FIE437B Valuation

1

Valuation

FIE437BValuation

AssessedProject Autumn semester 2015

Nabutola

GREGGSPLC VALUATION

Thereport aims at assessing the feasibility of taking over of GreggsPlc. by Domino’s Pizza Group Plc. Various valuation techniques willbe applied to measure the value of Greggs’ and also examine theneed or benefits of the acquisition. In this process, the valuationof equity and debt will be carried out separately to assess the valueof Greggs’ and after acquisition the value of the whole entitywill be determined to assess the importance of take over. Theresearch on the financial statements will explore the value of thefirms. The financial statements of the two firms have been predictedfor the next three years to come up with the financial and marketdata to be used in assessing the profitability of the take- over.

Ihave considered discounted cash flows also in the valuation process.Given the projected cash flows for the next three years, I was ableto assess the growth of Greggs Plc. aside with the capitalizationmodel. Regression analysis has also been formed which yielded acoefficient of determination (r2) value of 0.81. This confirmed thestrong positive correlation of the historical financial data betweentime and dividends paid (Aswath, 2012). The dividends payment fromthe retained earnings has got a great influence on the value of thefirm. The two main elements considered in the calculation of thediscounted cash flows were the working capital and the capitalexpenditure. Working capital is the difference between the projectedcurrent assets and the projected current liabilities. Capitalexpenditure, on the other hand, refers to the difference between theprojected and the previous years’ investment in fixed assets.

Predictivemodels of financial statements provide vital information to theinvestors in ascertaining and timing the amount of the future cashflows. This is because predicted financial statements provide usefulinformation about the likelihood of bankruptcy of the firm (Aswath,2012).

Predictivemodelling of financial statements

Themodels used to predict financial data was specified by the analystsin various dimensions. The financial information indicators,evaluation criteria and the choice of predictions was developed andanalysed to assess the future financial health of the corporation.Users of the financial statements have got high expectations of aninsight for the disclosures about the firm’s financial performanceand its profitability strategies.

Toforecast the financial statements, one needs to have an understandingof the historical and future trend. Predictive modelling involvestaking given values and adding appropriate formulas where necessary.While predicting the financial statements of Domino’s and Greggs’,the analyst has considered various factors such as company growth,inflation and other related factors that could have an influence onthe profitability level of the firms. Financial statements, whichinclude balance sheet the income statement and the statement of cashflows, have been developed for three years ahead to enhance thevaluation of the firms before and after the takeover. The predictivemodels also used incorporate various assumptions used to arrive atfuture intended cash flows and the appropriate financial statements.The assumptions used include

Assumptions

Assumptionsmade in predicting the income statement constituted the elements suchas growth rates and the trends of the changes in revenues andoperating expenses. This implies that each element was predicteddifferently using the relevant assumptions as per the line item. Forexample, based on the historical performance, the cost of goods soldwas predicted from the percentage of sales revenue. The following arepredicted financial statements for the next three years, and theassumption made disclosed at the bottom of each statement.

(PredictedGreggs ‘and Dominos ‘income statements you could find in Appendixin Tables 1A and 1B)

Table1A Predicted Greggs’ income statements

Table1B Predicted Dominos’ income statements

Revenueassumption:

Revenueof Gregg’s has been predicted using two years moving average with agrowth of 6%. This was derived from historical trend and was used toestimate the predicted revenues for the years 2015, 2016 and 2017.The only factor that influenced revenue for Dominos’ was thegrowth. The growth in revenues was estimated to be 3% for everyfinancial year.

Costof goods sold (COGS):

Thisis normally calculated as the percentage of total revenue. Therefore,the same trend followed in predicting the sales revenue was appliedin predicting the cost of goods sold for the next three years. Inthis assumption, I have ignored some of the unpredictable factorssuch as trade discounts that could affect the amount of the cost ofgoods sold.

Sellingand distribution expense:

Itwas assumed that this value would rely on the revenue and the growthof the firm.

Taxation:

Taxis calculated as the percentage of earnings before tax. It wastherefore noted that the predicted tax expense is directlyproportional to the firm’s operating income.

Predictivemodelling Balance sheets

Thebalance sheet provides information about the book value of assets.Such information is much important, especially when assessing thevalue of the firm. A firm that invests more in assets is more likelyto have a higher value than the one that does not. The balance sheetalso reveals the financial data that is important is assessing thesolvency of the firm and hence enables the firm to measure the futurestate of the company. Therefore, the balance sheets show the averagecorporate value of the firm. It provides useful information to theanalyst in assessing the value of the firm. The predicted balancesheets for Greggs and Dominos you could find in Appendix in Tables 2Aand 2B.

