Company Valuation Report: The Case of Goodman Fielder Ltd

Executive Summary

This company valuation analysis is based on five year performance of Goodman Fielder Group Ltd (GFL). GFL is a public company listed in the ASX and has its headquarters in Sydney Australia. The analysis is based on the period between financial years 2006 and 2010.This analysis has used different valuation models to establish the intrinsic value of the share of GFL which in this study has been equated to the value of the firm.

The valuation has also considered other firms in the firms in the food industry for the purposes of comparison. Associated British Foods Plc. and Campbell Soup Companies have been analyzed and their performance compared with that of GFL.

Various models have used for valuation purpose and they include: The DuPont analysis, the CAPM model, Dividend Valuation Model, The FCFE model, P/E ratio model and the Price/Book value model. DuPont model analyses three components of the firm and compare them with their peers in the Industry to evaluate its performance relative to the peers. The three components include the firm’s profitability, efficiency and level of leveraging which are measured using various ratios. All of the various models used in this analysis have arrived at different values of the firm. Hence, this study has suggested the DDM as the preferred model as explained at the last part of the analysis.

Goodman Fielder Ltd Overview

Goodman Fielder is a publically listed company in the Australian Securities Exchange (ASX) stock exchange dealing in food products. The company boasts of a wide range of reputed brands that have become engraved in the minds of many generations in Australia and New Zealand. Goodman Fielder has its capital in Sydney Australia and has an employee base of more than 7000in Australia and its Islands in the Pacific Ocean. The company has close to sixty plants but has other branches in New Zealand, Papua New Guinea, New Caledonia and Fiji.

Goodman products cover all essential meals supplements apt for breakfast, lunch, dinner and a wide range of snacks. The company sells its goods in its two categorized markets; the retail grocery and the Commercial and food services markets. In the grocery market, the company supplies branded and private labeled packaged goods such as dairy products sauces backed goods dressings and condiments. In the Commercial and food Services Market, Goodman supplies voluminous and packaged edibles such as fats, oils, flowers mainly to manufacturers and wholesalers either in branded or unbranded form.

Recent financial Performance

The financial statements of Goodman Fielder were prepared according the Australian accounting standards and audited by KPMG audit firm. The operating revenue for Goodman Fielder has been increasing in the period between 2006 and 2009 but a slight decline was witnessed in the FY 2010. The increase amounted to $1326 million in the period between FY 2006 and 2009 which is an increase of 87.08%. The revenue decreased in the FY 2010 by 6.61% from $2848.60 to $2660.10. This could have been catalyzed by the expansion of the operations as a result of the acquisition of the remaining 50% of Oilstream joint venture in the FY 2010 and the opening of new head office and research facility in North Ryde, NSW. In general, the operating revenues of the company grew implying that the successive mergers and acquisitions resulted in an expanded customer base hence more sales.

The Earnings before Interest and Tax (EBIT) is used to measure the ability of the firm to generate revenue regardless of deductions such as the government tax and the interest charged by the lenders of business finance. The EBIT margin increased marginally in the year 2007 as shown in table 1. The EBIT declined in the years 2008 and 2009 respectively but saw a slight improvement in 2010. The EPS grew in the year 2009 which can be attributed to three acquisitions three interests namely: LaBiscuitere, Copperpot, and River Mill Bakeries and Canterbury Flour Mills businesses in New Zealand. Acquisitions lead to increase in asset base that enable more revenue generation and an increased customer base.

Table 2: An analysis of the changes in the level of debt and earnings

The company was heavily financed using debt as shown by the debt to EBITDA ratio. The level of debt financing was growing consecutively from the year 2006 to 2009 indicating that gearing rate of the firm was high. The EPS reduced in the year 2007 and 2008 explained by the use of debt in the acquisition of more assets to generate more revenue.

Table 1: Comparison between EPS growth and EBIT growth

The increase of EBIT in 2007 (18.30%) did not result in increased EPS due to the fact that the new assets acquired and which had not started generating enough revenue to cover financing costs. The dividends were still paid every year with the expectation of high EPS in the future. The EPS was least in the year 2009 when it fell by 16 cents resulting from the decline in the EBIT at the same duration. The EBIT improved in the year 2010 by 14.50% though the increase was not enough to reflect a positive EPS as shown in the tabl1. This implies the in the year 2010, the company was not able to generate profits for the investors.

