Free Essay

Submitted By bri123

Words 6977

Pages 28

Words 6977

Pages 28

2011

| The following document is a complete valuation JBH based on DCF and Relative Valuation. All input justifications are provided and a final recommendation is presented. | |

Business Summary

JB Hi Fi (JBH) has experience unprecedented growth in the past few years in excess of 10% despite the Global Financial Crisis and weak consumer spending environments. JBH is likely to continue its strong growth (although below expectations) through a combination of recovering market conditions, a new era of smart products and with official interest rates likely to be placed on hold by the RBA until the end of 2011.

(A) CHOICE OF MODELS

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1. Discount Models

Why FCFF Discount Model?

DDM would not be a suitable model because JBH paid dividends which are significantly greater than or lower than FCFE to the firm between 2006 and 2010 thereby underestimating or overestimating the value of JBH (dividends less than 80% of FCFE or greater than 110% FCFE) .

The debt to equity ratio has been volatile declining from 82.90% in 2003 to 23.73% in 2010 with a spike of 120.96% in 2006. Estimating future debt issues and repayments will prove to be difficult given that changes are expected because JBH has raised their senior debt facility by $105 million expiring by 2014 possibly to finance the roll out of up to 193 new stores by 2014 as well. The recent stock repurchases of $173 million and possible future repurchases if JBH continues to accumulate cash, will also have significant impacts on leverage.

FCFF will certainly be the most appropriate model to apply since debt is not directly considered in determining the cash flow whereas in the FCFE model, the value of net debt issued must be backed out.

Furthermore, FCFF refers to cash flows available to investors so recent stock repurchase of $173 million can be ignored since stock repurchases refer to uses of those cash flows. However, if we ignore the effect of repurchase (common approach by analysts) in DDM, we may well under-estimate the value of equity.

DDM or FCFE Discount Model?

Must we choose one of the two, DDM is preferred. As mentioned earlier, FCFF is inappropriate due to a fluctuating leverage making it difficult to forecast future net debt issues. Despite the weakness in using DDM leading to over/under valuation, its simplicity will render it more useful than FCFE.

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2. Number of Growth Stages

Three-Stage Growth

Some indicators suggest JBH has not reached stable growth. * There is potential for JBH to exploit an online market and larger market share since JBH’s market capitalisation is well less than $10 million, sitting at $1.714 billion.

* Moderately high equity reinvestment rate of 39.86%.

We assume the high growth period to extend for another 2 years because of: * Their focus on a Cost of Doing Business (CODB) Model to reduce business cost and increasing labour productivity. The cost of doing business has declined from 15% in 2007 to 13.2% in 2010 with further drops expected. JBH’s unique management has allowed them promise the “cheapest price” thus differentiating them from competitors.

* Increase in sales from release in popular electronics including the Nintendo 3DS and Ipad2 in early 2011 as well as the expected release of Iphone5 in the latter half of 2011.

* Initiatives to develop an online presence with online sales grown over 35% in the first half of 2011.

* Rollout of new stores from 130 stores in 2010 to 193 in 2014. This has been the driving factor for solid growth in comparison to its competitors such as Myers and Harvey Norman.

With a growing market share and firm size, JBH’s high growth will eventually become unsustainable because the retail sectors has few barriers to entry (international firms such as Costco have entered the Australian market) with other firms increasingly wanting to have “a bite of the cherry” . The stronger AUD will also direct buyers towards imports rather than local purchases. Eventually growth will enter a transitional period towards a stable growth that we assume to be the industry level of 3.01% for EBIT and 5.49% for NI.

Some analysts consider JBH to possess mature firm characteristics but we believe there is still much room for growth in light of current double figure growth rates – a view shared by Patrick Elliot, Chairman of JBH. We assume JBH to be able to sustain a transitional growth period of 6 years.

For the 2 models that are discussed we apply the three stage growth.

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(B) FREE CASH FLOW TO FIRM (FCFF)

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1. Estimating Discount Rate

Cost of Equity (ke) 1. Risk Free Rate, rf

The risk free rate is one that has no default risk and no reinvestment risk. We will use the 10-Year Australian Government Treasury bond of 5.51% as a proxy because we are valuing a firm in Australian dollars and since firms are valued as a going concern we use the bond with the longer time to maturity. This will be kept constant for the entire valuation period.

2. Equity Risk Premium

To compute the required risk premium we first use US historical equity risk premium of 5.01% by: * Choosing T-Bond since valuation is longer term. * Choose the longest study period to reduce the standard error. * Use geometric averaging because of the compounding effect expressing returns over multiple periods.

We will then adjust it for the country risk of Australia to proxy the required equity risk premium. For simplicity we assume country risk equals to a country’s default spread. Since Australia has a rating of Aaa the default spread is 0% and so the equity risk premium remains at 5.01% which will be kept constant for the entire analysis.

ERPTotal=ERPUS+Counry Risk Prem

5.01%=5.01%+0%

3. Beta, β

We will use current levered beta of 1.26 from Finanalysis because other financial services such as NineMSN Finance are also in consensus. Other analyst may prefer a Bottom-ups-Approach which considers the fundamentals but that would require estimation of certain inputs - financial services firms such as I/B/E/S and Finanalysis are better equipped in doing so.

The assumption that current beta will decline to the industry level of 1.19 at stability is applied. 4. Cost Of Equity

Cost of equity is calculated by using:

ke=rf+βl(equity risk premium)

which will yield a current figure of 11.82% and 11.47% at stability.

