should
be about 1 because this would mean that each dollar of accruals (credit) is supported
by a dollar of sales. Below is a graph that plots Temple-Inland and its competitor’s
accruals to sales ratio over time:
As illustrated in the chart above, there is no clear industry trend but it is clear
that Temple-Inland’s ratio peaked relative to its competitors in 2003 it then dropped to
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a constant level until a drastic decrease in 2007. The 2003 peak can be attributed to a
sharp one time increase in the firm’s cash flow from operations which lead to increased
total accruals. This increase in cash flow from operations was the result of increases in
a loans held for sale account that belonged to the firm’s financial services division. This
account decreased by over half in the following year, possibly from the sale of some of
the loans, bringing the cash flow from operations and total accruals back down to their
normal level. The ratio was held stable from 2004 through 2006 but decreased
drastically in 2007.
The 2007 decrease is due to a large one time gain that inflated that year’s net
income. This inflation of net income resulted in a large negative total accruals,
meaning that the firm paid off more of its outstanding accounts than it generated. This
dramatic decrease in accruals relative to sales shows decrease in credit tolerance which
lowers Temple-Inland’s default risk.
The Change form of the accruals to sales ratio is created by dividing the change
in accruals by the change in sales. This form helps to illustrate how yearly changes
affect accruals to sales ratio. Below is a chart plotting the change form of the accruals
to sales ratio.
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As explained above, the changed form graph displays the increase in accruals
relative to sales from 2002 to 2003, the corrective drop in accruals relative to sales from
2003 to 2004 and the decrease in accruals which was far greater than the decrease in
sales from 2006 to 2007 (the offsetting negative make the change form ratio positive).
Conclusion
Although variances exist they can be explained by either a change in accounting
policies like the pension plan expense ratio, or changes in business strategy. It is
interesting to note the differences in the building products industry and the corrugated
product industry. Even though both industries are driven by cost leadership strategies
their accounting strategies are different, Temple-Inland’s middle of the road
performance in many of these ratios correlates with their positioning between the
industries.
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Potential Red Flags
Introduction
When analyzing for questionable accounting analysts search for red flags. These
red flags allow analysts to identify certain areas of accounting that are questionable and
allow them to determine whether or not to look more in depth into the questionable
area. After closely investigating, the analyst can reverse the managers’
misrepresentation, and portray the true value of the firm.
When looking at Temple-Inland’s accounting strategies we have found that the
representation of their business’s financial statements is correct and fair. There is
nothing involved with Temple-Inland’s accounting strategies that is alarming or would
mislead investors or analysts in their judgment of the firm. While no firm has perfect
financial statements, there is one “red flag” that we noticed while analyzing Temple-
Inland’s accounting strategies. This “red flag” has to do with the stated goodwill from
the year of 2007 which ended up being just over 6% of total assets. This high
percentage of goodwill did not accurately describe Temple-Inland’s financial statements
as it overstated their assets.
Financial Analysis, Forecasting Financials, and Cost of Capital Estimation
When valuing a company, it is essential to look at that company’s financial
statements and the financial statements of its competitors. The reason we perform a
financial analysis, forecast financials, and estimate the cost of capital is to better
understand the firm by looking at it compared to its competitors. In the ratio analysis
we will be better able to identify industry wide trends and determine how a company is
performing compared to its competitors. It is important to forecast the financial
statements to determine the future performance of a company which will help
individuals make investment decisions. We estimate the cost of capital to determine
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the capital structure of a firm which will help us value the company by determining how
much of its assets equity financed and debt is financed.
Financial Ratio Analysis
In the Financial Ratio Analysis section, we create different ratios using line items
from the financial statements. These ratios are important for analysts and investors to
understand because it helps to illustrate how the company is doing financially in regards
to its competitors and the industry. The ratios we will perform will measure liquidity,
profitability, and capital structure of the firm. Liquidity ratios measure how solvent a
firm is, meaning how easily it is for a firm to convert its assets to cash. Profitability
ratios measure the how efficient a company is at utilizing its assets to make a profit.
The capital structure of a firm is useful to study because it shows how a company
finances its assets. These ratios can also be used for is to forecast the financial
statements ten years into the future.
Liquidity Ratio Analysis
In this section of our analysis we will be performing ratios to measure the
liquidity of Temple-Inland. Liquidity as defined by Investopedia “The ability to convert
an asset to cash quickly.” (www.investopedia.com). To get an accurate measure of
what Temple-Inland’s liquidity ratio should look like we will be performing this analysis
on all of its competitors in order to determine an industry average. It is generally
better for a company to have higher liquidity ratios, which creates more flexibility for
the company to satisfy debt requirements.
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Current Ratio
This ratio is useful because it shows the liquidity of a company. The current ratio
shows you the amount of current assets, or liquid assets, a company has per each
dollar of current liabilities. This shows an investor how well a company can pay off their
short-term debt without losing value. To find the current ratio you must take current
assets and divide them by current liabilities. The higher the ratio the more easily a
company can pay off their short term debt. Although, a company with an extremely
high ratio can also be seen as a company who is not investing their cash and other
current assets and may be seen as an inactive company. An investor can see this as a
company who does not allocate their assets very well at all and should not be invested
in. When looking at Temple Inland, this may apply for 2004 and 2005. The reason their
current ratio is so high for these years is due to their financial services of Guaranty
Bank being placed on the balance sheet with investments and securities being held to
maturity. This raised their current assets, therefore inflating the ratio. The decision to
discontinue Guaranty bank in 2006 brought their assets back to a more stable position.
Other than these two years, Temple Inland has over-preformed the industry average,
but have kept this ratio above 1 proving they can pay off their current liabilities if need
be.
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Current Ratio
0
0.5
1
1.5
2
2.5
3
3.5
2002 2003 2004 2005 2006 2007
TINPKGUSGSSCCIPPCLIndustry Avg.
2002 2003 2004 2005 2006 2007
TIN 1.65 1.6 3.11 3.19 1.84 1.43
PKG 1.72 1.65 2.21 1.89 1.67 1.3
USG 1.48 1.65 1.33 1.56 0.32 0.52
SSCC 1.43 1.24 1.13 1 0.87 1.01
IP 1.69 1.37 1.72 1.53 1.86 1.75
PCL 1.59 1.65 1.89 1.05 0.97 0.79
Industry Avg. 1.59 1.53 1.90 1.70 1.26 1.13
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Quick Ratio
The quick asset ratio is a step beyond the current ratio to give a clearer picture
on the company’s ability to pay off their current liabilities. To get this ratio you take the
current assets without inventory (this means cash, marketable securities, and accounts
receivable) and divide them by the current liabilities. The wanted result from this ratio
would be 1 or above to show that for every dollar in current liabilities, the company has
one dollar or more in quick assets. The reason this ratio is a better ratio then the
current ratio is because it isn’t smart to rely on inventory to sell quickly or for the price
that you expect. This could cause monetary problems if relying on inventory to pay off
current liabilities. In the graph below, we have including the industry average along
with the industry average without the ratios from USG. This is due to the fact that
USG’s ratio raises the industry average greatly. Therefore, we will use the average
without USG.
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Quick Ratio
0
0.5
1
1.5
2
2.5
3
3.5
4
2002 2003 2004 2005 2006 2007
TINPKGUSGSSCCIPPCLIndustry Avg.avg w/o usg
2002 2003 2004 2005 2006 2007
TIN 0.79 0.78 0.73 0.95 0.86 0.74
PKG 1.03 1.03 1.4 1.11 1.09 0.9
USG 2.24 2.64 3.37 2.84 0.58 1.28
SSCC 0.17 0.41 0.23 0.19 0.16 0.18
IP 0.84 0.77 0.67 0.94 0.93 1.06
PCL 1.80 1.86 2.10 1.21 1.18 0.92
Industry
Avg. 1.15 1.25 1.42 1.21 0.80 0.85
avg w/o usg 0.93 0.97 1.03 0.88 0.84 0.76
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As you can see Temple Inland has under-preformed the industry average for 4
out of the 6 years. The last two years they have been right around the industry
average. This shows that the inventories from the current ratio were a significant part
of their current ratio. They now are not prepared to pay off their current liabilities by
using their more liquid current assets as it would deplete those liquid assets completely
and would have to rely on the selling of inventories to cover all current liabilities.
Working Capital
The working capital ratio can be found by taking sales and dividing it by working
capital, which is current assets minus current liabilities. This ratio explains the amount
of sales generated from the money used in operations. If a company has a higher ratio
then it shows that the company used its working capital efficiently. Like the quick ratio,
we had to take a company out of the industry average due to the severity of the
difference it makes when included in the average. SSCC is off the charts throughout all
years that it had to be taken out to get a justified industry average. The high ratio in
2002 and 2003 can be explained to larger sales with the inclusion of their financial
services. Although they had the sales from financial services until 2004, current assets
were raised, like stated above, in 2004 and 2005 which then lowered this ratio. Their
ratio then began to rise, along with the industry, in 2006 and 2007. With an increasing
ratio this shows Temple Inland is using their working capital efficiently. Other than 2004
and 2005 with Guaranty Bank on the balance sheet, Temple Inland has over-preformed
the industry average.
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Working Capital
-10
-5
0
5
10
15
20
25
30
2002 2003 2004 2005 2006 2007
TINPKGUSGSSCCIPPCLIndustry Avg.
2002 2003 2004 2005 2006 2007
TIN 14.91 15.88 2.14 1.96 8.81 10.14
PKG 8.16 7.76 5.1 7.65 8.46 13.59
USG 3.65 3.38 3.7 3.25 6.16 7.61
SSCC 12.68 27.38 45.38 -17.03 -50.76 570.8
IP 2.89 2.37 1.86 3.25 2.55 3.25
PCL 5.10 0.28 0.36 7.92 7.01 10.95
Industry
Avg. 6.94 5.93 2.63 4.81 6.60 9.11
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Accounts Receivable Turnover
The accounts receivable turnover ratio is found by taking sales and dividing them
by accounts receivable. This would give the investor the picture of how many sales are
made on account with the rest being cash. A higher ratio is preferred as it shows a
company that receives cash instead of having to put their sales on account. This gives
the company a larger cash flow from sales. Obviously, a larger cash flow gives the
company more flexibility and security and gives investors another reason to invest.
Once again there is another company, PCL, which we did not include in the average due
to its misrepresentation of the industry. Temple Inland began being right in line with
the industry average until 2004 when it began to under-perform compared to the rest
of the industry. This fall in ratio is due to the larger amount of accounts receivable and
a somewhat steady sales amount. This does not favor Temple Inland as it shows a low
cash flow from sales which obviously constricts the company’s flexibility in cash usage
and pushes investors away from their company.
A/R Turnover
05
101520253035404550
2002 2003 2004 2005 2006 2007
TINPKGUSGSSCCIPPCLIndustry Avg.
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2002 2003 2004 2005 2006 2007
TIN 12.84 12.96 11.88 9.35 9.26 9.07
PKG 9.88 9.07 8.73 9.35 8.31 8.39
USG 12.21 11.42 10.92 11.34 12.77 12.1
SSCC 13.86 16.43 26.44 30.41 43.11 43.65
IP 8.04 7.65 8.52 8.24 8.13 6.94
PCL 34.45 35.18 38.20 25.84 28.05 41.88
Industry
Avg. 11.37 11.51 13.30 13.74 16.32 16.03
Days Sales Outstanding (DSO)
This ratio is taken from dividing 365 by the accounts receivable turnover ratio.
This would obviously show the amount of days it takes for a company to turn its
accounts receivables into cash. This is an important ratio due to the fact that a
company’s ability to turn its receivables to cash quickly helps the company to
continually use their cash. Therefore a lower ratio is preferred since a high ratio would
show a company’s inefficiency with their accounts receivable.
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Days Sales Outstanding
0
10
20
30
40
50
60
2002 2003 2004 2005 2006 2007
TINPKGUSGSSCCIPPCLIndustry Avg.
2002 2003 2004 2005 2006 2007
TIN 28.43 28.16 30.72 39.047 39.42 40.24
PKG 36.95 40.25 41.83 39.03 43.92 43.48
USG 29.89 31.96 33.43 32.17 28.14 30.17
SSCC 26.34 22.22 13.8 12 8.47 8.36
IP 45.38 47.71 42.86 44.32 44.87 52.56
PCL 10.59 10.38 9.55 14.13 13.01 8.72
Industry
Avg. 29.60 30.11 28.70 30.12 29.64 30.59
Other than the first two years, Temple Inland has over-performed the industry average.
While the average is rather spread out, it shows that Temple Inland does a decent job
at collecting their accounts receivable in comparison to the amount of days. This graph
can also show that they probably have used a 30 day account for their customers to
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pay on. Although the last three years can show they have either switched to a 60 day
period and are doing well collecting on accounts or are continuing to use a 30 day
period and are lacking in their collections. We assume that Temple Inland has stuck to
the 30 day period and is therefore lacking in their collections. Although they are
personally under-performing, with their position compared to the industry average,
Temple Inland is secure in their amount of time it takes them to collect on their
accounts receivable.
Inventory Turnover
Inventory turnover can be found by taking the company’s COGS and dividing it
by inventory. This ratio would give you an idea on the amount of times that the
company’s inventory is sold and replaced throughout each year. A company can be
seen as having an inefficiently high amount of inventory if this ratio is low. This would
mean the company is not investing their money wisely within the company. Like
discussed in the Quick Ratio, Temple Inland has a high amount of inventory. This
obviously shows their inefficiency of inventory and help pushing investors away from
investing. This also explains why their inventory ratio is so low. Their COGS has stayed
at a steady amount meaning the lowering of the ratio would come from the increasing
amounts of unused inventory. Throughout the past 6 years, they have consistently
under-performed the industry average.
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Inventory Turnover
5.006.007.008.009.00
10.0011.0012.0013.0014.0015.0016.00
2002 2003 2004 2005 2006 2007
TINPKGUSGSSCCIPPCLIndustry Avg.
2002 2003 2004 2005 2006 2007
TIN 8.94 9.82 7.51 7.96 7.99 7.35
PKG 8.79 8.64 8.88 8.79 8.9 8.76
USG 10.68 11.15 10.86 12.82 4.8 12.21
SSCC 9.23 9.39 7.39 8.25 11.5 11.86
IP 7.40 7.09 9.25 9.42 9.58 9.63
PCL 12.48 15.11 13.66 13.81 6.38 7.44
Industry
Avg. 9.59 10.20 9.59 10.17 8.19 9.54
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Days Supply of Inventory (DSI)
The days supply of inventory is found just like the Days Sales Outstanding ratio.
It can be found by taking 365 and dividing it by the inventory turnover ratio. This ratio
will give you the amount of days that the company uses to sell and replace their
inventory. Once again the graph below shows Temple Inland’s inefficiency of inventory.
While they are only slightly over-performing the industry average, this is not a ratio to
over-perform on. This once again means they hold their inventories longer than need
be and are showing a small increase in days holding of inventory.
Days Supply of Inventory
20.0025.0030.0035.0040.0045.0050.0055.0060.0065.0070.0075.0080.00
2002 2003 2004 2005 2006 2007
TINPKGUSGSSCCIPPCLIndustry Avg.
2002 2003 2004 2005 2006 2007
TIN 40.82 37.15 48.60 45.87 45.68 49.64
PKG 41.52 42.22 41.11 41.51 41.03 41.65
USG 34.17 32.75 33.6 28.48 77.93 29.89
SSCC 39.56 38.89 49.4 44.25 31.75 30.78
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IP 49.32 51.48 39.47 38.76 38.10 37.91
PCL 29.24 24.15 26.72 26.42 57.25 49.03
Industry
Avg. 39.11 37.77 39.82 37.55 48.62 39.82
Cash to Cash Cycle
The cash to cash cycle is found by adding the Days Sales Outstanding ratio and
the Days Supply Inventory ratio. Like stated before the DSO explains the time it takes
to collect on its accounts receivable from what was sold while DSI explains the time it
takes for inventory to turnover. By adding these two together this would show how long
it takes for a company to realize the actual cash flow from its inventory. Therefore a
company with a lower cash to cash cycle is more liquid than a company with a higher
cash to cash cycle.
Cash to Cash Cycle
35.0040.0045.0050.0055.0060.0065.0070.0075.0080.0085.0090.0095.00
100.00105.00
2002 2003 2004 2005 2006 2007
TINPKGUSGSSCCIPPCLIndustry Avg.
2002 2003 2004 2005 2006 2007
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TIN 69.25 65.32 79.32 84.91 85.09 89.88
PKG 78.47 82.48 82.94 80.54 84.95 85.13
USG 64.06 64.71 67.03 60.65 106.08 60.01
SSCC 65.9 61.11 63.21 56.26 40.22 39.14
IP 94.70 99.20 82.33 83.09 82.98 90.47
PCL 39.83 34.53 36.27 40.55 70.27 57.75
Industry
Avg. 68.70 67.89 68.52 67.67 78.27 70.40
This graph and chart show once again that Temple Inland is under-performing
the industry when it comes to liquid ratios. This ratio portrays the large amount of days
it takes for Temple Inland to actually see a profitable cash flow from its inventory. Not
only is it currently under-performing the industry average but it is also showing an
increasing cash to cash cycle ratio meaning they are taking longer and longer to
recognize their profits from inventory. Although this may be attributed to a more lenient
credit approval for customers, it does send a cause for concern for potential investors.
Conclusion
By using these ratios, we were able to compare and contrast Temple Inland’s
liquidity to the rest of the industry. When looking at the current ratio, Temple Inland
has over-performed the industry average while they are under-performing in the quick
ratio. The industry’s operating efficiency can be found by the accounts receivable
turnover and inventory turnover. From these ratios, Temple Inland is shown as having
very low operating efficiency. Their inefficiency can also be seen by their cash to cash
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cycle ratio. Although these ratios vary, they seem to have a somewhat similar level of
liquidity as the rest of the industry. Temple Inland’s trends seem to either be increasing
or decreasing depending on the ratio, but are overall decreasing.
Liquidity Ratio Performance Trend
Current Ratio Over-performed Decreasing Trend
Quick Ratio Under-performed Stable
Working Capital Turnover Over-performed Increasing Trend
A/R Turnover Under-performed Decreasing Trend
Inventory Turnover Under-performed Decreasing Trend
Cash to Cash Cycle Under-performed Decreasing Trend
Overall Average Decreasing Trend
Profitability Ratio Analysis
In the profitability ratio analysis, we will perform ratios to determine how
efficient Temple-Inland and its competitors are at generating profits. In order to
determine how effective Temple-Inland is, we will compute an industry average for
each of the profitability ratios. The goal is for a company to have higher ratios, which
means that the company is better at using its resources to create a profit. The ratios
we performed in this analysis will be the gross profit margin, operating expense ratio,
operating profit margin, net profit margin, asset turnover, return on assets, and return
on equity.
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Gross Profit Margin
The graph and chart bellow show the gross profit margin for Temple-Inland and
its competitors. The gross profit margin was computed by dividing gross profit by
Revenues. Gross profit is computed by subtracting the direct costs of production and
sales, cost of sales. A high gross profit margin indicates the firm is more productive at
creating and selling its product.
Gross Profit Margin
0.0%5.0%
10.0%15.0%20.0%
25.0%30.0%
35.0%40.0%
2002 2003 2004 2005 2006 2007
TINPKGUSGIPPCLSSCC
Gross Profit Margin
2002 2003 2004 2005 2006 2007
TIN 7.8% 5.6% 9.9% 12.0% 16.9% 13.7%
PKG 18.7% 17.2% 15.8% 15.4% 20.3% 22.7%
USG 16.8% 14.9% 18.6% 21.4% 23.6% 11.5%
IP 18.4% 15.1% 22.9% 32.2% 26.1% 26.6%
PCL 36.3% 31.8% 36.5% 34.3% 34.2% 32.9%
SSCC 16.5% 13.6% 13.5% 11.1% 13.6% 13.7%
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Gross profit margin is a very important ratio in our industry because of the
adverse effects high cost of goods sold can have on a firm. In a competitive commodity
type industry any advantage in gross profit margin is important. It is interesting to note
Temple-Inland started out at the bottom of the industry and has increased its way
towards 15%. Since it is competing in two industries it is important to note it is getting
beat by quite a bit by PCL who specializes in wood building products but is beating USG
who specializes in gypsum materials. Since Temple-Inland is attempting to expand in
the gypsum segment and away from hardwood manufacturing it is important to note
Temple-Inland seems to be better at utilizing its resources than USG. In the corrugated
products manufacturing segment however Temple-Inland is not faring as well. The
only competitor it is not worse than is SSCC which is a much larger company who can
cover up some of its inefficiencies with pure volume of sales. Among the corrugated
product manufactures International Paper has the best gross profit margin, IP however
also has a large writing paper segment whose cost of goods sold is different than
predominately container board manufactures.
Operating Expense Ratio
The graph and chart bellow show the gross profit margin for Temple-Inland and
its competitors. The operating expense ratio is computed by dividing selling and
general administrative expenses by sales. Operating expenses are indirect costs of
administrative and marketing. (Jordan & Miller). A low operating expense ratio
indicates the firm dose not spend a large portion of revenues on business activities not
directly associated with the production or sell of its product.