Theanalysis revealed that there is an increasing evidence indicatingdiscretion of the management in the financial reporting process. Thiswas as evidenced due to lack of consistency that is contrary to thefinancial reporting standards.

Inpredicting the financial data, various influencing factors that couldhave a significant impact on the financial statement are considered.However, the estimation could not be much accurate due to someunavoidable risks that are known as systematic risk.

Valuationanalysis of Greggs Plc.

Futuredebt level

Thisvaluation model is intended to estimate the future solvency orinsolvency of a firm. It is a valuation model that involvesassessment of the shareholder’s equity as compared to the debt. Weare going to measure the debt level of Greggs Plc. for the next threeyears using the predicted financial data.

Table4: Debt value

Capital expenditure (CAPEX):

2017

2016

2015

2014

Expenditure on PPE

-46333

-45705

-46409

-44456

Expenditure on Intangible assets

-2711

-3078

-2311

-3809

Acquisitions/investments in joint ventures &amp associates

-5574

-6051

-5030

-7000

Net CAPEX

-54,618

-54,834

-53,750

-55,265

Net increase/(decrease) in debt

-1,667

6,555

-9,940

33,607

Valuationusing the growth rate

Valuationof a firm using the growth rate is most important, especially whenassessing the future financial state of the corporation. It isimportant also to estimate key drivers and their impact on thehistorical facts when calculating the growth. As previouslyindicated, the growth of the firm will majorly depend on the freecash flow, return on capital and the additional economic value. Themajor hindrance to the company’s growth is the competitive trends.Therefore, it is important for one to assess the competitiveenvironment in which the business is operating.

Inthis case, the company growth has been estimated using the dividendspayment and the regression analysis. For the next three years, thegrowth rate of Greggs was found to be 3.0%. That is

Table5: Growth analysis

2017

2016

2015

£`000

£`000

£`000

NET INCOME

37086

37249

32725

Dividends

21,384.67

20,761.81

20,157.10

Retention ratio

0.4233763

0.4426209

0.3840458

Shareholders` equity

269579

261727

254104

ROE

0.1375701

0.1423201

0.1287859

Growth rate =

3.00%

(Seethe regression analysis in the excel spread sheet)

Valuationusing residue income

Thisrefers to the process of valuing a firm by using the residualexpression valuation. It is another method that the analysts haveused in assessing the value of Greggs Inc. the formula is as shownbelow

Where

ytis the book value of net assets at time t

y0is the current book value on net assets

xtis its net income, net of taxes, over the period (t-1) to t and

risthe cost of equity capital.

P0is the current market value of the firm’s equity shares.

Forthe case of Gregg’s PLC in this project, we will try to estimatethe value of Gregg’s in the next 3 years. That is

Value2017: y0= 269,597,000

yt=261,272,000

xt= 37,249,000

r= 9.5%

269,579,000+ 122,265,160/1.3129 = £362,702,730

Therefore,the value of Gregg’s in the year 2017 using the residue income is£362,702,730.

Consolidatedfinancial statements

Thesestatements are arrived at combining the element of the acquiringcompany with those of the acquired company. (In Appendix, in Table6A you can find the consolidated income statement for the next threeyears for Dominos’ Pizza Group PLC)

Table6A: Consolidated income statement

Theconsolidated income statement has been prepared after adding up theelements in the income statement of Greggs to those of the acquiringcompany, Dominos’.

ConsolidatedBalance sheet

Theconsolidated balance sheet is obtained by combining the total assetsof the two companies. The Consolidated balance sheet Of Domino’s isas presented in the appendix, in Table 6B

Assessingthe short-term impact of the take-over

Liquidityratios analysis

Theseratios show the capability of the firm to meet its short-termobligations as they become due (Aswath, 2012,). The liquidity ratiosare expressed as the relationship between the current assets and thecurrent liabilities. Two common ratios used in this analysis includecurrent ratio and the acid test ratio.

Currentratio

Currentratio gets by dividing the current assets by the current liabilities.

Thatis: Current ratio =

Beforethe take-over, the current ratios are as summarized in the tablebelow

Dominos

2017

2016

2015

2014

Current Ratios

0.94984

0.94984

0.94984

0.94984

Acid test Ratio

0.88844

0.88844

0.88844

0.88844

Currentratios indicate the number of times a firm can pay its currentliabilities from its current (Aswath, 2012,). The recommended ratiois 2:1 for a financially stable firm. The analysis revealed that theDominos’ Pizza Group Plc. might experience short-term financialdistress since its current ratios for the next three years areapproximately 0.95 which is much lower than the recommended limit.