DuPont Analysis

DuPont Analysis is an analysis that seeks to measure the Return on Equity of a firm. DuPont analysis incorporates the measurement of the firm’s profit margin, the total asset turnover, and impact of the financial leverage on the firm including the effect of income taxes on ROE. The profit margin measures the operating efficiency of the firm while the asset use efficiency is measured using the total asset turnover. In conducting the DuPont ROE analysis, Goodman’s Fielder Ltd financial performance was evaluated vis-à-vis that of its peers in the food industry. Two companies namely; Associated British Foods Plc. (ABF) and Campbell Soup Company (CSC) financial performance was analyzed and compared to Goodman Fielder Ltd as shown in table4.

Table 4: A Summary of DuPont Analysis

Analysis based on the three Companies Audited reports for FY 2006-10

EBIT/Sales

This is a ratio that measures the profitability of the firm by evaluating its ability to generate earnings before interest and tax expenses (Atrill & Mclaney, 2008, p. 19). By analyzing the EBIT to Sales ratio, an investor is able to compare the specific firm’s ratio with its peers in the industry and hence be in a position of making a rational decision.

The EBIT/Sales margin was high in the FY and 2007 but decreased in the FY 2008. The margin finally picked momentum to grow through the FY 2010. When compared with its peers, Goodman Fielder Ltd (GFL) EBIT/Sales margin was higher in the year 2006 but the trend changed in the following years.

Sales/Total Assets

This ratio is known as the Total Asset Turnover (TAT) and measures the efficiency of the assets in generating the sales. A high TAT ratio indicates the ability of the firm to utilize its assets to generate high sales. Compared to the two peers in the industry, GFL has the least asset turn over in the five year period except for the FY 2010 when it exceeded the asset turnover CSC. The TAT for CSC was the highest for the period between FY 2006 to FY 2009.

Interest Expense/Total Debt

This is a ratio that measures the proportion of debt financing charges in relation to the debts. A high ratio is not desirable because it indicates that the firm is paying high interests on the funds borrowed thus increasing the firm’s total expenses for the fiscal period (Weston & Copeland, 1992, p. 23). The interest expense to debt ratio for GFL was at 3.6% for FYs 2006 and 2007 but rose to 8.3% in the FYs 2008 and 2009. Finally, the ratio shot to 25.3% in the FY 2010 which was as a result of growing interest expense in these periods.

The interest expense ratio for ABF was at 7.2% in 2006, declined to an average of 5.1 in FYs 2007-8 and finally maintained at 5.4% in the FY 2010. CSC was at an average of 6% with minor fluctuations around this mean

Net before Tax/Common Equity

This is a ratio that measures the pre-tax return on a firm’s equity and represents the returns generated using the owners’ equity before the payment of tax. The ratio for GFL was lower as compared to its peers which is attributable to low level of earnings before tax. GFL has a larger common equity in comparison to its peers in the market which implies that the return on owners’ investments was low for the firm. The ratio is likely to increase in the coming years when the assets acquired through the owners equity start generating more returns.

Tax Retention Rate

This is a ration that measures the proportion of earning before tax that is retained after the payment of income tax for the period (Wild, Subranyam, & Hasley, 2007, p. 63). A higher ratio indicates that the income tax expense is low in relation to the earnings before tax, hence this is desirable.

The tax retention ratio for GFL was highest in the FY 2007at 0.77 and lowest in the FY 2008 at 0.2.Compared to its peers; the GFL’s retention rate was the least for all the five years analyzed indicating its high income tax expenses and a low net profit before tax.

Return on Equity (ROE)

The average ROE for GFL for the five year period was at 22.93% which is higher than that of ABF which stood at 8.37%. The average ROE for CSC was the highest among the three companies in the food industry and stood at 77.84%. The return on equity for GFL was lower than the average of the three firms which stood at 36.38%. The ROE for GFL is likely to increase due to the project increase in the profit level as a result of asset efficiency.

Estimation of the value of Goodman Fielder

Capital Asset Pricing Model (CAPM)

Capital asset pricing model (CAPM) seeks to predict the risk-return connection among all the risky assets in a portfolio. CAPM model is built on diversification assumptions that are often inexistent in the real business situation. Various assumptions are taken into account for the CAPM to be applicable for prediction purposes. The purpose of assumptions in applying the principles of CAPM is that they are designed to equalize all investors in certain market as practicable.

First, CAPM assumes that all investors so small in the market that they cannot determine the price of the securities in a portfolio. As such investors are viewed as price takers as opposed to being price setters. Secondly, CAPM assumes that there are no restrictions on trading with infinite risk free borrowing and lending opportunities. This implies that investors can purchase and sell any number of securities he desires without limitation. CAPM also assumes that all the investors are planning to hold their securities for just one trading horizon; hence it takes a short term perspective. Also, the model assumes a frictionless market in that there are no transactional costs and taxes and therefore investors are indifferent between capital gains and receipt of dividends.

