Financial Report on Village Roadshow Ltd.
By, Devvrat Patney Taijas Kumar
Table of Contents EXECTIVE SUMMARY ....................................................................................................................... 3 Company Analysis .................................................................................................................................. 4 Company Background ...................................................................................................................... 4 Core operations ................................................................................................................................. 5 Opportunities and its Factors .......................................................................................................... 5 Company Strategy ............................................................................................................................ 7 Industry Analysis .................................................................................................................................... 8 Competitive Landscape .................................................................................................................... 8 Economic Attributes Framework .................................................................................................. 11 Porter’s Five Forces ........................................................................................................................ 13 SWOT Analysis ............................................................................................................................... 15 Product Life Cycle .......................................................................................................................... 16 Financial Analysis................................................................................................................................. 17 Profitability Ratios .......................................................................................................................... 17 Asset management Ratio ................................................................................................................ 19 Liquidity Ratios............................................................................................................................... 21 Long term Leverage Ratio ............................................................................................................. 22 Market Performance Ratio ............................................................................................................ 24 Bankruptcy Analysis....................................................................................................................... 25 Financial Performance Forecasts .................................................................................................. 27 Valuations ............................................................................................................................................. 34 Valuation Method 1 - Gordon Growth model .............................................................................. 36 Valuation Method 2 - Free Cash Flow Model .............................................................................. 37 Comparison of Valuations (Free cash flow model and Gordon Growth model) ....................... 38 Recommendations ................................................................................................................................. 39 Reference list ........................................................................................................................................ 40
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EXECTIVE SUMMARY By KUMAR T, PATNEY D
Aims of the report and methods
This report provides the evaluation and analysis of Village Roadshow Limited. Thus, providing a forecast from the valuations with recommendations for the investors. The methods used for this analysis are, company risk assessment, performance ratios and its trends over the past 5 years. These performance measurements were compared with Walt Disney Limited using prior assumptions as well for the next 5 years. The following 2 methods were used for the valuations,
Free Cash Flow Model
Gordon Growth Model
Recommendations
Below is our recommendation for the investors, Current shareholders – HOLD Potential shareholder – DO NOT INVEST
Assumptions
Forecasting and valuations have certain limitations and trend projections which are based on subjective assumptions.
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Company Analysis
Company Background Establishing the first drive-in cinema in 1954, Village Roadshow Limited (VRL) is an Australian-owned entertainment company rooting in Melbourne. Ever since, the company grew and diversified its businesses. Thus, today, VRL operates in theme parks, film and DVD distribution, cinema and film production. Below highlights the historical growth of the company since 1954 (Diagram 1).
(Diagram 1 - Historical chart of VRL)
VRL revolutionized the cinemas of its time by using modern projection technology, stadium seatings and advanced sound systems. Hence, laying the foundation for nowadays high-tech movie theaters. In 1988, Village Roadshow took over De Laurentis Entertainment Limited to go public and be listed on the stock market; therefore raising its capital structure. Since then, the company is listed on the Australian Security Exchange (ASX). Village Roadshow took it one step further and in the 90â€&#x;s, expanded its business internationally in to 20 different countries. Nevertheless, todayâ€&#x;s operations are run mainly in Australia, Singapore and the US - where it almost owns 47% of the entertainment division 4
based in Los Angeles. In addition, the company recently launched a marine park in China and is further exploring business opportunities in Asia (Annual report, 2014).
Core operations As mentioned before, VRLs core businesses are in theme parks, cinema exhibitions, film distribution and production which underlines the fact that these businesses are great retailbrands, generating strong cash flows. While creating concrete and diverse earnings streams, these businesses are supportively unified, targeting a similar customer demographic and providing noteworthy cross-promotional opportunities. Companies like Warner Bros. Movie World, Sea World, Wet „nâ€&#x; Wild, Village Roadshow Studios at Queensland and Village Road Show Pictures are some of the well-admired operations since 1971 (Annual report, 2014).
Opportunities and its Factors VRLs current ventures have gained them a $7million growth from the previous year of total $84million. Diagram 2 showcases the breakdown of the operations accordingly.
(Table 1 - Operating result comparison)
Operating results DIVISIONS
2014 (mil)
2013 (mil)
Theme parks
$
33.10
$
30.70
Cinema exhibitions
$
43.80
$
40.40
Film Distribution
$
34.80
$
38.00
Corporate & Other
$ (32.30)
$ (27.10)
Reported Results
$
$
79.40
82.00
Adding One-off costs 5
Pre-opening costs- Sydney
$
5.40
Pre-opening costs- Las Vegas „Theme park Capital' Campaign
$
3.60
Accelerated Dep‟t - Gold Coast
$
2.90
Reported Results excluding One-off costs
$
91.30
$
2.00
$
84.00
Keeping in mind the operations contribution towards the revenue of the company, all three sectors of the company show prominent growth in the reported results (Annual report 2014a) which highlight the two major factors for its consistent form in recent years. First factor is the effective cost management for operations and marketing investments, which showcases increase in costs from $2million in 2013 to $11.9million in 2014. Second factor would be the increase in investments for global opportunities which can be observed as per below Diagram 2.
(Diagram 2 – Location of current opportunities)
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Company Strategy VRLs strategy is clearly based on diversification, as their core businesses are a combination portfolio of entertainment assets. On a local level, the emphasis has been on creative campaign/new media for the Gold Coast Parks which also helps in packaging plans and ticket pricing. Various factors such as operating cost pressures on increase of wages, utility costs and workers compensation were controlled in 2014 by taking such initiatives via cost management. Moreover, in the distribution landscape, Roadshow entertainment has consistently been the number one independent distributor in Australia with a 14.5% market share. VRLs investment towards Roadshow Films also paid off specifically in the second half of the 2014 financial year as they increase their lead by 2.9% totaling their market share to 28.4%. In the past few years, the company has mainly been focused on expansion and market penetration towards Southeast Asia and China. According to the companyâ€&#x;s annual report (2014), VRL has already signed Letters of Intent and other agreements with plenty of parties regarding the development of entertainment parks in Asia. To emphasis on the expansion plans in these regions, the company divested Hawaii and Phoenix water parks in 2013. It seems quite reasonable to state that VRLs 20 years of experience in the theme parks development and management in Australia, makes it considerably a facile capitalization on the humongous potential that Asia holds. Substantial investment in management resources to conduct field trips, research, analysis, discussions with partners and investors not only showcases judicious use of VRLs elite expertise, but also highlights how conducting business is all about respect and trust, which are vital to deepen relationships. A good example is of the Consulting Service Agreement with Hainan R&F Ocean Paradise Development Co. Ltd for the building and development of a mega park. This mega park (Ocean Paradise Project) is situated at Hainan Island, China which is a popular tourist destination towards 15 to 20 million visitors each year. Another example is of the strategic alliance agreement with CITIC Trust Co. Ltd of the CITIC group (one of Chinaâ€&#x;s largest financial conglomerates), which aims to leverage the financial strengths of both parties for investment purposes in real estate and theme parks in China and Southeast Asia (Annual report, 2014).