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Operating Expense Ratio
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
2002 2003 2004 2005 2006 2007
TINPKGUSGIPPCLSSCC
Operating Expense Ratio
2002 2003 2004 2005 2006 2007
TIN 7.7% 7.6% 7.3% 7.7% 7.7% 7.9%
PKG 7.5% 7.4% 7.2% 7.3% 7.3% 7.3%
USG 9.0% 8.8% 7.0% 6.8% 7.2% 7.8%
IP 9.2% 8.9% 7.8% 7.4% 8.4% 8.4%
PCL 6.6% 6.4% 5.6% 5.8% 6.7% 7.6%
SSCC 9.9% 11.4% 9.8% 10.1% 9.5% 8.5%
The operating expense ratio for TIN and the rest of its competition is relatively
consistent, the exception being SSCC. Although SSCC seems to change the most it has
streamlined its operations the past few years to reach the industry medium of around
7.8%. Temple-Inland is consistently around the industry average.
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Operating Profit Margin
The graph and chart bellow show the operating profit margin for Temple-Inland
and its competitors. The operating profit margin was computed by dividing Operating
Profit by Revenues. Operating Profit is computed by subtracting selling, general and
administrative expenses, and other operating expense from revenues. A high operating
profit margin indicates the firm is more productive at running its business operations.
The difference between a firm with a high gross profit margin and low operating profit
margin means there could be extra costs hidden in the general and administrative
expenses or other operating expenses.
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Operating Profit Margin
-60.0%
-40.0%
-20.0%
0.0%
20.0%
40.0%
60.0%
2002 2003 2004 2005 2006 2007
TINPKGUSGIPPCLSSCC
Operating Profit Margin
2002 2003 2004 2005 2006 2007
TIN 7.4% 1.3% 9.7% 3.1% 10.0% 53.3%
PKG 8.4% 5.6% 7.4% 5.8% 10.3% 12.7%
USG 7.4% 5.7% 11.3% -45.8% 17.0% 3.2%
IP 1.5% 1.3% 3.1% 2.4% 14.5% 7.6%
PCL 29.7% 25.3% 31.2% 28.4% 28.3% 25.3%
SSCC 6.2% 0.6% 2.6% -3.7% 3.9% 4.1%
The operating profit margin for Temple-Inland is remarkably consistently around
the industry average. Since Temple-Inland and the rest of the industries are strongly
effected by changes in the overall economy it is interesting to see the firms follow a
similar pattern. The jump from 10% to 53% can be explained by the sell of timberland
at the end of 2007. The next years operating profit will be back in line with the rest of
the industries. The building products firms of PCL and USG also follow a similar pattern
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with PCL consistently 20% higher than the corrugated products industry. USG is on the
same level as the corrugated product industry except for 2005, which was the year a
large law suit was settled by USG, this settlement ate into its operating profit.
Net Profit Margin
When measuring the net profit margin, we divide the net income by net sales.
It is ideal for a company to have a high net profit margin because it means that the
company is retaining a higher percentage of its sales as net income. Generally when
sales increase and a firm grows in size, its unit costs drop which will produce a higher
net profit margin. There can be an inverse effect though, in which situation a firm’s net
profit margin decreases when there is an increase in sales. The following graph and
chart illustrate Temple-Inland and its competitors’ net profit margin.
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For the past six years both the packaging industry and the building supply
industry’s net profit margin has remained fairly constant. From 2002 to 2005, Temple-
Inland’s net profit margin has increased at a moderate rate which shows that they have
been improving at controlling their costs. The jump in 2006 can best be explained by
the discontinued operations as a result of selling off their financial services company.
In 2007 the increase is explained by the sale of Temple-Inland’s strategic timberland.
USG’s drop in 2005 is attributed to lawsuits that the company faced. The reason that
USG and PCL’s net profit margins may differ than the rest of the competitors is that
they are not direct competitors of Temple-Inland since roughly only 20% of TIN’s
business is in the building supply industry.
2002 2003 2004 2005 2006 2007
TIN 2% 3% 4% 5.00% 11.00% 33%
IP -4% 1% 0% 5.00% 5.00% 5%
PKG 2.8% -0.8% 3.60% 2.60% 5.70% 7.30%
USG 1.20% 3.3% 6.90% -27.90% 5.00% 1.5%
SSCC 0.9% -2.6% -0.70% -4.8% -0.80% -1.40%
PCL 20.5% 16.1% 23.7% 22.5% 19.5% 16.8%
Industry 3.73% 3.17% 6.08% .4% 7.57% 10.37%
Asset Turnover
The asset turnover ratio is computed by dividing total assets from the previous
year into net sales. This ratio shows how effective a company uses its assets. It is
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essentially what kind of return a firm produces from its assets in the form of sales. The
higher the ratio the more efficiently a firm utilizes its assets. Many scenarios provide
that companies generate more sales than their total assets, but in many cases where
firms have a large amount of assets sales generated are less than total assets.
Therefore it is important to determine what the industry average of the asset turnover
ratio is. The graph and chart below show what Temple-Inland and its competitors’
asset turnover ratios have been for the past six years.
From looking at the graph, it seems that there is no industry standard regarding
the value of the asset turnover ratio. Temple-Inland was one of the leaders from 2002
to 2004 but dropped in 2005. Temple-Inland now has one of the worst asset turnover
ratios, with the exception of 2007 which was due to the sale of TIN’s strategic
timberland. We feel that the primary reason that Temple-Inland currently has such a
low asset turnover ratio, is not effectively utilizing its assets to create sales.
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2002 2003 2004 2005 2006 2007
TIN 1.1 0.94 1.02 0.6 0.71 1.08
IP 0.6 0.66 0.66 0.7 0.76 0.91
PKG 0.88 0.876 0.952 0.958 1.108 1.166
USG 1.001 1.008 1.187 1.201 0.946 0.97
SSCC 0.702 0.715 0.665 0.711 0.785 0.954
PCL .276 .279 .347 .36 .338 .359
Industry .7598 .7463 .8052 .6867 .6878 .7582
Return on Assets
A firm’s return on assets (ROA) is a ratio that measures the firm’s profitability
and assesses how efficient a company is at turning its assets into profits. To find a
firm’s ROA for a given year, one must divide the firm’s net income in that year by the
firm’s total assets in the previous year. The result of this division will provide the
percentage of that year’s beginning assets that translated into net income. This ratio
was calculated for Temple-Inland and its leading competitors from 2002-2007. The
results of this calculation are displayed in the table below and plotted on the graph
below:
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Return On Assets
2002 2003 2004 2005 2006 2007
Temple-Inland 1.29% 1.93% 3.56% 0.87% 2.16% 6.37%
Plum Creek 5.65% 4.48% 8.21% 8.09% 6.59% 6.05%
Smurfit-Stone 0.61%
-
1.82%
-
0.46% -3.44%
-
0.65%
-
1.32%
International Paper
-
2.00% 1.00% 0.00% 3.00% 4.00% 5.00%
USG 1.24% 3.36% 8.21%
-
33.57% 4.69% 1.42%
Packaging Corp. 2.44%
-
0.72% 3.46% 2.53% 6.34% 8.56%
Industry Average 1.54% 1.37% 3.83% -3.75% 3.85% 4.35%
Return On Assets
-6.00%-4.00%-2.00%0.00%2.00%4.00%6.00%8.00%
10.00%
2002 2003 2004 2005 2006 2007
Temple-InlandPlum CreekSmurfit-StoneInternational PaperUSGPackaging Corp.Industry Average
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As illustrated in the graph above, Temple-Inland was well within the range of the
industry’s norm before a sudden decrease in 2005. After this decrease, Temple-Inland’s
ROA has displayed an upward trend that has put it back in the competitive range.
The drop in ROA in 2005 is the result of an increase in assets in 2004 (2005’s
ROA’s denominator). This increase came from an increase in cash, inventories,
property plant and equipment, and other asset categories. These increases appeared
to be aimed at increasing the firm’s capacity but resulting increase in revenue on would
expect to see on 2005’s income statement didn’t materialize. Because the 2005’s
revenue stayed relatively constant, the net income did as well; this constant net income
combined with increased assets in 2004 depressed Temple-Inland’s ROA in 2005.
The increases in ROA that occurred in 2006 was the result of Temple-Inland
managing to increase it’s net revenue by only 9% while keeping its costs relatively
constant. This lead to a 166% increase in net income. This increase in income was
partially offset by an increase in 2005’s assets and the fact that net income is a small
percentage of total assets. The combined effect if the increase in income and the
offsetting factors was a 1% increase in Temple-Inland’s 2006 ROA.
The final and largest increase in Temple-Inlands ROA was in 2007 when the ratio
jumped roughly 4% from approx. 2% in 2006 to approx. 6% in 2007. This increase
was the result of an enormous increase in net income. This increase was the product
of the selling off of the firm’s timber-land, a sale that resulted in a gain of $2 billion.
Return on Equity
A firm’s return on equity (ROE) is a ratio that is a measure of profitability and
assesses how efficient a company is at turning its equity into profits. To find a firm’s
ROE for a given year, one must divide the firm’s net income in that year by the firm’s
total equity in the previous year. The result of this division will provide the percentage
of that year’s beginning equity that translated into net income. This ratio was
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calculated for Temple-Inland and its leading competitors from 2002-2007. The results
of this calculation are plotted on the graph below:
Return On Equity
2002 2003 2004 2005 2006 2007
Temple-Inland 0.027954 0.049256 0.083841 0.083531 0.225 0.596163
Plum Creek 10.37% 8.64% 17.08% 15.80% 13.63% 13.50%
Smurfit-Stone 2.62% -8.49% -2.03% -14.61% -3.13% -5.79%
International
Paper -9.00% 4.00% 0.00% 13.00% 13.00% 15.00%
USG 8.76% 22.80% 45.28%
-
140.23%
-
95.36% 4.95%
Packaging Corp. 6.26% -1.80% 8.62% 6.43% 18.35% 24.58%
Industry
Average 3.63% 5.01% 12.89% -18.54% -5.17% 18.64%
Return on Equity
-20.00%
0.00%
20.00%
40.00%
60.00%
80.00%
2002 2003 2004 2005 2006 2007
Temple-InlandPlum CreekSmurfit-StoneInternational PaperUSGPackaging Corp.Industry Average
As illustrated in the graph above, Temple-Inland’s ROE has followed an upward trend
allowing it to reach unprecedented levels in recent years. The reason for this exuberant
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grown in the last 2 years is Temple-Inland has been repurchasing large amounts of
their outstanding stock thus greatly reducing their total shareholder’s equity (the
denominator of this ratio).
This drop in the firm’s equity has been complimented by the sale of timberland
which increased 2007’s net income (the numerator of the ratio) by approximately $2
billion. This combination of stock repurchases and a one-time gain has inflated Temple-
Inland’s ROE to the point where it is no longer a rational number.
Firm Growth Rate Ratios
In this section of the analysis we will attempt to measure the growth rate of
Temple-Inland and its competitors. Determining growth rates is an important part of
the analysis because it allows us as analysts to predict how the company will perform in
the future. The two ratios that we will use in this analysis are the internal growth rate
and the sustainable growth rate.
Internal Growth Rate
A firm’s internal growth rate (IGR) is the rate at which a firm can be expected to
grow assuming is borrows no money and all growth is funded by the firms equity. To
calculate a firm’s IGR the following equation is used:
IGR = ROA x [1 – (DIV/NI)]
Where,
IGR = Internal growth rate
ROA = return on assets
DIV = cash dividends paid
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NI = net income
This equation states that without debt financing a firm’s grow is dependant upon
two things, how much of the firm’s earnings are retained by the firm ([1-DIV/NI] also
known as the retention ratio), and how efficiently those earnings are used (ROA). Listed
below are the IGR’s for Temple-Inland and its leading competitors:
Internal Growth Rate
2002 2003 2004 2005 2006 2007
Temple-Inland
-
0.34% 0.46% 0.63% 0.37% 1.66% 0.45%
Plum Creek
-
1.02%
-
1.52% 2.31% 1.71% 0.56%
-
4.42%
Smurfit-Stone 0.71%
-
1.72%
-
0.35% -3.32%
-
0.52%
-
1.17%
USG 1.24% 3.36% 8.21% OUTLIER 4.69% 1.42%
Packaging Corp. 2.44%
-
0.72% 0.25% -2.13% 1.01% 3.27%
Industry Average 0.61%
-
0.03% 2.21% -0.84% 1.48%
-
0.09%
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IGR
-6.00%-4.00%-2.00%0.00%2.00%4.00%6.00%8.00%
10.00%
2002 2003 2004 2005 2006 2007
Temple-InlandPlum CreekSmurfit-StoneUSGPackaging Corp.Industry Average
As illustrated in the graph above, Temple-Inland’s IRG has remained relatively
constant relative to its competitors over the past six years reaching its highest point in
2006 at approximately 1.7%. This peak in the firm’s IGR is due to a combination of the
high ROA of that year (See the section: Return on Assets for further discussion) as well
as the high retention ratio of that year. This high IGR was not maintained in 2007 in
spite of the even higher ROA of that year because a large dividend was paid which
resulted in a retention ratio low enough to offset the high ROA.
Sustainable Growth Rate
Like IGR, sustainable growth rate (SGR) is an estimation of how a firm can be
expected to grow in the future. Unlike IGR, sustainable growth rate assumes that the
firm will use debt as well as equity financing. An additional assumption used to find a
firm’s SGR is that the firm’s debt equity ratio will remain constant. To calculate a firm’s
SGR, the following equation is used:
SGR = IGR x [1 + (D/E)]
Where,
SGR = Sustainable Growth Rate
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IGR = internal growth rate (See Internal Growth Rate section for further
discussion)
D/E = debt equity ratio
Because the only difference between a firm’s SGR and IGR is that the SGR
assumes that the firm will continue to borrow at a rate that will keep its debt/equity
ratio constant, one need only multiply the IGR by 1 + D/E to account for the difference.
The following is a table and graph detailing the SGR for Temple-Inland and its main
competitors:
Sustainable Growth Rate
2002 2003 2004 2005 2006 2007
Temple-Inland -0.87% 1.09% 5.98% 3.82% 15.56% 3.46%
Plum Creek -0.07% 0.12% 0.11% -0.12% -0.13% 2.01%
Smurfit-Stone -1.90% 4.22% 0.78% 9.43% 1.22% 2.32%
USG -5.95% -11.79%
-
17.89% OUTLIER -7.02%
-
0.15%
Packaging
Corp. OUTLIER OUTLIER -0.14% 1.90% -0.88%
-
2.21%
Industry
Average -2.20% -1.59% -2.23% 3.76% 1.75% 1.08%
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SGR
-20.00%
-10.00%
0.00%
10.00%
20.00%
2002 2003 2004 2005 2006 2007
Temple-InlandPlum CreekSmurfit-StoneUSGPackaging Corp.Industry Average
As show by the graph above, Temple-Inland’s SGR over the last 6 years has
been more volatile than its competitors peaking in 2004 and 2006. The 2004 peak can
be explained by an increase in total debt relative to total equity, this dramatically
increased the firm’s debt/equity ratio and thus it’s SGR. The increase in liabilities in
2004 can be largely attributed to increases in accounts that pertained to the now
discontinued financial services division.
The next large spike in Temple-Inland’s SGR came in 2006, the same year the
firm’s IGR peaked. This high IGR was exacerbated by the year’s high debt/equity ratio
which was the result of an added liability account called “Liabilities from Discontinued
Operations” which had a balance of $15.3 billion. This account arose from the liabilities
associated with the discontinued financial services division, so even thought the
financial services division was no longer operational, total liabilities in 2006 remained a
level similar to that of 2004.
Conclusion
After running several profitability ratios we found Temple-Inland was in the middle of
the industry the majority of the time, a few areas Temple-Inland excelled at while a few
others needs improvement. Temple-Inland’s net profit margin was an industry leader
while their gross profit margin was one of the worst. This is interesting given Temple-
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Inland’s strategy of cost leadership. It appears Temple-Inland is able to generate profit
in other ways then generating earnings from gross profit. Their operating expense ratio
however is an industry average and has been so for some time, the only logical
conclusion you could make given this information is Temple-Inland is not exceptional at
cutting selling, administrative, and other costs not associated with cost of goods sold.
In conclusion it appears Temple-Inland has managed to maintain a high net profit
margin by recognizing gains on its discontinued operations. If they do not become low
cost leaders and improve their gross profit margins they will be pushed out by the
other, more efficient firms in the industry.
Profitability Ratio Performance Trend
Gross Profit Margin Under-performed Stable
Operating Expense Ratio Average Stable
Operating Profit Margin Average Stable
Net Profit Margin Over-performed Decreasing Trend
Asset Turnover Under-performed Stable
ROA Average Increasing Trend
ROE Average Increasing Trend
IGR Average Stable
SGR Over-performed Decreasing Trend
Overall Average Stable
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Capital Structure Ratios
Capital structure is the configuration of how a firm finances its assets. A
company funds its assets through two sources, debt and equity. In debt financing, a
firm obtains funds through a lender, and when funding is obtained using equity, a firm
sells off ownership in the company through shares of stock. The ratios performed in
this analysis will allow us to determine which method Temple-Inland and its competitors
are primarily financed. The ratios that we will use are debt to equity ratio, times
interest earned ratio, debt service margin, and we will also compute the Z-Scores.
Debt to Equity
In this section of the analysis we will be looking at the debt to equity ratio. The
debt to equity ratio is calculated by dividing total liabilities by total equity. A debt to
equity ratio over 1 indicates that the company is incurring more debt than equity;
therefore, it is important to investors that a company has a low debt to equity ratio.
Another reason that owners and investors of a company would like to see a low debt to
equity ratio is because if the company goes bankrupt, it is required to liquidate its
assets to cover all of its liabilities before it can pay out to the shareholders. Illustrated
in the graph and chart below is the debt to equity ratios for Temple-Inland and its
competitors for that past six years.
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As illustrated in the graph above, Temple-Inland now has one of the highest debt
to equity ratios in the industry. This is the case because in 2004 the company greatly
increased its total liabilities. This affects the capital structure of the company greatly
because although the firm was primarily debt financed, it is now highly debt levered.
This affects investors because if the company goes bankrupt, when it liquidates its
assets it is required to pay off its liabilities before the equity shareholders are paid back.
2002 2003 2004 2005 2006 2007
TIN 1.55 1.36 8.56 9.4 8.35 6.62
IP 3.58 3.31 3.15 2.45 2.02 1.79
PKG 2.22 1.72 1.55 1.9 1.87 1.68
USG 5.8 4.51 3.18 ‐21.34 2.5 1.11
SSCC 3.66 3.45 3.24 3.84 3.37 2.98
PCL .93 1.08 .95 1.07 1.23 1.45
Industry 2.957 2.572 3.438 ‐.447 3.223 2.605
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Times Interest Earned
In this section of the analysis we will be computing times interest earned. To
compute times interest earned we will divide operating income by the company’s
interest expense. This ratio is important for analysts and investors to understand
because it portrays how much flexibility a firm has for paying off its interest expense.
An ideal situation would be that a company have a high times interest earned ratio,
because it means that the company has plenty of income available to cover its interest
expense. The graph and chart below illustrate the times interest earned ratio for
Temple-Inland and its competitors for the past six years.
As the graph and table illustrate, Temple-Inland is well below the industry
average for the times interest earned ratio from 2002 through 2006. Though the
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industry average may be affected by USG and IP’s times interest earned ratios, Temple-
Inland still has one of the lowest ratios after the outliers have been taken out of the
average. The increase in 2007 is best explained by the sale of TIN’s strategic
timberland. Temple-Inland’s historical times interest earned ratios could cause concern
for investors because it means that TIN may have difficulty covering its interest
expense.
2002 2003 2004 2005 2006 2007
TIN 1.89 0.34 2.86 1.1 3.41 17.43
IP 7.23 3.43 27.85 48.83 187.53 68.92
PKG 2.15 0.8 4.75 4.13 7.24 11.47
USG 32.25 35 101.6 -470.8 1.77 1.57
SSCC -1.3 -0.14 -0.5 0.73 -0.81 -1.07
PCL 3.28 2.59 4.3 4.11 3.47 2.88
Industry 7.583 7.003 23.477 -68.65 33.768 16.867
Debt Service Margin
In this section of the analysis we will be examining the debt service margin. To
calculate the debt service margin we divide cash flows from operations by the current
notes payable from the previous year. This is important to analysts and investors
because it shows a company’s ability to pay its debt through operating cash flows. The
ideal situation would require a company to have a high debt service margin in order to
155
give them flexibility when paying off debt. The graph and chart below illustrate the
debt service margin for Temple-Inland and its competitors for the past six years.
Although the graph above shows that the firms have a substantial difference in
the value of their ratios, most of the companies seem to follow a similar trend. Temple-
Inland has a very low debt service margin which means that they are not generating
enough cash flows through their operations to cover the current portion of long-term
debt due. We feel that if this trend continues, this could be warning signs that the
company could suffer financially. It is interesting to note however that Temple-Inland is
highly leveraged and therefore has a lot more debt to pay off than many of its
competitors. Therefore we can conclude if Temple-Inland would become less heavily
leveraged their debt service margin would improve dramatically.
