Study with the several resources on Docsity
Earn points by helping other students or get them with a premium plan
Prepare for your exams
Study with the several resources on Docsity
Earn points to download
Earn points by helping other students or get them with a premium plan
Community
Ask the community for help and clear up your study doubts
Discover the best universities in your country according to Docsity users
Free resources
Download our free guides on studying techniques, anxiety management strategies, and thesis advice from Docsity tutors
A company report on Asos PLC, focusing on its value, market share, and financial analysis. The report includes an abstract, historical data on sales and market share, sensitivity analysis, DCF conclusion, and a comparison of valuation models. The report also provides information on Asos' capital structure, liquidity ratio, and solvency ratio.
Typology: Lecture notes
1 / 87
This page cannot be seen from the preview
Don't miss anything!
Dissertation submitted in partial fulfillment of requirements for the degree of MSc in Business Administration, Major in Corporate Finance and Control, at the Universidade Católica Portuguesa, 9th^ March 2015.
i
Abstract
This thesis aims to study the value of Asos PLC. The valuation was based in four methodologies, the Discounted Cash Flow (DCF), the Economic Value Added (EVA), the Trading Multiples and the Transaction Multiples.
Using the DCF method, a price of 3.054p was obtained and the EVA yielded a comparable lower value of 2.528p. Regarding the Relative Valuation, this was the method which delivered the lowest values of 1.573p for the Trading Multiples and 1.253p for the Transaction Multiples.
It was concluded that the four methodologies yielded different prices per share, though the DCF being the most accurate and complete model to demonstrate Asos’ intrinsic value. Given this and comparing the DCF output to the market valuation, Asos’ stock was rated as being Overweight. Nonetheless, a sensitivity analysis was conducted in order to test how the valuation could change, along with the variation of some of the model’s sources of uncertainty. The conclusion of this analysis was that, changes in both WACC and perpetual growth rate variables, would significantly affect the outcome of the valuation, although the WACC being responsible for greater impacts.
Additionally, a more in-depth analysis to Asos’ stock price performance from 2001 to 2014 was conducted. When applying the Value at Risk statistical technique, it was concluded that, with 99% confidence level, an investor is exposed to the risk of losing 8,90% of the total amount invested in Asos.
Finally, this thesis’ valuation was compared to the most recent J. P. Morgan report about this equity. Both final recommendations were DCF-based and some fundamental inputs were estimated very closely, such as the WACC and the perpetual growth rate. The report presented a final recommendation of Overweight, with a price target of 3.100p, being very approximate to the result of this study of 3.054p.
ii
Preface
I would like to express gratitude to my thesis’ instructor, José Carlos Tudela Martins, for giving me guidance and for his willingness to solve doubts and revise my work.
I would also like to show appreciation for the valuable inputs of my work colleagues, in special to Patricia Costa and Afonso Lima, for accompanying me during this learning process which is a master’s thesis.
Finally, I would like to acknowledge the importance of my family support, in special of my parents and my sister, Catarina Marques, who actively intervened and gave valuable advices.
1 Introduction
Financial assets are acquired based on the returns they are expected to yield for the investor. Therefore, in order to justify the price of any asset it is important to support it with a real and extensive valuation. Given the above, the aim of this thesis is to evaluate an European listed company, Asos PLC.
As a corporate finance discipline, Valuation has a lot of objectivity in its quantitative models, but also depends upon individual assumptions and subjectivity, thus not yielding clear-cut conclusions. The study begins by introducing the state-of-the-art in the field of Equity Valuation, explaining in depth the different techniques available, based on the work of the most recognized practitioners and researchers in the area. This section will also try to define the best models to apply for the company under analysis.
Afterwards, a study of the industry where Asos is present, its business and historical performance is going to be conducted in order to get a deeper knowledge of the company and its macroeconomic environment.
Before applying the different valuation methodologies, the valuation estimates and assumptions are going to be computed along with the definition of Asos’ peer group.
In the following chapters the DCF, EVA and Relative Valuation methods are going to be implemented and the final outputs of each technique compared both to each other and to the market value of the company as of the 30th^ of August of 2014 (date of valuation).