After Tax Cost of Debt (kd)

After tax cost of debt will be computed using:

rf+default spread(1-tax rate)

which yields 4.21% given the inputs below and risk free rate from above for the entire valuation time line. 1. Default spread

Since JBH does not have widely traded bonds, default spread is ascertained by using a synthetic rating. JBH has an interest coverage ratio of 31.8 in 2010 thus a synthetic rating of AAA. This translates to a default spread of 0.50%

2. Tax Rate, t

The marginal tax rate of 30% is applied for the period of analysis rather than an effective tax rate because it does not just reflect the difference between accounting and tax books but the tax paid on the additional dollar earned. Although the marginal tax rate may understate the EBIT(t-t) in earlier years but more accurate in later years.

WACC

1. Market Value of Debt to Market Value Equity

Rather than systematically calculating the respective market values (MV) we obtained the following values for 2010 from Damodoran’s website: * MV Debt / MV Capital = 2.89% * MV Equity / MV Capital = 97.11%

The reason being that market value of debt includes book value of debt and the present value of tradable bonds but this is difficult to ascertain.

The proportions are assumed to increase linearly towards industry level of the following at stability: * MV Debt / MV Capital = 20.14 * MV Equity / MV Capital = 79.86%

This is acceptable since stable firms are expected to take up higher levels of debt. 2. WACC

WACC is calculated using the formula: keMV EquityMV Capital+kdMV DebtMV Capital

Given the inputs earlier we will yield a current WACC of 11.60% and 10.01% at stability.

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2. Estimating Growth, g

We have three ways to estimate growth either: a) Historical data, b) Analyst Forecast or c) Fundamentals

For our valuation we have decided to estimate growth based on fundamentals because it allows us to relate a firm’s reinvestments and the quality of those reinvestments to future growth. This is the most appropriate method out of the selection range because reliance on historical data via arithmetic/geometric mean or linear/log regression is not a good indicator of future growth. Although analyst forecasts are better than historical data as they factor in firm specific data, they my may often fail to recognise changes in a firm’s fundamentals.

Essentially fundamental growth in EBIT is given by: g=ROC×reinvestment rate (b)

We will forecast operating income after tax by assuming 2 year high growth followed by a 6 year transition period to stable growth. * High Growth Stage – We assume JBH to sustain their current ROC of 49.37% and reinvestment rate of 27.26% for a further 2 years which will translate to a high growth of 13.45%.

* Transitional Growth Stage – We assume ROC and reinvestment rate to decline linearly to industry levels of 15.82% and 19.03% respectively. Consequently there will be gradual decline in growth rate to 3.01% at stability.

* Stable Growth Stage - Using a combination of industry ROC and reinvestment rate we obtain a stable growth of 3.01%. The use of this value in stable growth is justified by it being essentially the long term growth rate of the economy at 3%

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3. Adjusting Earnings

Financing expenses are treated as operating expenses by accountants. Therefore, we have adjusted 2010 accounting EBIT by operating leases based on:

Adj EBIT=EBIT+Operating Lease Expenses-Depreciation on lease asset

Therefore 2010 Adj.EBIT(1-t) is:

Adj.EBIT2010 =$175.10+$53.38-$8.73=$224.75

Adj.EBIT20101-t=$224.751-0.3=$157.33

Future earnings are forecasted by the growth rates calculated earlier.

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4. Calculating FCFF

FCFF can be computed by using either: adj.EBIT1-t-Net Capex- ∆NCWC

OR

adj.EBIT1-t×reinvestment rate (b)

As previously mentioned the reinvestment rate is assumed to be constant for the 2 years of high growth at 27.26% and then declined linearly to 19.03% at stable growth.

Therefore,

FCFF2010=$157.33×27.26%=$114.45

Future FCFF are calculated in the same manner with their respective EBIT(1-t), growth rate and retention rate.

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5. Terminal Value

Terminal value was calculated using the formula:

Adj.EBIT2018(1-t)(1+gstable)WACC-gstable

Therefore we arrive at the terminal value of $3240.78 million.

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6. Valuation

Based on a three-stage FCFF discount model we: 1. Discounted the individual cash flows at their respective WACC to obtain a present value (PV). PV of: * High Growth FCFF = $218.35 million * Transitional FCFF = $633.05 million * Terminal Value = $1486.90 million

Total Value of operating asset today is equal to $2338.67 million. 2. Add cash & marketable securities and subtract debt. * Cash =$51.74 million * Debt = $366.33 million

Total Value of Equity is $2023.71 million. 3. Divide by 109.36 million shares outstanding

Value of Equity per share = $18.50

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7. Sensitivity Analysis

The sensitivity of the value estimates equity value per share to changes in: 1. Periods of High Growth, 2. Stable EBIT growth and 3. Stable WACC are summarized in the tables below.

| Stable Cost of WACC (%) | stable ebit growth (%) | | 9.01 | 10.01 | 11.01 | | 1.01 | 16.60 | 15.30 | 14.26 | | 2.01 | 18.38 | 16.70 | 15.39 | | 3.01 | 20.77 | 18.50 | 16.81 | | 4.01 | 24.11 | 20.91 | 18.62 | | 5.01 | 29.12 | 24.28 | 21.05 |

stable ebit growth (%) | | Years in High Growth | | | | 1.00 | 2.00 | 3.00 | | 1.01 | 14.10 | 15.30 | 16.52 | | 2.01 | 15.48 | 16.70 | 17.95 | | 3.01 | 17.25 | 18.50 | 19.78 | | 4.01 | 19.61 | 20.91 | 22.23 | | 5.01 | 22.92 | 24.28 | 25.66 |

By examining the table it is clear that changes in stable growth rates have the greatest impact on the valuation followed by change in stable WACC and then the number of years in high growth.