Acidtest ratio

Thismeasures the ability of the firm meeting its current obligationsusing the most liquid assets (Aswath, 2012). This ratio is also knownas a quick ratio. In the computation of quick ratio, inventory is notincluded as the current because it is not easy to convert inventoryinto cash. The stock is also valued at a historical cost that makesit not included when measuring the financial health of the firm usingquick ratio. The ratio is calculated as shown in the formula:

Acidtest/Quick ratio =

Likewise,the acid test ratio shows that the firm is incapable of meeting itscurrent obligations as they become due.

Assessingthe effect of the take-over,

Dominos (After acquisition)

2017

2016

2015

Current Ratios

0.974739

0.974738

0.974738

Acid test Ratio

0.863419

0.863422

0.863418

Sinceboth companies are having low liquidity ratios, it implies that thetake-over will increase the risk of short-term financial health.

Cut-offvalue-K

IfDominos choose to retain the current directors of Greggs, it isimportant to motivate them raising the profitability of the companyin the next three years. Offering the directors a bonus will act asan incentive to them and they will dedicate much of their attentiontowards success of the organization. For example, I would suggestTarget Company’s value is 25milion for year 3 and therefore, thedirectors are worth the bonus.

Fromthe predicted financial data, the directors should receive a bonus ascalculated below

Y× (year 3 EBITDA – K) = Y × (37,086,000-35,000,000) = 15,000,000

Thisimplies that, the multiplier Y = 15,000,000/2,086,000 = 7.19

Conclusion

Themain goal of the predictive models built for Dominos was intended atdetermining and identifying the prominent financial ratios. Theanalysis of the predicted financial statements has also helped inassessing the short-term trend of the financial status. All thepredictive models and valuation techniques have proven that thetake-over is feasible as it will offer distinct advantages.

Thevaluation of Greggs’ Plc. has proved that it is profitable for itsacquisition as it will help the organization to grow its value in thelong-run. Despite the growth factor, Dominos’ will also benefit itsstakeholders by maximizing their wealth. Even if Domino’s will haveto pay more salaries to the directors of Gregg’s, the incentivegranted to them will help in maximizing the profitability of thesubsidiary, and therefore, increasing the value of the firm. Dominoswill also increase it solvency ratios by this acquisition. Theanalysis has shown that the liquidity ratios have increased after theacquisition. For instance, the current ratio of Dominos was 0.94984before the takeover but this ratio rose to 0.97474 after thetakeover. This confirms that the acquisition of Gregg Plc. is worth.

Reference

AswathD. (2012).Investment Valuation&nbsp3rdEdition. New York: John Wiley and sons.

Appendix

(Relevantadditional supplementary information)

Table1A Predicted Greggs’ income statements

GREGGS PLC INCOME STATEMENTS

Year ending:

31-Dec-17

30-Dec-16

31-Dec-15

£`000

£`000

£`000

Revenue

899,010

866,084

830,160

Cost of Sales

-356,628

-342,484

-330,399

Gross profit

542,381

523,600

499,761

Selling &amp distribution expenses

-446,671

-429,115

-413,660

Administrative expenses

-46,147

-44,920

-42,150

Other income

Operating profit

49,563

49,565

43,951

Finance income/(expenses)

36

84

-16

Profit before tax

49,599

49,649

43,934

Taxation

-12,513

-12,400

-11,210

Profit after tax

37,086

37,249

32,725

Table1B Predicted Dominos’ income statements

DOMINOSPIZZA GROUP PLC INCOME STATEMENTS

Year end

31/12/2017

31/12/2016

31/12/2015

Revenue

321,675

312,306

303,209

Cost of sales

-201,767

-195,890

-190,184

Gross profit

119,908

116,416

113,025

Distribution costs

-17,992

-17,468

-16,959

Administrative costs

-44,025

-42,743

-41,498

Share of post-tax profits of associates &amp joint ventures

1,144

1,111

1,078

Operating profit

59,036

57,316

55,647

Other gains and losses

1,253

1,217

1,181

Profit on sale of subsidiary

Profit before interest &amp taxation

60,289

58,533

56,828

Finance income

677

658

639

Finance expense

-2,181

-2,118

-2,056

Profit before taxation

58,785

57,073

55,411

Taxation

-12,084

-11,732

-11,391

Profit for period

46,701

45,341

44,020

Profit attributable to:

