Forecast: 1
Key elements 1
Income Statement and Balance Sheet 2
Forecast assumptions for key items 2
Valuation: 4
Free Cash Flow Valuation Method 4
Abnormal Earnings Valuation Method 4
Valuation parameter estimation 5
Sensitivity Analysis 5
Estimated value per share 7
Recommendation 8
Summary of findings 8
Final Recommendation 8
Bibliography 10
In the prospective analysis for this report, a forecast over the next 5 financial years of Gazel Corporation will be conducted. The key elements of the income statement and balance sheet will be forecasted, and the assumptions behind these will be discussed. Finally, an estimation of the share price for Gazel will be calculated using two different valuation methods, including a sensitivity analysis for both of these. All figures from the income statement and balance sheet are (‘000).
Forecast:
Key elements
Key Items of Income Statement 2015F 2016F 2017F 2018F 2019F
Sales growth -2.0% -0.4% 1.8% 3.2% 4.8%
Gross margin 85.1% 86.2% 86.5% 87.0% 87.5%
Depreciation expense to PPE 23.0% 23.0% 23.0% 23.0% 23.0%
SG&A expenses to sales 58.6% 58.2% 57.6% 57.0% 56.4%
Effective interest rate 8.0% 8.0% 10.0% 10.0% 10.0%
Key Items of Balance Sheet
PPE $ 407,978 $ 391,220 $ 371,531 $ 342,722 $ 339,218
Net debts $ (186,241) $ (186,241) $ (185,241) $ (184,241) $ (184,241)
Operating Working Capital to Sales 3.3% 3.3% 3.3% 3.3% 3.3%
Fixed Assets to Sales 21.5% 20.5% 19.0% 18.0% 17.0%
Dividend Payout ratio 40.0% 40.0% 40.0% 40.0% 40.0%
Net Debt to Equity ratio 9.0% 9.0% 9.0% 8.5% 8.0%
Interest Coverage ratio 62.44 98.48 98.97 87.75 87.95
Each of the key items for both the income statement and balance sheet are listed above and were forecasted using information provided in the annual report, and assisted by the Strategy, Accounting and Financial Analysis performed in the group report.
Income Statement and Balance Sheet
Refer to Appendix A for the condensed income statement and balance sheet.
Forecast assumptions for key items
Income Statement
Sales Growth – As per the strategy analysis, Gazel has been going through a transition in its strategy of moving towards digital business over the traditional print media that it has dominated in the past. The declining print business was the reason for negative sales growth over the last few years evident in annual reports, though this figure has been increasing more recently. Due to the successful implementation of their new digital strategy, it is assumed that Gazel’s sales growth will become positive once again over the forecast.
COGS – Also due to Gazel’s strategy change towards a digital focus, COGS will be decreasing over the forecast due to the significantly reduced cost of producing a digital, intangible service over the physical print product.
Interest received – Constant over the last few years, so will remain the same figure.
Other income – Significantly larger in 2014 than previous years due to the sale of controlled entities. Future forecast years will reduce back to their typically constant levels.
Depreciation expense to PPE – Stayed constant over the last few years as per the annual reports and will remain the same % for the forecast, though as PPE reduces so will this exp.
SG&A expense to sales ratio – Decreasing ratio slowly over the forecast due to recent redundancies made and less selling and administration costs associated with operating a primarily digital business due to new strategy.
Interest rate – Will remain as it is, but will increase to a higher level in the later forecasting, which drives the forecasted slow increase in finance cost, after the initial for drop next year.
Rental cost – Has remained consistent over the last few years, so will stay the same.
Other costs – Too many volatile factors to include, though has remained relatively constant.
Company tax rate – A standard 30% company tax rate is used.
Balance Sheet
Cash – Cash is assumed to remain the same over the forecast, as it is close to the 3-year historical average as per the last few annual reports.
Receivables & Investments – Receivable and Investment accounts are assumed to remain the same over the forecast, as they have been consistent over the last few years.
Fixed assets to sales ratio – A significant item. This ratio is assumed to decrease consistently over the forecast, as Gazel moves away from the traditional print industry towards digital ventures. This will result in the sale of the large amount of PPE that is required in order to produce and distribute print media, being replaced instead by less PPE-heavy digital media. The PPE that still remains will not have as much of a relation to sales due to primary revenue being gained by digital business. PPE is assumed to decrease in value over the forecast for this reason, as the value of intangible assets increases.
Intangibles to sales ratio – A significant item. It is assumed there will be an inverse relationship between PPE and Intangible assets as Gazel continues to move towards its digital media strategy over traditional print media. This is assumed to increase the intangibles to sales ratio over the forecast as the intangible assets have a greater impact on sales due to the inclusion of website brands and other digital ventures being valued as intangible assets. Intangible assets will decrease initially due to the impairment of traditional print related intangibles before increasing again due to the digital strategy.