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2002 2003 2004 2005 2006 2007
TIN .19 .49 .3 .3 .46 .19
IP 2.19 0 1.14 6.8 1.04 2.73
PKG 2.8 1.92 13.42 8.98 2.07 2.27
USG 3.16 1.39 2.12 1.87 -13.18 4.31
SSCC -0.3 -0.07 -0.54 -0.14 -2.85 -0.26
PCL 10.85 11.27 18.18 16.13 2.64 4.14
Industry 44.45 21.482 25.887 5.657 -1.713 5.993
Z-Score
Ed Altman’s Z-Score was developed to determine the likelihood of a company
filing for bankruptcy. Scoring below 1.8, means that a company has a much higher
chance of entering into bankruptcy. A score between 1.8 and 2.7 typically means that
a company is still somewhat vulnerable. A score above a 3 provides that a company is
not likely to enter into bankruptcy. The z-score found by calculating several ratios,
weighting the ratios, and then adding the weighted ratios together.
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The graph above illustrates Temple-Inland and its competitors’ z-scores.
Although there is no defined trend, Temple-Inland’s z-score is very good. As the table
below shows, TIN’s z-score is above the level at which to even be concerned about it
entering into bankruptcy.
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2002 2003 2004 2005 2006 2007
TIN 4.12 4.39 4.4 4.47 2.99 4.66
IP 3.24 2.88 3.39 3.38 4.38 4.03
PKG 4.38 4.38 4.98 4.63 4.73 4.79
USG 5.4 5.57 6.03 1.32 4.34 5.94
SSCC 2.81 2.62 2.51 1.87 2 2.26
PCL 4.78 3.02 2.05 3.12 3.68 7.69
Industry 4.122 3.81 3.893 3.132 3.687 4.895
Conclusion
It is important for a firm to analyze the capital structure of a firm to understand
whether the firm finances its assets through debt or equity. Temple-Inland having a
high debt to equity ratio, low times interest earned ratio, low debt service margin
makes us uneasy about the company and its ability to pay off its debt, but having a
high z-score shows that the company is not likely to go bankrupt. With the sale of its
strategic timberland in 2007, TIN was able to reduce debt obligations by $700 million.
Reducing its debt is a good start, but Temple might consider restructuring to reduce its
debt obligations.
Estimating Cost of Capital
Estimating a firm’s cost of capital is an important part of valuing a firm. In this
section of the analysis we will be estimating the cost of debt and using two methods to
159
estimate the cost of equity. After we have estimated the cost of debt and equity we
will find the weighted average cost of capital to estimate the total cost of capital that
Temple-Inland requires.
Cost of Equity
A firm’s cost of equity is the rate of return required by the firm’s shareholders.
This rate is largely dependent on how risky the firm is and how much risk the firm’s
shareholders undertake when they invest in the firm; the riskier the firm, the higher the
cost of equity. Because risk plays such a crucial role in determining a firm’s cost of
equity, determining the level of the firm’s risk is the first step of the process. To do this
for Temple-Inland a regression analysis was performed.
The regression analysis was used to compare Temple-Inland’s monthly dividend
yields to the market risk premium, in order to find the firm’s Beta. The Beta is the
number used to measure the level of Temple-Inland’s market risk (the lower the
better). While the Beta is the number needed to calculate Temple-Inland’s cost of
equity, the Adjusted R2 is important because it is used to determine which Betas out of
a list of Betas to use. To make this decision, the Beta with the highest corresponding
Adjusted R2 was used, because the Adjusted R2 measures the percent of the variation of
Temple-Inland’s dividend yield that can be explained by market fluctuation.
Before a regression analysis could be performed to compare Temple-Inland’s
monthly dividend yields to the monthly market risk premiums, the monthly dividend
yields had to be found. The first step to finding the dividend yield is to “split adjust” all
historical prices and dividends that occurred before a stock split. To do this the, the
month in which the split occurred must be identified, once found all dividends and
prices prior to this split must be divided accordingly. In Temple-Inland’s case, a 2:1
stock split took place in April of 2005. To adjust for this split, all prices and dividends
prior to April of 2005 were divided by 2 (because it was a 2:1 split), this division
160
resulted in split adjusted figures. Once all prices and dividends have been split adjusted
they are plugged into the following formula to find the dividend yield:
Div. Yield0 =[(Price1 + Dividend1)/Price0) - 1]
Once the monthly dividend yields have been computed, they are ready to be
compared to the monthly market risk premiums with a regression analysis.
To perform a regression analysis on Temple-Inland, The market risk premium
was found by subtracting the monthly risk-free rates from the S&P 500’s corresponding
monthly returns. Five risk-free rates were used (3 month, 2 year, 5 year, 7 year and 10
year), creating five different market risk premiums for the 5 different risk free rates.
The use of these five market risk premiums makes it possible to determine where the
firm lies on the yield curve. If the Beta with the highest Adjusted R2 was derived using
the 3 month or 2 year market risk premium, the firm is a short term investment and is
farther left on the yield curve. Conversely, if the Beta with the highest Adjusted R2 uses
the 7 or 10 year market risk premium, the firm is a long term investment and is farther
to the right on the yield curve.
For each market risk premium, five regressions were performed, containing 72,
60, 48, 36 and 24 months of data. Using these different amounts of data, it is possible
to test the stability of the firm’s beta over time. Firm’s whose beta with the highest R2
used more months of data has a beta that is more stable over time. In total, 25
regressions were calculated each resulting in a unique Adjusted R2 and Beta. The Beta
with the highest Adjusted R2 was used, this Beta was found to be 1.69.
After selecting the proper Beta from the 25 regression outputs, this Beta was
plugged in to the Capital Asset Pricing Model (CAPM) to determine the cost of equity.
The CAPM equation is as follows: Ke = Rf + (β x MRP)
Ke= cost of equity
Rf= risk free rate
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β= Beta
MRP= market risk premium
While the Rf was a given, found on the St. Louis fed web site, the MRP took
some estimation. According to Aswath Damodaran of NYU, the average risk premium
in the U.S. from 1926-1998 is 6.10% (Damodaran). While this figure does include a
number of serious economic recessions (which increase the MRP), it also includes times
of great economic prosperity (which lower the MRP). Given the current economic
conditions, approximately 3% was added to the average MRP to account for the threat
of an upcoming recession. Using the given Rf of 4.02% and the estimated MRP of 9%
we were able to estimate Temple-Inland’s cost of equity.
The following is a table summarizing the results of the regression analysis and
CAPM used to estimate Temple Inland’s cost of equity:
3 Month MRP
Months Adj. R2 Beta Ke
Upper
Ke
Lower
Ke
72 0.2128 1.69 17.53 23.53 11.53
60 0.1627 1.70 17.59 25.28 9.90
48 0.1371 1.69 17.50 26.83 8.18
36 0.0977 1.49 15.93 26.99 4.87
24 0.0640 1.40 15.19 29.63 0.75
2 Year MRP
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Months Adj. R2 Beta Ke
Upper
Ke
Lower
Ke
72 0.2108 1.68 17.47 23.47 11.47
60 0.1608 1.69 17.51 25.22 9.81
48 0.1355 1.67 17.41 26.74 8.09
36 0.0961 1.48 15.82 26.86 4.79
24 0.0626 1.38 15.09 29.50 0.68
5 Year MRP
Months Adj. R2 Beta Ke
Upper
Ke
Lower
Ke
72 0.2108 1.68 17.48 23.49 11.47
60 0.1606 1.69 17.50 25.20 9.81
48 0.1357 1.67 17.39 26.69 8.09
36 0.0963 1.47 15.79 26.78 4.79
24 0.0630 1.38 15.07 29.43 0.71
7 Year MRP
Months Adj. R2 Beta Ke
Upper
Ke
Lower
Ke
72 0.2103 1.68 17.45 23.45 11.45
60 0.1593 1.67 17.39 25.06 9.72
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48 0.1349 1.65 17.26 26.49 8.02
36 0.0957 1.45 15.63 26.51 4.75
24 0.0627 1.36 14.94 29.14 0.73
10 Year MRP
Months Adj. R2 Beta Ke
Upper
Ke
Lower
Ke
72 0.2112 1.68 17.48 23.48 11.48
60 0.1603 1.68 17.44 25.11 9.77
48 0.1357 1.66 17.31 26.55 8.07
36 0.0965 1.46 15.70 26.60 4.80
24 0.0635 1.37 15.01 29.24 0.77
Interpretation of these regression outputs provides a couple of useful insights.
First, the fact that the regressions with the highest Adjusted R2s are the regressions
that used 72 months of data indicates that Temple-Inland’s systematic risk, and beta,
has been stable over the last six years. Additionally, the fact that the betas found using
the different amounts of data vary only slightly from one market risk premium to the
next, indicates that Temple-Inland is a long run investment.
As shown in the table above, the regression output with the highest Adjusted R2 was
the regression that used the 3 month MRP and 72 months of data as its inputs; this
regression yielded a Beta of 1.69. This Beta along with the 4.02% Rf and a 9% MRP
resulted in a 18.77% CAPM estimated cost of equity. This regression also gave upper
and lower bound Betas, these Betas create a 95% confidence interval meaning that
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there is a 95% chance the firm’s true Beta falls between these two limits. These Betas
were plugged into the CAPM model to create upper and lower bound costs of equity
meaning that there is a 95% chance that the firm’s true cost of equity falls between
these two values. The upper and lower bound costs of equity were found to be
23.53% and 11.53% respectively
Alternative Cost of Equity
Another way to find a firm’s cost of equity is through the market-to-book equation, this
method is commonly referred to as the “back door method”. The market to book
equation is as follows:
M/B = 1 + (ROE-Ke)/(Ke-g
Where,
M/B= market-to-book ratio
ROE= return on equity
Ke= cost of equity
g= expected growth rate
By solving this equation for Ke, the following equation is derived:
Ke = [ROE + (M/B – 1)g]/(M/B)
After deriving this equation, the next step in this process is finding the proper
inputs for Temple-Inland. The market-to-book ratio was found on YaHoo.com, and
quoted at 0.66. The growth rate was derived from the firm’s forecasted financials by
taking the average change in net income from the years 2009 to 2017 (years 2007 and
2008 were excluded because the net income in these years is effect by nonrecurring
165
events), using this method, the expected growth rate was found to be 4.33%. Finding
the firm’s ROE was a little trickier. Due to large stock repurchases that drastically
decreased Temple-Inland’s equity and non-reoccurring events that distorted its income,
the return on equity found on YaHoo.com was far too high. This exaggerated ROE led
to a nonsensical cost of equity that exceeded 100%. To undo the effects of these
distortions, the average ROE from the 10 year forecast was used because this ROE is
more representative of the firm’s continuing operations. The average ROE was found
to be 8.90%. Given these inputs and the equation shown above, the “back door
method” yielded a cost of equity of 11.26%. This cost of equity is clearly too small as it
doesn’t fall within the 95% confidence interval (the lower bound of which is 11.53%)
found using regression analysis and CAPM equation.
Cost of Debt
Because firm’s have many different liabilities and many different interest rates for
those liabilities, it can be difficult to calculate a firm’s cost of debt (Kd), the rate at
which a company pays to borrow money. To help overcome this problem and find
Temple-Inland’s cost of debt, we took a weighted average of the firm’s interest rates to
arrive at a comprehensive estimation of the firm’s total cost of debt. To find this
weighted average, each liability account was divided by the total liabilities making each
account a percentage of the whole, this percentage was used as the weight (W). Then
the percentages for each account were multiplied by that account’s corresponding
interest rate (R). After this had been done for all accounts, the resulting numbers were
totaled creating the total weighted average cost of debt.
Finding the liability accounts was the easy part because this information is
provided on Temple-Inland’s balance sheet, finding the corresponding interest rates, on
the other hand, was not so simple. The Interest rates for Temple-Inland’s various long-
term debt accounts where disclosed in the firm’s 10-K, a sub-weighted-average was
taken for these account to arrive at the interest rate for the account labeled “Long-term
Debt” on the firm’s balance sheet this rate was also applied to the liabilities of special
166
purpose entities. The rates for the firm’s pension and postretirement liabilities were
also disclosed in the 10-K and reported to be 6.13%. To approximate the interest rates
associated with the firm’s deferred and accrued tax liabilities the ten year risk free rate
was used, according to the St. Louis fed’s web site, this rate was 3.81% as of October
1,2008. The commercial paper rate was used to approximate the rates for the firm’s
other accruals and payables, this rate was quoted at 1.28% as of November 21, 2008
on the St. Louis Fed’s web site.
After finding all of the relevant rates, Temple-Inland’s weighted average cost of
debt was found to be 4.73%, meaning Temple-Inland pays an interest rate of 4.73%
on average to borrow money. The table below summarized the weighted average cost
of debt calculations:
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Current Liabilities Weight (W) Rate (R) W x R
Accounts payable $ 244 4.7% 1.28% 0.06%
Accrued employee compensation and benefits 108 2.1% 1.28% 0.03%
Accrued interest 31 0.6% 1.28% 0.01%
Accrued property taxes 11 0.2% 3.81% 0.01%
Accrued income taxes 258 5.0% 3.81% 0.19%
Other accrued expenses 173 3.4% 1.28% 0.04%
Current portion of long-term debt 3 0.1% 6.93% 0.00%
Current portion of pension and postretirement benefits 62 1.2% 6.13% 0.07%
Long-Term Debt 852 16.5% 1.28% 0.21%
Nonrecourse Financial Liabilities of Special Purpose Entities 2,140 41.5% 6.93% 2.87%
Deferred Tax Liability 762 14.8% 3.81% 0.56%
Liability for Pension Benefits 71 1.4% 6.13% 0.08%
Liability for Postretirement Benefits 123 2.4% 6.13% 0.15%
Other Long-Term Liabilities 324 6.3% 6.93% 0.44%
TOTAL 5,162 100% 4.73%
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Weighted Average Cost of Capital
A firm’s cost of capital is a figure that combines the firm’s cost of equity (Ke) and
cost of debt (Kd), providing a more complete estimation of the rate of interest firms pay
acquire funds for their daily and long-term operations. To compute this rate, we took a
weighted average of the cost of equity and debt, finding what is known as the weighted
average cost of capital (WACC). To find a firm’s WACC, the following equation is used:
WACC = [(Ve/Vf) x Ke] + [(Vd/Vf) x Kd]
Ve= Market value of the firm’s equity (the firm’s market cap.)
Vd= Book value of the firm’s liability
Vf= the value of the firm (Ve + Vf)
Ke= cost of equity
Kd= cost of deb
In this equation, the value of equity/debt divided by the value of the firm is the
weight used to multiply the cost of equity/debt by. The products of these
multiplications are then added to create the weighted average. Because of the
equation above does not account for the tax benefit received from borrowing money, it
is commonly referred to as the weighted cost of capital before tax (WACCBT). To
account for the tax benefit received from borrowing money, this modified version of the
WACCBT is used:
WACCAT* = [(Ve/Vf) x Ke] + {[(Vd/Vf) x Kd] x (1 – tax rate)}
*After Tax
Both the weighted cost of capital before and after tax were computed for
Temple-Inland using the Ke from the regression analysis, the Kd form the weighted cost
169
of debt, the market cap, and the book value of liabilities per the balance sheet. Each of
these variables is defined below, along with the results of the computation:
Ve = 598.58 million
Vd = 5,162 million
Vf = 5,761 million
Ke = 17.53%Kd = 4.73%
Tax rate = 38.52%
WACCBT = 6.06%
WACCAT = 4.41%
This calculation was also performed using the firm’s upper and lower bound Ke creating
the upper and lower bounds of a 95% confidence interval for the firm’s WACC:
Upper Bound Ke = 23.53%
Upper Bound WACCBT = 6.68%
Upper Bound WACCAT = 5.03%
Lower Bound Ke = 11.53%
Lower Bound WACCBT = 5.44%
Lower Bound WACCAT = 3.78
Due to dramatic drops in Temple-Inland’s stock prices and large amounts of
stock repurchases, the firm’s market value of equity has been greatly reduced. Because
of this reduction, the firm’s market value of equity is a small portion of the firm’s total
value giving its cost of equity a small weight relative to the cost of debt. This
disproportionate weighting has heavily skewed the firm’s weighted cost of capital
170
creating a WACC that is biased in favor of the cost of debt. The tax benefit displayed in
the WACCAT widens the gap between the cost of capital and the cost of equity.
Financial Statement Forecasting
The process of forecasting plays an important role in determining the future
value of a company. This is done by looking at past statements, identifying trends and
then using these trends to estimate how a company will perform in the future. The
financial statements we will forecast for Temple-Inland will be the Income Statement,
Balance Sheet and the Statement of Cash Flows. Though forecasting is a good
estimate of how the company will be valued in the future, it is not certain because an
analyst cannot establish what the market conditions will be in the future.
Income Statement
To forecast future financial statements it is imperative to forecast the income
statement correctly. The income statement connects revenues, the backbone of any
business and net income. Because of the importance of revenue forecasting it is
important any assumptions are based on past performance and future expectations.
The quality of our forecasting will rely on our ability to justify our assumptions with
general economic data relating to business activities and assumptions based on
Temple-Inland’s past performance. All our assumptions pertaining to income statements
will flow into the balance sheet and statement of cash flow.
The first forecast we must make is the forecasting of future revenues. To
accomplish this goal we must make a few assumptions. The first assumption we are
going to make pertains to Temple-Inland’s past sales performance. After looking at the
past 5 years of data, it is clear Temple-Inland’s revenue is driven by changes in the
general economy and thus will be affected by any downturn in consumer spending on
food industrial production products, and construction spending. Because of this we
believe it is important to forecast 2008 and 2009 revenues separate from the 2010 to
2018 revenues. The likelihood of being correct in 2008 and 2009 is much higher than
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in 2010, any errors in our forecasting will increase as the years pass. Also because at
the time of this report we are able to see 3 quarters of unaudited sales data our 2008
assumptions will be based more on reality than theory.
Construction spending is down 6.6% from last year, this decrease in spending
however was not as drastic as some economists predicted. However the news was not
all good. Ken Simonson, the chief economist for the Associated General Contractors of
America (AGC), warned that nonresidential construction could see a prolonged slide.
"Contractors have been reporting that developers put lots of projects on hold because
of the credit freeze and weakening demand for stores, offices and other facilities,".
(Bizjournals)
The other portion of Temple-Inalnd’s business, corrugated products is directly
connected to consumer spending. “The economy contracted at a 0.3 percent annual
pace last quarter, Commerce reported yesterday. Consumer spending fell at a 3.1
percent rate, the first drop since 1991 and the biggest since 1980, after President
Jimmy Carter imposed credit controls.”Households cut spending on non-durable goods,
like clothing and food, last quarter by the most since 1950, and slashed purchases of
durable goods by the most since 1987, the GDP report showed.” (bloomburg.com)
Given the current situation and the past history of US recessions we believe we
can reasonably predict a negative sales growth of around 6% followed by another
negative sales growth of 9% with a corresponding sales growth of 15% in 2010. 2010-
2017 we assume Temple-Inland will continue an average sales growth rate of 5% given
the last 5 years of data.
We used the current forecasts for consumer spending and construction spending
to attempt to explain the magnitude of the impending economic slow down. To predict
the length we used previous economic recessions with similar characteristics to our
current credit crisis.
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1929 70'S 91
43 16 8
POSSIBLE WEIGHTS PREDICTIONS
0.5 0.1 0.4 26
0.4 0.2 0.4 24
0.3 0.2 0.5 20
0.2 0.3 0.5 17
0.2 0.4 0.4 18
0.2 0.2 0.6 17
0.245 0.415 0.44 21
0.1 0.15 0.75 13
We are going to assume a 13 month slowdown in the US economy, especially
those areas which effect Temple-Inland. Given the current banking situation we felt the
Great Depression, which lasted 43 months, represents about 10% of the current
downturn. The 1970’s also had their share of banking who’s complete with government
bail outs and drastic changes in interest rates. We assigned a 15% to this era. The rest
was allocated to the 1991 recession which lasted 8 months. This recession was also
brought on by a downturn in the housing market and was also followed a presidential
election. Not since the 1991 recession has consumer spending dropped. These
similarities and the fact this recession is the newest of the three we chose lead us to
allocate 75% to it.
We believe these assumptions about growth rates in 2008, 2009 and 2010 are
reasonable given the current amount of information available from quarterly statements
and economic data available.
173
For 2008 we are going to assume Temple-Inland continues its trend over the
past 3 quarters and looses 2% of revenue in 2008. In 2009 we are assuming a much
worse -9% loss as the recession hits full swing, in 2010 we are going to assume a
increase of 15%, given Temple-Inlands performance of a 20% increase in revenue after
the 2001 slowdown.
Another critical assumption we are going to make pertains to cost of goods sold
and by extension the gross profit margin. If Temple-Inland is going to survive in the
highly competitive industries of the corrugated products manufacturing and building
products manufacturing a sustainable low cost of goods sold must be maintained.