Despite the stable growth being the key driver of the value of JBH, in reality we cannot obtain a stable growth of much higher than 3.01% because we cannot exceed the long term growth rate of the Australian economy.

(C) DIVIDEND DISCOUNT MODEL

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1. Common Inputs to FCFF

The ROC and and cost of equity will be obtained in the same was discussed earlier as those in the FCFF model for the entire period of valuation.

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2. Estimating Growth

1. Return on Equity

The 2010 ROE was calculated to be 51.74% and we assume this to be constant for the 2 years of high growth. From the end of high growth to stable growth we calculated the ROE using:

ROE=ROC+DEROC-i1-t

This method ensures consistency rather than making a new assumption that ROE decline linearly to industry levels. Consequently, at stable growth the ROE is at 18.71%. 2. Payout Ratio

The payout ratio was calculated via:

payout ratio=DPS/EPS

The 2010 payout ratio was computed to be 60.14% which reflects JBH’s currently policy to maintain a 60% payout. We make the assumption that the payout ratio declines linearly to 70% at stability. This is higher than then industry levels quoted by Damodoran because we prefer a value that better reflects characteristics of a stable firm.

3. Retention Rate

The retention rate is calculated by:

1-payout ratio

Subsequently, retention rate falls from 39.86% to 30% at stable growth. 4. Growth

The growth in NI was forecasted by applying:

g=ROE×equity retention rate(b)

* High Growth Stage – Since we made the assumption 2010 ROE is constant for the 2 years of high growth, it means that growth will be also constant at 20.62% during this period.

* Transitional to Stable Growth – Growth will decline linearly 6.08% at stability.

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3. Calculating Dividends

We first calculated the future EPS by multiplying the base EPS of $1.10 by their respective growth rates.

The DPS is then determined by multiplying the EPS by its respective payout ratio.

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4. Terminal Value

Terminal value was calculated using

DPS2018(1+gstable)ke-gstable

Note that the growth rate computation earlier, refers to growth in NI but the formula applies growth in dividends. However we can use the stable growth in NI of 5.51% also as the growth in dividend because at stability payout ratio is also constant.

Therefore terminal value is $44.11

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5. Valuation

Based on the three-stage DDM model we discount all the dividends at their respect cost of equity.

Therefore we obtain a present value (PV) of: * High Growth dividends = $1.48 * Transitional dividends = $5.76 * Terminal Dividends = $18.43

Value of Equity Per Share $25.67

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VI) Sensitivity Analysis

Akin to the FCFF model, the DDM is also highly sensitive to the changes in input values as can be seen below which can significantly under/overvalue JBH. | Stable Cost of Equity (%) | Stable Growth in NI (%) | | 10.47 | 11.47 | 12.47 | | 3.61 | $22.68 | $20.71 | $19.20 | | 4.61 | $25.49 | $22.83 | $20.85 | | 5.61 | $29.46 | $25.67 | $22.98 | | 6.61 | $35.48 | $29.66 | $25.84 | | 7.61 | $45.72 | $35.73 | $29.88 |

| Number of Years in High Growth | Stable Growth in NI (%) | | 1 | 2 | 3 | | 3.61 | $15.01 | $20.71 | 22.28 | | 4.61 | $16.58 | $22.83 | $24.56 | | 5.61 | $18.68 | $25.67 | $27.00 | | 6.61 | $21.66 | $29.66 | $31.95 | | 7.61 | $26.17 | $35.73 | $38.52 |

A 1% change in stable growth in NI leads to a greater change in equity value per share than a 1% change in stable cost of equity. Both a 1% change in stable growth or cost of equity has a greater impact than changing high growth period by one year.

We can conclude that the stable growth rate in NI is certainly the key driver in our valuation.

(D) RELATIVE VALUATION

Given the “rule of thumb”, for the retailing sector, the multiple used generally would either be PS or VS depending on whether the leverage across firms are similar or different, respectively. Firms | Financial Leverage2 | JBH | 246.55% | DJS | 160.56% | HVN | 171.73% | MYR | 227.88% | SRA | 252.36% | WTF | 267.14% | WHS | 222.60% | BRG | 158.97% | FAN | 185.86% | TRS | 259.83% |

Hence the multiple VS is chosen, as given the financial leverage across firms, they appear to be different. 1. -------------------------------------------------

Definition

Value-to-sales multiple * The numerator becomes the enterprise value, that is the market value of the operating assets (debt and equity) of the firm, net of cash. * The denominator is the total revenue of the firm.

This ratio is consistent as both numerator and denominator represent values of the firm. The ratio is also uniformly measured, as data used are retrieved from the current (i.e. most recent) financial year, yielding the current enterprise value and total revenue of the firm.

VS gives investors an idea of how much it costs to buy the company's sales. It is seen as more accurate measure than PS because PS uses market capitalization, equity portion of the firm, which does not take into account the amount of debt of a firm as well as enterprise value, the total capital structure of the firm.

The average VS multiple for the retailing sector is 0.59 with an average after-tax operating margin of 4.41% and average expected growth of 13.74%. 2. -------------------------------------------------

Fundamentals

To analyse the relationship between value and sales,we could consider the 2-stage high growth firm valuation model: where After-tax operating margin = EBIT(1-t)/Sales

From the equation, the underlying fundamental factors observed for high growth firms that determine the standardised enterprise value to sale multiple, include its growth, cost of capital, reinvestment rate and after-tax operating margin. 3. -------------------------------------------------

Relationship

Firms with increasing growth, decreasing cost of capital with increasing after-tax operating margin and better ability to sustain lower reinvestment needs are expected to have the larger enterprise value to sales multiples.