Subsequently, a sensitivity analysis is going to be conducted in order to understand the impact of some sources of uncertainty in Asos’ valuation. Also, the Value at Risk statistical measure is going to be calculated by analyzing the company’s share price performance between 2001 and 2014, with the objective of quantifying the risk an investor faces when buying Asos’ stock.
In the end, a comparison between this study and a J. P. Morgan investment report is going to be performed in order to analyze the differences and similarities in the inputs, outputs and final recommendations of both works.
2 Literature Review
The purpose of this chapter is to show the state-of-the-art in the field of equity valuation. According to Rosenbaum and Joshua Pearl (2009), “While valuation has always involved a great deal of “art” in addition to time-tested “science”, the artistry is perpetually evolving in accordance with market developments and conditions”. In this regard, this section aims, not only to give a better understanding of the different valuation techniques available, but also the most important valuation drivers in accordance to current market conditions. Moreover, this analysis will never lose the focus on the company being valued, therefore showing relevant discussions regarding the best methods to conduct Asos’ valuation.
“Value is the defining dimension of measurement in a market economy” and reflects the growth expectations of the investor in any asset compared to its initial cost, taking into account the amount of risk to which the investor is exposed. “The ultimate source of value” are the cash flows, which directly depend on the ability of the company “to earn a healthy return on invested capital (ROIC) and by its ability to grow” (Koller et al. 2010).
The measurement of value can be generally split into three main approaches, following Damodaran’s (2002) line of thought. The first is called the Discounted Cash Flow valuation and is based on the estimation of the future cash flows of an asset discounted to the present at a rate that appropriately incorporates risk. The second approach is the Relative Valuation and this method is based on variables of other comparable assets. Finally, there is the Contingent Claim approach, which can be used in any asset that incorporates an option. Additionally to
There are different methods to compute it and this thesis will follow Koller et al (2010) approach, which is based on collecting all the companies within the same industry (by industry classification) and then narrow the list by comparing the size, the profitability, the growth profile, the return on investment, the debt profile and other important ratios of each company against the one being valued.
Regarding the industry filter, these authors advise to try to use the finest industry classification as possible to have true comparables and to reach more accurate results.
There are Enterprise Value (EV) and Equity Value multiples. The main difference between the two is the measure of market valuation in use, where the latter has the flaw of being distorted by the capital structure. The multiples are calculated using an operating metric in the denominator, metric that has an important impact in the valuation depending on its degree of quality in translating the value of the company.
The EV to EBITDA “tells more about a company’s value than any other multiple” (Koller et al. 2010). The authors justify this by showing that this multiple depends on four main factors, which are the company’s growth, return on invested capital, operating tax rate and the cost of capital. Damodaran (2002) also refers that this multiple benefits from the fact that is not affected by different depreciation methods and is less probable of having a negative value, thus not being useful. On the other hand, there are some pitfalls identified in the literature about this multiple, such as the fact that it doesn’t include capital investments or the changes in net working capital (Fernández, 2002).
Another widely used multiple is the Price to Earnings. Besides the referred flaw of being distorted by capital structure, it also has the weakness of being affected by non-operating gains and losses, much of which non-cash items, and different taxation rules across countries.
There are other EV multiples, such as the EV to EBIT, the EV/EBT, the EV/earnings and the EV/sales. This last metric is not considered one of the best for valuation because companies among the same industry can have different operating margins and also because cash-flow generating capacity is what ultimately gives a company its value. However, it has become one important measure as it is the least accounting-affected multiple, available for every single
company, being the most comparable multiple across industries. Moreover, it has also become one of the most accepted metrics for valuing retailing companies.
Regarding the Equity multiples there is also the Price to Book, which compares the market capitalization to the book value of equity. This multiple is frequently used to make judgments about how over or under valued a company is, though getting a lot of criticism from those who do not believe that book values are a good measure of a company’s value (essentially because they are highly linked to the acquisition prices). However, if used across companies with consistent accounting standards, this multiple can be a good tool for Relative Valuation purposes.