Total Non-Current Assets – Too many factors to estimate accurately, so is assumed to grow at 3% (inflation rate) pa over the forecast.
Long-Term debt – Long-term debt is assumed to decrease slowly over the forecast due to Gazel’s continually payoff of their debt obligations as per previous annual reports.
Total Non-Current Liabilities – Too many factors to estimate accurately, so is assumed to grow at 3% (inflation rate) pa over the forecast.
Net Debt – Calculated using the net debt formula. It is a negative value due to Gazel having more cash and cash equivalents than its debt obligations. Assumed to remain constant over the forecast.
Operating working capital to sales – Calculated at 3.3% for 2014 and assumed to remain constant over the forecast due to relative consistency in previous years.
Dividend payout ratio – Calculated using the dividend per share over earnings per share formula. The DPS and EPS figures were presented by Gazel in their annual report, and the ratio is expected to remain consistent over the forecast.
Valuation:
FCF Analysis 2015 2016 2017 2018 2019
PV of FCF= $ 102,322.75 $ 97,281.96 $ 103,753.43 $ 109,469.12 $ 118,947.84
Sum of PV of FCF (2015-2019) $ 531,775
TV of FCF $ 1,231,764.18
Equity Value $ 1,763,539 (‘000)
Number of shares 2,351,955,725
Estimated value per share $ 0.75
Free Cash Flow Valuation Method
The Free Cash Flow valuation method determines the value of a company through the cash flow that it generates for its shareholders. This is done by calculating the present value of the Free Cash Flows that are forecasted to be generated over the next five years and then adding this figure to the terminal value of the FCF to get an equity value. Dividing this figure by the number of shares gives an estimated value per share, which is $0.75 for Gazel.
Abnormal Earnings Valuation Method
AE analysis 2015 2016 2017 2018 2019
Required (normal) earnings $ 218,973.59 $ 223,383.37 $ 228,229.74 $ 233,273.64 $ 239,130.99
Abnormal earnings $ (65,306.41) $ (59,464.35) $ (40,479.75) $ (13,843.15) $ 18,188.36
PV of abnormal earnings $ (58,834.61) $ (48,262.60) $ (29,598.44) $ (9,118.91) $ 10,793.91
Sum of PV $ (135,020.66)
TV of AE $ 111,776.28
Equity Value $ 1,792,950.63 (‘000)
Number of shares 2,351,955,725
Estimated Value per share $ 0.76
The Abnormal Earnings valuation method determines the value of a company through the abnormal earnings that it is forecasted to generate in the future. Abnormal earnings are calculated by first determining the forecasted yearly required earnings and subtracting them away from the forecasted net profit for each year. The present value of these abnormal earnings over the next 5 years are summed and then added to the terminal value of the abnormal earnings beyond the 5 year forecast to get an equity value. Dividing this figure by the number of shares gives an estimated value per share, which is $0.76 for Gazel.
Valuation parameter estimation
In order to calculate the value of a company using these two valuation methods, the two parameters; Cost of equity and Terminal growth rate, must be estimated.
Cost of equity (R_e) = 11%
The cost of equity estimation for Gazel was taken directly from the FY2014 annual report as their calculated discount rate. This estimation is reasonable to be used as the company would have greater knowledge as to the value of its cost of equity than an outside source. Doing the CAPM calculation to determine the cost of equity gave a similar result to the company estimation.
Terminal growth rate (g) = 1.225%
The terminal growth rate estimation for Gazel was also taken directly from the FY2014 annual report. Gazel determined that the terminal growth rate for its print business was 0% and 3.5% for its digital business. Using a revenue mix calculation, with print resulting in 65% of revenues and digital being 35% resulted in an overall terminal growth rate of 1.225%
〖TV〗_g=(0.65×0)+(0.35×0.035)
〖TV〗_g=0.01225
Sensitivity Analysis
A sensitivity analysis is used to understand what the estimated value of the share price would be under slightly varying economic conditions. These different economic conditions are determined by a change in the cost of equity and in the terminal growth rate. In order to best examine the sensitivity of the share value estimation components (in large portion due to the Terminal Value), I have presented six distinct varying conditions. Downside and upside of just terminal growth rate, downside and upside of just cost of equity and the downside and upside of both rates simultaneously. This can be seen in the sensitivity analysis tables on the follow page.