Each multiple has one variable that it is most closely linked to, with the VS multiple, it is the after-tax operating margin. An increase in after-tax operating margin directly supports a larger VS multiple.

The after-tax operating margin has a two-fold effect on the sales multiple.

An increase in after-tax operating margin will have a direct effect supporting a larger value to sales ratio.

An indirect effect also occurs, whereby an increase in after-tax operating margin causes an increase in expected growth in operating income. A higher expected growth in operating income increases the ROC, which in turn induces higher growth in after-tax operating income leading to a higher value to sales multiple or vice versa.

4. -------------------------------------------------

Application

For selected comparable firms:

Firms | Enterprise Value ($m) | Total revenue ($m) | EV/S ($m) | JBH | 2,084.03 | 2,731.60 | 0.7629 | DJS | 2,538.89 | 2,104.00 | 1.2067 | HVN | 3,858.19 | 2,397.60 | 1.6092 | MYR | 2,318.47 | 2,990.00 | 0.7754 | SRA | 47.01 | 58.40 | 0.8050 | WTF | 1,028.57 | 133.20 | 7.7220 | WHS | 920.16 | 1,348.60 | 0.6823 | BRG | 267.99 | 422.80 | 0.6338 | FAN | 226.86 | 423.50 | 0.5357 | TRS | 434.77 | 470.90 | 0.9233 |

Descriptive Characteristics | Average | 1.5656 | Standard deviation | 2.185837 | Median | 0.7902 | Minimum | .5357 | Maximum | 7.722 |

JBH’s VS in comparison to the other comparable firms, are quite similar whereby the multiple is around the same range below one, other than DJS, HVN and WTF. This may be attributed to the fact that DJS and HVN has lower reinvestment rates and a higher after-tax operating margin, resulting in a higher VS multiple. FAN’s VS, the smallest of our sample, is the opposite, where it has an extremely high reinvestment rate and a lower after-tax operating margin.

Implied Firm ValueJBH

= Average VS × Total revenue

= 1.5656 × 2731.60

= $4276.67 million

This value would be much larger than the actual firm value in the current period, which may be due to an outlier, an excessively large multiple, that is the WTF’s VS multiple. JBH’s VS and other comparable firm’s VS is much smaller compared to WTF, as for an internet firm, it has a much higher expected growth rate and higher after-tax operating margin, possibly due to the increasing market and usage of the world wide web. Due to the presence of an outlier, it causes the mean to exceed the median.

Since an outlier exists in our sample, we may use the median VS value can be used to determine the firm value.

Firm ValueJBH

= Median VS × Total revenue

= 0.7902 × 2731.60

= $2158.47 million

However, this value may not be very reliable, as it does not take into account the fundamental factors that influence the value to sales multiple.

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4.1 Modified Multiple

Since after-tax operating margin plays such an important role in determining the VS, we may regress the VS on the after-tax operating margin.

Estimated VS modified multiple regression model:

VS = -.3873749 (.1996171)

+ .2101291(After-tax operating margin) (.0148779)

VSJBH = -.3873749 + .2101291(4.49) = 0.5555

Implied JBH firm value

= VSJBH × Total revenue

= 0.5555× 2731.60

= $1517.40 million

The actual VS ratio is 0.7629. This would suggest that the market has undervalued JBH significantly by 27.19%.

This significant difference can be due to the fact that this adjustment assumes that the differences in the multiples of the firms in our sample are due to a single fundamental factor.

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4.2 Sector Regression

Since the differences in multiples are determined by a range of fundamental factors, we may regress the multiples of comparable firms in the retailing sector, VS, on the all the corresponding fundamental variables; growth, cost of capital, after-tax operating margin and reinvestment rate.

We can consider squaring the after-tax operating margin in our regression model to account for its non-linearity effect due to its direct and indirect effects.

Inputs for selected comparable firms in the retailing sector: Firms | Expected growth in operating income | Cost of Capital | Reinvestment rate | After-tax operating margin | JBH | 13.02% | 11.27% | 33.84% | 4.49% | DJS | 7.83% | 11.44% | 35.50% | 8.28% | HVN | 1.03% | 12.20% | 9.06% | 12.50% | MYR | 0.56% | 12.08% | 3.40% | 6.33% | SRA | 0.90% | 15.19% | 28.37% | 1.69% | WTF | 21.96% | 11.29% | 31.68% | 37.15% | WHS | 11.94% | 11.09% | 47.44% | 6.22% | BRG | -8.03% | 11.76% | -45.22% | 7.17% | FAN | 17.32% | 10.67% | 92.00% | 4.25% | TRS | 51.80% | 11.02% | 121.68% | 4.86% |

Estimated VS sector regression model:

VS = -0.3702486 (.689656)

+ 0.006907(Expected Growth) (.0088852)

+ 0.0804872(Cost of Capital) (.0571426)

- 0.0005454(Reinvestment rate) (.0029979)

+ 0.0051235(After-tax operating capital)2 (.0001692)

VSJBH = -0.3702486 + 0.006907(13.02) + 0.0804872(11.27) - 0.0005454(33.84) + 0.0051235(4.49)2 = 0.711698746

Implied JBH firm value

= 0.711698746 × 2731.60

= 1944.08 million

At its actual VS ratio of 0.7629, JBH appears to be undervalued by the market by 6.72%. This is a better model than the previous as the model has a higher r-squared, that is the change in dependent variables that is explained by changes in the independent variable.