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Industry Analysis Competitive Landscape Village Roadshow Limited is currently Australia‟s leading entertainment group with a phenomenal global presence in U.S.A and Asia-Pacific as well (Annual Report 2014). However, the company has to deal with mainly 3 competitors in the entertainment and distributions industry: Walt Disney Company for Theme Parks, 21st Century Fox Inc. for Cinema distribution and production, Hoyts Corporation Pty. Ltd. for Cinema Exhibition. ● The Walt Disney Company with its subsidiaries is a diversified entertainment company with operations in mainly Networks, Parks, Media and Studio Entertainment. Walt Disney World Resort, located in U.S.A, France, China and Japan, comprises of theme parks (the Magic Kingdom, Epcot, Disney‟s Hollywood Studios, Disney‟s Animal Kingdom and other related parks) which is marketed through variety of national, international and other advertising promotional activities. Since the company has its own media networks, they understand the importance of growth of revenue for advertising and promotions and thus have a strong balance sheet with free cash flows (Walt Disney 2014).For example, their theme parks attracted $132.5 million guests in 2013 which is 4.8% more than 2012 as per the AECOM Economics and the Themed Entertainment Association (2013). Theme parks are the core of the business model at American giants Walt Disney Company. In 2013, 11 parks around the world provided nearly one-third of its $45 billion revenue and 20.7% of its $10.7 billion operating profit (Walt Disney 2013). In spite of the flourishing success in this decade, Disney has been increasing their ticket prices consistently. They recently increased their prices by 3%-6% in all parks to a record $100 per ticket. This price hike seems to be working pretty well as the parent company Walt Disney World Resorts reported 7% increase in revenue yearover-year, mainly from theme parks (CNN, 2015). The company has been taking consistent advantage of the supply and demand globally and is a big competitor towards VRL for the long haul. As compared to VRL, the driving force of international success of Disney‟s theme parks can be credited towards the scale of its operations. However, in Australia, VRL has been the consistent theme park and attractions operator since 1988 (Annual report 2014). By comparison, Australia theme park market is smaller to that of its 8
international counterparts (IMETT, 2012). The numbers needed to support Walt Disney‟s higher development and administrative costs simply cannot be achieved in Australia. ● In the Cinema production and distribution industry, 21st Century Fox Inc. (formerly known as News Corporation) is the fiercest competitor to VRL. It‟s a diversified global entertainment company with its core operations in filmed entertainment, television, broadcasting and network. Their activities are conducted principally in United States of America, United Kingdom, Asia, Latin America and Continental Europe. Twentieth-century Fox film (TCFF) is responsible for motion pictures and distributions under 21st Century Fox Film Inc. With the company having an arrangement with DreamWorks Animation SKG Inc., TCFF typically seeks to generate revenues primarily from 4 main sources: (i) Through premium pay and video-on-demands. (ii) Theatrical exhibition in USA, Canada and a few international markets. (iii) Home media formats including digital distribution through collaborations, example, Netflix. (iv) Exhibition on free television services, broadcast program services (21cf, 2014).
(Diagram 3 - Market share for Cinema exhibition and distribution in 2013)
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(Diagram 4 - Market share for Cinema exhibition and distribution in 2014)
From the above market share distribution (Diagram 3 & 4) of Australia taken from Screen Australia (2015), Fox had a massive jump from 15% to 23% while Roadshow remained at the top sitting at 27% market share. Since the strength of the major distributors comes from the continuous access to a stream of successful films in the box office, it is this continuity that gives the distributors a significant advantage over a period of time against their competitors (ACCC, 1998) . In 2014, Fox Films focused on India as they highlight strong operations for film distributions and television studios with over 650 million viewers per week. By this staggering growth in market share, Fox Films showcase how success of the film‟s division‟s diversified approach, delivers industry-leading margins, consistency and an unprecedented global reach (21cf, 2014). ● In the Cinema Exhibitions department, the Hoyts Corporation Pty. Ltd. is an entertainment company which operates and owns cinema theatres in Australia and New Zealand. Founded in 1908 based in Sydney, the chain owns and operates more than 45 movies theatres, about 18% in Australia. Subsidiary Hoyts Distribution manages the distribution for international films in Australia and New Zealand. The company is owned by group of funds advised by Pacific Equity Partners after they bought 50% of Publishing and Broadcasting that valued the company at $440 million. Val Morgan is the fastest growing business of the company with 95% of cinema advertising in Australia (The Australian 2014). As compared to Hoyts, Village Roadshow sits on top of the cinema exhibition market share for Australia with ownership stakes in 51 cinema theatres, 16% of the local 10
digital film market and 14.5% of retail distribution (Smh 2014). On the flip side, Hoyts group CEO has signaled a $900 million stock market float of the cinema chain in 2015 which was equally supported by Village Roadshow as both companies predict growth in cinema exhibition in 2015 (Australian Financial Review 2014). In conclusion, Village Roadshow is forecasted for a prominent long term growth as they are focused in penetrating the market within Asia and Europe with multiple agreement signed and projects already underway. Walt Disney and 21st Century Fox Inc. are major competitors in a global scale while Hoyts is the minor competitor as they are based only in Australia and New Zealand, However, Hoyts plans to public float in 2015 which could give them an advantage of greater access to funds and opportunities to reduce their debts but then the company would be viable to market fluctuations and pressure to consistently perform as the demands for dividends would be high.
Economic Attributes Framework For Village Roadshow to grow in the entertainment industry, it is vital for the company to give-in towards the requirements of audience. As we are slowly moving towards the digital age, the idea of creating premium value of the company in other parts of the world is transforming into a more user-friendly interface. Hence, Village Roadshow is affected by the digital distribution, television industry and the theatrical business.
â—? Demand - Box office takings across the industry fell 2.3% to $1.1 billion in 2013 according to figures from the Motion Picture Distributors Association of Australia which also showcases gradual decrease in demand for the theatrical business. To tackle that in 2013, Village Roadshow reported 14.6% increase in profit to $36.1 million by crediting the outstanding performance towards increasing the ticket prices (Annual report 2013). In the theme parks division, the industry has grown tremendously in the past 5 years due to high level of tourism in Australia. Further, industry value added is estimated to increase at an annualized 2.3% in the 10 years through 2019-20, which is slightly lower than estimated national GDP growth over the same years of 2.7% which is good news for Village Roadshow in the long run (IBIS World, 2014). 11
● Supply - With the constant increase in the ticket and movie-on-demand prices globally, Village Roadshow maintains its profits for the year 2014.With a long term program supply agreement with Channel Nine, the company is credited towards Roadshow TV being one of the leading suppliers of films to the Foxtel Movies channels. They emphasize on product differentiation by Roadshow Entertainment being the leading independent distributor of DVD, Blu-ray and digital to the retail and rental channel and online platforms (Annual report, 2014). Roadshow Films also has longstanding contracts to distribute movies for Warner Bros., The Weinstein Company, Lionsgate, Film Nation, and other leading independent production houses. These long term contract contribute to the major high-tech quality distribution and supply. With consistent increase in tourism, theme park attendances have always been high with Village Roadshow Studios having attracted projects with a combined budget of around 2.5 billion dollars since 1988 with approximately $1.3 billion spent locally (Annual report 2014).