The next line item we will forecast is cost of goods sold. This will be forecasted
by utilizing the common sized income statement. We noticed in 2004 cost of goods sold
was 93% of revenue which was the largest the past 5 years. Given the price of lumber
for most of 2008 was higher than normal we are going to assume a higher cost of
goods sold for 2008.
Because of the commodity nature of the products in our industry cost leadership
is an important strategy. An important part of any cost leadership strategy is keeping
costs low. Temple-Inland is actively buying timber products from its suppliers at market
prices and is subject to changes in the market prices, directly effecting cost of goods
sold.
Economists attempt to explain changes in something using changes in different
stuff to explain the changes. To do this simplifications and assumptions must be made.
We assumed since timber products where a large input to our products, our cost of
goods sold should mirror the prices of timber at market prices since currently our
company does not hedge its exposure to these changes. Also since timber is traded on
the Chicago Mercantile Exchange futures contracts would be a good indicator of what
the market believes the future prices to be, thus our future cost of goods sold.
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The following graph shows the cost of goods sold for Temple-Inland from 1999
to 2007 and the yearly average price of volume weighted hardwood during the same
time frame. We found the average price of hardwood per ton then multiplied our cost of
goods sold by .001 to allow for comparability. As you can see movements of the two
lines are similar in direction and magnitude.
Currently the futures prices of timber are increasing, since the cost of goods sold
of Temple-Inland follows the cost of timber we are also going to assume the future cost
of goods sold will increase.
We are going to assume cost of goods sold of 95% of revenue for 2008. We
believe the cost of goods sold for 2009 will be 94% and 2010 will be 93% of revenue.
Eventually Temple-Inland will be able to offset the extra cost of good sold marginally.
For the remainder of the forecast from 2011-2017 we are going to assume cost of
goods sold will return to a more reasonable level of 90%. Given we are attempting to
be conservative in our forecasting of cost of goods sold this process of slowly reducing
the cost to a reasonable level makes since.
175
The next line item we are going to forecast is gross profit. Gross profit was
calculated using the formula revenue – cost of goods sold. Therefore gross profit for
2008 is -4%, 2009 is 6%, 2010 is 7% and 2011-2017 is 10%. Excluding 2007 and
2006, which were exceptional years, the average gross profit margin over 5 years was
9%. This is in line with our estimates the next few years.
The next line item on the income statement is total expenses. Again we utilized
the common sized income statement because of the structure it provides. We believe a
rate of 101% for 2008 is reasonable given the increase in cost of goods sold. In the
past Temple-Inland has shown it can control total expenses experiencing ranges from
102% to 90% of revenue. We believe a long term ratio of 97% is reasonable, excluding
2007 the average total expenses of revenue was 97%.
The next line item we will forecast is the income from operations. To get this we
simply subtracted total expenses from revenue. Therefore for 2008 we have a negative
operating profit of -1%, in 2009-2017 we assume a ratio of 3% of revenue. Over the
past 5 years Temple-Inland had a operating profit margin of 5%, however we believe a
lower rate of 3% is more adequate given the increase in expenses over the past few
years. Also is interesting to note Temple-Inland had a large operating income from their
financial portion of their business which they have since sold. We believe the future
operating income margin will be lower because the industries Temple-Inland now
operate have less potential to increase operating profit margin to levels above the 3%
we are going to assume.
The last line item we are going to forecast is net income. This line item is very
important because it feeds into the retained earnings. To get an estimate of net
income we used our net profit margin ratio. After looking at the past 5 years of data we
decided to ignore 2007 and 2006 because the ratios where abnormally high. This left
us with three years of data to draw a conclusion. The average of these years was 3%,
however as mentioned before we believe Temple-Inland was a beneficiary of its
176
profitable financing operations in these years so we believe a slightly lower net profit
margin of 2% is acceptable for our forecasting.
Because of the importance of the income statement, in particular net income, we
felt it was important to be conservative in our estimates of Temple-Inlands profitability.
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Temple-Inland Inc.Income Statement(In millions, expect per share amounts)
20022003
20042005
20062007
20082009
20102011
20122013
20142015
20162017
Net Revenues3374
35013707
38434185
39263847
35014026
41474272
44004532
46684808
4952Cost of Goods Sold
(3022)(3242)
(3237)(3382)
(3476)(3390)
36553291
37453732
38443960
40794201
43274457
Gross Profit352
259470
461709
536192
210282
415427
440453
467481
495Total Cost and Expenses
(3287)(3636)
(3522)(3723)
(3765)(1835)
(3886)(3396)
(3906)(4023)
(4143)(4268)
(4396)(4528)
(4663)(4803)
Operating Income87
(135)185
120420
2091(38)
105121
124128
132136
140144
149Net Income
5396
165176
4681305
470
8183
8588
9193
9699
Temple-Inland Inc.Common Sized Income Statement% of Net Sales
20022003
20042005
20062007
20082009
20102011
20122013
20142015
20162017
Net Sales100%
100%100%
100%100%
100%100%
100%100%
100%100%
100%100%
100%100%
100%Cost of Goods Sold
90%93%
87%88%
83%83%
95%94%
93%90%
90%90%
90%90%
90%90%
Gross Profit10%
7%13%
12%17%
17%5%
6%7%
10%10%
10%10%
10%10%
10%Total Expenses
97%104%
95%97%
90%47%
101%97%
97%97%
97%97%
97%97%
97%97%
Income From Operations3%
-4%5%
3%10%
53%-1%
3%3%
3%3%
3%3%
3%3%
3%Net income
2%3%
4%5%
11%33%
0%2%
2%2%
2%2%
2%2%
2%2%
Actual Financial StatementsForecasted Financial Statements
Actual Financial StatementsForecasted Financial Statements
178
Balance Sheet
The balance sheet is a summary of a firm over a period of time. The balance
sheet provides a story about the firm’s assets, liabilities, and equity. Revenues
forecasted from the income statement are used to give the forecasted assets structure.
We used our asset turnover ratio to link the revenues from the income statement to the
total assets on the balance sheet. The common size balance sheet is created by taking
the line item and dividing it by its corresponding total. For example current assets are
15% of total assets.
We are going to make a few assumptions about our asset turnover ratio. First of
all we looked at the past five years of asset turnovers and found Temple-Inland stays
between .80 and .20. This is a large disparity that can be explained by the selling
business operations in the years 2005, 2006, 2007. During these years 2005-2006
Temple-Inland’s asset turnover was .20 because by selling portions of the company
total assets dropped while net income increased, lowering the turnover ratio. The asset
turnover ratios for 2002-2004 were a more reasonable .70. Given this information we
are going to assume a .70 asset turnover ratio for Temple-Inland’s forecasted year. We
believe this is appropriate given the ratios on hand.
After using the asset turnover to forecast out total assets our attention was
turned to noncurrent assets as a percentage of total assets. We calculated this by
using the common sized balance sheet. Since current assets represented about 15% of
the total assets we concluded 85% of the assets must be non current assets.
We then turned our attention to the Equity section of the balance sheet. Using
ROE we estimated our total equity for 2008. We assumed a rate of 9% for the ROE
because before the explosion of ROE in 2006 and 2007 Temple-Inland posted back to
back 8% years. We feel 9% is conservative given the upcoming economic situation.
This assumption is also further backed up by our debt ratio of 5.85. It appears Temple-
Inland is attempting to maintain a debt to equity ratio of almost 6.00.
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After estimating the Total Assets, Total Liabilities, and Total Equity we can turn
our attention to other line items such as inventory and accounts receivable. Given our
ratios of inventory turnover and account receivable turnover it is possible to further
assume Temple-Inland is going to maintain a steady ratio for the next 10 years. The
inventory turnover average the last 5 years is 8.26 although for the past 3 years it has
been under 8. For this reason we are going to assume a ratio of 7.85 for the rest of
the forecast period. Also the account receivable turnover average the past 5 years is
10.89. However the past three years it has been closer to 9.00. We are going to
assume a ratio of 9.25 instead of the average because Temple-Inland has shown vast
improvement from 2002.
The last item we are going to forecast is retained earnings. To do this we are
going to use the equation beginning retained earnings + NI – Dividends. We pull NI
from the income statement and dividends from the statement of cash flows.
Conclusion
To make sure our estimates are not overstated we used our IGR and SGR to give
us a reality check. Our IGR shoots up to around 13% a point which it has previously
been, our SGR levels off after the predicted slowdown.
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Temple-Inland IncBalance Sheet(In millions, expcet per share amounts) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017ASSETSCurrent AssetsCash and cash equivalents 17.00 20.00 372.00 444.00 30.00 227.00
Trade receivables 352.00 359.00 400.00 411.00 452.00 433.00 190.07 218.58 225.13 231.89 238.84 246.01 253.39 260.99 268.82 276.88Inventories:Work in process and finished goods 69.00 83.00 0.00 0.00 109.00 116.00Raw materials 269.00 247.00 0.00 0.00 211.00 224.00Supplies and other 0.00 0.00 0.00 0.00 115.00 121.00Total inventories 338.00 330.00 431.00 425.00 435.00 461.00 150.05 419.25 477.01 475.47 489.74 504.43 519.56 535.15 551.20 567.74Deferred tax asset 0.00 0.00 0.00 0.00 61.00 99.00
Prepaid expenses and other 64.00 69.00 715.00 644.00 60.00 57.00Securities Available for Sale 0.00 0.00 841.00 654.00 0.00 0.00Loans held for sale 0.00 0.00 510.00 280.00 0.00 0.00Total current assets 771.00 778.00 3,269.00 2,858.00 1,038.00 1,277.00 600.21 690.24 710.95 732.27 754.24 776.87 800.17 824.18 848.91 874.37Investment in Financial Services 1,178.00 1,123.00 0.00 0.00 0.00 0.00Timber and Timberland 508.00 497.00 496.00 498.00 315.00 0.00Property and Equipment
Land and buildings 614.00 600.00 307.00 322.00 637.00 641.00Machinery and equipment 3,436.00 3,454.00 1,905.00 1,826.00 3,400.00 3,423.00Construction in progress 92.00 48.00 0.00 0.00 82.00 120.00Less allowances for depreciation (2,101.00) (2,259.00) 0.00 0.00 (2,491.00) (2,552.00)Total property and equipment 2,041.00 1,843.00 2,212.00 2,148.00 1,628.00 1,632.00Investment in Federal Home Loan Bank Stock 0.00 0.00 277.00 300.00 0.00 0.00Securities held to maturity 0.00 0.00 3,864.00 5,558.00 0.00 0.00Loans, Net of Allowences 0.00 0.00 9,618.00 9,845.00 0.00 0.00
Financial Assets of Special Purpose Entities 0.00 0.00 0.00 0.00 0.00 2,383.00
Assets held for sale 78.00 61.00 0.00 0.00 0.00 0.00Goodwill 249.00 237.00 382.00 395.00 365.00 365.00Assets of Discontinued Operations 0.00 0.00 0.00 0.00 16,847.00 0.00Other Assets 146.00 99.00 0.00 0.00 281.00 285.00Other Intangibles Assets 0.00 0.00 26.00 31.00 0.00 0.00Total Non Current Assets 6,241.00 5,703.00 19,087.00 20,923.00 21,064.00 6,297.00 4,401.52 5,061.74 5,213.60 5,370.00 5,531.11 5,697.04 5,867.95 6,043.99 6,225.31 6,412.07
TOTAL ASSETS 7,012.00 6,481.00 22,356.00 23,781.00 22,102.00 7,574.00 5,001.72 5,751.98 5,924.54 6,102.28 6,285.35 6,473.91 6,668.12 6,868.17 7,074.21 7,286.44
LIABILITIES
Current Liabilities
Accounts payable 188.00 218.00 1,052.00 896.00 229.00 244.00Accrued employee compensation and benefits 67.00 72.00 0.00 0.00 126.00 108.00
Accrued interest 30.00 27.00 0.00 0.00 32.00 31.00Accrued property taxes 28.00 23.00 0.00 0.00 19.00 11.00Accrued income taxes 0.00 0.00 0.00 0.00 0.00 258.00
Other accrued expenses 147.00 141.00 0.00 0.00 129.00 173.00Current portion of long-term debt 8.00 4.00 0.00 0.00 13.00 3.00
Current portion of pension and postretirement benefits 0.00 0.00 0.00 0.00 15.00 62.00
Total Current Liabilities 468.00 485.00 1,052.00 896.00 563.00 890.00 375.13 431.40 444.34 457.67 471.40 485.54 500.11 515.11 530.57 546.48Long-Term Debt 1,883.00 1,611.00 1,691.00 1,709.00 1,584.00 852.00Nonrecourse Financial Liabilities of Special Purpose Entities 0.00 0.00 0.00 0.00 0.00 2,140.00
Deferred Tax Liability 213.00 25.00 89.00 143.00 244.00 762.00
Liability for Pension Benefits 142.00 250.00 289.00 270.00 229.00 71.00Liability for Postretirement Benefits 147.00 146.00 143.00 137.00 122.00 123.00
Liabilities of Discontinued Operations 28.00 22.00 0.00 0.00 15,291.00 0.00
Other Long-Term Liabilities 141.00 131.00 0.00 0.00 252.00 324.00
Deposits 0.00 0.00 8,964.00 9,201.00 0.00 0.00
Federal Home Loan Bank Liabilities 0.00 0.00 4,717.00 6,892.00
Preferred Stock Issued by Subsidiaries 0.00 0.00 305.00 305.00 0.00 0.00
Securities sold under repurchas agreements 0.00 0.00 787.00 0.00 0.00 0.00Total Noncurrent Liabilities 2,554.00 2,185.00 16,985.00 18,657.00 17,722.00 4,272.00 3,885.15 4,551.52 4,673.02 4,796.88 4,927.43 5,060.50 5,200.40 5,342.98 5,492.54 5,644.94
TOTAL LIABILITIES 3,022.00 2,670.00 18,037.00 19,553.00 18,285.00 5,162.00 4,260.28 4,982.92 5,117.36 5,254.55 5,398.84 5,546.05 5,700.51 5,858.09 6,023.11 6,191.42
SHAREHOLDERS’ EQUITYPreferred stock — par value $1 per share: authorized 25,000,000 shares; none issued 0.00 0.00 0.00 0.00 0.00 0.00Common stock — par value $1 per share: authorized 200,000,000 shares; issued 123,605,344 shares in 2007 and 2006, including 0.00 0.00 123.00 124.00 124.00 124.00
Additional paid-in capital 0.00 0.00 350.00 445.00 468.00 475.00Accumulated other comprehensive loss 0.00 0.00 (192.00) (189.00) (191.00) (139.00)Retained earnings 0.00 0.00 2,067.00 2,141.00 2,501.00 987.00 948.44 976.06 1,014.19 1,054.72 1,093.51 1,134.86 1,174.61 1,217.08 1,258.11 1,302.02Cost of shares held in the treasury: 17,464,189 shares in 2007 and 18,754,907 shares 0.00 0.00 (241.00) (441.00) (713.00) (667.00)
TOTAL SHAREHOLDERS’ EQUITY 1,949.00 1,968.00 2,107.00 2,080.00 2,189.00 780.00 741.44 769.06 807.19 847.72 886.51 927.86 967.61 1,010.08 1,051.11 1,095.02TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY 4,971.00 4,638.00 20,144.00 21,633.00 20,474.00 5,942.00 5,001.72 5,751.98 5,924.54 6,102.28 6,285.35 6,473.91 6,668.12 6,868.17 7,074.21 7,286.44
Actual Financial Statements Forecasted Financial Statements
181
Temple-Inland IncCommone Sized Balance Sheet% of TA,TL,TE 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017ASSETSCurrent AssetsCash and cash equivalents 0% 0% 2% 2% 0% 3% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Trade receivables 5% 6% 2% 2% 2% 6% 3% 3% 3% 3% 3% 3% 3% 3% 4% 4%Inventories:Work in process and finished goods 1% 1% 0% 0% 0% 2% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Raw materials 4% 4% 0% 0% 1% 3% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Supplies and other 0% 0% 0% 0% 1% 2% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%
Total inventories 5% 5% 2% 2% 2% 6% 2% 6% 6% 6% 6% 7% 7% 7% 7% 7%Deferred tax asset 0% 0% 0% 0% 0% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Prepaid expenses and other 1% 1% 3% 3% 0% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Securities Available for Sale 0% 0% 4% 3% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Loans held for sale 0% 0% 2% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Total current assets 11% 12% 15% 12% 5% 17% 8% 9% 9% 10% 10% 10% 11% 11% 11% 12%Investment in Financial Services 17% 17% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Timber and Timberland 7% 8% 2% 2% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Property and Equipment 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Land and buildings 9% 9% 1% 1% 3% 8% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Machinery and equipment 49% 53% 9% 8% 15% 45% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Construction in progress 1% 1% 0% 0% 0% 2% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Less allowances for depreciation -30% -35% 0% 0% -11% -34% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Total property and equipment 29% 28% 10% 9% 7% 22% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Investment in Federal Home Loan Bank Stock 0% 0% 1% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Securities held to maturity 0% 0% 17% 23% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Loans, Net of Allowences 0% 0% 43% 41% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Financial Assets of Special Purpose Entities 0% 0% 0% 0% 0% 31% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Assets held for sale 1% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Goodwill 4% 4% 2% 2% 2% 5% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Assets of Discontinued Operations 0% 0% 0% 0% 76% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Other Assets 2% 2% 0% 0% 1% 4% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Other Intangibles Assets 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Total Non Current Assets 89% 88% 85% 88% 95% 83% 58% 67% 69% 71% 73% 75% 77% 80% 82% 85%TOTAL ASSETS 100% 100% 100% 100% 100% 100% 66% 76% 78% 81% 83% 85% 88% 91% 93% 96%
LIABILITIESCurrent LiabilitiesAccounts payable 6% 8% 6% 5% 1% 5% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Accrued employee compensation and benefits 2% 3% 0% 0% 1% 2% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Accrued interest 1% 1% 0% 0% 0% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Accrued property taxes 1% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Accrued income taxes 0% 0% 0% 0% 0% 5% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Other accrued expenses 5% 5% 0% 0% 1% 3% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Current portion of long-term debt 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Current portion of pension and postretirement benefits 0% 0% 0% 0% 0% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Total Current Liabilities 15% 18% 6% 5% 3% 17% 7% 8% 9% 9% 9% 9% 10% 10% 10% 11%Long-Term Debt 62% 60% 9% 9% 9% 17% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Nonrecourse Financial Liabilities of Special Purpose Entities 0% 0% 0% 0% 0% 41% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Deferred Tax Liability 7% 1% 0% 1% 1% 15% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Liability for Pension Benefits 5% 9% 2% 1% 1% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Liability for Postretirement Benefits 5% 5% 1% 1% 1% 2% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Liabilities of Discontinued Operations 1% 1% 0% 0% 84% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Other Long-Term Liabilities 5% 5% 0% 0% 1% 6% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Deposits 0% 0% 50% 47% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Federal Home Loan Bank Liabilities 0% 0% 26% 35% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Preferred Stock Issued by Subsidiaries 0% 0% 2% 2% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Securities sold under repurchas agreements 0% 0% 4% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Total Noncurrent Liabilities 85% 82% 94% 95% 97% 83% 75% 88% 91% 93% 95% 98% 101% 104% 106% 109%Total Liabilities 100% 100% 100% 100% 100% 100% 83% 97% 99% 102% 105% 107% 110% 113% 117% 120%Total Liabilities 61% 58% 90% 90% 89% 87% 85% 87% 86% 86% 86% 86% 85% 85% 85% 85%Total Shareholders' Equity 39% 42% 10% 10% 11% 13% 15% 13% 14% 14% 14% 14% 15% 15% 15% 15%Total Liabilities and Shareholders' Equity 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
Actual Financial Statements Forecasted Financial Statements
182
Statement of Cash Flows
The statement of cash flows is the most difficult the forecast because of the lack
of structure given by ratios connected to sales and total assets and the nature of
estimating the usage of cash. It is however an important section because of its impact
on retained earnings. We are going to assume an average for all of these ratios given
the unpredictability of the use of cash.
Using the CFFO/revenues and CFFO/OI ratios we will attempt to estimate the
amount of cash flows from these activities in the future periods. CFFO/Revenues gives
us a number of ratios varying from 5% to 19%, CFFO/OI gives us even less predicable
numbers. Since revenues are a cleaner number than operating income we will use the
CFFO/revenues to estimate the amount of cash flows for the length of our forecasting
period. The average we choose was 12%. Using CFFI/revenues and CFFI/OI we will
attempt to estimate the amount of cash flows from these activities in the future
periods. Again CFFI/revenues turned out to be the better ratio to use. We are going to
assume an average of -6%. Using CFFF/revenues and CFFI/OI we will use
CFFF/revenues and take the average of -8%.
The only line item we are going to predict is the dividends paid to shareholders.
To forecast dividends we will observe Temple-Inlands dividend payment history. Over
the past 5 years they have paid about 15% of their net income in dividends each year.
They also have a history of steadily rising dividends. We are going to assume they are
going to keep paying $0.40 per year and will increase this number $0.04 every other
year for the next 10 years.