Sensitivity Analysis Market Price Downside Upside
Terminal Growth Rate 1.225% 1% 1.5%
Cost of equity 11% 11% 11%
Sum of PV of FCFs $ 531,775 $ 531,775 $ 531,775
TV of FCF $ 1,231,764 $1,201,373 $ 1,270,864
Equity Value $ 1,763,539 $1,733,148 $ 1,802,639
FCF share value $ 0.75 $ 0.74 $ 0.77
Sum of PV of AEs $ (135,021) $ (135,021) $ (135,021)
TV of AE $ 111,776 $ 109,018 $ 115,324
Equity value $ 1,792,951 $1,790,193 $ 1,796,499
AE share value $ 0.76 $ 0.76 $ 0.76
Estimated value $ 0.76 $ 0.75 $ 0.77
Sensitivity Analysis Downside2 Upside2 Downside3 Upside3
Terminal Growth Rate 1.225% 1.225% 1% 1.5%
Cost of equity 12% 10% 12% 10%
Sum of PV of FCFs $ 517,304 $ 546,879 $ 517,304 $ 546,879
TV of FCF $ 1,068,444 $1,435,650 $ 1,044,263 $ 1,486,124
Equity Value $ 1,585,748 $1,982,529 $ 1,561,567 $ 2,033,003
FCF share value $ 0.67 $ 0.84 $ 0.66 $ 0.86
Sum of PV of AEs $ (207,547) $ (58,637) $ (207,547) $ (58,637)
TV of AE $ (18,928) $ 285,989 $ (18,500) $ 296,044
Equity value $ 1,589,720 $2,043,547 $ 1,590,148 $ 2,053,602
AE share value $ 0.68 $ 0.87 $ 0.68 $ 0.87
Estimated value $ 0.68 $ 0.86 $ 0.67 $ 0.87
This sensitivity analysis shows that the share price will fluctuate between the downside of $0.67 per share and upside of $0.87 per share depending on how the economic situation changes. The majority of this fluctuation arises due to the sensitivity of the terminal value on the assumptions of both terminal growth rate and cost of equity.
Estimated value per share
As can be seen in the above sections of the company valuation, the share price is valued approximately $0.66 – $0.86 per share using the FCF method and $0.67 – $0.87 per share using the AE method. This averages out to be valued $0.67 – $0.87 per share.
Using the companies own nominated terminal growth rate and cost of equity arrives at an average value between FCF and AE methods of $0.76 per share.
Recommendation
Summary of findings
Gazel Coporation is a company operating within the print and digital publishing industries. In the strategy analysis, Porter’s five forces and a competitive strategy analysis were undertaken, and it was determined that the print publishing industry has a high collective profitability, but has been in a significant decline over the last few years. On the other hand, the digital publishing industry has a low collective profitability, but has experienced an even more significant growth in the same time. Gazel’s main strategy over the last couple of years has been to transition away from the dying industry of traditional print publishing and move into the digital space, which it has so far been success in doing through its ownership of a number of news websites, as well as domain.com.au and rsvp.com.au.
The accounting analysis supported the opportunity for profitability growth due to the importance that is placed on the valuation of intangible assets, which will be a large part of the company due to their digital ventures.
Within the financial analysis, it is evident that their transition has been more successful than that of their print publishing competitors who have attempted to do the same, as their ROE and Net Profit Margins for 2014 were substantially higher.
Overall, the analysis has shown that Gazel has demonstrated its ability to translate the dominant position held within the traditional print industry into a rapid expansion into the digital publishing industry. It is well position to continue expanding into the digital world, and to benefit from the significant growth of the industry.
Final Recommendation
According to the ASX (2015), the current market value of Gazel shares is $1.022. In comparison to the estimated value per share of $0.76 using the FCF and AE methods, it can be seen that the market is overvaluing Gazel and its forecasted performance. The reason these shares are overvalued could be a result of Gazel’s poor financial performance over the last few years due to the decline of the print publishing industry, but investors having confidence that the media giant will have the resources to turn itself around and implement their digital strategy successfully. This may have resulted in investors choosing not to sell their shares, as they expect Gazel to do much better financially in the future over it is doing right now.
The share price has continued to increase in the long-term even after the many years of financial decline. This gives an indication of the hope that investors have in Gazel’s ability to generate cash flows in the future. Due to this, and due to the findings in the Strategy, Accounting and Financial analysis of Gazel, it is recommended that shares be bought in Gazel in order to benefit from their future financial success through digital media ventures.
Bibliography
Asx.com.au, (2015). Gazel Limited (FXJ) Share Price & Information. Available at: http://www.asx.com.au/asx/research/company.do#!/FXJ [Accessed 27 May 2015].
Gazel, (2014). Annual Report 2014. Available at: http://www.gazel.com.au/ArticleDocuments/191/2014%20GAZEL%20Annual%20Report.pdf.aspx?Embed=Y [Accessed 25 May 2015].