A possible extentions of this analysis by transforming the dependent variable to a log variables, log(VS) in the regression model. It is often an appropriate choice for positive variables to satisfy the OLS assumptions more closely, eliminating problems of heteroskedasticity or skewed results, it make its distribution normal. Also it provides a more accurate representation of the effects of the independent variables on the dependent variable, with coefficient estimates that provide an approximate percentage change in VS rather than linear parameter value in the previous VS regression model. These coefficients give us an estimate that is always between the absolute value of the estimates for an increase and a decrease. Moreover, taking logs usually narrows the range of the variable, making estimates less sensitive to outliers on the dependent or independent variables.

Estimated log(VS) multiple regression model: log(VS) = -1.250702 (1.22859)

+ .010456(Expected Growth) (.0158285)

+ .0834727(Cost of Capital) (.1017968)

- .0028525(Reinvestment rate) (.0053406)

+ .0016417(After-tax operating capital)2 (.0003015) log(VSJBH) = -1.250702 + .010456(13.02)

+ .0834727(11.27) - .0028525(33.84)

+ .0016417(4.49)2 = -0.237073274

VSJBH = e-0.237073274 = 0.788933477

Implied JBH firm value

= 0.788933477 × 2731.60

= 2155.05 million

Share price

= 2155.05 million/109.36 million

= $19.71

Given that the VS in the recent financial year was actually 0.7629, we could say that the market was slightly overvalues the firm. However, this is a better VS regression model as the difference between actual and market predicted VS is closer, with JBH’s VS being 3.30% below market expectations.

Limitations of the data used in relative valuation regression model include that the sample size is not very large and that there is no guarantee that any sample will be precisely represent that sector from which it comes, when inferences are made for the firms in the market. Hence, a possible reason why the direction of the coefficients of the explanatory variables do not all match to expectations. A larger sample size would enable you to assume normality and also result in smaller standard deviations around estimate.

(E) RECOMMENDATION

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1. Final Value Estimate The value obtained from the DDM is much higher than both FCFF discount model and relative valuation. DDM is not an appropriate model and is likely to overstate the value of equity as mentioned earlier. This is because share repurchase has been ignored which has a potential impact on the payout ratio, cost of equity and NI growth. Since the method is inaccurate and not appropriate given the volatility of the firms leverage, we assigned a weighting of 0.1 to our DDM value per share estimate. The value of JBH estimated from relative valuation is based on what the market is paying for similar firms. The sector regression model from which the value of the firm was estimated was based on a small sample size making it difficult to draw precise inferences and estimates of input parameters. Furthermore, it relies heavily on historical data, hence the effect of the fundamental factors hold. Thus we assign the relative estimated value a weighting of 0.1 in determining our final value. FCFF is the most appropriate model for firms with changing leverages over time. It embodies the effects of debt also avoids the need to account for JBH’s $173 million share repurchases. Given the higher reliability and accuracy we assigned a weighting of 0.8 to FCFF valuation in assessing our final value. Therefore;

Equity per share = $25.67(0.1) + $19.71(0.1) + $18.50(0.8) = $19.34

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2. Recommendation

The current listed share price is 17.36.

Our valuation yields $19.34

The stock of JBH is currently undervalued in the market, hence it is recommended to purchase JBH stocks.