CAPM assumes a mean variance investor, implying that investors desire to construct efficient frontier portfolios. Additionally, the model assumes that the investors have homogenous expectations in that they should arrive at the same inference.

CAPM equation is made up of three components, the Risk free rate (r_f), the Market risk premium (r_m), and the beta (β).

Valuation Assumptions

The valuation on Goodman Fielder will be conducted to ascertain the intrinsic value of the shares using various valuation models. The analysis will use the S&P 200 historical data in tandem with the economic outlook analysis.

The three components of the CAPM equation are necessary in the calculation of the discount rate in the valuation model as explained below.

Risk-free rate (R_f)

This is the rate of return that investors expect to receive without any risk associated with it. In the case of Goodman Fielder, the rate used in this evaluation will be the present 10 year Australian government Treasury bond which is 5.575% according to the Reserve Bank of Australia in 2011.

The Market Return (R_m)

The market return will be derived from the economic situation deduced from the present economic environment. The market return was calculated using the economic outlook prevailing in the year 2010. The expected market return will be 11.5% as calculated in table3.

Table 3: Estimation of the Market Return

Market Risk Premium (R_m-R_f)

This is the difference between the market return and the risk free rate of return and calculated as follows.

Beta (β) Estimation

The CAPM formula shown below is used to estimation of the required rate of return by utilizing the beta derived using Microsoft Excel. Based on regression analysis, beta is calculated and substituted in the CAPM formula to derive the required rate of return as shown below. From the regression analysis, the beta was established as 0.00253.

The beta coefficient of a firm is used to measure the non-diversifiable risk also known as the market risk. The beta measures the market risk of a specific risky asset in relation to the fully diversified market portfolio. In this analysis, the valuation of the market portfolio will be based on the S&P 200 index.

Method

First, the monthly market returns represented by ASX 200 will be computed. This will be followed by computation of the individual GFL stock price indices for a five year period between 30^th June 2006 and 30^th June 2010. The monthly market returns are denoted as R_m while GFL stock return is denoted as R_i.

From the calculation as shown in the Excel sheet (appendix 2) attached to this paper, the required rate of return for GFL stock is calculated to be 19.1564%. Hence, this is the rate of return that will be used in the valuation models.

Dividend Valuation Model (DDM)

Dividend valuation model is applicable to firms whose dividend policy allows them to pay dividends to the shareholders consistently (Olweny, 2011, p. 5). The theory of the model is built on the concept that the value of a firm is equal to the present value of all dividends issued to the shareholders infinitely (Reilly & Brown, 2009, p. 24). In the valuation process, the assumptions for the dividend growth rates will be taken into account.

There are two models for DDM brought about by the presence of stable dividend growth rate and the unstable dividends growth. For the stable dividend growth model to apply, the expected rate of return (r_e) should be bigger than the dividend growth rate (g). The formula for the computation of the constant growth DDM is as shown below:

Second is the multi-stage dividend growth rate model that takes into account the different attributes of the company and the future economic outlook. In this model, the growth rate varies in different fiscal periods and the growth could exceed the expected rate of return. The formula for calculating the Multi-stage growth model is shown below:

Where: D₁= D₀ (1+g₁), D₂= D₁ (1+g₂), D_n= D₂ (1+g_n).

Both models will be used in the estimation of the intrinsic value of Goodman Fielder Ltd share price. This will necessitate for the forecasting of the future dividend growth rate.

Table 4: Estimation of dividend growth for Goodman Fielder Ltd

GFL Dividend Forecast

The dividend for GFL has not been stable as depicted in the growth analysis as shown in table4.The DPS grew significantly in the FY 2007 by 145.5%. The DPS maintained in the year 2009 but continued to decline through FY 2011. The DPS growth decline was highest in the FY 2011 when it fell by 27.91%. The dividend for FY is not known since dividends have not been issued. The firms operating environment is projected to continue being fluid due to the high food price inflation, cost volatilities and currency translation uncertainties expected in the coming years. In the year 2010, the company’s management expected the Net profit after tax (NPAT) to grow by at between 5% and 9 % in the year 2011.

GFL is projected to experience a high dividend as from the period FYs 2014-16 averaging at around 13%. The company is expected to have a stable growth of about 3% in the long-run, that is, from 2017 into the future.

Table 6: GFL Dividend Forecast

Table 7: GFL Intrinsic Share Price (Cents)

The intrinsic share price was established at $0.88 per share as indicated in table 7. The computations were based on the combination of both stable growth rate model and the multi-stage dividend growth model. The rate of return used in the calculation was 19.16% as established using the CAPM model.