● Manufacturing - To build adequate cinema theatres and theme parks, a consistent investment in the commercial estate is important. In the distribution industry, to affect product differentiation, digital tech manufacturing is a critical step before content distribution. All in all, VRL is a capital intensive based company, for example, according to Australian Financial Review (2015), VRL created a $US500 million ($641 million) investment fund with Chinese state-owned finance giant CITIC Trust Co.
● Marketing - As per the Jon Satterley (Head of Digital Development at VRL), the company‟s main focus is primarily customer engagement. Company‟s key ambitions is to shift Roadshow‟s traditional model of marketing products over a set timeline (such as promoting films at the time of cinematic release and then again later when the home entertainment “window” opens) into a connected series of communications and insights that anticipate and respond to customers‟ entertainment needs and wants. The company also emphasizes on of a robust measurement system for marketing. For 12
example, ExactTarget, is a CRM platform for Village Roadshow‟s divisions. It plays a critical role for theme parks to market the right experiences for the right people (CMO, 2014). ● Investing and Financing - VRL believes in market penetration and creating value for the shareholders. Long term investing seems to be the way for long term growth of the company. For example, Consulting Service Agreement with Hainan R&F Ocean Paradise Development Co. Ltd for the building and development of a mega park. Another example is of the strategic alliance agreement with CITIC Trust Co. Ltd of the CITIC group (one of China‟s largest financial conglomerates), which aims to leverage the financial strengths of both parties for investment purposes in real estate and theme parks in China and Southeast Asia. Lastly, increase in investments from $2million in 2013 to $11.9million in 2014 for theme park local operations. Risks however are of understanding the local public‟s demands and tourism levels in the respective countries (Annual report 2014a). Porter’s Five Forces The Porter‟s five forces is a tool for understanding where the power lies in a business. Helps in understanding the strength of the position of the company in a competitive situation as well as strength of the position you‟re considering moving into (Wahlen et al., 2011).
(Diagram 5 - Porter’s five forces) 13
Regarding the qualitative evaluation of Village Roadshow Limited‟s strategic position (as per Diagram 5), following is the analysis,
1. Threat of New Entrants → Low Possibility: The entertainment industry is quite broadly dominated by giant entertainment companies like Fox, Universal Studios, VRL, Walt Disney Limited, and many more. Considering the fact that Australia has a relatively smaller market to that of its international counterparts, the market is dominated by Companies established since the 1950‟s. However, to penetrate the digital technology market would be a possibility as we are still progressing into the digital age, thus, providing opportunities through low cost barriers.
2. Bargaining power of the Suppliers → High Possibility: The chances are greater in the film industry and low for theme parks, for the suppliers to have power. A unique nature of the movie industry is that famous actors can be classified as suppliers. For example, success was attained in sequel of movies like LEGO, The Matrix because they attracted A-list actors who had great bargaining power.
3. Threat of Substitute → Medium Possibility: VRL is one of the market leaders in the industry. However, products like Netflix (if successful) can substitute and reduce the revenue earnings as it is an internet service than can be viewed at home. Theme parks and cinema exhibition have low possibility of a substitute.
4. Bargaining Power of Buyers → High Possibility: This is quite significant as buyers bargaining power can be fuelled by abundance of offers in films and manufacturing industry.
5. Industry Rivalry → Medium to High: Rivalry in the global industry is intense as there are giant companies like Paramount Pictures, Walt Disney, Fox Film Industries who compete on a large-scale level.
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SWOT Analysis This analysis helps in developing a strong business strategy by assessing certain key strengths, weaknesses, opportunities and threats in the marketplace. STRENGTH
WEAKNESS
Local competitive edge because of its enormous size.
Major revenue comes from Australia whereas the main competitors have distinct reach globally.
Company size has a positive attribute because it makes higher quality production, quality actors, skilled crew and better marketing approach.
Demand decrease could be caused by high priced movie tickets, along with poor economic conditions.
Holds various special licenses Has several long term agreements and contracts Have different sources of income since it’s diversified. OPPORTUNITIES
THREATS
New market opportunities for theme parks in Asia
Development of new technology changes the way television and films are distributed. These changes are happening in a rapid pace now.
To decline piracy by agreements with ISP (Internet Service Providers).
Immediate global competitors in all core operations
(Table 2 – SWOT Analysis for Village Roadshow Limited)
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Product Life Cycle This method has 4 very clear stages, Introduction, Growth, Maturity and Decline. Since most companies understand the different product life cycles. The majority therefore, heavily invest in new product development.
(Diagram 6 – Product Life Cycle of Village Roadshow Limited)
As per Diagram 6, Village Roadshow is clearly still in the growth stage, as they still are impaling the global market share. The company has attained a mainstream audience in Australia while their market grows globally as their sales increases.
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Financial Analysis Financial analysis is the backbone of evaluating a company and its value. The use of financial ratios via extraction from the companyâ€&#x;s financial reports carries tremendous importance to determine the intrinsic value of the company and its potential. Furthermore, it can be used a tool to identify potential growth in the company, or potential downfalls in some major aspects associated with the core functions of the company being analyzed. Profitability Ratios The return on equity (ROE) is a critical tool when analyzing how effective management is at user equity to generate income. As you can see from Figure 1, VRL return on equity (ROE) in 2014 and 2013 were quite similar 8.8% and 8.9% for the respective years. This number has been on the rise from the very low returns from 3.1% in 2010 and 1.4% in 2011. This shows, at least for the past 2 years the return on equity is heading in the right direction for shareholders of Village Roadshow Limited. Disney return on equity is extremely high, yielding a minimum of 10.1% in the past 5 years and a high of 15.6% return in 2014. Village Roadshow is not keeping up with Disney high return on equity.
(Figure 1 - Return on equity comparison b/w VRL and Disney)
Return on Assets (ROA) (Figure 2) indicates to the investor how hard the companyâ€&#x;s assets are working to generate an income. The return on asset for Village has been ranging from 17
3.2% to 5.1% in the past 5 years, this shows they have a moderately steady return from their assets. However, they are no match for Disney, which in comparison has been ranging from 7% to 9.9% in the same time frame, illustrated in the graph below.
(Figure 2 - Return on asset comparison b/w VRL and Disney)
The profit Margin ratio (Figure 3) calculated the net income over sales. It illustrates how much profit they make compared to their sales. For example Village in 2014 made a profit of 6.9 cents per every dollar of sales made. Village profit margin has been ranging between 5.9% to 8.8% in the past 5 years. Disney on the other hand has had a range of 12.1 %to 16.8%, their return on profit margin is more than double compared to Village Roadshow.
(Figure 3 - Profit margin for ROA comparison b/w VRL and Disney)
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Asset management Ratio
The accounts receivable ratio (Figure 4) indicates how effectively the company at collecting its accounts receivable from credit sales. Village has improved their accounts receivable over from 4.89% in 2010 to a high of 8.53% in 2014. This may be due to more effective strategies in collecting payments from creditors. Village is slightly better overall in collecting payments from their creditors compared to Disney; this is demonstrated in the table below.
