Discounted Cash Flow (DCF) Analysis
The DCF analysis is a great tool that provides information to analysts allowing them to see if the stock price of the company is undervalued or overvalued. Based on the results, it gives an investor good insight on whether they should invest in the company or look elsewhere.
Below are the assumptions that were made from the pro forma income statement forecasting the predictions of future growth in the next ten years. These assumptions were also compared with other analysts expectations of Avon.
According to Yahoo Finance, (http://finance.yahoo.com/q/ae?s=AVP+Analyst+Estimates) analysts have the assumption that Avon's stock has a growth rate -13%. This could be due to the steady decline in stock prices over the past couple years coupled with the recent drastic cut in quarterly dividends. This is way off the firms 10-year historical sales growth rate of 7%. We decided to use a growth rate of 7% over the next 3 years because although Yahoo predicts a -13% growth, it predicts a 22% growth within the next year. Also according to Yahoo Finance, S&P 500 estimates a growth rate of 9.12% for Avon in the next 5 years. For the next three years, we predict a 5.33% sales growth rate which is on par with the 5-year historical rate. After that, we believe the growth rate will sit at about the industry rate of growth at 6%.
Our forecasted gross margin for the next ten years was calculated using the average of the 5 most recent yearly gross margins. We were then able to calculate gross profit using the formula(forecasted GP margin* forecasted sales). SG&A expenses were also calculating using an average of the SG&A from the past 5 years. EBIT was calculated using the forecasted gross profit and SG&A.
We were able to calculate CAPEX and depreciation based off the forecasted net Property, Plant, & Equipment. PPE was taken as a percentage of sales.
Impairments of Goodwill and Intangible assets weren't forecast due to the fact that they were only paid once within the past 5 years. Other random expenses/incomes were also left out because they varied greatly over the past 5 years. We did use a constant net interest expense of 93,000 which was the net interest expense of 2011.
The 5-year historic average for the tax rate was 41.25%, but due to the assumed tax rate under the Obama plan, the new tax rate was dropped to 34%. This new tax rate was used for the next 10 years.
The number of shares outstanding was based on the number of shares outstanding (diluted) as of 7/30/12 (2012 10-Q report).
Finally, net working capital was also calculated as a percentage of sales.
Our WACC which we solved for in part 4 was 5.88.
Key assumptions for present value calculations are that our WACC for FCF 1-10 is 6.59%. The Long term WACC is 8.59%. The Terminal Growth rate is 2.00%.
To Solve for our Intrinsic Value, we took our PV of cash flows- MV of debt(less cash) to get the value of equity. We then divided the value of equity by the number of diluted shares outstanding to get our share price. The numbers are seen in the table below.
|Total PV of Cash Flows:||8,594,904|
|Less MV of debt||1,869,855|
|Less: Underfunded Pension||-|
|FCF available for Equity ($000s)||6,725,049|
|Diluted Shares Outstanding (000s)||432,500|
|Price per Share/ Intrinsic Value||$15.55|
|Current Market Price Per Share||$13.95|
Based on our WACC the intrinsic value using the DCF model with a 10 year forecast period the value of the firm’s stock is $15.55, which is greater than the current stock price $13.95. According to this, it means that Avon's stock is currently undervalued. The values differ because our analysis is just looking at the numbers where the current market value is taking into account all public information such as managers performance.
Using Excel we preformed a sensitivity analysis which generated the results below.
|Discount/ Terminal Rate||1.0%||2.0%||3.0%||4.0%|
In this section we have evaluated the total enterprise value of the firm using the P/E ratio for Avon and for its industry. This evaluation can be useful because it does not rely on many of the assumptions that must be made for the DCF valuation. In the table below we have calculated the trailing P/E ratio over the past five years.
|Avon Trailing P/E Ratio||2007||2008||2009||2010||2011||Average|
|Year-End Closing Price (12/31/xx)||$39.53||$24.03||$31.50||$29.06||$17.47||$28.32|
|Earnings Per Share||$1.21||$2.04||$1.45||$1.39||$1.18||$1.45|
|Price-to-Earnings Ratio (ttm)||32.669||11.779||21.724||20.906||14.805||20.377|
We also calculated a forward P/E ratio for next year using our EPS estimates and the aggregate of those found by analysts.