Free Cash flow to Equity Model (FCFE Model)

The free cash flow equity model establishes the amount of free cash flows available to the owners of a firm after settling all the other capital lenders and providing for sustained company growth. The model uses discounted free cash flows to calculate the intrinsic value of a firm’s share price. The model is more apt for firms that do not pay any dividends or is inconsistent in dividend payment. The concept of the model seeks to calculate the present value of the entire firm’s future free cash flow to equity available to the shareholders (Wilkes, 1977 , p. 188)

The difference between FCFE Model and the DDM Model is that the later uses the discounted future dividends while the former discounts the free cash flows to equity (Garbarino & Holland, 2009, p. 24). The model however, measures the present value of the earnings concept taking into account the capital expenditures and the changes in working capital. The FCFE are usually available to the ordinary shareholders before they receive the dividends and measures what the firm can afford to pay as dividends.

Like the dividend valuation model, FCFE has two models with the first assuming constant growth cash flows. The model has an assumption that the required rate of return (r_e) should be higher than the FCFE growth rate (g_FCFE). The FCFE constant growth model formula is as indicated below:

Where:

• FCFE₁= FCFE₀ (1+g₁)
• FCFE₂= FCFE₁ (1+g₂)
• FCFE_n= FCFE₂ (1+g_n)

The second model considered is the FCFE multi-growth rate model in which the growth rate can exceed the expected rate of return in the short-run (Gibson, 2009, pp. 48-50). Various factors contribute to the multi-stage growth rates including the future economic outlook, the company’s specific characteristics and the stages in the business cycle (The Treasury, 2002, p. 44).The FCFE multi-stage model equation is shown below:

In calculation of the GFL intrinsic share price, both models will be utilized in tandem with the other valuation models. The different growth phases that the firm is likely to go through necessitated the forecasting of the FCFE growth rate.

Cash Flow Forecast

FCFE is calculated using the formula below:

Table 5: GFL Historical Free Cash Flow to Equity Values

The FCFE growth is very inconsistent ranging from -94.8% in the 2008 and 2648.2% in 2009. FCFE future projections cannot be done with certainty and is affected by various external forces such global financial crisis likely to negatively impact the company performance.

Table 10: FCFE Forecasting Model for GFL

The intrinsic value of the firm’s share price is $1.27 which is much lower than the market price of the shares. The shares are therefore overvalued in the market.

Price / Earnings Ratio Model (P/E)

This P/E model compares companies with similar characteristics such as business lifecycle and the risk level (Wilkes, 1977 , p. 43). It attempts to compare the current share price with the firm’s EPS. It is also known as the Earning Multiplier Model and is used by investors to measure the value of ordinary shares. The earning model is calculated as follows:

The P/E ratio can also be determined using the infinite period dividend discount model as indicate in the equation below:

If the price of the share is expressed as a fraction of the EPS, the resultant equation is shown below:

Table 8: P/E Ratio forecast for 2011

The earnings multiplier model will be used to calculate the P/E ratio in this analysis because GFL EPS growth is not constant as shown in table 8. From the P/E ratio calculated, the analysis indicates the investors are willing to pay $6.855 for every $1 of earning made by GFL. The P/E ratio for GFL amounts to $6.855 as shown in table 8. The P/E is bound to change in the future depending on the growth of dividends. In this analysis has assumed that dividends will grow in the same direction with the EPS. EPS and P/E ratio have a reverse relationship, hence a positive dividend growth will surmount into P/E reduction.

Price/ Book Value Ratio (P/B)

This model seeks to compare the firm’s book value of equity and the market value of equity. The model is thus useful in establishing the stocks that are undervalued and hence help the investors know which stock to buy. First the Expected equity book is calculated using the dividend growth rate as shown below:

In the case of GFL, Price/Book value ratio is calculated as shown below:

• Current share price (As at 30^th June 2010) = $85.82
• EBV in 2011= 1668m (1.07) = 1784.76m

Number of outstanding shares= 1380.386m

Hence price to book value ratio is calculated as;

= 66.3757

The analysis is based on the forecasted growth of 7%. From the calculations above, the company’s share will be trading at a 66.38 times price higher than the book value of 1.29 per share. Table 9 indicates the P/E ratio for the five year period.

Table 9: GFL Book Share value 2006-10

From the table 9, the P/E ratio was not stable but was above the value of 1. This indicates that no single financial year did the share trade below its book value. Hence, the investors will be interested in the shares of GFL due to this high ratio as it indicates the undervaluing of the shares by the company (Viney, 2009, p. 15). However, for better decisions, the ratio should be compared with that of peers in the market.