(Figure 4 - Accounts receivable turnover comparison b/w VRL and Disney)
The asset turnover (Figure 5) measures the ability to generate sales from the average assets. This formula is very useful in determining how well the companyâ€&#x;s assets are at generating sales. Village Roadshow has had a steady asset turnover ratio of 0.66, 0.65, and 0.65 for the 2014, 2013 and 2012 respectively. This is slightly above Disneyâ€&#x;s asset turnover ratio of 0.59, 0.58 and 0.58 for the same time frame. Show below:
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(Figure 5 - Asset turnover ratio comparison b/w VRL and Disney)
Inventory turnover is the measure of cost of goods sold over the average inventory. This formula indicates how well the company is at converting its inventory to cost of goods sold. Village Roadshow turnover ratio is slightly getting higher from 2010 low point of 16.91 to 19.52 in the last financial report (2014). Village manages its inventory turnover slightly better than Disney, thus illustrated in the table below:
(Figure 6 - Inventory turnover comparison b/w VRL and Disney)
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Liquidity Ratios
The current ratio (Figure 7) is an indication of how efficiently the company can meet their short term obligations. It measures the relationship of current assets to the current liabilities. As shown the table below in 2014, 2013 and 2010 Village Roadshow had a ratio of 0.90, with the abnormal spikes in 2011 to 1.89 and in 2012 to 1.32, this is because they have sold some parts of their business, thus gaining proceeds of sales. The investor should not pay too much attention to these two years as they are not an accurate reflection of their current ratio. Disney has a moderately better current ratio, which means their liquidity is a little higher compared to Village.
(Figure 7 - Current ratio comparison b/w VRL and Disney)
The quick ratio (Figure 8) measures the relationships between the companyâ€&#x;s available cash and other items which could be easily converted into cash over the current liabilities. This measure is a slightly different the current ratio is the sense, it does not include inventory in the current assets, this is because inventory cannot be always relied upon in terms on liquidity. Disney has a better quick ratio compared to village in 2010, 2013 and 2014. We cannot take into account Villageâ€&#x;s abnormal quick ratio in 2011 and 2012 as these were caused by proceeds of sales.
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(Figure 8 - Quick ratio comparison b/w VRL and Disney)
Long term Leverage Ratio
Liabilities to Assets (Figure 9) also sometimes referred to as Debt Ratio, is the measure of total liabilities to total assets. The higher the ratio, the greater leverage in the firmâ€&#x;s capital structure. Village liabilities to asset ratio are ranging from 0.55 to 0.66 for the past 5 years, while Disney has been 0.41 to 0.45 for the same period. This exhibits that the Village relies much more heavily on leverage compared to its competitor in Disney.
(Figure 9 - Liability to asset ratio comparison b/w VRL and Disney)
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The liabilities to equity (Figure 10) ratio also known as the debt to equity ratio, measures the proportion of liabilities to equity in the firm‟s capital structure. The table below demonstrates that about Village is approximately two and a half to three times higher leveraged to equity compared to its competitor in Disney. This level of leverage is quite high, and management has to be mindful, that although it is not an imminent problem, it still needs to be kept in check. If this number begins to get significantly higher this could increase Village‟s risk of potential bankruptcy.
(Figure 10 - Liability to equity ratio comparison b/w VRL and Disney)
The interest coverage ratio (Figure 11) is calculated by EBIT divided by interest expense. This ratio illustrates the company‟s ability to cover its interest expense using its earning capacity. Village interest ratio has improved from a mere 2.30 in 2010 to a 3.59 in 2014. Even with this improvement this is a warning sign for investors as it is still very low. On the other hand Disney interest coverage ratio has improved from 15.53 in 2010 to a massive 42.65 in 2014. Disney shareholders don‟t have to worry about the company‟s ability to meet their interest payments as they fall due, while Village shareholders, should be quite concerned with their relatively low interest coverage ratio.
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(Figure 11 - Interest Coverage ratio comparison b/w VRL and Disney)
Market Performance Ratio The earnings per share (EPS)(Figure 12) is calculated by net income minus preferred stock then divided by the outstanding ordinary shares. As show in the table below VRL EPS ranges from $0.21 to $0.37 in the last 5 years. On the other hand its competitor in Disney range has been growing from a $2.07 EPS in 2010 to a $4.31 in 2014 which can be supported by the stock price increase of over 310% in the last 5 years (Yahoo finance, 2015). The graph below demonstrated the enormous difference between VRL EPS and Disney EPS:
(Figure 12 - Earnings per share comparison b/w VRL and Disney)
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In Figure 13, the price to earnings ratio for Disney showed a sideways trend showcasing a neutral share price trend. VRL in 2013 to 2014 grew by 9.09% mainly because of the average share price growth of 64.17%. This showcase to the investor‟s a promising future company performance with accordance to the stock price.
(Figure 13 - Price to Earnings comparison b/w VRL and Disney)
Bankruptcy Analysis We know that financial ratios help in understanding the firm‟s long term viability. However the ratio calculation of the firm sometimes gives conflicting views. To help eliminate the confusion, NYU Professor Mr. Altman developed the Z-score in the 1960‟s (Wahlen et al, 2011). The Z-scores help in predicting the corporate defaults and provide a control measure for company‟s financial distress measure. Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E Altman‟s Z-score consists of 5 performance ratios explained as below, A → working capital ÷ total asset B → retained earnings ÷ total asset C → earnings before interest & taxes ÷ total assets D → market value of equity ÷ total liabilities E → sales ÷ total assets 25
Interpretation of Z-Score: -
Below 1.8 indicates a firm is headed for bankruptcy.
-
Above 3.0 indicates a firm is unlikely to enter bankruptcy.
-
Between 1.8 and 3.0 is a statistical „grey area‟.
(Figure 14 - Bankruptcy analysis using Altman’s Z-score)
Village Roadshow is currently in the financial distress zone. The z-score increase of 0.84 between 2010 and 2011 highlights the significant increase of retained earnings increased by 3.24%, working capital increased by 86.63%.
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Financial Performance Forecasts Our forecasts are based on a detailed assumption structure for all line items for VRLâ€&#x;s financial statements. These assumptions have been explained in the following three excel charts which represent the three financial statements. The first step of the process for these estimations was to create a variability analysis for all historical data over the assessment period. We then calculated the Total Variation between 2010 and 2014, as well as a 3 year average of the variability for all of the line items. The 3 year average is seen as a good estimate of the growth rate for the line items as it provides an unbiased view of the trend for that particular item. However, the variability analysis has some flaws as it ignores outliers. We have accounted for this by making additional assumptions for our forecast wherever such a trend occurs. In our forecast we have endeavored to look beyond just the trend of variations and look at other ratios and line items that drive the particular transaction. The following pages have the Assumptions for each financial statement followed by the forecast for that financial statement. Statement IS IS BS BS CF CF
Type ASSUMPTIONS FORECAST ASSUMPTIONS FORECAST ASSUMPTIONS FORECAST
Below you can find the assumptions and forecast as per the color in the above table.