Owners of the parent

46,920

45,553

44,226

Non-controlling interests

-219

-212

-206

46,701

45,341

44,020

Table2A Predicted Greggs’ Balance sheet

PREDICTED GREGGS PLC BALANCE SHEETS

2017

2016

2015

ASSETS

Non-current assets

Intangible assets

5,159

5,009

4,863

PPE

287,080

278,719

270,601

Investments

Defined benefit pension asset

57

292,239

283,727

275,463

Current assets

Inventories

16,708

16,221

15,749

Trade &amp other receivables

28,510

27,680

26,874

Assets held for sale

7,103

6,896

6,695

Cash &amp cash equivalents

47,659

46,271

44,923

Other investments

10,927

10,609

10,300

110,907

107,677

104,541

Total assets

403,146

391,404

380,004

LIABILITIES

Current liabilities

Trade &amp other payables

-98,295

-95,432

-92,653

Current tax liabilities

-8,803

-8,547

-8,298

Provisions

-4,490

-4,359

-4,232

-111,588

-108,338

-105,183

Non-current liabilities

Other payables

-7,163

-6,954

-6,752

Defined benefit pension liability

-9,308

-9,037

-8,774

Deferred tax liability

-2,774

-2,694

-2,615

Long-term provisions

-2,734

-2,654

-2,577

-21,979

-21,339

-20,717

Total liabilities

-133,567

-129,677

-125,900

Net assets

269,579

261,727

254,104

EQUITY

Capital &amp reserves

Issued capital

2,023

2,023

2,023

Share premium account

13,533

13,533

13,533

Capital redemption reserve

416

416

416

Retained earnings

253,607

245,755

238,132

Total equity attributable to equity holders of the Parent

269,579

261,727

254,104

Table2B Predicted Dominos’ Balance sheet

DOMINOS PIZZA GROUP PLC PREDICTED BALANCE SHEETS

2017

2016

2015

£`000

£`000

£`000

Non-current assets

Intangible assets

9,639

9,937

10,244

PPE

62,694

60,868

59,095

Prepaid operating lease charges

978

1,009

1,040

Trade &amp other receivables

5,004

4,858

4,716

Net investment in finance leases

1,404

1,363

1,324

Investments in associates &amp joint ventures

7,835

7,607

7,385

Deferred tax asset

7,764

8,004

8,252

95,318

93,646

92,056

Current assets

Inventories

5,274

5,120

4,971

Prepaid operating lease charges

216

210

204

Trade &amp other receivables

38,226

37,112

36,031

Net investment in finance leases

983

955

927

Cash &amp cash equivalents

36,872

35,798

34,755

81,571

79,195

76,888

Total assets

176,889

172,841

168,945

Current liabilities

Trade &amp other payables

-56,899

-55,242

-53,633

Deferred income

-309

-300

-291

Financial liabilities

-17,543

-17,032

-16,536

Deferred &amp contingent consideration

-4,197

-4,075

-3,956

Current tax liabilities

-5,542

-5,381

-5,224

Provisions

-1,388

-1,347

-1,308

-85,879

-83,377

-80,949

Non-current liabilities

Financial liabilities

-7,355

-7,141

-6,933

Deferred income

-2,075

-2,015

-1,956

Deferred &amp contingent consideration

-2,713

-2,634

-2,557

Deferred tax liabilities

-104

-101

-98

Provisions

-2,185

-2,122

-2,060

-14,433

-14,012

-13,604

Total liabilities

-100,311

-97,390

-94,553

Net assets

76,578

75,451

74,392

Shareholders` equity

Called up share capital

2,832

2,750

2,670

Share premium account

27,971

27,156

26,365

Capital redemption reserve

425

425

425

Capital reserve – own shares

-2,446

-2,374

-2,305

Currency translation reserve

625

607

589

Other reserve

3,432

3,432

3,432

Retained earnings

40,319

40,036

39,796

Equity shareholders` funds

73,158

72,031

70,972

Non-controlling interests

3,420

3,420

3,420

Total equity

76,578

75,451

74,392

Table3A Predicted Greggs’ statement of cash flows

GREGGS PLC PREDICTED CASH FLOW STATEMENTS

PREDITED CASHFLOWS

2017

2016

2015

Operating activities

Cash generated from operations

100,114

102,938

96,096

Income tax paid

-12,262

-11,994

-12,383

Net cash inflow from operating activities

87,852

90,944

83,712

Investing activities

Acquisition of PPE

-46,333

-45,705

-46,409

Acquisition of intangible assets

-2,711

-3,078

-2,311

Proceeds from sale of PPE

2,627

2,495

2,729

Interest received/(paid)