|Avon Forward P/E Ratio||Our EPS estimates||Analysts' EPS estimates|
|Recent share price||$13.95||$13.95|
|Projected 2012 EPS (Diluted)||$1.35||$0.75|
|2012 Forward P/E Ratio||10.333||18.600|
Using recent share prices we have also found the P/E ratios for the firms in the industry and calculated industry averages.
|Competitor P/E Ratios||Estee Lauder||Revlon||L'Oreal||Elizabeth Arden||Ulta||Industry Average|
|Recent share price||$58.25||$14.92||$136.41||$46.41||$100.28||$71.25|
|Earnings Per Share||$2.22||$0.78||$5.63||$1.67||$2.41||$2.54|
|Forward Earnings per Share (Mean of Analysts)||$2.57||$1.44||$6.28||$2.66||$2.61||$3.11|
|Price-to-Earnings Ratio (ttm)||26.24||19.13||24.24||27.79||41.61||25.64|
|Price-to-Earnings Ratio (Forward)||22.67||10.36||21.72||17.45||38.42||21.54|
To estimate the intrinsic value of Avon using P/E multiples valuation we have taken the forward industry average P/E ratio and multiplied it by the projected earnings for Avon, including our EPS estimates and the mean of analysts estimates.
|Avon Stock Price Estimate using Industry P/E Ratio||Our EPS estimates||Analysts' EPS estimates|
|Projected 2012 earnings||$1.35||$0.75|
In order to calculate the TEV we took the market capitalization and added in the long term debt that was outstanding and subtracted the cash the company had on hand. The main difference between calculating our share price using TEV/EBITDA and the P/E ratio is that the P/E ratio does not take into account debt. The following table shows the TEV/EBITDA ratio of Avon over the past five years.
|Total Enterprise Value/EBITDA||2007||2008||2009||2010||2011||Average|
|Year-End Share Price||$39.53||$24.03||$31.50||$29.06||$17.47|
|Diluted Shares Outstanding||436,890,000||429,530,000||428,540,000||431,350,000||432,100,000|
|Total Enterprise Value||$18,405,261,700||$11,872,605,900||$14,632,010,000||$14,491,231,000||$9,612,187,000|
The highest the TEV/EBITDA has been in the last five years was in 2007 when it was almost 9.5. Once the economic downturn started their stock price took a big hit which resulted in that ratio dropping to below 5 in 2008. It has had some small fluctuations since then and in 2011 it had dropped back to under 5. This is a result of their stock price drastically falling again during 2011. They also had the highest amount of debt during 2011 and lowest enterprise value in the past five years.
Additionally we compared the TEV/EBITDA ratios for the competitors of Avon using Yahoo! Finance and use those values to calculate an average. We found that Avon’s ratio was significantly lower than their competitors average which shows that their competitors are more appealing to invest in.
|Total Enterprise Value/EBITDA for Competitors||2011|
|Elizabeth Arden Inc.||12.420|
|L'Oreal Sa Adr||15.150|
|Estee Lauder Inc.||13.090|
|Ulta Salon Cosmetics & Fragrances||18.45|
Using Avon's TEV/EBITDA ratio we were able to calculate what the share price should be and calculated it to be $18.29 which is a few dollars higher than the current price per share.
|Present Value of Forecast Period Cash Flows||3,525,534,000|
|Projected 2021 EBITDA||1,984,234,000|
|Discounted Terminal Value||7,683,628,702|
|PV of Cash Flows||11,209,162,702|
|Less: Underfunded Pensions||-|
|FCF Available to Equity||7,901,162,702|
|Diluted Shares Outstanding||432,100,000|
Recommendation for Stock
Since the Stock is undervalued based on the calculations preformed by the WACC we suggest that it is a stock one should buy. Being under valued, one can exploit the inefficiency in the market and make money once the market catches up and realizes that Avon is an undervalued stock. When one purchases the undervalued Avon stock they are helping to correct the market, while making large profits potentially. Below are all of the different value calculations from above summarized.
|Current Stock Price||$13.95|
|Sensitivity IV (range)||$15.63 -$24.89|
|P/E IV based analysis' est. per share||$16.15|
No discussion of peer PE ratios. MV debt differs on DCF analysis from WACC analysis. Discussion of sensitivity analysis is required