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INCOME STATEMENT $$$- in thousands
Revenues
Cost of Sales Gross Income
Assumptions Revenues go up from additional income through new parks in SE Asia. In addition to the 3 year variability average rate, we will use an increase of 3% to account for this growth in operations Cost of Sales includes (COGS + Operating Expenses for Parks + Film Hire Expenses). We estimate growth of Cost of Sales based on the prediction for Revenue growth. We are using the ratio of Cost of Sale/ Revenue to estimate this
It is difficult to estimate this line item as other income composes of uncertain line items. However, seeing that this has been relatively constant over the years, we use a 3 year average to estimate our projections Other Income
(Add) Share of Profits (loss) from Associates
Employee Expenses
Occupancy Expenses
We find this line item to be immaterial to the forecast high degree of variance between the years. Thus, it makes a forecast that would be counterintutive for getting a reasonable estimate of the future. 3 year average variability calculated at 2.07%. We will be using the same growth rate over the forecast period. Occupancy Expenses appear to be relatively constant over the 5 year period. The Average 3 year growth rate will be used for forecasting We use the average of 3 year variance to estimate this expense. Additionally, we add the growth derived from the ratio of Advertising & Promotions/ Revenue . We use this relationship as we expect advertising to increase as a result of expansion in SE Asia. We add this proportion from the time park is estimated to start operations
Advertising and Promotions
General and Admin Expenses
Other
We use an average of the proportion of General &Admin Expenses/ Revenue over the 3 most recent financial years We use the average of the 3 year variance , as the expense can not be estimated through relevant information on the annual reports We are using the average of the proportion of Finance Costs/ Non Current Liabilities over the 3 most recent fianncial years
Finance Costs EBITDA
We use the average proportion of the Depreciation & Ammortization/ Total Non Current Assets over the 3 year period. (Less) Depreciation and Ammortisation Earnings Before Interest and tax (EBIT)
(Less)Interest Expense
We use an average of the proportion of interest exps/finance exps. Over the 3 most recent fianncial years
Profit Before Income Tax (PBIT)
Tax Expense
Considering Australia's company Tax rate is 30%, we will use this rate multiplied by the corresponding year's PBIT.
Net Profit after interest and Tax (NPAT) Payments to Minority Interest from net profits Net Profit to Ordinary Shareholders from Discontinued Ops Net Profit attributable to Ordinary Shareholders (After Discountinued Op. Income)
Assume to be same as of 2014 for the forecast period.
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INCOME STATEMENT $$$- in thousands
Applied Change
Average of 3 years
2014
2015
2016
FORECAST 2017
2018
2019
Revenues
1.30%
4.30%
939,170.00
979,554.31
1,021,675.15
1,065,607.18
1,111,428.29
1,159,219.70
Cost of Sales Gross Income
0.15%
0.15% 2.04%
(330,781.00) 608,389.00
(331,277.17) 648,277.14
(331,774.09) 689,901.06
(332,271.75) 733,335.43
(332,770.16) 778,658.13
(333,269.31) 825,950.39
Other Income
7.68%
7.68%
26,612.00
28,654.77
30,854.35
33,222.77
35,772.99
38,518.97
-18.19%
-18.19%
8,480.00
0.00
0.00
0.00
0.00
0.00
Employee Expenses
2.07%
2.07%
(218,946.00)
(223,477.54)
(228,102.88)
(232,823.94)
(237,642.72)
(242,561.23)
Occupancy Expenses
1.05%
1.05%
(73,401.00)
(74,174.78)
(74,956.72)
(75,746.91)
(76,545.42)
(77,352.35)
3.41%
(102,958.00)
(102,958.00)
(102,958.00)
(102,958.00)
(102,958.00)
(102,958.00)
-3.44%
-7.96%
(26,697.00)
(25,778.25)
(24,891.11)
(24,034.51)
(23,207.38)
(22,408.72)
Other
3.29%
3.29%
(55,403.00)
(57,226.26)
(59,109.52)
(61,054.76)
(63,064.02)
(65,139.40)
Finance Costs EBITDA
9.02%
-12.46% 30.30%
(33,126.00) 159,014.00
(36,113.43) 180,235.46
(39,370.28) 211,719.27
(42,920.85) 245,003.90
(46,791.62) 280,114.36
(51,011.47) 317,081.73
-4.88%
6.81%
(65,349.00)
(62,158.34)
(59,123.46)
(56,236.76)
(53,491.00)
(50,879.30)
88.12%
93,665.00
118,077.12
152,595.81
188,767.14
226,623.36
266,202.43
-11.63%
(26,064.00)
(23,031.82)
(20,352.39)
(17,984.67)
(15,892.41)
(14,043.55)
-202.29%
67,601.00
95,045.30
132,243.43
170,782.47
210,730.96
252,158.88
-73.55%
(20,989.00)
(28,513.59)
(39,673.03)
(51,234.74)
(63,219.29)
(75,647.66)
20.91%
46,612.00
66,531.71
92,570.40
119,547.73
147,511.67
176,511.22
116.99%
843.00
843.00
843.00
843.00
843.00
843.00
-33.33%
-
65,688.71
91,727.40
118,704.73
146,668.67
175,668.22
(Add) Share of Profits (loss) from Associates
Advertising and Promotions
General and Admin Expenses
(Less) Depreciation and Ammortisation Earnings Before Interest and tax (EBIT)
(Less)Interest Expense
-11.63%
Profit Before Income Tax (PBIT)
Tax Expense Net Profit after interest and Tax (NPAT) Payments to Minority Interest from net profits Net Profit to Ordinary Shareholders from Discontinued Ops Net Profit attributable to Ordinary Shareholders (After Discountinued Op. Income)
30%
-13.71%
45,769.00
29
CASH FLOW $$$- in thousands CF from Operating Activites Receipts from Customers
Payments to Suppliers/ Employees
Dividends and distribution received Interest and items of similar nature
Finance Cost
Income Tax paid Net Cash Flow from Operations CF From Investing Activities Purchase of PPE
Assumptions
Sales Revenue- Accounts Receivable for each corresponding year We are using the Forecasted Cost of Sales+ Employee Expenses - Accounts Payable to estimate this Even though the line item is impractical to predict due to the unavailabilty of future financial performance estimated for entities VRL has invested in, we do find the line item relevant. We will take an average dollar value for the past 5 years We use an average of the ast 5 years' dollar value We us the 3 year variability average to forecast this line item as it is evident that FInance Costs are reducing over the years We use the company tax rate (30%)* Average Tax Paid over past 5 years for the 5-year forecast.