183
Temple-Inland IncStatement of Cash Flows(In millions, expcet per share amounts) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
CASH PROVIDED BY (USED FOR) OPERATIONSNet income 53 96 165 176 468 1305 4 70 81 83 85 88 91 93 96 99Adjustments:Gain on sale of timberland 0 0 0 0 0 -2053Impairments 0 0 0 24 0 64Loss on early payment of debt 0 0 0 0 0 40Loss on sale of Pembroke 0 0 0 25 0 0Depreciation and amortization 260 270 254 218 225 214Amoritization and acceration of financial instruments 60 82 58 0 0 0Non-cash share-based compensation 0 0 0 26 38 39Non-cash pension and postretirement expense 0 0 0 58 56 44
Cash contribution to pension and postretirement plans 0 0 0 -76 -76 -80Deferred income taxes 33 -155 58 40 34 435Earnings of joint ventures 0 0 0 -39 -11 -5Dividends from joint ventures 0 0 0 43 12 8Tax benefit of stock options exercised 0 0 0 7 0 0net assets of discontinued operations 0 0 0 15 -5 -24provision for loan losses 40 43 -12 0 0 0cummulative effect of accounting change 11 1 0 0 0 0other non-cash charges and credits, net 17 71 26 0 0 0Other 19 58 67 16 18 14Changes in:Receivables 41 -8 -45 -16 -28 19Inventories -2 12 -77 0 -10 -30Accounts payable and accrued expenses -41 30 0 4 32 274Prepaid expenses and other 0 0 0 2 22 8loans held for sale, originations -10799 -12955 -6898 0 0 0loans held for sale, sales 10626 13447 6920 0 0 0collections on loans serviced for others, net -70 -77 -32 0 0 0Total CFFO 248 915 484 508 780 296 462 420 483 498 513 528 544 560 577 594CASH PROVIDED BY (USED FOR) INVESTINGCapital expenditures -128 -170 -264 -192 -187 -225Reforestation and net acquisition of timber and timberland 0 0 0 -28 -17 -12Sale of timberland 0 0 0 0 0 -21Sales of non-strategic assets and operations and proceeds from sale of property and equipment 39 69 66 45 64 24 Securities available-for-sale, net 739 545 251 0 0 0 Securities held-to-maturity, net -2781 -1164 817 0 0 0 Loans originated or acquired, net of principal collected 67 453 -644 0 0 0 Proceeds from sale of loans and mortgage servicing rights 54 67 37 0 0 0 Branch acquisitions 364 0 148 0 0 0Acquisitions, net of cash acquired, and joint ventures -631 -10 -20 -5 -148 -5Other 10 35 93 2 1 4Total CFFI -2267 -175 484 -178 -287 -235 -231 -210 -242 -249 -256 -264 -272 -280 -288 -297CASH PROVIDED BY (USED FOR) FINANCING deposits -277 -500 113 0 0 0Nonrecourse borrowing secured by financial assets of special purpose entities 0 0 0 0 0 2140Payments of debt -975 -1201 -1014 -502 -47 -567repurchase aggrements and short term borrowing -612 -2 -308 0 0 0Borrowings under accounts receivable securitization facility, net 0 0 0 15 133 -163Borrowings under revolving credit facility, net 0 0 0 0 -56 -12Change in book overdrafts 0 0 0 -13 2 13Fees associated with debt 0 0 0 0 0 -42Other additions to debt 2948 978 375 500 10 0Cash dividends paid to shareholders -67 -73 -136 -102 -108 -1212 -42 -42 -42 -42 -47 -47 -51 -51 -55 -55 Bridge financing facility 880 0 0 0 0 0 Payment of bridge financing facility -880 0 0 0 0 0 Payment of Gaylord assumed debt -285 0 0 0 0 0 Sale of common stock, Upper DECSSM, senior notes, and exercise of stock options 1060 13 62 0 0 0 Purchase of deposits 104 0 0 0 0 0Repurchase of common stock 0 0 0 -527 -318 -24Exercise of options 0 0 0 48 47 20Tax benefit of stock options exercised 0 0 0 0 10 15Settlement of equity purchase contracts 0 0 0 345 0 0Other -27 -6 -63 -7 -4 0Total CFFF 1869 -791 -971 -243 -331 168 -308 -280 -322 -332 -342 -352 -363 -373 -385 -396
Actual Financial Statements Forecasted Financial Statements
184
Temple-Inland IncStatement of Cash Flows% of CFFO, CFFI, CFFF 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017CASH PROVIDED BY (USED FOR) OPERATIONSNet income 21% 10% 34% 35% 60% 441% 1% 17% 17% 17% 17% 17% 17% 17% 17% 17%Adjustments: 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Gain on sale of timberland 0% 0% 0% 0% 0% -694% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Impairments 0% 0% 0% 5% 0% 22% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Loss on early payment of debt 0% 0% 0% 0% 0% 14% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Loss on sale of Pembroke 0% 0% 0% 5% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Depreciation and amortization 105% 30% 52% 43% 29% 72% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Amoritization and acceration of financial instruments 24% 9% 12% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Non-cash share-based compensation 0% 0% 0% 5% 5% 13% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Non-cash pension and postretirement expense 0% 0% 0% 11% 7% 15% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%
Cash contribution to pension and postretirement plans 0% 0% 0% -15% -10% -27% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Deferred income taxes 13% -17% 12% 8% 4% 147% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Earnings of joint ventures 0% 0% 0% -8% -1% -2% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Dividends from joint ventures 0% 0% 0% 8% 2% 3% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Tax benefit of stock options exercised 0% 0% 0% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%net assets of discontinued operations 0% 0% 0% 3% -1% -8% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%provision for loan losses 16% 5% -2% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%cummulative effect of accounting change 4% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%other non-cash charges and credits, net 7% 8% 5% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Other 8% 6% 14% 3% 2% 5% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Changes in: 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Receivables 17% -1% -9% -3% -4% 6% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Inventories -1% 1% -16% 0% -1% -10% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Accounts payable and accrued expenses -17% 3% 0% 1% 4% 93% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Prepaid expenses and other 0% 0% 0% 0% 3% 3% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%loans held for sale, originations -4354% -1416% -1425% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%loans held for sale, sales 4285% 1470% 1430% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%collections on loans serviced for others, net -28% -8% -7% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Total CFFO 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
CASH PROVIDED BY (USED FOR) INVESTINGCapital expenditures 6% 97% -55% 108% 65% 96% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Reforestation and net acquisition of timber and timberland 0% 0% 0% 16% 6% 5% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Sale of timberland 0% 0% 0% 0% 0% 9% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Sales of non-strategic assets and operations and proceeds from sale of property and equipment -2% -39% 14% -25% -22% -10% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Securities available-for-sale, net -33% -311% 52% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Securities held-to-maturity, net 123% 665% 169% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Loans originated or acquired, net of principal collected -3% -259% -133% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Proceeds from sale of loans and mortgage servicing rights -2% -38% 8% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Branch acquisitions -16% 0% 31% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Acquisitions, net of cash acquired, and joint ventures 28% 6% -4% 3% 52% 2% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Other 0% -20% 19% -1% 0% -2% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Total CFFI 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
CASH PROVIDED BY (USED FOR) FINANCING deposits -15% 63% -12% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Nonrecourse borrowing secured by financial assets of special purpose entities 0% 0% 0% 0% 0% 1274% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Payments of debt -52% 152% 104% 207% 14% -338% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%repurchase aggrements and short term borrowing -33% 0% 32% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Borrowings under accounts receivable securitization facility, net 0% 0% 0% -6% -40% -97% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Borrowings under revolving credit facility, net 0% 0% 0% 0% 17% -7% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Change in book overdrafts 0% 0% 0% 5% -1% 8% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Fees associated with debt 0% 0% 0% 0% 0% -25% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Other additions to debt 158% -124% -39% -206% -3% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Cash dividends paid to shareholders -4% 9% 14% 42% 33% -721% 14% 15% 13% 13% 14% 13% 14% 14% 14% 14% Bridge financing facility 47% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Payment of bridge financing facility -47% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Payment of Gaylord assumed debt -15% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Sale of common stock, Upper DECSSM, senior notes, and exercise of stock options 57% -2% -6% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Purchase of deposits 6% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Repurchase of common stock 0% 0% 0% 217% 96% -14% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Exercise of options 0% 0% 0% -20% -14% 12% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Tax benefit of stock options exercised 0% 0% 0% 0% -3% 9% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Settlement of equity purchase contracts 0% 0% 0% -142% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Other -1% 1% 6% 3% 1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%Total CFFF 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
Actual Financial Statements Forecasted Financial Statements
185
Forecasting Conclusions
In our attempts to conservatively forecast Temple-Inland’s future earnings we
have done our best to ignore the temptation to predict future the earnings growth
Temple-Inland has experienced the past few years. We believe much of that previous
growth was due to gains on sales of assets and the managements ability change the
direction of the company. We believe if the business structure continues to be
dominated by the corrugated products business sector and inroads into the building
products manufacture sector continue to improve Temple-Inland’s future earnings will
be similar to our forecasted earnings.
186
Valuation Analysis
Method of Comparables
The methods of comparables are a way for investors and analysts to value
companies using ratios. These companies are valued by determining industry averages,
and using substitution to find the price that the company should be. These valuation
methods are easy to perform, but are not very explanative. We will be using the
method comparables to determine the value of Temple-Inland, and have set a 15%
margin of safety for the valuations to fall.
Price to Earnings Trailing
The trailing price to earnings ratio is computed by taking the current price per
share and dividing by the current period’s earnings per share. This method of
comparable uses information easily accessible through yahoo.finance.com. To get a
suggested price for Temple-Inland we had to compute an industry average trailing price
to earnings ratio. We took the ratios of Temple-Inlands competitors, taking Temple-
Inland out of the average to avoid any unnecessary weighting towards Temple-Inland.
To calculate the suggested price for Temple-Inland we took the industry average P/E
ratio and set it equal to Temple-Inland’s P/E ratio. We then added Temple-Inland’s
3-Nov PPS P/E EPS Average P/E Suggested PriceTIN 5.61 0.46 12.31 16.045 197.54PKG 16.34 11.43 1.43IP 16.34 11.03 1.48SSCC 1.36 17.07 0.08USG 14.59 N/A N/APCL 35.56 24.65 1.44
Trailing P/E
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earnings (EPS) to the equation and solved for p. P is the price Temple-Inland should be
if the industry moved towards an average P/E. Since we are assuming a plus or minus
15% on the stock prices for our evaluation we adjusted the suggested price to be either
plus 15% or minus 15%, giving us a suggested buy and sell price for Temple-Inland.
Unfortunately because Temple-Inland had such an abnormal amount of earnings
last year from the sell of its Timberland operations the price we see using this method
of comparable was to large. After adjusting Temple-Inland’s net income by excluding
the sell of Timberland we found the price was to small. We can not conclude anything
using this method of comparables.
Even if Temple-Inland had not had abnormal earnings there is a flaw using a
trailing P/E ratio. For one the method assumes an industry average exists and firms
move towards the average, it dose not take into account the individual business plans
of each firm. Some firms may be generating profit in other areas of business within the
same industry, therefore to get a true industry you’d have to have several identical
firms in direct competition with each other. The second flaw using trailing P/E ratios
comes from the inputs themselves. Both inputs are backwards looking numbers,
financial theory however attempts to explain current prices using forward looking
numbers such as future cash flows.
Price to Earnings Forward
3-Nov PPS P/E EPS Average PSuggested PriceTIN 5.61 148.66 0.04 26.21 0.99PKG 16.34 10.58 1.54IP 16.34 10.03 1.63SSCC 1.36 54 0.03USG 14.59 N/A N/APCL 35.56 30.23 1.18
Forward P/E
The forward price to earnings ratio uses a one year forward looking earnings
estimate instead of the previous years earnings to give an estimate of Temple-Inland’s
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appropriate price. The forward price to earnings ratio is computed by taking the current
price per share and dividing by the estimated earnings per share. The estimated
earnings per share for Temple-Inland we used our forecast, for others in the industry
we used information found on Yahoo.finance.com. To get a suggested price for Temple-
Inland we computed an industry average trailing price to earnings ratio. We took the
ratios of Temple-Inlands competitors, taking Temple-Inland out of the average to avoid
any unnecessary weighting towards Temple-Inland. To calculate the suggested price for
Temple-Inland we took the industry average P/E ratio and set it equal to Temple-
Inland’s P/E ratio. We then added Temple-Inland’s earnings next year (EPS forward) to
the equation and solved for p. P is the price Temple-Inland should be if the industry
moved towards an average P/E. Since we are assuming a plus or minus 15% on the
stock prices for our evaluation we adjusted the suggested price to be either plus 15%
or minus 15%, giving us a suggested buy and sell price for Temple-Inland.
Price/Book
P/B Comparable
PPS BPS P/B IND AVG TIN PPS
TIN $5.61 7.31 0.77 1.42 $10.35
USG $14.59 22.12 0.66
PKG $16.34 7.35 2.22
PCL $35.56 11.11 3.20
SSCC $1.36 7.22 0.19
IP $16.34 20.27 0.81
Using the Price to Book ratio we can find the comparable price of the stock
market value and the value based on the company’s book value. To do this ratio you
take the stated market price per share (PPS) and divide it by the book price (BPS). To
find the BPS you must divide the book value of equity by the amount of shares
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outstanding. You must then find the industry average by averaging the industry’s P/B.
This average must does not include Temple-Inland to keep this a ratio to be compared.
The final step is to find the company’s comparable PPS. To find this you multiply the
industry average, 1.42, and multiply it by Temple-Inland’s market PPS, $5.61. In this
model, Temple-Inland’s compared PPS comes out to be $10.35 meaning that the
company is currently being undervalued by $4.74.
Dividends/Price (D/P)
DPS PPS D/P IND AVG TIN PPS
TIN 0.3 $5.61 0.053 0.045 $6.74
USG n/a $14.59 n/a
PKG n/a $16.34 n/a
PCL 1.72 $35.56 0.048
SSCC 0.031 $1.36 0.023
IP 1.02 $16.34 0.062
The dividends to price ratio is another to compare the company to the industry
to find how the company is valued. To compute this ratio you take the amount of
dividends per share and divide it by the price per share. Once we found this ratio for
our competitors, we found the industry average by taking the average of the companies
who actually pay dividends. Therefore, the average did not include USG or PKG as
neither pay dividends. We of course also did not include TIN in the average. We then
divided our DPS by the industry average to get TIN’s comparable PPS. Our error of
tolerance is +/- 15% which means the price should be in a range from $4.77-$6.45 to
be fairly valued. Obviously $6.74 falls above this range meaning that TIN is undervalued
when using the D/P ratio of comparables.
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Price to Free Cash Flow
Market Cap FCF P/FCF Ind Avg P/FCF PER SHARE
TIN 596.17 (2,019)
(0.30)
7.64
(0.02)
USG 1430 577 2.48
PKG 1560 186.96 8.34
PCL 5650 255 22.16
SSCC 278 311 0.89
IP 6240 1441 4.33
Another method of comparables is the price to free cash flows model. This takes
the free cash flows of the company, being cash flows from operations and cash flows
from investing, and compares it to the equity value in the market. We then took the
market cap and divided it by the free cash flows to get this ratio. We took the average
of TIN’s competitors to find the industry average and multiplied that by TIN’s price to
free cash flow ratio. With this number, we then multiplied that by TIN’s market cap and
then divided that by TIN’s shares outstanding. This gives us the price to free cash flow
per share price. The price we found was $- 0.02. This number is negative due to the
negative cash flows for TIN. Since you cannot have a negative share price, we would
move the share price to $0.00 meaning the company is currently overvalued. This is a
reason why the method of comparables is not as much of a reliable valuation of the
firm.
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Price Earnings Growth (P.E.G.)
P.E.G. Comparable
Company P/E Growth P.E.G. Industry
Avg.
TIN PPS
($)
TIN .46 -93.64 -.0049 3 -.34585
IP 7.48 4.857 1.54
PKG 10.5 N/A N/A
USG N/A N/A N/A
SSCC 5.9 N/A N/A
PCL 22.14 4.96 4.46
The price earnings growth model is another way to value a company. In order to
calculate the price earnings growth ratio must first gather the price to earnings ratio
that we have previously calculated and the forecasted earnings growth. Once we have
the price to earnings ratio and the five year expected growth rate of the firm, we divide
the P/E ratio by the growth rate. To find the value of Temple-Inland, we look at the
P/E and P.E.G. ratios of its competitors and through substitution we find the valuation
price of TIN.
We gathered the competitors’ ratios from Yahoo Finance, but we were not able
to include PKG, USG, or SSCC’s P.E.G. ratios in the industry average due to a lack of
information provided. We found that using the industry average P.E.G. ratio, which did
not include TIN, Temple’s valuation price came to be $-.35. We attribute this
extremely low price to the abnormally high earnings per share that Temple experienced
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due to the sale of their strategic timberland. The sale of strategic timberland caused
2007’s earnings to be inflated. The extremely inflated earnings we predict will cause
extreme volatility over the next five years, and will take the earnings growth into
negative numbers. Therefore, we feel that the price earnings growth method to valuing
Temple-Inland is not a good method to use because the valuation price falls outside of
our 15% margin of safety of the observed share price of $5.61.
Price/EBITDA
In order to compute the price to EBITDA ratio, we must first find the market
capitalization rate which is the price per share times the number of shares outstanding.
After finding the market cap, we need to find EBITDA, earnings before interest, taxes,
depreciation, and amortization. We then divide the firm’s market cap by its EBITDA.
This ratio is important because we are able to compute an industry average, and
through substitution, able to create a valuation price for Temple-Inland.
We found Temple-Inland’s market cap and EBITDA on their 2007 10-K, and
found the competitor’s market cap and EBITDA on Yahoo finance. We discovered an
industry average of the competitors, excluding USG, to be 4.32.
Using this average we found that TIN’s price per share based on the valuation model to
be $9.96, which is out of our 15% margin of safety of the observed share price of
$5.61. We believe that the explanation of the high valuation price is due to the high
level of earnings due to the sale of TIN’s strategic timberland, and therefore judge that
this model does not accurately portray Temple’s value.
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P/EBITDA Comparable
Company Mkt Cap
($)
EBITDA
($)
P/EBITDA Industry
Avg.
TIN PPS
TIN .6934B 2.305B .301 4.32 $9.96
IP 6.24B 2.84B 2.2
PKG 1.56B .418B 3.73
USG 1.43B .024B 59.58 Throw Out
SSCC .278B .544B .51
PCL 5.65B .522B 10.83
EV/EBITDA
The EV/EBITDA ratio is relatively new when valuing firms, and has grown in
popularity because it ignores the value of debt and the capital structure of firms. To
calculate EV/EBITDA we first find the enterprise value. The enterprise value of a firm is
the market value of equity and the book value of liabilities minus the firm’s cash and
investments. After finding EBITDA, earnings before interest, taxes, depreciation, and
amortization, we divide the enterprise value by EBITDA.
We found Temple-Inland’s Enterprise Value and EBITDA on their 2007 10-K,
and the competitors’ on Yahoo Finance. After finding TIN’s competitors EV/EBITDA, we
discovered the industry average excluding Temple-Inland and excluding USG as an
outlier to be 8.74. Using the industry average computed, we discovered the value of
the stock to be $33.03, which is much higher than the 15% margin of safety of the
observed share price of $5.61. We believe that this is caused by the inflated operating
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income due to the sale of TIN’s strategic timberland, which is not sustainable.
Therefore we cannot rely on this ratio to provide an accurate estimation of value.
EV/EBITDA ComparableCompany EV
($) EBITDA
($) EV/EBITDA Industry
Avg. TIN PPS
TIN 5.628B 2.305B 2.44 8.74 $33.03 IP 18.11B 2.84B 6.38 PKG 2.16B .418B 5.16 USG 2.73B .24B 113.74 Throw
Out
SSCC 3.99B .544B 7.34 PCL 8.38B .522B 16.06
Conclusion
The method of comparables done above gives an insight on whether a firm is
under-valued, fairly-valued or over-valued. Unfortunately this method does not need to
be weighed upon when making a decision when investing. The method of comparables
really has no financial theory as it is just used as a guiding tool with numbers that
somewhat correlate. Not to mention that some of the comparables were not even used
due to certain information like a negative cash flow, in our case, from TIN. This system
is also flawed by the fact that it is one company compared to an industry average. This
is bad because with this method you don’t actually have all competitors in the industry
and also take some of the competitors you are actually using out because they are
outliers. This can be due to something like the competitor not paying dividends.
Therefore this minimizes the view on the industry and distorting the numbers. Due to
this inefficiency, we will look to more valuable and reliable ways of finding the value of
the firm.
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Intrinsic Valuation Models
The intrinsic valuation models are the best way to find the true value of the
company because they use the most theory based ideas and are much more
explanatory. The intrinsic valuation models used in this analysis will include the
discount dividend model, residual income model, long-run residual income model,
discounted free cash flow model, and the abnormal earnings growth model.
Discounted Dividends Model
The discounted dividend model is an intrinsic valuation tool that attempts to
measure the intrinsic value of firm through the dividends the firm pays. The basic
assumption behind this model is that the dollar value a stock is a reflection of the
present value of all expected future dividends. While this model is widely accepted it is
clearly flawed. Because future dividends are so unpredictable, a model based solely on
these dividends is bound to be unreliable. Additionally, this model assumes that buy
and sell decisions are based only on expected dividends, which certainly is not the case.