APPENDIX A - Free Cash Flow to Firm | | | | | | | | All values are in $ millions | | | | | | | | | | | | | | | | | | | | | | A1 - Valuation Schedule | | | | | | | | | | | | Current year | High growth | | | | | | | Stable Growth | INPUTS REQUIRED | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | ROC | 49.37% | 49.37% | 49.37% | 44.58% | 39.78% | 34.99% | 30.20% | 25.41% | 20.61% | 15.82% | Reinvestment rate | 27.26% | 27.26% | 27.26% | 26.08% | 24.91% | 23.73% | 22.56% | 21.38% | 20.21% | 19.03% | Expected growth | 13.45% | 13.46% | 13.46% | 11.63% | 9.91% | 8.30% | 6.81% | 5.43% | 4.16% | 3.01% | EBIT | $175.10 | $198.66 | $225.39 | $251.60 | $276.53 | $299.49 | $319.89 | $337.26 | $351.31 | $361.89 | (+)Operating Lease Expenses | $58.38 | $52.38 | $46.98 | $46.98 | $46.98 | $46.98 | $46.98 | $46.98 | $46.98 | $46.98 | (-)Lease Depreciation | $8.73 | $8.73 | $8.73 | $8.73 | $8.73 | $8.73 | $8.73 | $8.73 | $8.73 | $8.73 | Adj EBIT | $224.75 | $242.32 | $263.65 | $289.85 | $314.78 | $337.74 | $358.14 | $375.52 | $389.57 | $400.14 | Marginal Tax rate, t | 30.00% | 30.00% | 30.00% | 30.00% | 30.00% | 30.00% | 30.00% | 30.00% | 30.00% | 30.00% | Adj EBIT(1-t) | $157.33 | $169.62 | $184.55 | $202.90 | $220.35 | $236.42 | $250.70 | $262.86 | $272.70 | $280.10 | CASHFLOWS | | | | | | | | | | | FCFF | $114.45 | $123.39 | $134.25 | $149.98 | $165.47 | $180.32 | $194.15 | $206.66 | $217.60 | $226.80 | Terminal Cash Flow | | | | | | | | | $3,240.78 | | WACC | | | | | | | | | | | Cost of Equity Calculation | | | | | | | | | | | Treasury-bond rate (risk free rate) | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | Risk premium | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | Beta | 1.26 | 1.26 | 1.26 | 1.25 | 1.24 | 1.23 | 1.22 | 1.21 | 1.20 | 1.19 | Cost of equity | 11.82% | 11.82% | 11.82% | 11.77% | 11.72% | 11.67% | 11.62% | 11.57% | 11.52% | 11.47% | Cost of Debt Calculation | | | | | | | | | | | Synthetic rating | 0.50% | 0.50% | 0.50% | 0.50% | 0.50% | 0.50% | 0.50% | 0.50% | 0.50% | 0.50% | Pre-tax cost of debt | 6.01% | 6.01% | 6.01% | 6.01% | 6.01% | 6.01% | 6.01% | 6.01% | 6.01% | 6.01% | (1-t) | 70.00% | 70.00% | 70.00% | 70.00% | 70.00% | 70.00% | 70.00% | 70.00% | 70.00% | 70.00% | After-tax cost of debt | 4.21% | 4.21% | 4.21% | 4.21% | 4.21% | 4.21% | 4.21% | 4.21% | 4.21% | 4.21% | WACC | | | | | | | | | | | Market Equity/Market Capital | 97.11% | 97.11% | 97.11% | 94.65% | 92.18% | 89.72% | 87.25% | 84.79% | 82.32% | 79.86% | Market Debt/Market Capital | 2.89% | 2.89% | 2.89% | 5.35% | 7.82% | 10.28% | 12.75% | 15.21% | 17.68% | 20.14% | Cost of Capital (WACC) | 11.60% | 11.60% | 11.60% | 11.37% | 11.13% | 10.90% | 10.68% | 10.45% | 10.23% | 10.01% | Present Value of Cash Flows | | $110.56 | $107.79 | $108.58 | $108.47 | $107.47 | $105.63 | $103.05 | $99.84 | | Present Value of Terminal Cash Flow | | | | | | | | | $1,486.90 | | VALUATION | (million) | | | | | | | | | | Shares Outstanding | 109.36 | | | | | | | | | | PV of High Growth FCFF | $218.35 | | | | | | | | | | PV of Transition Period FCFF | $633.05 | | | | | | | | | | PV of Terminal Value | $1,486.90 | | | | | | | | | | Value of Operating Assets Today | $2,338.30 | | | | | | | | | | (+) Cash and marketable securities | $51.74 | | | | | | | | | | (-) Long and short Term Debt | $69.60 | | | | | | | | | | (-)Debt Value of Leases | $296.73 | | | | | | | | | | Value of Equity | $2,023.71 | | | | | | | | | | Value of Equity Per Share | $18.50 | | | | | | | | | |

Note 2010 data is obtained from JBH Annual Financial Report 2010 | | | | | | | | | | | | | | | | | | A2 - Earnings | 2010 | | | A7 - Minimum Lease Payment | | | | EBIT | $175.10 | | | Years | $million | Present Value | | | | (+) Operating lease expenses | $58.38 | | | 1 | $52.38 | $49.41 | | | | (-) Lease depreciation | $8.73 | | | 2 | $46.98 | $41.81 | | | | Adjusted EBIT | $224.75 | | | 3 | $46.98 | $39.44 | | | | Adj.EBIT(1-t) | $157.33 | | | 4 | $46.98 | $37.20 | | | | | | | | 5 | $46.98 | $35.09 | | | | A3 - Retention Rate Calculation, b | 2010 | | | 6 | $46.98 | $33.10 | | | | (+)capex | 55.85 | | | 7 | $46.98 | $31.23 | | | | (-)depreciation | 23.28 | | | 8 | $46.98 | $29.45 | | | | (+)acquisition | | 2.40 | | | Debt Value of Leases | $296.73 | | | | ∆NCWC

∆NCWC

(+) | 7.91 | | | Cost of Debt | 6.01% | | | | | Capital Reinvested | 42.88 | | | | | | | | | b = Capital Reinvested / Adj.EBIT(1-T) | 0.27 | | | A8 - Sensitivity Analysis | | | | | | | | | | | | | | | | | | | | Stable Cost of WACC (%) | | A4 - ROC Calculation | 2010 | | | stable ebit growth (%) | | 9.01 | 10.01 | 11.01 | | adj EBIT(1-T) (2010) | 157.33 | | | | 1.01 | 16.60 | 15.30 | 14.26 | | Bk Debt (2009) | 89.40 | | | | 2.01 | 18.38 | 16.70 | 15.39 | | Bk Equity(2009) | 229.30 | | | | 3.01 | 20.77 | 18.50 | 16.81 | | Capital Reinvested (2009) | 318.70 | | | | 4.01 | 24.11 | 20.91 | 18.62 | | ROC = Adj.EBIT(1-t) / Capital Reinvested | 0.49 | | | | 5.01 | 29.12 | 24.28 | 21.05 | | | | | | | | | | | | A5 - Growth Rate Calculation | 2010 | | | | | | | | | Retention Rate, b | 0.27 | | | | Years in High Growth | | ROC | 0.49 | | | stable ebit growth (%) | | 1.00 | 2.00 | 3.00 | | Growth Rate = ROC x b | 0.13 | | | | 1.01 | 14.10 | 15.30 | 16.52 | | | | | | | 2.01 | 15.48 | 16.70 | 17.95 | | A6 - Other Inputs | 2010 | | | | 3.01 | 17.25 | 18.50 | 19.78 | | Firm Beta | 1.26 | | | | 4.01 | 19.61 | 20.91 | 22.23 | | Industry Beta | 1.19 | | | | 5.01 | 22.92 | 24.28 | 25.66 | | | | | | | | | | | | Year | 2009 | 2010 | | | | | | | | Total Capital Invested | 318.7 | 362.90 | | | | | | | | | | | | | | | | | |