Evaluation of the Value/Price of the company

The value of the company as indicated by the intrinsic share price differs with the current market price for a number of reasons. First, the value of the firm is calculated using different models and each model is based on assumptions that may not apply in the real world. For instance, the FCFE and the P/E ratio models are dependent on a sustained dividends’ growth into the future.

In the real business world, various reasons may hinder the applicability of these models based on the fact that the prevailing firm’s performance may not support sustained dividend growth into the future. Most firms’ dividend policies recommend that firms should pay dividends from the profits generated rather than from the reserves (Wilkes, 1977 , p. 199). As such, in economic periods when the firm is not performing well in terms of operating profits, it may not be possible to issue dividends.

From the ensuing, the various models that are dependent on the issuance of dividends become defunct if the issuance of the dividends is discontinued. The dividend valuation model for instance, works by forecasting the dividend growth based on the prevailing economic environment including the global GDP changes as reported by the concern bodies. As such, the dividend growth forecast cannot be predicted with much certainty. This inaccuracy in the DDM model will apparently arrive at a different value of the firm different from the prevailing market price. Most of the models such as the DDM and the FCFE models use discounted cash flows which are factored using the be in expected rate of return derived from the CAPM model which in return is derived using the Individual company’s index which represent their market return. As such, the discounted cash flows may not be accurate due to the fact that the stock return is based on the information available in the market which may be inaccurate due to the market inefficiency orchestrated by the lack of information by the market players.

Secondly, it is also difficult to factor all the variables that may affect the value of a given model. For instance, it is very difficult to factor all the macroeconomic factors in to a model (United Nations, 2012, p. 12). Such factors are active in the real business world and they will bear on the share price in the market. These factors may include the world GPD changes, or the global economic downturns which may have widespread economic implications.

The market share price is based on forces of demand and supply. The share price may be high due to its high demand stemming from the psychological aspect of investors in the market as opposed to the real share value. As such, the share prices in an efficient market are driven by the value of information. Lack of useful information may lead to mispricing of the shares in the market.

This analysis favors the dividend discount model based on the fact that Goodman Fielder paid out dividends consistently. The firm also indicates that it will continue to pay dividend though they may vary from year to year. The model was preferred to the FCFE model due to the difficulty in determining the future FCFE due to the fact that the FCFE is based earning growth which is less predictable. As such, FCFE are very volatile ad in the normal situation, they make forecasting difficult. The DDM model was preferred to the P/E ratio due to the difficulty in identifying other firms with similar attributes and structure for comparison.

The P/E ratio in addition does not give the insights into the stocks intrinsic value but only gives insights into the firms share price when compared with other firms. Hence, it is useful only for comparison purposes and cannot be used in seclusion or in comparison with fair market value. The P/E ratio is just but a figure and may not be useful to the firm in gauging the value of the firm, hence, when compared with other forms in the industry, it may enable the firm evaluate its performance.

Price/Book ratio model calculates the expected book value of the stock to establish as to whether they are undervalued or overvalued. However, the model is dependent on the rate of the dividend growth which in essence is a projection. As such, the various methods build their development on the DDM hence; this model is preferred to the others.

The Price/book ratio model also, does not take into account the time value of money. Though it considers the dividend growth rate, it does not peg the aspect of the time value of money on the model hence, it may be inaccurate in the long-run.

Conclusion

Valuation of a firm is almost indispensable to rational investors who are interested in making rational investment decisions in their day to day engagements. The main objective why firms exist is to create value for the shareholders. This value is usually measured inform of increased share prices and a consistent stream of dividends. As such, the value of the firm, expressed by the intrinsic value of a share, is very crucial in making investment decisions by the investors.

The various methods of valuation of a firm are necessary in the estimation of the value of a firm though they may give different results. As such, more than one method should be utilized in determining the value of a firm for comparison purposes. The value of the firm helps investors know the mispriced shares in the market by comparing the intrinsic value with the prevailing market price. Investors will have high propensity to purchase the undervalued shares in order to make gains as the market adjusts to reflect the value of information.

The DuPont analysis is useful in evaluating the gauging the performance of the firm and for comparison with the peers in the market. Poor performance as reflected by the DuPont analysis will translate into declining value of the firm. In conclusion, the value of the firm is of great interest to many stakeholders and its establishment cannot be overemphasized regardless of the valuation model used. Hence, the understanding of establishing the value of the firm and the interpretation of the result is indispensable in the world of finance.

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