There are also other multiples based on non-financial information, which are the industry multiples. In the case of Internet companies like Asos, a widely used metric is the EV to active customers. Active customers are the clients that have actively been buying in the last year, which is a reasonable metric for valuing future cash flows. This type of multiples has the advantage of not depending on the financial results of the companies. There is also the EV to unique visitors, however “the market believed that merely stopping by would not translate to future cash flow for e-tailers” (Koller et al. 2010). There is a substantial pitfall in using this type of multiple, linked to the fact that it can only be computed for one specific industry, which is the possibility of persistent over or under valuation of an entire industry and the lack of a comparison basis.
The intrinsic value is the value of a company based on the expected cash flows from its business, discounted by a rate implied by the risk of these cash flows. The models we are going to talk about in this section try to estimate this value. Damodaran (2002) underlies that intrinsic value can differ from a company’s price in the market.
This method is easy to use when the company has regular and positive cash flows. However, when the company is at early-stages or has negative cash flows, the discounted cash flow approach is more difficult to apply. There are other situations that create difficulties in using this method, which are the case of cyclical companies or private firms that require the use of information not publicly available. This type of model has the disadvantages of being very sensitive to the underlying assumptions, dependent on financial projections and of putting too much weight on the terminal value. On the other hand, it can be very flexible, market
2.2.2.1 Dividend Discount Model (DDM)
The DDM can be considered a special case of FCFE, where the cash flows are considered the dividends that the company is expected to pay. Myron J. Gordon and Eli Shapiro introduced the first version of this model in 1956.
The reasoning of the model comes from the fact that an investor when buying a stock can only expect to receive its dividends and the price for which it will sell the stock in the end. On its turn, the selling price is determined by the expectations on future dividends. The foundation of DDM is simply calculating the present value of all the expected future dividends.
If a company pays dividends equal to the FCFE, this model will give the same valuation as the FCFE method. It is only applicable to companies that regularly pay dividends. Due to this not being the case of Asos, this method is not going to be used.
Finally, there is another method that breaks down the value of the company in several pieces, valuing it separately (see Equation 3). According to Koller et al (2010) this model “follows directly from the teachings of economists Franco Modigliani and Merton Miller who proposed that (…) a company’s choice of financial structure will not affect the value of its economic assets.” Moreover, this author adds that “only market imperfections, such as taxes and distressed costs, affect enterprise value”.
This method starts by valuing the equity of the firm, assuming that it has no debt and discounts the FCFF at an unlevered cost of capital. After this, the debt effect is incorporated by adding up two components: the Present Value of Interest Tax Shields (PV ITS), which are the tax benefits of having a certain level of debt and the expected Bankruptcy Costs (BC). On its turn, the bankruptcy costs translate the risk that debt introduces in the company, which is the risk of going bankrupt.
𝑬𝑽 = 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑤ℎ𝑜𝑙𝑒 𝑒𝑞𝑢𝑖𝑡𝑦 𝑓𝑖𝑛𝑎𝑛𝑐𝑒𝑑 𝑓𝑖𝑟𝑚 + 𝑃𝑉 𝐼𝑇𝑆 + 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝐵𝐶
Equation 3
This method has the advantage of allowing to discount separately, at different discount rates, each of the relevant components of the firm, depending on the riskiness it is exposed to. Also,
on the contrary of the previous DCF methods, APV doesn’t assume a constant capital structure. On the other hand, calculating the probability of default and bankruptcy costs can be rather a difficult task.
In order to discount the relevant cash flows it is necessary an appropriate discount rate, which will depend on the type of cash flow used. How the discount rates can be estimated for each of the financing sources of the company, will be theme of this section.
2.2.4.1 Cost of Equity
There are different models for measuring the cost of equity, such as the Capital Asset Pricing Model (Sharpe 1964) and the Arbitrage Pricing Theory (Ross 1976). There are also other CAPM variations, such as the Fama and French three-factor model (1993), which adds up the size and growth dimensions and the Carhart model (1997) that inputs the momentum factor into the equation.
Even though there has been an extensive study on this area, CAPM is still the most common model currently in use and was first introduced by William Sharpe in 1964. It is given by the following formula:
𝑬(𝑹) = 𝑅𝑓 + 𝛽(𝑅𝑚 − 𝑅𝑓)
Equation 4
As it can be seen in the formula above, this model says that the “risk of any asset to an investor is the risk added by that asset to the investor’s overall portfolio” and “in the CAPM world, where all the investors hold the market portfolio, will be the risk that this asset adds on to the market portfolio.” (Damodaran 2002).