APPENDIX B - Dividend Discount Model | | | | | | | | All values in $million | | | | | | | | | | | | | | | | | | | | | | B1 - Valuation Schedule | | | | | | | | | | | | Current year | High growth | | | Transitional Period | | | | Stable Growth | INPUTS REQUIRED | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | ROC | 49.37% | 49.37% | 49.37% | 44.57% | 39.78% | 34.99% | 30.20% | 25.40% | 20.61% | 15.82% | Average (interest expense/Total Debt(BV)) | 7.30% | 7.30% | 7.30% | 7.30% | 7.30% | 7.30% | 7.30% | 7.30% | 7.30% | 7.30% | Debt (BK) / Equity (BK) | 23.73% | 23.73% | 23.73% | 24.19% | 24.66% | 25.12% | 25.59% | 26.05% | 26.52% | 26.98% | ROE | 51.74% | 51.74% | 51.74% | 54.12% | 48.33% | 42.50% | 36.62% | 30.69% | 24.72% | 18.71% | Payout Ratio | 60.14% | 60.14% | 60.14% | 61.55% | 62.96% | 64.37% | 65.78% | 67.18% | 68.59% | 70.00% | Retention Rate | 39.86% | 39.86% | 39.86% | 38.45% | 37.04% | 35.63% | 34.22% | 32.82% | 31.41% | 30.00% | Earnings Growth | 20.62% | 20.62% | 20.62% | 20.81% | 17.90% | 15.14% | 12.53% | 10.07% | 7.77% | 5.61% | EPS | $1.10 | $1.32 | $1.60 | $1.93 | $2.27 | $2.62 | $2.95 | $3.24 | $3.50 | $3.69 | DPS | $0.66 | $0.80 | $0.96 | $1.19 | $1.43 | $1.69 | $1.94 | $2.18 | $2.40 | $2.58 | | | | | | | | | | $44.11 | | Cost of Equity | | | | | | | | | | | Treasury-bond rate (risk free rate) | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | 5.51% | Risk premium | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | 5.01% | Beta | 1.26 | 1.26 | 1.26 | 1.25 | 1.24 | 1.23 | 1.22 | 1.21 | 1.20 | 1.19 | Cost of equity | 11.82% | 11.82% | 11.82% | 11.77% | 11.72% | 11.67% | 11.62% | 11.57% | 11.52% | 11.47% | Present Value of Dividends | | $0.71 | $0.77 | $0.85 | $0.92 | $0.97 | $1.00 | $1.01 | $1.00 | | Present Value of Terminal Price | | | | | | | | | $18.43 | | Valuation | | | | | | | | | | | Present Value of High Growth Dividends | $1.48 | | | | | | | | | | Present Value of Transitional Period Dividend | $5.76 | | | | | | | | | | Present Value of Terminal Price | $18.43 | | | | | | | | | | Value of Equity Per Share | $25.67 | | | | | | | | | |

APPENDIX C – Operating Leases | | | | | | | | | | | | Operating lease payment commitments in future years | | | | Time | ($millions) | | | < 1 year | 52.384 | | | 1 – 5 years | 187.934 | | | > 5 years | 113.569 | | | | | | | Assuming that the operating rental commitment due 1-5 years are distributed equally over the years 2011-2014. | | Yearly payments (187.934/4) | 46.984 | | | | | | | For the payment period beyond year 5, we assume that operating lease payments are equally distributed, equal to operating lease commitment due in year 5. | Payment period beyond year 5 (113.569/46.984) | 3 | (rounded off for calculation) | | Total payment period (5+3) | 8 | | | | | | | Complete operating lease payment schedule ($millions) | | | | Time | Lease Expense | Present Value (@6.01% Cost of Debt) | | 1 | 52.384 | $49.41 | | 2 | 46.984 | $41.81 | | 3 | 46.984 | $39.44 | | 4 | 46.984 | $37.20 | | 5 | 46.984 | $35.09 | | 6 | 46.984 | $33.10 | | 7 | 46.984 | $31.23 | | 8 | 46.984 | $29.45 | | Debt Value of Leases | | $296.73 | | | | | | Depreciation of lease asset is assumed to be straight line through the life of the lease, therefore equal to $8.727 million for future periods. | | Appendix D - Free Cash Flow to Equity | | | | | | | | All values are in $ millions | | | | | | | | | | *Values obtained from Finanalysis | | | | | | | | | | | | | | | | | | | | INPUTS REQUIRED | 2006 | 2007 | 2008 | 2009 | 2010 | | | | | Net Income | 25.81 | 40.39 | 65.08 | 94.44 | 118.65 | | | | | Capex | 29.05 | 34.41 | 51.57 | 44.44 | 56.85 | | | | | Depreciation | 7.44 | 10.85 | 14.74 | 18.75 | 23.28 | | | | | Change in NCWC | 14.32 | -2.54 | 41.52 | -25.56 | 7.91 | | | | | Debt ratio | 12.31% | 8.32% | 13.08% | 3.25% | 2.89% | | | | | CALCULATING CASHFLOWS | | | | | | | | | | FCFE | -$5.70 | $21.12 | -$3.03 | $94.31 | $78.37 | | | | | Dividends Paid | $7.86 | $11.51 | $27.58 | $47.18 | $71.50 | | | | | Dividends / FCFE | -138.01% | 54.50% | -911.63% | 50.02% | 91.23% | | | | | | | | | | | | | | | | | | | | | | | | |