This model’s short comings are illustrated by the formula on which the model is based.
The discounted dividend models derived from the following formula:
Price0 = Dividend1/Rate
This formula states that today’s stock price is equal to next year’s dividend
divided by the discount rate. Considering this formula, it is clear that this model is
flawed because of the fact that a firm’s prices in the real world are far more volatile
than the firm’s dividends or cost of capital.
To apply this model to Temple-Inland, the firm’s future dividends were
forecasted 11 years out into the future on a per share basis. This dividends where then
discounted back to time zero, using 2007 as zero and years 2008-2018 as years 1-11.
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To discount the dividends, each year’s dividend was multiplied by that year’s
corresponding present value factor (PV factor). The formula for the PV factor is as
follows:
PV factor = 1/(1 + Ke)t
Where,
Ke = cost of capital
t = period (ex: for 2008, t=1)
This PV factor formula for this model uses Ke as the discount rate because this is
the rate of return required by the firm’s equity investors (shareholders). Using the PV
factor formula, the PV factors were found for years 1-10. Once found, these PV factors
were multiplied by their corresponding dividends to discount the dividends back to time
zero (2007). To account for the expected dividends that will be paid in the future
beyond the forecast, perpetuity was taken in year 10. To find this perpetuity the year
11 dividend was divided by the cost of capital minus the observed dividend growth rate.
The dividend growth rate was found by taking the average of yearly percent change in
the dividends. This perpetuity was then multiplied by the year 10 PV factor to discount
it back to year zero.
After the years 1-10 dividends and the year 10 perpetuity had been discounted
back to year zero, they were totaled to get the implied model price. This implied model
price was then “grown” by 10 months to bring it up to November, 2008. To grow the
implied price it was multiplied by 1+Ke10/12.
Using a Ke of 17.53%, and a growth rate of 3.05% Temple-Inland’s discount
dividend model estimated price was $3.12. To test the effect of these variables on the
price, a sensitivity analysis was performed, the results of which are shown below:
g 0.00% 3.05% 6.00% 9.00% 12.00% 15.00% 18.00%
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11.53% 4.51 5.15 6.44 10.82 -40.77 -3.15 -0.42 13.53% 3.84 4.21 4.86 6.39 13.91 -9.27 -1.33 15.53% 3.34 3.57 3.94 4.66 6.58 30.32 -3.61
Ke 17.53% 2.96 3.12 3.34 3.72 4.53 7.24 -24.67 19.53% 2.67 2.77 2.91 3.14 3.55 4.50 9.19 21.53% 2.43 2.50 2.59 2.74 2.97 3.42 4.63 23.53% 2.23 2.28 2.35 2.44 2.58 2.83 3.34 Price > 6.45 4.77<Price<6.45 Price<4.77
To perform a sensitivity analysis, different growth rates were tested while
holding the cost of capital constant, and different costs of capital were tested while the
growth rates constant. Using a 15% margin of error, the results were marked as over
or under valued. To find the price above which the firm is undervalued, the observed
share price of $5.61 was multiplied by the 1 plus the 15% margin of error resulting in
$6.45. If the model price is above $6.45, the firm is undervalued at $5.61 and should
be purchased. To find the lower limit, the same logic was followed but the 15% margin
of error was subtracted (not add) to 1, the result was $4.77. If the model price is
below $4.77, the firm is overvalued at $5.61 and should be sold. The margin of error
was set at 15% because rates lower 15% can lead to over activity (in terms of buying
and selling) and higher rates can lead to under activity and missed opportunities. As
illustrated above this model is insensitive to both varying growth rates and costs of
capital. Based on the sensitivity analysis Temple-Inland is overvalued in most instances,
namely at the model estimated price of $3.13.
Discounted Cash Flows Model
The discounted free cash flows model is an intrinsic valuation model that
estimates a firm’s value using forecasted future free cash flows generated by the firm’s
assets. Generally speaking, this model tends to have a higher explanatory power than
the discount dividend model because it provides a more comprehensive look at the firm
and functions without some of the faulty assumptions required by the discount dividend
model. The free cash flows model is able provide a more comprehensive valuation than
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the dividend model because the free cash flow model looks at cash flows generated by
the firm’s assets, as opposed to looking only at dividends which is an equity number.
The broadened scope allows this model to function without the assumption that a firm’s
value depends on the dividends the firm pays, instead this model implies that a firm’s
value depends on the firm’s ability to generate cash with its assets (a far stronger
assumption). These advantages generally result in a higher explanatory power that
that of the discounted dividend model. While the discounted free cash flows model has
its advantages, it has a major pitfall. The problem presented by this model is that it
places too great of an emphasis on expected future cash flows. This heavy emphasis
makes this model extremely sensitive to growth rates with effect the model’s
perpetuity. To understand why this is one must understand how the model is
constructed.
To use discounted free cash flows model to value a firm, one must first forecast
the firm’s cash flows from operations (CFFO) and cash flows from investments (CFFI)
11 years out. Once the CFFO and CFFI have been forecasted, the CFFI from each year
must be added to (subtracted from if the CFFI is negative) the CFFO of that year, this
subtraction will result in the free cash flows from assets for each year (YBY FCF). Once
derived, the YBY FCFs must be discounted back to time zero, this is done by multiplying
the appropriate present value factor. The present value factor formula is as follows:
1/(1+WACCBT)t
Where
WACCBT = weighted average cost of capital before tax
t = period (for example: t=1 for the first forecasted period)
It is important to note that this valuation uses WACCBT as the discount rate in
the present value factor. This is because the discounted free cash flows model, unlike
other valuation models, deals with cash flow from the firm’s assets (including both debt
and equity). This being the case, the model must use a discount rate that applies both
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the firm’s equity and debt, and WACC does just that. The before tax WACC is used to
avoid over accounting for tax which is already accounted for because FCF is an after tax
number. After finding the present value factor for years 1-10, each of the first 10
year’s FCF must then be multiplied by their corresponding present value factor. The
products of these multiplications are the year by year present value of FCFs (PV YBY
CFC).
The next step in this valuation is to create a perpetuity in year 10 using year 11’s
FCF as the perpetuity seed. This is simply done by taking the year 11 FCF and dividing
it by WACCBT minus the FCF’s growth rate. The FCF growth rate is the average
percentage change in the YBY FCF. This year 10 perpetuity must also be discounted
back to time zero by multiplying it by the year 10 present value factor. The product of
this multiplication is the present value of the perpetuity (PV PERP). This PV PERP will
dwarf the PV YBY FCFs.
After finding the 10 PV YBY FCFs, and the PV PERP, these 11 figures are totaled
to create the market value of the firm’s assets at time zero (MVA0). Because, the PV
PERP is so large compared to the sum of the PV YBY FCFs, it will make up the majority
of the MVA0. The book value of the firm’s debt at time zero (BVD0) is then subtracted
from the MVA0 to get the market value of the firm’s equity at time zero (MVE0). After
the MVE0 has been found, it can be divided by the number of shares outstanding to get
the implied share price at time zero. To find the share price as of the valuation date,
the implied share price can be “grown” by multiplying it by (1+WACCBT)m/12, where m is
the number of months the price is to be grown by.
This method was used to find Temple-Inland’s discounted free cash flow
valuation. The year 2007, the last year of actual financial data, was time zero and years
2008-2018 were years 1-10. The yearly free cash flows were discounted using the
firm’s WACCBT of 6.06% and the free cash flow growth rate was 3%. These figures, in
addition to the forecasted FCFs, were used to find the implied price which was grown
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by 10 months to get a time consistent price of $22.04. To test the effect WACCBT and
the growth rate had on the time consistent price, a sensitivity analysis was used.
To perform a sensitivity analysis, different growth rates were tested while
holding the cost of capital constant and different costs of capital were tested while the
growth rates constant. Using a 15% margin of error, the resulting prices were marked
as over or under valued. To find the price above which the firm is undervalued, the
observed share price of $5.61 was multiplied by the 1 plus the 15% margin of error
resulting in $6.45. If the model price is above $6.45, the firm is undervalued at $5.61
and should be purchased. To find the lower limit, the same logic was followed but the
15% margin of error was subtracted (not add) to 1, the result was $4.77. If the model
price is below $4.77, the firm is overvalued at $5.61 and should be sold. The margin of
error was set at 15% because rates lower 15% can lead to over activity (in terms of
buying and selling) and higher rates can lead to under activity and missed
opportunities. Given the WACCBT, growth rate and margin of error assumptions, the
discounted free cash flows model indicates that Temple-Inland is greatly undervalued
assuming the 6.06% weighted cost of capital and the 3% growth rate.
As mentioned above, as well as illustrated in the sensitivity analysis, the results
of this valuation are extremely sensitive to the growth rate. The reason for this in
Temple-Inland’s case is that the perpetuity, which uses the growth rate, makes up over
70% of the MVE0. This over dependence on the perpetuity causes the model price to
vary wildly with minor changes in the growth rate. This model should not be used as a
g0 0.010 0.020 0.030 0.040 0.050 0.060
0.0544 0.58 7.88 19.43 40.44 90.65 369.03 -346.820.056 -0.98 5.78 16.28 34.87 76.68 257.88 -466.92
0.0583 -3.07 2.99 12.21 27.94 60.86 173.13 -1035.36WACCBT 0.0606 -5 0.045 8.58 22.04 48.565 125.11 2753.37
0.0622 -6.27 -1.19 6.29 18.42 41.49 102.36 716.600.0653 -8.55 -4.11 2.3 12.34 30.31 71.78 269.730.0668 -9.59 -5.41 0.55 9.75 25.82 61.01 199.72
Price > 6.45 4.77<Price<6.45 Price<4.77
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proxy of Temple-Inland’s value because of volatility that comes with the use of different
growth rates. This volatility creates an unrealistic “win big/loose big” scenario that fails
to reflect real market fluctuations.
Residual Income Growth Model
The residual income model is a very important model to pay attention to for a
number of reasons. The equation for the residual income model is the sum of 10 years
of data plus the perpetuity in the eleventh year. The first part of the equation is current
year’s net income minus “bench mark net income” multiplied by the present value
factor. The present value factor is found by adding 1 to the cost of equity and rising to
sum to whatever power brings your total back to time zero. If your cash flow is two
years away square the sum. The “bench mark net income” is cost of equity computed
previously multiplied by last year’s total equity. Essentially given the equity you stared
with it is what the market expects your firm to produce in net income for the year. Thus
you take what you earned subtract what was expected and you either outperformed
and created value, underperformed and lost value, or pushed and met expectations.
The sum of these activities over the next ten years is added together and added to the
current total equity in time zero. The next step is to find the value of the perpetuity.
The value of the perpetuity is an estimated residual income for the eleventh year
divided by the cost of equity minus the growth rate at which you expect your industry
to move to equilibrium, zero. All of this multiplied by the present value factor to bring
the sum back to time zero.
The perpetuity is split into a denominator and a numerator. The numerator is an
estimated residual income in year 11. The residual income in year 11 is estimated after
looking at growth rates of the previous years, Temple-Inland smoothes out to a growth
rate of 3% per year therefore we took the residual income value in year 10 and took
103% of the value to find a residual income for year 11. The denominator is the cost of
equity we assumed earlier minus the growth rate to equilibrium. The growth rate is the
volatility of net income in your industry. If your industry consistently swings from large
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increases in net income to large losses the growth rate or rate of movement to the
equilibrium is bigger than a company which experiences small changes in net income.
The perpetuity is then added to the sum of the current equity and the sum of the
estimated residual income. This number is then divided by the shares outstanding and a
price appears representing the amount of value you have estimated the firm will
produce or loose in the following ten years. The price found is then brought forward 10
months to the end of October or the beginning of November for a time consistent price.
This model is very cool. The model assumes the firm will destroy value until it
goes out of business, add value and thus increase its cost of equity until the excess
amount of value is decreased to zero, or continue to meet the expected earnings and
keep the same cost of equity. The model assumes firms that outperform the market
and firms that underperform the market will eventually either not beat the market or
improve to the markets standards. This model assumes an efficient market exists, firms
gaining more than the market expectations will be valued higher than firms not meeting
expectations. This model attempts uses the cost of equity to explain market
expectations. The inputs are all forward looking accounting numbers and therefore are
not as sensitive to growth rates as the discount dividend model or free cash flows
model. It is much easier to estimate net income and total equity than it is to estimate
dividends or cash flows, thus less sensitive to changes in growth rates or the cost of
equity. Because this model relies on accounting numbers the management of a firm can
manipulate these numbers. Therefore it is important to asses the accounting standards
of a company before applying this model. Important inputs for this model are net
income, dividends, by extension retained earnings, total equity, cost of equity, and
growth rate or movement towards zero.
Temple-Inland’s residual income model inputs were a cost of equity of 17.53%
and a growth rate of -10% giving us an estimated value of $3.89 per share.
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(0.10) (0.20) (0.30) (0.40) (0.50) (0.60) (0.70) 11.53% 6.15 6.27 6.33 6.37 6.40 6.42 6.43 13.53% 5.20 5.37 5.47 5.53 5.57 5.59 5.62 15.53% 4.47 4.66 4.76 4.83 4.88 4.91 4.9417.53% 3.89 4.08 4.18 4.25 4.30 4.34 4.3719.53% 3.43 3.60 3.71 3.78 3.83 3.86 3.8921.53% 3.05 3.21 3.31 3.38 3.43 3.46 3.4923.53% 2.75 2.89 2.98 3.04 3.09 3.12 3.15
Undervalued < $6.45 $6.45 < Fairly Valued > $4.77 $4.77 > Overvalued
The above table is the sensitivity analysis for Temple-Inland using the Residual
Income model. We adjusted the growth rates and cost of equity from -10% to -70%
and the cost of equity from the upper bounds of equity of 23.35% to the lower bounds
of 11.53%. The current price as of November 3rd 2008 is $5.61, with a plus or minus
15% which gives us an undervalued price of $6.45 and a overvalued price of $4.77. The
residual income model shows that Temple-Inland is overvalued the majority of the time.
This model does not predict Temple-Inland is undervalued at any variation of cost of
equity or growth rate in the perpetuity.
Abnormal Earnings Growth Model
The abnormal earnings growth (AEG) is one of the most reliable intrinsic
valuation models because of the financial theory that backs it. The basic assumption
behind this model is that the value of a firm’s stock today is the present value of an
abnormal earnings adjusted income perpetuity. Like the residual income model, this is
largely based upon the theory that income can be bench marked by growing it by 1 +
Ke each year. This model is also supported by the theory that cumulative earnings can
be calculated by adding the interest earned on the previous year’s dividend to the
current year’s income. Because these are theories that hold true in practice, the
abnormal growth earnings model provides fairly accurate valuations and has a great
deal of explanatory power.
204
To estimate the Temple-Inland’s value using the AEG, net income and total
dividends were forecasted 12 years out. Setting 2008 as time zero, and years 2009-
2019 as years 1-11, the firm’s normal incomes are calculated and subtracted from the
calculated cumulative dividend earnings to find the yearly abnormal earnings. The
cumulative dividends are calculated by adding interest payments earned on the
previous year’s dividends to the current year’s income. The interest rate earned by the
dividend is assumed to be Ke. The logic behind this is that dividends paid will be
reinvested into another project that will generate a return that is equal to or greater
than the firm’s cost of capital, if not these funds will simply be reinvested back into the
firm (thus earning Ke) . These indirect interest earnings from the previous year’s
income add to the current year’s income. The normal income is calculated by
multiplying the previous year’s net income by 1+Ke. The logic behind this is that
income is an equity figure and as an equity figure it should grow at the rate required by
equity share holders (the cost of capital). Once found, the normal income is subtracted
from the cumulative dividends earnings in each year, to find the year by year abnormal
earnings. A negative abnormal earnings implies that the firm underperformed its cost
of capital for that year, and a positive implies that the firm’ out performed it. To check
the abnormal earnings calculation, each year’s abnormal earnings was compared to a
residual income check figure, which is the yearly change in residual income. A chart
comparing yearly abnormal earnings and the residual income check figure is presented
below:
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Abnormal earnings 72.94 5.66 (4.27) (4.62) (4.24) (4.61) (4.25) (4.64) (4.31) (4.74)RI check figure 72.94 5.66 (4.27) (4.62) (4.24) (4.61) (4.25) (4.64) (4.31) (4.74)
After the yearly abnormal earnings have been calculated for years 1-10, a
perpetuity is calculated in year 10 using year 11’s abnormal earning as the perp. seed.
Because abnormal earnings are not sustainable forever, the perpetuity growth rate
205
must be negative thus reducing the abnormal earnings in perpetuity (approaching but
never reaching 0). The yearly abnormal earnings and the perpetuity were discounted
back to year zero (2008) by multiplying them by their corresponding present value
factor (using Ke as the discount rate). These present values were then totaled creating
the present value of future abnormal earnings. This figure was then added to the
“core” 2008 income to get the abnormal earnings adjusted income. To get the adjust
income on a per share basis, it was divided by the number of shares outstanding. This
abnormal earnings adjusted EPS at time zero in 2008 was then used as the perpetuity
seed value to get the present value of the adjusted EPS in 2007. This was done by
dividing the adjusted EPS by the cost of capital; the result of this division was the
implied model price. To get the price as of November, 2008, the implied model price
was grown by 10 months using the Ke.
Using a cost of capital of 17.53% and growth rate of -10%, the AEG estimated
stock price is $3.26. To test the effect of these variables on the price, a sensitivity
analysis was performed, the results of which are shown below:
g 0.1 0.2 0.3 0.4 0.5 0.6 0.7
11.53% 5.48 5.59 5.64 5.67 5.69 5.71 5.72 13.53% 4.47 4.56 4.61 4.64 4.66 4.68 4.69 15.53% 3.77 3.84 3.89 3.91 3.93 3.95 3.96
Ke 17.53% 3.26 3.32 3.36 3.38 3.39 3.41 3.42 19.53% 2.87 2.92 2.95 2.97 2.99 3 3.01 21.53% 2.58 2.62 2.64 2.66 2.67 2.68 2.68 23.53% 2.34 2.37 2.39 2.4 2.41 2.42 2.43
Price > 6.45 4.77<Price<6.45 Price<4.77
To perform a sensitivity analysis, different growth rates were tested while
holding the cost of capital constant, and different costs of capital were tested while the
growth rates constant. Using a 15% margin of error, the results were marked as over
or under valued. To find the price above which the firm is undervalued, the observed
206
share price of $5.61 was multiplied by the 1 plus the 15% margin of error resulting in
$6.45. If the model price is above $6.45, the firm is undervalued at $5.61 and should
be purchased. To find the lower limit, the same logic was followed but the 15% margin
of error was subtracted (not add) to 1, the result was $4.77. If the model price is
below $4.77, the firm is overvalued at $5.61 and should be sold. The margin of error
was set at 15% because rates lower 15% can lead to over activity (in terms of buying
and selling) and higher rates can lead to under activity and missed opportunities. As
illustrated above this model is insensitive to both varying growth rates and costs of
capital. Based on the sensitivity analysis Temple-Inland is overvalued in all instances
where the cost of capital is greater than 13.53%. Given the initial Ke and growth rate
the AEG model indicates that Temple-Inland is overvalued.
207
Long Run Residual Income Model
The long run residual income model is very similar to the residual income model.
The difference is the long run residual income model attempts to estimate market cap
using the average of ROE over the forecast period and the growth rate of equity. The
first step is finding the long run return on equity. This is found by taking the net income
and dividing it by the previous year’s total equity, over the forecast period. We
determined our long run return on equity average will be 9.84%. The second step was
finding the growth of the return on equity. This was accomplished by using the time
tested formula (new/old) -1. (ROE for year 2 / ROE for year 1) – 1 for our forecast
period. We then took an average of these growth rates and found an average of 4%.
This seems reasonable given the slow climb over a long period of time. We use the
same cost of equity as before which we found was 17.53%. After finding these three
inputs we inserted them into the long run residual income model formula:
Estimated Market Capitalization = BVE * (1+ ( (ROE-Ke)/(Ke-g))
We then take the estimated market capitalization and divide by the number of
shares to get a suggested share price of $5.10.