We use the same growth as the revenue growth rate
(Dollar Average of the last 3 years expenses * Rate of Revenue Growth) used for the first forecast, following which the revenue growth rate is applied. Purchase of Software and other intangibles
Proceeds from sale of PPE
Purchase of Equity Investments
Proceeds from sale of Investments/Businesses
Proceeds from sale of Equity Investments
Tax on Disposal of investments
Loans to (or repaid to) other entities
Loans from (or repaid by) other entiites Other Net Cash Flow from Investing
We assume an average of the past 5 years will be a good forecast for the future. Given the lack of information for the future proceeds from sale of PPE we use have to assume it remains the same over the next 5 years This line item is deemed immaterial to the forecast as there have been no transaction in 4 of the past 5 years. As explained in the Balance sheet, this item is immaterial due to its variability over the years. Moreover, it would be impractical to predict which investments/businesses the company management decide to sell. Due to the nature of this item it is impractical to make a forecast and so, we will ignore it in our forecast. Immaterial to the forecast, as it is difficult to predict which investments will be sold and for what amount It is inappropriate to forecast this line item, as it is impossible to predict what amount/ and to whom VRL will lend We take an average of the past 5 year dollar value and use that value for the whole forecast. We do this due the consistency of receits over the years Immaterial to forecast due to absence in the past 4 years
CF From Financing Activities
Proceeds from borrowings
Proceeds from Issues of Share
Repayment of Borrowing/ Derivatives
Dividends and Distributions Paid
Capital Reduction/ Share Buyback
We use the average proportion of the proceeds from borrowings to the total assets over the past 3 years. The 3 year variability average is skewed due to a significant rise in 2013 and due to there being no proceeds in 2010 and 2011 from share issues. For this reason we are unable to ascertain a resonable reasoning for wether VRL will need to issue more shares to raise Average proportion of the repayments to the (current + non current debts) over the past 5 years. We take the average dollar value for the past 2 years' dividends paid and apply the revenue growth rate to it for our forecast We use the proportion of capital reduction to the the total shareholders equity (from the previous year)
30
CASH FLOW $$$- in thousands CF from Operating Activites
Applied Change
Average of 3 years
Receipts from Customers
2014
2015
2016
2017
2018
2019
-6.06%
1,035,629.00
871,818.31
913,939.15
957,871.18
1,003,692.29
1,051,483.70
-4.59%
-4.59%
(908,094.00)
(773,572.44)
(804,221.14)
(837,944.14)
(875,090.80)
(916,051.05)
8,119.20 9,746.60
24.20% -23.81%
20,865.00 4,665.00
8,119.20 9,746.60
8,119.20 9,746.60
8,119.20 9,746.60
8,119.20 9,746.60
8,119.20 9,746.60
-19.57%
-19.57%
(29,487.00)
(23,716.01)
(19,074.48)
(15,341.36)
(12,338.86)
(9,923.98)
30%
528.42% -10.69%
(26,865.00) 96,713.00
(3,924.06) 88,471.60
(3,924.06) 104,585.26
(3,924.06) 118,527.41
(3,924.06) 130,204.37
(3,924.06) 139,450.41
CF From Investing Activities Purchase of PPE
1.30%
33.03%
(135,784.00)
(137,549.19)
(139,337.33)
(141,148.72)
(142,983.65)
(144,842.44)
Purchase of Software and other intangibles
1.30%
256.82%
(17,060.00)
(13,273.34)
(13,445.89)
(13,620.69)
(13,797.76)
(13,977.13)
641.80
-29.07%
125.00
641.80
641.80
641.80
641.80
641.80
Payments to Suppliers/ Employees
Dividends and distribution received Interest and items of similar nature
Finance Cost
Income Tax paid Net Cash Flow from Operations
Proceeds from sale of PPE
Purchase of Equity Investments
-
11.11%
(9,284.00)
0.00
0.00
0.00
0.00
0.00
Proceeds from sale of Investments/Businesses
-
689.90%
43,524.00
0.00
0.00
0.00
0.00
0.00
Proceeds from sale of Equity Investments
-
-33.33%
-
0.00
0.00
0.00
0.00
0.00
Tax on Disposal of investments
-
-33.33%
-
0.00
0.00
0.00
0.00
0.00
Loans to (or repaid to) other entities
-
47.41%
-
0.00
0.00
0.00
0.00
0.00
Loans from (or repaid by) other entiites Other Net Cash Flow from Investing
-
-46.61% 0.00% -48.88%
4,534.00 (113,945.00)
16,395.20 0.00 (133,785.53)
16,395.20 0.00 (135,746.22)
16,395.20 0.00 (137,732.41)
16,395.20 0.00 (139,744.41)
16,395.20 0.00 (141,782.57)
297.72%
126,770.00
127,604.75
128,445.00
129,290.77
130,142.12
130,999.08
1263.28%
187.00
0.00
0.00
0.00
0.00
0.00
-28.36%
(45,191.00)
(45,191.00)
(45,191.00)
(45,191.00)
(45,191.00)
(45,191.00)
71.07%
(62,202.00)
(49,767.17)
(50,414.14)
(51,069.53)
(51,733.43)
(52,405.97)
-42.26% -67.43%
(19,139.00) 425.00
(19,139.00) 13,507.58
(19,139.00) 13,700.85
(19,139.00) 13,891.25
(19,139.00) 14,078.69
(19,139.00) 14,263.11
81.70% -105.72% -30.17%
146,909.00 (16,527.00) 130,382.00
130,382.00 (31,806.35) 98,575.65
98,575.65 (17,460.11) 81,115.53
81,115.53 (5,313.74) 75,801.79
75,801.79 4,538.65 80,340.44
CF From Financing Activities
Proceeds from borrowings
Proceeds from Issues of Share
0.66%
-
Repayment of Borrowing/ Derivatives
Dividends and Distributions Paid
Capital Reduction/ Share Buyback Net Cash Flow from Financing
Beginning of the Year Increase or Decrease in Cash and Cash Equivalents End of Year Cash Position
1.30%
31
80,340.44 11,930.95 92,271.39
BALANCE SHEET ASSETS
Cash and Cash Equivalents Accounts Receivables
Inventory
Current Tax Assets
Other Current Assets Current Investments Prepayments
Available for Sale Investments
Property, Plant and Equipment
(Less) Accumulated Depreciation
Intangible Assets
Goodwill Deffered Tax Assets Non Current Investments
Other Non Current Assets LIABILITIES
Assumptions Previous Year's End of year Cash Balance plus the net change in Cash over the financial year as per the Cash Flow We assume it remains the same as the 2014 financial year Average of the Inventory Turnover Ratio over the last 3 years divided by the cost of sales of current year Immaterial line item due to the small size compared to other line items. It is also difficult to estimate and thus we take it as zero for our forecast Impractical to assess this line item, due to the variability of VRL's operations. However, it is a material item and as such we estimate the futur using the average We assume it remains the same We estimate this line item using the same growth as of Revenue These are described as derivative assets that are listed as avaible for sale investments or not classified under any other asset class. Income from theses assets fo into Other Comprehensive Income. It is an immaterial item as a proportion of total assets, and so we will not add this to our forecast. We estimate the PPE for each year by adding the Expenditure for Purchase of PPE (from CF) and subtract the Sale of PPE (from CF) VRL uses a straight line depreciation method. We think the best estimate for this amount will be the proportion of Accumulated Dep to the PPE of the previous year. We use a 3 year average of this proportion in order to Intangible Assets include Film Rights, Softwares and Brand Names (brand name mainly pertains to the Amusement Parks operation). As this a significant part of the business and knowing that VRL is increasing its amusement park business in Asia we will take a growth rate for the past three years variability. We use this as, it has been relatively stable over the assessment period. Moreover, we don't expect a significant change in the Goodwill applies mostly from brand value of the theme parks, as mentionjed in the financial reports. This being the case, we assume the average of 3 year variability to hold true. We also Immaterial and impractical to mease. We will ignore this for our estimates We will take the proportion of Other Non Cuurent Assets to the purchase of PPE over the past three years. We use the average of this to estimate for the future. We compare this with the average growth rate calculated via the variability analysis to confirm validity of estimate.