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[ 1 ]. Goldman Sachs JBH Report 2011

[ 2 ]. Appendix D

[ 3 ]. Appendix B – B5 Interest Calculation

[ 4 ]. http://www.jbhifi.com.au/documents/news/_2011-03-29_9-09-02.pdf

[ 5 ]. http://www.jbhifi.com.au/documents/news/_2011-05-16_8-08-18.pdf

[ 6 ]. http://www.bloomberg.com/apps/quote?ticker=JBH:AU 17/05/2010

[ 7 ]. Appendix B – B4 Payout Ratio

[ 8 ]. Macquarie Conference Presentation 2011, http://www.jbhifi.com.au/documents/reports/_2010-06-02_9-09-10.pdf

[ 9 ]. http://www.jbhifi.com.au/about-us/

[ 10 ]. http://savingpoint.com.au/expense-reduction/red-blue-and-yellow-a-short-business-tale-609

[ 11 ]. Macquarie Conference Presentation 2011, http://www.jbhifi.com.au/documents/reports/_2010-06-02_9-09-10.pdf

[ 12 ]. , http://pages.stern.nyu.edu/~adamodar/ - Growth Rate Estimation

[ 13 ]. http://www.abc.net.au/lateline/business/items/201102/s3132482.html

[ 14 ]. http://www.rba.gov.au/statistics/tables/index.html#interest_rates - Government bonds.

[ 15 ]. We use the US Market because it is a mature market with a long history of data.

[ 16 ]. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html - Historical Risk Premium

[ 17 ]. SE=σ/√n

[ 18 ]. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html - Country Spread & Risk Premium

[ 19 ]. Finanalysis - JBH

[ 20 ]. http://finance.ninemsn.com.au/news-and-markets/company/financials?code=JBH

[ 21 ]. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/Betas.html. – Levered & Unlevered Betas.

Note: we use values from damodoran rather than Finanalysis for industry levels because beta from Finanalysis refers to the entire retail sector rather than the niche market of retail that JBH is part of.

[ 22 ]. ke,current=5.51%+1.265.01%=11.28%

[ 23 ]. ke,stable=5.51%+1.195.01%=11.47%

[ 24 ]. Appendix A – A1 Valuation Schedule

[ 25 ]. 5.51%+0.50%×0.7=4.2% See also Appendix A.

[ 26 ]. Interest coverage = EBIT/interest exp = 175.1/5.5 =31.8

[ 27 ]. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/Betas.html

[ 28 ]. http://www.stern.nyu.edu/~adamodar/pc/datasets/restcompfirm.xls - JBH Data

[ 29 ]. (MV Debt / MV Capital) = 1 - (MV Equity / MV Capital)

[ 30 ]. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/wacc.htm - WACC

[ 31 ]. WACC=11.82%97.11%+4.21%2.89%=11.60%

[ 32 ]. WACC=11.47%79.86%+4.21%20.14%=10.01% See also Appendix A.

[ 33 ]. Damodoran, A 2002, Investment Valuation:Tools & Techniques for Determining the Value of any Asset, 2nd edn, John Wiley and Sons, New York, p282.

[ 34 ]. http://news.smh.com.au/breaking-news-business/australias-economic-growth-surges-20100526-wc7o.html

[ 35 ]. Appendix A and C

[ 36 ]. Appendix A – A1 Valuation Schedule

[ 37 ]. NCWC = Non-Cash Working Capital

[ 38 ]. Appendix A – A3 Retention Rate

Note: by assuming linear decrease in retention rate we assume a changing composition of Net Capex and NCWC as well.

[ 39 ]. Appendix A – A1 Valuation Schedule

[ 40 ]. Appendix A – A1 Valuation Schedule

[ 41 ]. Debt = Debt Value of Leases + 2010 BV of Debt.

[ 42 ]. http://www.bloomberg.com/apps/quote?ticker=JBH:AU

[ 43 ]. Appendix B – B3 ROE calculation

[ 44 ]. Appendix B – B5 interest Calculation

Note: i is the average interest expense to total debt (BV) worked out by examining book values between 2003 and 2010.

[ 45 ]. Appendix B – B4 Payout Ratio

[ 46 ]. http://www.jbhifi.com.au/documents/news/_2011-03-29_9-09-02.pdf

[ 47 ]. Appendix B – B1 Valuation Schedule

[ 48 ]. Appendix B – B1 Valuation Schedule

[ 49 ]. Appendix B – Valuation Schedule

[ 50 ]. Appendix B – Valuation Schedule

[ 51 ]. Appendix B – Valuation Schedule

[ 52 ]. http://www.investopedia.com/terms/e/enterprisevaluesales.asp

[ 53 ]. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/psdata.html

[ 54 ]. Finanalysis: Annual Ratio Analysis – JBH, DJS, HVN, MYR, SRA, WTF, WHS, BRG

[ 55 ]. Finanalysis: Annual Profit and Loss – JBH, DJS, HVN, MYR, SRA, WTF, WHS, BRG

[ 56 ]. Statistical numbers provided by Finanalysis are used in calculation in appendix: http://www.aspectfinancial.com.au

[ 57 ]. Expected growth = Reinvestment rate × ROC

ROC = After-tax operating margin × Sales/ Invested Capital

[ 58 ]. Reinvestment rate = (Capex – Depreciation + Change in Non-cash Working Capital)/EBIT(1-t)

[ 59 ]. After-tax operating margin = EBIT(1-t)/Sales

[ 60 ]. http://www.bloomberg.com/apps/quote?ticker=JBH:AU - 17/04/11