ROE = .0384 ROE = .0584 ROE = .0784 ROE = .0984 ROE = .1184 ROE = .1384 ROE = .1584
Ke = .1153 (0.22) 2.76 5.76 8.77 11.77 14.77 17.77Ke = .1353 (0.19) 2.21 4.62 7.03 9.44 11.84 14.25
g = .04 Ke = .1553 (0.16) 1.86 3.88 5.90 7.91 9.93 11.95Ke = .1753 (0.14) 1.61 3.35 5.10 6.84 8.59 10.33Ke = .1953 (0.12) 1.42 2.96 4.50 6.05 7.59 9.13Ke = .2153 (0.11) 1.27 2.66 4.04 5.43 6.82 8.20Ke = .2353 (0.10) 1.16 2.42 3.68 4.94 6.20 7.46
Undervalued < $6.45 $6.45 < Fairly Valued > $4.77 $4.77 > Overvalued
208
ROE = .0384 ROE = .0584 ROE = .0784 ROE = .0984 ROE = .1184 ROE = .1384 ROE = .1584
g = .01 2.03 3.46 4.89 6.31 7.74 9.17 10.60 g = .02 1.40 2.92 4.44 5.96 7.48 9.00 10.52
Ke = .1753 g = .03 0.68 2.31 3.93 5.56 7.18 8.81 10.43 g = .04 (0.14) 1.61 3.35 5.10 6.84 8.59 10.33 g = .05 (1.09) 0.79 2.68 4.56 6.45 8.33 10.22 g = .06 (2.21) (0.14) 1.88 3.93 5.98 8.03 10.08 g = .07 (3.54) (1.30) 0.94 3.18 5.43 7.67 9.91
Undervalued < $6.45 $6.45 < Fairly Valued > $4.77 $4.77 > Overvalued
Ke = .1153 Ke = .1353 Ke = .1553 Ke = .1753 Ke = .1953 Ke = .2153 Ke = .2353
g = .01 9.49 8.09 7.08 6.31 5.71 5.23 4.83 g = .02 9.3 7.8000 6.74 5.9600 5.36 4.8700 4.48g = .03 9.06 7.45 6.35 5.56 4.96 4.48 4.1
ROE = .0984 g = .04 8.77 7.03 5.9 5.10 4.5 4.04 3.68g = .05 8.38 6.51 5.35 4.56 3.99 3.56 3.21g = .06 7.85 5.85 4.69 3.93 3.4 3.00 2.7g = .07 7.09 4.99 3.88 3.18 2.71 2.37 2.11
Undervalued < $6.45 $6.45 < Fairly Valued > $4.77 $4.77 > Overvalued
We conducted the sensitivity analysis similar to the residual income model with
the addition of another variable, ROE was also varied. Each sensitivity analysis holds
one of the variables constant to help us understand each stock price given the change
in the other two variables. We applied the range of cost of equity as before 11.53% -
23.52%. We also chose to keep our plus or minus 15% for undervalued and overvalued
recommendations. This model’s recommendation is not as clearly cut as the residual
income model. The long run residual income model is split down the middle with the
majority of the cells showing us Temple-Inland is overvalued. Given the split and the
fact our model predicts a fairly valued $5.10 we can conclude this model believes
Temple-Inland to be fairly valued.
209
Appendices
Sales Manipulation Diagnostics
Net Sales/Cash From Sales
2002 2003 2004 2005 2006 2007Temple‐Inland 0.99 1.00 1.01 1.00 1.01 1.00Packaging Corp. 1.00 1.01 1.01 1.00 1.02 1.01International Paper 1.00 1.00 1.01 1.00 1.00 1.01Plum Creek 1.00 1.00 1.00 1.00 1.00 1.00USG 1.00 1.01 1.02 1.01 1.00 0.98Rock‐Tenn 1.00 1.00 1.01 0.99 1.01 1.00Smurfit‐Stone 1.00 0.99 1.01 0.99 1.00 1.01 Ne
t Sales/Accounts Receivable
2002 2003 2004 2005 2006 2007Temple‐Inland 9.59 9.75 9.27 9.35 9.26 9.07Packaging Corp. 9.88 9.07 8.73 9.35 8.31 8.39International Paper 7.21 6.87 7.55 7.42 8.13 6.94Plum Creek 34.45 35.18 38.20 35.82 40.68 50.76USG 12.21 11.42 10.92 11.34 12.97 12.10Rock‐Tenn 9.06 8.79 8.91 8.69 9.26 10.04
Smurfit‐Stone 32.39 33.14 26.44 30.41 43.11 43.65
Net Sales/Inventory
TIN IP PKG SSCC USG PCL 2002 9.982 8.301 10.812 16.374 12.844 19.603 2003 10.609 8.001 10.435 10.861 13.093 22.148 2004 8.956 8.739 10.539 8.545 13.34 21.521 2005 9.042 11.232 10.393 9.281 16.314 21.013 2006 9.621 11.522 11.161 13.303 16.695 19.602 2007 8.516 10.57 11.333 13.741 13.798 20.427
210
Core Expense Manipulation Diagnostics
Asset Turnover
TIN PKG IP SSCC PLUM USG 2003 0.70 0.88 0.59 0.57 0.28 1.01 2004 0.80 0.95 0.58 0.67 0.35 1.19 2005 0.19 0.96 0.63 0.71 0.36 1.20 2006 0.19 1.11 0.76 0.79 0.34 0.95 2007 0.19 1.17 0.91 0.95 0.36 0.97
Change in Asset Turnover
TIN PKG IP SSCC PLUM USG 2003 -0.35 1.00 -2.94 1.57 0.53 1.21 2004 0.01 146.75 -0.64 -1.53 -10.06 1.76 2005 0.10 109.80 -0.18 -0.20 0.11 0.34 2006 -0.30 191.64 -0.06 -0.26 -0.34 -0.86 2007 0.02 125.90 -0.84 -0.67 16.00 0.82
CFFO/OI
TIN IP PKG PLUM
2003 3.45 1.03 17.43 1.232004 0.87 1.14 3.12 1.262005 1.60 0.93 4.58 1.152006 1.45 0.59 1.98 1.212007 0.82 0.78 1.76 1.22
CFFO/OI CHANGE
TIN IP PKG SSCC PLUM USG 2003 -19.03 -0.40 -0.06 0.74 -0.09 4.27 2004 -1.71 1.80 -0.35 0.75 1.31 0.64 2005 -0.23 1.89 -1.75 0.13 2.90 -0.03 2006 1.23 -0.64 0.06 0.07 3.08 -1.26 2007 2.70 1.90 1.18 -0.76 1.05 -6.11
211
CFFO/NOA
TIN IP PKG SSCC USG PCL 2002 0.1288584 0.1478083 0.1703336 0.136934 0.247204 0.094472003 0.4663609 0.1374057 0.177713 0.031447 0.130363 0.0968072004 0.2566929 0.1954813 0.1598513 0.057137 0.230977 0.1514442005 0.2782037 0.1664279 0.1839516 0.052061 0.260021 0.1252122006 0.4791155 0.1359947 0.1972843 0.071027 -1.67557 0.1358752007 0.1813725 0.1860763 0.2469136 0.070353 0.503467 0.124548
CFFO/NOA CHANGE
TIN IP PKG SSCC USG PCL 2002 2.2954545 -0.846325 1.7619048 -0.06125 -17.0833 1.3272732003 -8.253165 0.2998897 -0.111111 -0.27474 -6.83333 0.2253522004 7.4736842 -0.542146 1.0357143 -0.37801 5.457143 -1.470152005 -0.240506 0.2793509 -1.166667 0.111959 0.83871 -0.237412006 -1.373737 3.5875 -0.057971 -0.0856 -15.9432 -1.379312007 -121 0.5783972 -1.432432 0.079422 12.97927 -0.66102
TOTAL ACCRUALS/SALES
2002 2003 2004 2005 2006 2007 Temple-Inland -0.07 4.47 -5.35 0.18 0.03 5.10 Packaging Corp. 0.29 -208.02 -0.73 0.42 -0.35 0.07 International Paper -0.62 9.89 1.08 -2.06 -0.80 -5.20 Rock-Tenn -6.19 -0.05 -0.08 0.41 -0.03 0.18 Smurfit-Stone 0.07 -0.37 -0.07 -0.18 -0.58 0.08 USG 1.03 -1.43 0.00 2.90 -8.84 -8.59 Plum Creek 0.25 0.75 0.17 -1.58 1.51 -0.03
TOTAL ACCRUALS/ SALES (EXCLUDING OUTLIERS)
2002 2003 2004 2005 2006 2007 Temple-Inland -0.06538 4.474074 -5.35052 0.175355 0.025773 5.100386 Packaging Corp. 0.291046 -0.7287 0.420274 -0.35443 0.06578 International Paper -0.6191 9.891156 1.077566 -2.05618 -0.80339 -5.2 Rock-Tenn -6.19156 -0.05001 -0.07721 0.406754 -0.02694 0.178953 Smurfit-Stone 0.067308 -0.3682 -0.06503 -0.17579 -0.57971 0.08365 USG 1.034884 -1.43434 0.001186 2.898413 -8.84203 -8.58882 Plum Creek 0.252319 0.745763 0.174699 -1.58333 1.509804 -0.02899
212
Liquidity Ratios
CURRENT RATIO
2002 2003 2004 2005 2006 2007
TIN 1.65 1.6 3.11 3.19 1.84 1.43
PKG 1.72 1.65 2.21 1.89 1.67 1.3
USG 1.48 1.65 1.33 1.56 0.32 0.52
SSCC 1.43 1.24 1.13 1 0.87 1.01
IP 1.69 1.37 1.72 1.53 1.86 1.75
PCL 1.59 1.65 1.89 1.05 0.97 0.79
Industry 1.59 1.53 1.90 1.70 1.26 1.13
QUICK ASSET RATIO
2002 2003 2004 2005 2006 2007
TIN 0.79 0.78 0.73 0.95 0.86 0.74
PKG 1.03 1.03 1.4 1.11 1.09 0.9
USG 2.24 2.64 3.37 2.84 0.58 1.28
SSCC 0.17 0.41 0.23 0.19 0.16 0.18
IP 0.84 0.77 0.67 0.94 0.93 1.06
PCL 1.80 1.86 2.10 1.21 1.18 0.92
Industry Avg. 1.15 1.25 1.42 1.21 0.80 0.85
avg w/o usg 0.93 0.97 1.03 0.88 0.84 0.76
213
WORKING CAPITAL TURNOVER
2002 2003 2004 2005 2006 2007
TIN 0.79 0.78 0.73 0.95 0.86 0.74
PKG 1.03 1.03 1.4 1.11 1.09 0.9
USG 2.24 2.64 3.37 2.84 0.58 1.28
SSCC 0.17 0.41 0.23 0.19 0.16 0.18
IP 0.84 0.77 0.67 0.94 0.93 1.06
PCL 1.80 1.86 2.10 1.21 1.18 0.92
Industry 1.15 1.25 1.42 1.21 0.80 0.85
avg w/o usg 0.93 0.97 1.03 0.88 0.84 0.76
A/R TURNOVER
2002 2003 2004 2005 2006 2007
TIN 12.84 12.96 11.88 9.35 9.26 9.07
PKG 9.88 9.07 8.73 9.35 8.31 8.39
USG 12.21 11.42 10.92 11.34 12.77 12.1
SSCC 13.86 16.43 26.44 30.41 43.11 43.65
IP 8.04 7.65 8.52 8.24 8.13 6.94
PCL 34.45 35.18 38.20 25.84 28.05 41.88
Industry 11.37 11.51 13.30 13.74 16.32 16.03
DAYS SALES OUTSTANDING
2002 2003 2004 2005 2006 2007
TIN 28.43 28.16 30.72 39.047 39.42 40.24
PKG 36.95 40.25 41.83 39.03 43.92 43.48
USG 29.89 31.96 33.43 32.17 28.14 30.17
SSCC 26.34 22.22 13.8 12 8.47 8.36
IP 45.38 47.71 42.86 44.32 44.87 52.56
PCL 10.59 10.38 9.55 14.13 13.01 8.72
Industry 29.60 30.11 28.70 30.12 29.64 30.59
214
INVENTORY TURNOVER
2002 2003 2004 2005 2006 2007
TIN 28.43 28.16 30.72 39.047 39.42 40.24
PKG 36.95 40.25 41.83 39.03 43.92 43.48
USG 29.89 31.96 33.43 32.17 28.14 30.17
SSCC 26.34 22.22 13.8 12 8.47 8.36
IP 45.38 47.71 42.86 44.32 44.87 52.56
PCL 10.59 10.38 9.55 14.13 13.01 8.72
Industry 29.60 30.11 28.70 30.12 29.64 30.59
DAYS SUPPLY INVENTORY
2002 2003 2004 2005 2006 2007
TIN 40.82 37.15 48.60 45.87 45.68 49.64
PKG 41.52 42.22 41.11 41.51 41.03 41.65
USG 34.17 32.75 33.6 28.48 77.93 29.89
SSCC 39.56 38.89 49.4 44.25 31.75 30.78
IP 49.32 51.48 39.47 38.76 38.10 37.91
PCL 29.24 24.15 26.72 26.42 57.25 49.03
Industry 39.11 37.77 39.82 37.55 48.62 39.82
CASH TO CASH CYCLE (in days)
2002 2003 2004 2005 2006 2007
TIN 69.25 65.32 79.32 84.91 85.09 89.88
PKG 78.47 82.48 82.94 80.54 84.95 85.13
USG 64.06 64.71 67.03 60.65 106.08 60.01
SSCC 65.9 61.11 63.21 56.26 40.22 39.14
IP 94.70 99.20 82.33 83.09 82.98 90.47
PCL 39.83 34.53 36.27 40.55 70.27 57.75
Industry 68.70 67.89 68.52 67.67 78.27 70.40
215
Profitability Ratios
GROSS PROFIT MARGIN
OPERATING EXPENSE RATIO
Operating Expense Ratio
2002 2003 2004 2005 2006 2007
TIN 7.7% 7.6% 7.3% 7.7% 7.7% 7.9%
PKG 7.5% 7.4% 7.2% 7.3% 7.3% 7.3%
USG 9.0% 8.8% 7.0% 6.8% 7.2% 7.8%
IP 9.2% 8.9% 7.8% 7.4% 8.4% 8.4%
PCL 6.6% 6.4% 5.6% 5.8% 6.7% 7.6%
SSCC 9.9% 11.4% 9.8% 10.1% 9.5% 8.5%
Gross Profit Margin
2002 2003 2004 2005 2006 2007
TIN 7.8% 5.6% 9.9% 12.0% 16.9% 13.7%
PKG 18.7% 17.2% 15.8% 15.4% 20.3% 22.7%
USG 16.8% 14.9% 18.6% 21.4% 23.6% 11.5%
IP 18.4% 15.1% 22.9% 32.2% 26.1% 26.6%
PCL 36.3% 31.8% 36.5% 34.3% 34.2% 32.9%
SSCC 16.5% 13.6% 13.5% 11.1% 13.6% 13.7%
216
OPERATING PROFIT MARGIN
Operating Profit Margin
2002 2003 2004 2005 2006 2007
TIN 7.4% 1.3% 9.7% 3.1% 10.0% 53.3%
PKG 8.4% 5.6% 7.4% 5.8% 10.3% 12.7%
USG 7.4% 5.7% 11.3% -45.8% 17.0% 3.2%
IP 1.5% 1.3% 3.1% 2.4% 14.5% 7.6%
PCL 29.7% 25.3% 31.2% 28.4% 28.3% 25.3%
SSCC 6.2% 0.6% 2.6% -3.7% 3.9% 4.1%
NET PROFIT MARGIN
2002 2003 2004 2005 2006 2007
TIN 2% 3% 4% 5.00% 11.00% 33%
IP -4% 1% 0% 5.00% 5.00% 5%
PKG 2.8% -0.8% 3.60% 2.60% 5.70% 7.30%
USG 1.20% 3.3% 6.90% -27.90% 5.00% 1.5%
SSCC 0.9% -2.6% -0.70% -4.8% -0.80% -1.40%
PCL 20.5% 16.1% 23.7% 22.5% 19.5% 16.8%
Industry 3.73% 3.17% 6.08% .4% 7.57% 10.37%
217
ASSET TURNOVER
2002 2003 2004 2005 2006 2007 TIN 1.1 0.94 1.02 0.6 0.71 1.08 IP 0.6 0.66 0.66 0.7 0.76 0.91 PKG 0.88 0.876 0.952 0.958 1.108 1.166 USG 1.001 1.008 1.187 1.201 0.946 0.97 SSCC 0.702 0.715 0.665 0.711 0.785 0.954 PCL .276 .279 .347 .36 .338 .359 Industry .7598 .7463 .8052 .6867 .6878 .7582
RETURN ON ASSETS
2002 2003 2004 2005 2006 2007
Temple-Inland 1.29% 1.93% 3.56% 0.87% 2.16% 6.37%
Plum Creek 5.65% 4.48% 8.21% 8.09% 6.59% 6.05%
Smurfit-Stone 0.61% - - -3.44% - -
International Paper - 1.00% 0.00% 3.00% 4.00% 5.00%
USG 1.24% 3.36% 8.21% - 4.69% 1.42%
Packaging Corp. 2.44% - 3.46% 2.53% 6.34% 8.56%
Industry Average 1.54% 1.37% 3.83% -3.75% 3.85% 4.35%
218
RETURN ON EQUITY
2002 2003 2004 2005 2006 2007
Temple-Inland 2.30% 4.93% 8.38% 8.35% 22.50% 59.62%
Plum Creek 10.37% 8.64% 17.08% 15.80% 13.63% 13.50%
Smurfit-Stone 2.62% -8.49% -2.03% -14.61% -3.13% -5.79%
International -9.00% 4.00% 0.00% 13.00% 13.00% 15.00%
USG 8.76% 22.80% 45.28% - - 4.95%
Packaging Corp. 6.26% -1.80% 8.62% 6.43% 18.35% 24.58%
Industry 3.63% 5.01% 12.89% -18.54% -5.17% 18.64%
Firm Growth Rate Ratios
INTERNAL GROWTH RATE
2002 2003 2004 2005 2006 2007
Temple-Inland - 0.46% 0.63% 0.37% 1.66% 0.45%
Plum Creek - - 2.31% 1.71% 0.56% -
Smurfit-Stone 0.71% - - -3.32% - -
USG 1.24% 3.36% 8.21% OUTLIER 4.69% 1.42%
Packaging Corp. 2.44% - 0.25% -2.13% 1.01% 3.27%
Industry Average 0.61% - 2.21% -0.84% 1.48% -
219
SUSTAINABLE GROWTH RATE
2002 2003 2004 2005 2006 2007
Temple-Inland -0.87% 1.09% 5.98% 3.82% 15.56% 3.46%
Plum Creek -0.07% 0.12% 0.11% -0.12% -0.13% 2.01%
Smurfit-Stone -1.90% 4.22% 0.78% 9.43% 1.22% 2.32%
USG -5.95% -11.79% - OUTLIER -7.02% -
Packaging Corp. OUTLIER OUTLIER -0.14% 1.90% -0.88% -
Industry -2.20% -1.59% -2.23% 3.76% 1.75% 1.08%
Capital Structure Ratios
DEBT TO EQUITY
2002 2003 2004 2005 2006 2007
TIN 1.55 1.36 8.56 9.4 8.35 6.62
IP 3.58 3.31 3.15 2.45 2.02 1.79
PKG 2.22 1.72 1.55 1.9 1.87 1.68
USG 5.8 4.51 3.18 -21.34 2.5 1.11
SSCC 3.66 3.45 3.24 3.84 3.37 2.98
PCL .93 1.08 .95 1.07 1.23 1.45
Industry 2.957 2.572 3.438 -.447 3.223 2.605
TIMES INTEREST EARNED
2002 2003 2004 2005 2006 2007
TIN 1.89 0.34 2.86 1.1 3.41 17.43
IP 7.23 3.43 27.85 48.83 187.53 68.92
PKG 2.15 0.8 4.75 4.13 7.24 11.47
USG 32.25 35 101.6 -470.8 1.77 1.57
SSCC -1.3 -0.14 -0.5 0.73 -0.81 -1.07
PCL 3.28 2.59 4.3 4.11 3.47 2.88
Industry 7.583 7.003 23.477 -68.65 33.768 16.867
220
DEBT SERVICE MARGIN
2002 2003 2004 2005 2006 2007
TIN 1.89 0.34 2.86 1.1 3.41 17.43
IP 7.23 3.43 27.85 48.83 187.53 68.92
PKG 2.15 0.8 4.75 4.13 7.24 11.47
USG 32.25 35 101.6 -470.8 1.77 1.57
SSCC -1.3 -0.14 -0.5 0.73 -0.81 -1.07
PCL 3.28 2.59 4.3 4.11 3.47 2.88
Industry 7.583 7.003 23.477 -68.65 33.768 16.867
Z-SCORES
2002 2003 2004 2005 2006 2007
TIN 1.89 0.34 2.86 1.1 3.41 17.43
IP 7.23 3.43 27.85 48.83 187.53 68.92
PKG 2.15 0.8 4.75 4.13 7.24 11.47
USG 32.25 35 101.6 -470.8 1.77 1.57
SSCC -1.3 -0.14 -0.5 0.73 -0.81 -1.07
PCL 3.28 2.59 4.3 4.11 3.47 2.88
Industry 7.583 7.003 23.477 -68.65 33.768 16.867
Weighted Average Cost of Debt
Current Liabilities Weight (W)
Rate ( R ) W x R
Accounts payable $ 244 4.7% 1.28% 0.06% Accrued employee compensation and benefits 108 2.1% 1.28% 0.03% Accrued interest 31 0.6% 1.28% 0.01% Accrued property taxes 11 0.2% 3.81% 0.01% Accrued income taxes 258 5.0% 3.81% 0.19% Other accrued expenses 173 3.4% 1.28% 0.04% Current portion of long-term debt 3 0.1% 6.93% 0.00% Current portion of pension and postretirement benefits 62 1.2% 6.13% 0.07% Long-Term Debt 852 16.5% 1.28% 0.21% Nonrecourse Financial Liabilities 2,140 41.5% 6.93% 2.87%
221
of Special Purpose Entities Deferred Tax Liability 762 14.8% 3.81% 0.56%
Liability for Pension Benefits 71 1.4% 6.13% 0.08% Liability for Postretirement Benefits 123 2.4% 6.13% 0.15% Other Long-Term Liabilities 324 6.3% 6.93% 0.44% TOTAL 5,162 100% 4.73%
Weighted Average Cost of Capital
Cost of
Debt D/V Tax Rate E/V
Cost of Equity WACC
WACCBT 4.73% 0.90 0 0.10 0.1753 6.06% WACCAT 4.73% 0.90 38% 0.10 0.1753 4.45% WACCBT Upper 4.73% 0.90 0 0.10 0.2353 6.68% WACCBT Lower 4.73% 0.90 0% 0.10 0.1153 5.43% WACCAT Upper 4.73% 0.90 0.38 0.10 0.2353 5.07% WACCAT Lower 4.73% 0.90 0.38 0.10 0.1153 3.82%
Cost of Equity Regression Analysis
222
3 Month
72 monthsRegression Statistics
Multiple R 0.473127061R Square 0.223849216Adjusted R Square 0.212761348Standard Error 0.104140467Observations 72
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.006089974 0.012331666 0.49384842 0.622959309 ‐0.018504758 0.030684705X Variable 1 1.688591413 0.375812151 4.493179394 2.70444E‐05 0.939057722 2.438125104
60 monthsRegression Statistics
Multiple R 0.420627107R Square 0.176927163Adjusted R Square 0.162736252Standard Error 0.110033515Observations 60
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.00791098 0.014207144 0.556831112 0.579785215 ‐0.020527708 0.036349668X Variable 1 1.696255163 0.480395647 3.530954484 0.000818917 0.734638805 2.65787152
48 monthsRegression Statistics
Multiple R 0.394309549R Square 0.15548002Adjusted R Square 0.13712089Standard Error 0.12167618Observations 48