Accounts Payable
Short Term Debt Current Tax Payable
Provisions
Long Term Debt Deffered Tax Liability
Provisions
Common Share Holders Reserves excluding(Share Premium Reserves) Share Premium Reserve
Retained Earnings
Preferred Stock
Average proportion of the short term debt to the total assets over the past 3 years. We use the same proportion for the forecast. As lending is a measure of available assets from the bank's perspective, this seems to be a sound measure. We assume it takes the same growth rate as the revenue Historical trend suggest that Provision for Bad Debts and other company obligations usually follow the same trend as the revenue. Taking this into account, we will use the revenue growth to estimate provisions as well. We us the same gorwth rate as the revenue as we asume, that revenue and borrowings will follow a similar pattern. THere is no evidence to suggest VRL will be able to get cheaper borrowing or a higher than normal revenue Not immaterial to the statment. But we have assumed DTA to be zero Historical trend suggest that Provision for Bad Debts and other company obligations usually follow the same trend as the revenue. Taking this into account, we will use the revenue growth to estimate provisions as well. We use the average proportion of the common sh holders to the total assets of the firm over the past 3 years Average proportion of the reserves to the total assets of the firm Immaterial and not required to be forecasted We take this as the full Profit or Loss from the corresponding financial year for the forecast. We assume this to be zero over the forecasted period, as VRL has not had preferred stock in the past 4 years
32
BALANCE SHEET $$$- in thousands ASSETS Cash and Cash Equivalents Accounts Receivables Inventory Current Tax Assets Other Current Assets Current Investments Prepayments Total Current Assets Debtors Available for Sale Investments Property, Plant and Equipment (Less) Accumulated Depreciation Intangible Assets Goodwill Deffered Tax Assets Non Current Investments Other Non Current Assets Total Non Current Assets
Applied Change
Average of 3 years
-
Total Liabilities & Share Holders Equity
FORECAST 2017
2018
2019
98,575.65 107,736.00 17,767.54 0.00 75,941.54 254.00 6,541.95 306,816.68
81,115.53 107,736.00 17,730.16 0.00 99,397.07 254.00 6,627.00 312,859.77
75,801.79 107,736.00 17,692.85 0.00 130,097.16 254.00 6,713.15 338,294.95
80,340.44 107,736.00 17,655.63 0.00 170,279.36 254.00 6,800.42 383,065.84
92,271.39 107,736.00 17,618.48 0.00 222,872.35 254.00 6,888.83 447,641.05
12.74% 267.54% 9.01% 10.20% 8.57% 1.95% -22.73% -0.55% 28.05% 7.23%
14,071.00 483.00 1,070,923.00 414,030.00 70,939.00 248,295.00 913.00 12,125.00 88,518.00 1,092,237.00
14,071.00 0.00 1,158,581.00 572,106.26 77,019.86 256,391.94 0.00 12,125.00 113,344.93 1,059,427.48
14,071.00 0.00 1,298,560.13 790,535.90 83,621.98 398,196.55 0.00 12,125.00 145,135.16 1,161,173.92
14,071.00 0.00 1,440,350.65 1,092,361.76 90,790.02 603,832.39 0.00 12,125.00 185,841.70 1,254,649.00
14,071.00 0.00 1,583,976.10 1,509,424.44 98,572.50 904,123.08 0.00 12,125.00 237,965.33 1,341,408.57
14,071.00 0.00 1,729,460.34 2,085,721.27 107,022.10 1,341,034.95 0.00 12,125.00 304,708.25 1,422,700.36
-1.09%
1,412,894.00
1,366,244.16
1,474,033.69
1,592,943.95
1,724,474.42
1,870,341.41
11.67% -19.24% 254.56% 33.97% 11.78% 3.81%
195,958.00 23,106.00 8,573.00 60,685.00 39,059.00 327,381.00
218,817.72 23,624.01 8,684.45 61,473.91 39,059.00 351,659.09
244,344.18 24,153.64 8,797.35 62,273.07 39,059.00 378,627.23
272,848.45 24,695.14 8,911.71 63,082.62 39,059.00 408,596.92
304,677.93 25,248.78 9,027.56 63,902.69 39,059.00 441,915.97
340,220.51 25,814.84 9,144.92 64,733.42 39,059.00 478,972.70
26.29% 2.12% 63.14% 14.86% 24.22% 4.51%
46,197.00 457,762.00 43,796.00 13,668.00 2,780.00 564,203.00
46,197.00 463,712.91 0.00 13,845.68 2,780.00 526,535.59
46,197.00 469,741.17 0.00 14,025.68 2,780.00 532,743.85
46,197.00 475,847.81 0.00 14,208.01 2,780.00 539,032.82
46,197.00 482,033.83 0.00 14,392.72 2,780.00 545,403.55
46,197.00 488,300.27 0.00 14,579.82 2,780.00 551,857.09
3.49%
891,584.00
878,194.68
911,371.08
947,629.74
987,319.51
1,030,829.79
16.15%
-4.10%
219,191.00
254,596.05
295,719.94
343,486.41
398,968.41
463,412.20
6.60%
5.58%
96,750.00 190,504.00
12.05% -7.01%
14,865.00 521,310.00
109,936.12 0.00 142,141.54 0.00 14,865.00 562,662.61
117,188.54 0.00 169,774.25 0.00 14,865.00 645,314.21
124,919.39 0.00 198,402.10 0.00 14,865.00 737,154.90
133,160.24
-15.29%
103,132.54 0.00 115,455.88 0.00 14,865.00 488,049.47
-1.09%
1,412,894.00
1,366,244.15
1,474,033.69
1,592,943.95
1,724,474.42
1,870,341.41
-0.21% 30.89% 1.30%
9.01% 38.18% 8.57% 1.95% 28.05%
11.67% 2.24% 1.30% 1.30%
1.30% 1.30%
Total Liabilities Common Share Holders Reserves excluding(Share Premium Reserves) Share Premium Reserve Retained Earnings Preferred Stock Non Controlling Interest Total Shareholders Equity
2016
130,382.00 107,736.00 17,805.00 1.00 58,021.00 254.00 6,458.00 320,657.00
Total Assets
Creditors Long Term Debt Deffered Tax Liability Provisions Other Non Current Liability Total Non Current Liabilites
2015
-30.17% 3.37% -0.21% -33.32% 30.89% -64.97% 6.98% -16.76%
-
LIABILITIES Accounts Payable Short Term Debt Current Tax Payable Provisions Other Current Liabilities Total Current Liabilites
2014
0
228,074.18 0.00 14,865.00 839,511.62
33
Valuations Estimating the cost of equity with the Capital Asset Pricing Model (CAPM) is a widely accepted and known model, which we adapted. Therefore, we used the formula where (
equals the market risk premium. The beta of VRL was
calculated on the basis of the weekly share prices over the past five years and the relevant market index; those were already given to us. The following formula was applied to compute beta:
. Where
is VRLs return and
states the market index. Thus,