100

125

75

Redemption/(acquisition) of other investments

-5,574

-6,051

-5,030

Net cash outflow from investing activities

-51,890

-52,215

-50,946

Financing activities

Sale of own shares

3,656

4,192

3,077

Purchase of own shares

-4,986

-5,952

-3,960

Dividends paid

-19,840

-19,750

-19,693

Government grants received

Net cash outflow from financing activities

-21,169

-21,510

-20,577

Net increase in cash &amp cash equivalents

14,793

17,219

12,190

Cash &amp cash equivalents at start of year

21,031

21,212

20,599

Cash &amp cash equivalents at end of year

35,824

38,431

32,789

Table6A: Consolidated income statement

DOMINOS PIZZA GROUP PLC CONSOLIDATED INCOME STATEMENTS

Year end

31/12/2017

31/12/2016

31/12/2015

Revenue

1,220,685

1,178,390

1,133,369

Cost of sales

-558,395

-538,374

-520,583

Gross profit

662,289

640,016

612,786

Distribution costs

-464,663

-446,583

-430,619

Administrative costs

-90,172

-87,663

-83,648

Share of post-tax profits of associates &amp joint ventures

1,144

1,111

1,078

Operating profit

108,598

106,881

99,597

Other gains and losses

1,253

1,217

1,181

Profit on sale of subsidiary

Profit before interest &amp taxation

60,289

58,533

56,828

Finance income

713

742

623

Finance expense

-2,181

-2,118

-2,056

Profit before taxation

168,672

165,255

156,172

Taxation

-24,597

-24,132

-22,601

Profit for period

144,075

141,123

133,572

Table6B: Consolidated balance sheet

DOMINOS PIZZA GROUP PLC CONSOLIDATED BALANCE SHEETS

2017

2016

2015

£`000

£`000

£`000

Non-current assets

Intangible assets

14,798

14,946

15,107

PPE

349,774

339,587

329,696

Prepaid operating lease charges

978

1,009

1,040

Trade &amp other receivables

5,004

4,858

4,716

Net investment in finance leases

978

1,363

1,324

Investments in associates &amp joint ventures

7,835

7,607

7,385

Deferred tax asset

7,764

8,004

8,252

387,131

377,374

367,520

Current assets

Inventories

21,982

21,341

20,720

Prepaid operating lease charges

216

210

204

Trade &amp other receivables

66,736

64,792

62,905

Net investment in finance leases

983

955

927

Assets held for sale

7,103

6,896

6,695

Other investments

10,927

10,609

10,300

Cash &amp cash equivalents

84,531

82,069

79,678

192,478

186,872

181,429

Total assets

579,609

564,246

548,949

Current liabilities

Trade &amp other payables

-155,194

-150,674

-146,286

Deferred income

-309

-300

-291

Financial liabilities

-17,543

-17,032

-16,536

Deferred &amp contingent consideration

-4,197

-4,075

-3,956

Current tax liabilities

-14,345

-13,928

-13,522

Provisions

-5,878

-5,706

-5,540

-197,466

-191,715

-186,131

Non-current liabilities

Financial liabilities

-7,355

-7,141

-6,933

Deferred income

-2,075

-2,015

-1,956

Other payables

-7,163

-6,954

-6,752

Defined benefit pension liability

-9,308

-9,037

-8,774

Deferred &amp contingent consideration

-2,713

-2,634

-2,557

Deferred tax liabilities

-2,878

-2,795

-2,713

Provisions

-4,919

-4,776

-4,637

-36,411

-35,352

-34,322

Total liabilities

-233,877

-227,067

-220,453

Net assets

345,732

337,179

328,496

Shareholders` equity

Called up share capital

4,855

4,773

4,693

Share premium account

41,504

40,689

39,898

Capital redemption reserve

425

425

425

Capital reserve – own shares

-2,030

-1,958

-1,889

Currency translation reserve

625

607

589

Other reserve

3,432

3,432

3,432

Retained earnings

293,501

285,791

277,928

Equity shareholders` funds

342,312

333,759

325,076

Non-controlling interests

3,420

3,420

3,420

Total equity

345,732

337,179

328,496