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.006106671 0.017586738 0.3472316 0.73000102 ‐0.029293596 0.041506939X Variable 1 1.685393312 0.579148612 2.910122335 0.005551051 0.519627637 2.851158986
36 monthsRegression Statistics
Multiple R 0.351436184R Square 0.123507392Adjusted R Square 0.097728197Standard Error 0.13100994Observations 36
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.002776015 0.022018307 0.126077603 0.900413108 ‐0.041970568 0.047522599X Variable 1 1.488568321 0.680075246 2.188828852 0.035573785 0.106489143 2.870647498
24 monthsRegression Statistics
Multiple R 0.323603925R Square 0.1047195Adjusted R Square 0.064024932Standard Error 0.156202002Observations 24
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.004387205 0.032622029 0.134485968 0.894241087 ‐0.063266743 0.072041153X Variable 1 1.396324769 0.870444095 1.604152152 0.122941386 ‐0.408865789 3.201515327
223
2 Year
72 monthsRegression Statistics
Multiple R 0.471114907R Square 0.221949255Adjusted R Square 0.210834245Standard Error 0.104267853Observations 72
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.006725058 0.012334165 0.54523819 0.587322857 ‐0.017874659 0.031324775X Variable 1 1.681031363 0.376187111 4.468604358 2.95735E‐05 0.930749838 2.431312889
60 monthsRegression Statistics
Multiple R 0.418349652R Square 0.175016432Adjusted R Square 0.160792577Standard Error 0.11016116Observations 60
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.008503789 0.014221887 0.597936789 0.552209822 ‐0.01996441 0.036971988X Variable 1 1.686866669 0.480894707 3.507767175 0.000879969 0.724251333 2.649482005
48 monthsRegression Statistics
Multiple R 0.392235785R Square 0.153848911Adjusted R Square 0.135454322Standard Error 0.121793626Observations 48
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.006461672 0.017610882 0.366913622 0.715365967 ‐0.028987194 0.041910539X Variable 1 1.674329484 0.578946929 2.892025847 0.005827999 0.508969776 2.839689192
36 monthsRegression Statistics
Multiple R 0.349247437R Square 0.121973772Adjusted R Square 0.096149472Standard Error 0.131124505Observations 36
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.002865004 0.022045201 0.129960427 0.897363584 ‐0.041936236 0.047666243X Variable 1 1.475424775 0.678887997 2.173296306 0.036817585 0.095758379 2.855091171
24 monthsRegression Statistics
Multiple R 0.321531328R Square 0.103382395Adjusted R Square 0.062627049Standard Error 0.156318603Observations 24
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.004399244 0.032657425 0.134708858 0.894066912 ‐0.06332811 0.072126599X Variable 1 1.383475867 0.868641519 1.592689085 0.125497457 ‐0.417976377 3.184928112
224
5 Year
72 monthsRegression Statistics
Multiple R 0.471048216R Square 0.221886422Adjusted R Square 0.210770513Standard Error 0.104272063Observations 72
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.007513591 0.012320687 0.609835421 0.543945438 ‐0.017059244 0.032086427X Variable 1 1.68219947 0.376517014 4.467791383 2.9661E‐05 0.931259974 2.433138965
60 monthsRegression Statistics
Multiple R 0.418181367R Square 0.174875656Adjusted R Square 0.160649374Standard Error 0.110170559Observations 60
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.009105347 0.014223368 0.640168135 0.524584282 ‐0.019365817 0.037576511X Variable 1 1.685417666 0.480715989 3.506057017 0.000884639 0.723160074 2.647675258
48 monthsRegression Statistics
Multiple R 0.392586291R Square 0.154123996Adjusted R Square 0.135735387Standard Error 0.121773827Observations 48
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.006774874 0.017614755 0.384613596 0.702296187 ‐0.028681787 0.042231535X Variable 1 1.671358802 0.577309892 2.89508083 0.005780361 0.509294279 2.833423325
36 monthsRegression Statistics
Multiple R 0.349508994R Square 0.122156537Adjusted R Square 0.096337611Standard Error 0.131110857Observations 36
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.003073785 0.02205543 0.13936636 0.889982928 ‐0.041748241 0.047895811X Variable 1 1.471045162 0.676295864 2.175150317 0.036667115 0.096646614 2.845443711
24 monthsRegression Statistics
Multiple R 0.322100678R Square 0.103748847Adjusted R Square 0.063010158Standard Error 0.156286655Observations 24
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.00471802 0.032691184 0.144320853 0.886561032 ‐0.063079345 0.072515384X Variable 1 1.38118161 0.86549123 1.595835478 0.124791493 ‐0.413737334 3.176100554
225
7 Year
72 monthsRegression Statistics
Multiple R 0.470597376R Square 0.22146189Adjusted R Square 0.210339917Standard Error 0.104300504Observations 72
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.008123026 0.012315 0.659604201 0.511672209 ‐0.016438467 0.032684518X Variable 1 1.678880526 0.376236745 4.462298133 3.02586E‐05 0.928500008 2.429261044
60 monthsRegression Statistics
Multiple R 0.41659026R Square 0.173547444Adjusted R Square 0.159298262Standard Error 0.110259195Observations 60
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.00935774 0.014235549 0.657350105 0.513556116 ‐0.019137808 0.037853288X Variable 1 1.67128728 0.478891317 3.489909336 0.000929913 0.712682164 2.629892395
48 monthsRegression Statistics
Multiple R 0.391563023R Square 0.153321601Adjusted R Square 0.134915549Standard Error 0.12183157Observations 48
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.006582957 0.017619043 0.373627381 0.710398076 ‐0.028882336 0.04204825X Variable 1 1.654463577 0.573239174 2.886166284 0.005920395 0.500592984 2.80833417
36 monthsRegression Statistics
Multiple R 0.348645548R Square 0.121553718Adjusted R Square 0.095717063Standard Error 0.131155867Observations 36
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.00268557 0.022040397 0.121847621 0.903737032 ‐0.042105905 0.047477045X Variable 1 1.451481525 0.669183977 2.169032096 0.03716575 0.091536069 2.811426982
24 monthsRegression Statistics
Multiple R 0.32170255R Square 0.103492531Adjusted R Square 0.062742191Standard Error 0.156309002Observations 24
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.004631435 0.032685951 0.141694962 0.888610507 ‐0.063155079 0.072417949X Variable 1 1.364655736 0.856316312 1.593635105 0.125284847 ‐0.411235593 3.140547066
226
10 Year
72 monthsRegression Statistics
Multiple R 0.471473359R Square 0.222287128Adjusted R Square 0.211176944Standard Error 0.104245211Observations 72
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.005791418 0.01235118 0.468895926 0.640601099 ‐0.018842234 0.03042507X Variable 1 1.682562586 0.376161803 4.472975646 2.91075E‐05 0.932331535 2.432793637
60 monthsRegression Statistics
Multiple R 0.417795551R Square 0.174553122Adjusted R Square 0.160321279Standard Error 0.110192089Observations 60
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.00711171 0.01423321 0.499656092 0.619207533 ‐0.021379154 0.035602574X Variable 1 1.677424002 0.478971431 3.5021379 0.00089543 0.718658522 2.636189482
48 monthsRegression Statistics
Multiple R 0.39256682R Square 0.154108708Adjusted R Square 0.135719767Standard Error 0.121774927Observations 48
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.004508352 0.017580736 0.256437047 0.798756819 ‐0.030879833 0.039896537X Variable 1 1.661210381 0.573838136 2.894911085 0.005782998 0.506134141 2.816286621
36 monthsRegression Statistics
Multiple R 0.349780714R Square 0.122346548Adjusted R Square 0.096533211Standard Error 0.131096667Observations 36
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.000952136 0.021941965 0.04339336 0.965641818 ‐0.043639303 0.045543574X Variable 1 1.459648567 0.670462541 2.177076984 0.036511328 0.097104756 2.822192377
24 monthsRegression Statistics
Multiple R 0.322893183R Square 0.104260008Adjusted R Square 0.063544553Standard Error 0.156242081Observations 24
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95%Intercept 0.003015742 0.032462841 0.09289827 0.926825186 ‐0.064308069 0.070339553X Variable 1 1.373214616 0.858142049 1.600218306 0.123813626 ‐0.406463059 3.15289229
227
Method of Comparables
Price/Earnings Trailing
3-Nov PPS P/E EPS Average P/E Suggested PriceTIN 5.61 0.46 12.31 16.045 197.54PKG 16.34 11.43 1.43IP 16.34 11.03 1.48SSCC 1.36 17.07 0.08USG 14.59 N/A N/APCL 35.56 24.65 1.44
Trailing P/E
Price/Earnings Forward
3-Nov PPS P/E EPS Average PSuggested PriceTIN 5.61 148.66 0.04 26.21 0.99PKG 16.34 10.58 1.54IP 16.34 10.03 1.63SSCC 1.36 54 0.03USG 14.59 N/A N/APCL 35.56 30.23 1.18
Forward P/E
Price/Book
P/B Comparable
PPS BPS P/B IND AVG TIN PPS
TIN $5.61 7.31 0.77 1.42 $10.35
USG $14.59 22.12 0.66
PKG $16.34 7.35 2.22
PCL $35.56 11.11 3.20
SSCC $1.36 7.22 0.19
IP $16.34 20.27 0.81
228
Price Earnings Growth
P.E.G. Comparable
Company P/E Growth P.E.G. Industry
Avg.
TIN PPS
($)
TIN .46 -93.64 -.0049 3 -.34585
IP 7.48 4.857 1.54
PKG 10.5 N/A N/A
USG N/A N/A N/A
SSCC 5.9 N/A N/A
PCL 22.14 4.96 4.46
Price/EBITDA
P/EBITDA Comparable
Company Mkt Cap
($)
EBITDA ($) P/EBITDA Industry
Avg.
TIN PPS
TIN .6934B 2.305B .301 4.32 $9.96
IP 6.24B 2.84B 2.2
PKG 1.56B .418B 3.73
USG 1.43B .024B 59.58 Throw Out
SSCC .278B .544B .51
PCL 5.65B .522B 10.83
229
EV/EBITDA
EV/EBITDA ComparableCompany EV
($) EBITDA
($) EV/EBITDA Industry
Avg. TIN PPS
TIN 5.628B 2.305B 2.44 8.74 $33.03 IP 18.11B 2.84B 6.38 PKG 2.16B .418B 5.16 USG 2.73B .24B 113.74 Throw Out SSCC 3.99B .544B 7.34 PCL 8.38B .522B 16.06
Price / Free Cash Flows
Market Cap FCF P/FCF Ind Avg P/FCF PER SHARE
TIN 596.17 (2,019)
(0.30)
7.64
(0.02)
USG 1430 577 2.48
PKG 1560 186.96 8.34
PCL 5650 255 22.16
SSCC 278 311 0.89
IP 6240 1441 4.33
230
Dividends/Price
DPS PPS D/P IND AVG TIN PPS
TIN 0.3 $5.61 0.053 0.045 $6.74
USG n/a $14.59 n/a
PKG n/a $16.34 n/a
PCL 1.72 $35.56 0.048
SSCC 0.031 $1.36 0.023
IP 1.02 $16.34 0.062
231
Intrinsic Valuation Models
Discounted Dividends Approach
Discounted Free Cash Flows Approach
0.00% 3.05% 6.00% 9.00% 12.00% 15.00% 18.00%11.53% 4.51 5.15 6.44 10.82 -40.77 -3.15 -0.4213.53% 3.84 4.21 4.86 6.39 13.91 -9.27 -1.3315.53% 3.34 3.57 3.94 4.66 6.58 30.32 -3.61
Ke 17.53% 2.96 3.12 3.34 3.72 4.53 7.24 -24.67
19.53% 2.67 2.77 2.91 3.14 3.55 4.50 9.1921.53% 2.43 2.50 2.59 2.74 2.97 3.42 4.6323.53% 2.23 2.28 2.35 2.44 2.58 2.83 3.34
Price > 6.45 4.77<Price<6.45 Price<4.77
g
g0 0.010 0.020 0.030 0.040 0.050 0.060
0.0544 0.58 7.88 19.43 40.44 90.65 369.03 -346.820.056 -0.98 5.78 16.28 34.87 76.68 257.88 -466.92
0.0583 -3.07 2.99 12.21 27.94 60.86 173.13 -1035.36WACCBT 0.0606 -5 0.045 8.58 22.04 48.565 125.11 2753.37
0.0622 -6.27 -1.19 6.29 18.42 41.49 102.36 716.600.0653 -8.55 -4.11 2.3 12.34 30.31 71.78 269.730.0668 -9.59 -5.41 0.55 9.75 25.82 61.01 199.72
Price > 6.45 4.77<Price<6.45 Price<4.77
232
Residual Income Approach
Book Value Equity (Millions) 780.00 Total PV of YBY RI (354.39)
Terminal Value Perpetuity (64.83) MVE 12/31/07 360.78 Shares Outstanding 106.10 Model Price on 12/31/07 3.40Time Consistent Price 3.89
Observed Share Price (11/3/2008) 5.61
Initial Cost of Equity (You Derive) 0.1753Perpetuity Growth Rate (g) -0.1
(0.10) (0.20) (0.30) (0.40) (0.50) (0.60) (0.70) 11.53% 6.15 6.27 6.33 6.37 6.40 6.42 6.43 13.53% 5.20 5.37 5.47 5.53 5.57 5.59 5.62 15.53% 4.47 4.66 4.76 4.83 4.88 4.91 4.9417.53% 3.89 4.08 4.18 4.25 4.30 4.34 4.3719.53% 3.43 3.60 3.71 3.78 3.83 3.86 3.8921.53% 3.05 3.21 3.31 3.38 3.43 3.46 3.4923.53% 2.75 2.89 2.98 3.04 3.09 3.12 3.15
Undervalued < $6.45 $6.45 < Fairly Valued > $4.77 $4.77 > Overvalued
233
Abnormal Earnings Growth Approach
0.1 0.2 0.3 0.4 0.5 0.6 0.7
11.53% 5.48 5.59 5.64 5.67 5.69 5.71 5.7213.53% 4.47 4.56 4.61 4.64 4.66 4.68 4.6915.53% 3.77 3.84 3.89 3.91 3.93 3.95 3.96
Ke 17.53% 3.26 3.32 3.36 3.38 3.39 3.41 3.42
19.53% 2.87 2.92 2.95 2.97 2.99 3 3.01
21.53% 2.58 2.62 2.64 2.66 2.67 2.68 2.6823.53% 2.34 2.37 2.39 2.4 2.41 2.42 2.43
Price > 6.45 4.77<Price<6.45 Price<4.77
g
234
Long Run Residual Income Approach
Growth Rate 0.04 ROE 0.0984 Present Value of Equity from Year 10 472.65 Ke 0.1753 Shares Oustanding 106.10 Model Price 12/31/07 4.45 Time Consistant Price 5.10
ROE = .0384 ROE = .0584 ROE = .0784 ROE = .0984 ROE = .1184 ROE = .1384 ROE = .1584Ke = .1153 (0.22) 2.76 5.76 8.77 11.77 14.77 17.77Ke = .1353 (0.19) 2.21 4.62 7.03 9.44 11.84 14.25
g = .04 Ke = .1553 (0.16) 1.86 3.88 5.90 7.91 9.93 11.95Ke = .1753 (0.14) 1.61 3.35 5.10 6.84 8.59 10.33Ke = .1953 (0.12) 1.42 2.96 4.50 6.05 7.59 9.13Ke = .2153 (0.11) 1.27 2.66 4.04 5.43 6.82 8.20Ke = .2353 (0.10) 1.16 2.42 3.68 4.94 6.20 7.46
Undervalued < $6.45 $6.45 < Fairly Valued > $4.77 $4.77 > Overvalued
ROE = .0384 ROE = .0584 ROE = .0784 ROE = .0984 ROE = .1184 ROE = .1384 ROE = .1584g = .01 2.03 3.46 4.89 6.31 7.74 9.17 10.60 g = .02 1.40 2.92 4.44 5.96 7.48 9.00 10.52
Ke = .1753 g = .03 0.68 2.31 3.93 5.56 7.18 8.81 10.43 g = .04 (0.14) 1.61 3.35 5.10 6.84 8.59 10.33 g = .05 (1.09) 0.79 2.68 4.56 6.45 8.33 10.22 g = .06 (2.21) (0.14) 1.88 3.93 5.98 8.03 10.08 g = .07 (3.54) (1.30) 0.94 3.18 5.43 7.67 9.91
Undervalued < $6.45 $6.45 < Fairly Valued > $4.77 $4.77 > Overvalued
Ke = .1153 Ke = .1353 Ke = .1553 Ke = .1753 Ke = .1953 Ke = .2153 Ke = .2353
g = .01 9.49 8.09 7.08 6.31 5.71 5.23 4.83 g = .02 9.3 7.8000 6.74 5.9600 5.36 4.8700 4.48g = .03 9.06 7.45 6.35 5.56 4.96 4.48 4.1
ROE = .0984 g = .04 8.77 7.03 5.9 5.10 4.5 4.04 3.68g = .05 8.38 6.51 5.35 4.56 3.99 3.56 3.21g = .06 7.85 5.85 4.69 3.93 3.4 3.00 2.7g = .07 7.09 4.99 3.88 3.18 2.71 2.37 2.11
Undervalued < $6.45 $6.45 < Fairly Valued > $4.77 $4.77 > Overvalued
235
References
Temple-Inland, Inc. 10-K
Packaging Corporation of America 10-K
Plum Creek Timber Company, Inc. 10-K
USG Corporation 10-K
International Paper Company 10-K
Smurfit-Stone Container Corporation 10-K
Stlouisfed.org. stlouisfed.org. 10 Oct. 2008 < http://research.stlouisfed.org >
Lex team. "Timber." Ft.com. 27 Oct. 2008. 27 2008. 25 Nov. 2008 <http://www.ft.com>.
Answers.com. Answers.com. 15 Sept. 2008 <http://www.answers.com>.
Barris, Mike. "Temple-Inland 2Q Net Dives 88% Amid Housing Slump." Wall Street Journal 30 July
2008.
Corrugated Packaging Alliance. Corrugated Packaging. Corrugated Packaging Alliance. 15 Sept. 2008
<http://www.corrugated.org>.
Palepu, Krishna G., and Paul M. Healy. Business Analysis and Valuation : Using Financial Statements.
Mason: Cengage South-Western, 2007.
Temple-Inland. Temple-Inland. Temple-Inland, Inc. 15 Sept. 2008 <http://www.templeinland.com>.
Tibken, Shara. "Weyerhaeuser Posts Loss, Plans to Cut 1,500 Jobs." Wall Street Journal 5 Aug. 2008.
Gongloff, Mark. "Struggling To Fill Vacant Homes." Wall Street Journal 24 July 2008.
Hinton, Christopher. "Packaging Corp. reaches all-time high on improved pricing." MarketWatch 19 July
2007.
Chazan, Guy. "Oil Hits $145 As Supply Fears Push Up Prices." Wall Street Journal 3 July 2008.
Gelsi, Steve. "USG Corp. sees signs of stablization in construction market." MarketWatch 22 Apr. 2008.