resulting in a company beta of 0.5931. Comparing the company‟s beta with the overall market beta of 1.0, it shows that the market return grows by 1% VRLs return will only increase by 0.5931%. Since projects have long lives, the average on-year rate foreseen over the life of the project is chosen over today‟s one-year rate (Corporate Finance, 2013). Thus, historical bond information is used to evaluate an appropriate risk-free rate. However, there are three different assumptions that we have to consider: A. “The selection of proxy for the risk-free asset; B. The period of time at, or over, which the rate is estimated; and C. The term, or maturity, of bond used for setting the risk-free rate” (The Risk-free Rate and the Market Risk Premium, 2012). In fact, a government-backed security is a generally recognized proxy for the risk-free asset. Whilst some default risk is included in these securities, that risk is very low in Australia and other Anglo-Saxon countries. Resulting in providing a close proxy for the risk-free rate by the rate on domestic government debt (Lally, 2000). Even though, using Commonwealth Government bonds as proxies for the risk-free rate is controversial, Australia still insists using this method. Nevertheless, we applied the 10-year yield of Australian Government bonds of 3.01% estimating the cost of equity. As mentioned before the difference of the expected market return and the risk-free rate measures the market risk premium. There are two methods of calculating the market risk premium: historical data or the Dividend Discount Model. For calculating cost of equity we decided to use historical data. Different Australian regulators estimate a market risk premium of 6% applying Ibbotson historical averaging over a long period of time. Furthermore, the 34
Queensland Competition Authority estimated an average of 6% too (Figure 15) (The Riskfree Rate and the Market Risk Premium, 2012). Hence, a market risk premium of 6% is applied. Figure 15 - Estimates of the Market Risk Premium (Oct 2012) Method
Estimate (%)
Ibbotson Historical Averaging
6.21 4.32
Siegel Historical Averaging Cornell Method Survey Evidence Mean Median
8.70 5.80 6.26 6.00
In conclusion, with a market risk premium of 6%, a risk-free rate of 3.01%, and VRLs beta of 0.5931%, the cost of equity for Village Roadshow Limited is 6.57%. This indicates the return that the market requests for holding the asset including the risk of ownership (Corporate Finance, 2013).
35
Valuation Method 1 - Gordon Growth model Below is the Gordon Growth model to value Village Roadshow Limited. The model shows the intrinsic value of the stock by looking at the dividends to highlight the financial performance. Formula used,
(Diagram 7 - Gordon Growth Model)
According to the Diagram 7, the value of the current stock price would be $6.802 as compared to a market price of $6.10 For the calculations, three assumptions were taken into considerations. 1) VRL must distribute the dividend. 2) The dividend growth rate (g) should not exceed the cost of equity (Ke). 3) Dividends grow at the same rate as the stock price (Damodaran 2012). In the above diagram 7, the growth rate dividends were calculated on the basis of the last 3 years of dividend data which was further multiplied by the 2014 dividend price to get the expected dividends one year from now ( DPS1).
36
Further we calculated the sensitivity of the growth predicted which can be observed as per diagram 8.
(Diagram 8 - Sensitivity analysis of Gordon Growth Model)
Valuation Method 2 - Free Cash Flow Model Below (Figure 16) is our valuation for VRL through the Free Cash Flow Model. In order to estimate this we have used the Cash Flow forecasts to the next 5 years that is from 20152019. We then calculate the free cash flow left over for ordinary shareholders. The continuing value from the free cash flows for the 5th forecast year period is then adjusted for the growth rate assumed from the GDP growth of Australia over the past 30 years. We then discount the free cash flows for each year using the Present value factor which has been calculated using the Cost of Equity. Following this a sum of the free cash flows and continuing valued is adjusted by discounting it. This is total value available for the shareholders; dividing it by the total number of shares gives us an estimate of the share price. In this instance the share price is $6.042 which is lower than the market price of $6.10
37
2015 88,471.60 (163,810.69) (133,785.53) 834.75
2016 104,585.26 42,120.84 (135,746.22) 840.25
2017 118,527.41 43,932.03 (137,732.41) 845.78
2018 130,204.37 45,821.11 (139,744.41) 851.35
0 (208,289.87)
0 11,800.12
0 25,572.82
0 37,132.41
0 46,316.21
Present Value Factors (6.57%) Present value free cash flows
0.88052894 -183399.533
0.82625757 9749.479872
0.775331214 19826.1663
0.727543702 27013.34482
0.727543702 33694.43616
Sum of Present Value Free Cash Flows for Common Equity Shareholders Year Present value of Continuing value Total
-126810.542 1031016.142 904205.5999
Net Cash Flow from Operations Decrease/Increase in Cash required for Operations Net Cash Flows for Investing Net Cash Flows from Debt Financing Net Cash Flows into Financial Assets Net Cash Flows - Preferred Stock and Minority Interest Free Cash Flow for Common Equity Stakeholders
Adjust to midyear discounting Total present value free cash flow to equity Shares outstanding Estimated Value per share Current share price Pecentage difference
2.50%
2019 Continuing value 139,450.41 47,791.42 (141,782.57) 856.95
47474.11611
CIA Factbook GDP's average growth for the past 30 years in Australia equal to 2.5%
106.57% 963596.8581 159,490,636.00 6.041714312 6.1 -0.96%
(Figure 16 – Free cash flow for firm)
Comparison of Valuations (Free cash flow model and Gordon Growth model) The FCFF model estimates the share price at $6.042 whereas the GGM model estimates the price at $6.802. The current market price for VRL shares is $6.10. Although the same firm is being evaluated, the two method values originate from different sources. The FCFM was obtained from forecasted cash flow whereas the GGM was derived from the next period dividend rate.
We have an inconsistent view as per the two models. The FCFF model suggests that VRL shares are overvalued and that would mean we must SELL. The GGM model on the other hand suggests that VRL shares are slightly undervalued and would mean we must BUY.
38
Recommendations Keeping in mind that the two models provide an inconsistent view, we look into other information that helps base our final recommendation on the company. As regard as the financial analysis, our main conclusions are that the company managed the past acquisitions well, increased its revenue and assets turnover and stabilized its profitability. It also has a low long-term debt but a slight significant bankruptcy risk. From our bankruptcy analysis on the company we know that the Altmanâ€&#x;s z- score has been below 1.8 over the past 5 years indicating towards a distressed company. Keeping the above information in sight, this report suggests to „HOLD’ this stock.
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