2.2.4.1.1 The Risk Free Rate (Rf)
The risk free rate is the rate of return of a riskless asset. An asset is considered to be riskless when its returns can be predicted with certainty. This only happens if there isn’t any source of risk affecting the returns; mainly default risk or reinvestment risk, when talking about long-term investments. Given this framework, the only assets that meet these criteria are the government treasury bonds, because these are the entities that control the issuance of money, therefore being able to honor their commitments. The cash flows currency should
Equation 5
Relatively to the first part of the formula it is fair to use the analysts’ consensus of 5,51%, which basically corresponds to the “geometric average premium earned by stocks over treasury bonds” in the US “between 1928 and 2000”. This value is repeatedly in use because the US market is considered mature with “sufficient historical data to make a reasonable estimate” (Damodaran 2002).
The second element, the country risk premium, is added to the equity risk premium in order to compensate the investor for taking additional risk by investing in a non-domestic company. In this matter, there are two schools of thoughts, the ones who defend the existence of this premium and the ones who don’t.
The country risk is usually higher for developing markets than for developed ones, because of the higher uncertainty surrounding the macroeconomic conditions. In this point of view, Asos’ stock is listed in the United Kingdom, which isn’t considered a risky market, and most of its revenue comes from developed countries. Following this line of though, an investor investing in Asos’ equity would still be exposed to a country risk just because of the fact of investing in an international company. However, for this purposes, only the risk that cannot be diversified away matters.
Asos’ stock is currently held in 28,06% by a strategic investor (the Bestseller group) and in 10,19% by the CEO of the company (Nick Robertson). Most of the remaining investors consist of groups of investment companies or international funds, which have global exposure, holding global portfolios. The latter are the investors expected to trade on Asos’ stock the most, because of its purely financial purposes, which makes the company’s marginal investors diversified entities. For this reason, there is no need to add a country risk premium to the calculation of the cost of capital.
2.2.4.2 Cost of Debt
Usually there are other sources of financing in a company, such as debt or securities with a mix of debt and equity characteristics.
The cost of debt is the cost of borrowing money to the bank or other financial institution. If the company holds bonds highly traded, it is typically used its market price. If this doesn’t happen, the correspondent spread to the company rating can be used. In the case of private companies we usually look to its borrowing history to see the typical spread used.
The calculation of the cost of debt should also take into account the fact that interest is tax deductible. The after-tax cost of debt of a company can be calculated using the following formula:
𝑨𝒇𝒕𝒆𝒓 𝑻𝒂𝒙 𝑹𝒅 = (𝑅𝑓 − 𝐷𝑒𝑓𝑎𝑢𝑙𝑡 𝑆𝑝𝑟𝑒𝑎𝑑) × (1 − 𝑡)
Equation 6
2.2.4.3 The WACC
The WACC, or the cost of capital, is the weighted average of all the costs of financing that exist in a company, usually the cost of equity, the cost of debt and eventually the cost of preferred stock. It is the rate used to calculate the present value of the cash flows and the terminal value. The formula is the following:
𝑾𝑨𝑪𝑪 = 𝐸𝑉 𝐷 × 𝑅𝑑 × (1 − 𝑡) + 𝐸𝑉 𝐸 × 𝑅𝑒 + 𝐸𝑉 𝑃 × 𝑅𝑝
Equation 7
Each cost is weighted by its value over the total Enterprise Value. These ratios have to be considered according to the market values and not the book values.
The Equity market value is the market capitalization of the company, which is obtained by multiplying the total number of shares by its current market valuation.
In order to reach the market value of debt, if it is in form of bonds, we use directly its market value, but if it is in form of bank debt it should be treated as an one-coupon bond.
The terminal value is calculated to estimate the value of a company after the explicit forecast period, being an important part of a DCF valuation, as it gives it the necessary closure, whether the company is sold afterwards or lives infinitely. The explicit forecast
