Valuation

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.

Sales Forecast
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 
Difference $1.60 

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.

Sensitivity Analysis

Using Excel we preformed a sensitivity analysis which generated the results below.

  Discount/ Terminal Rate 1.0% 2.0% 3.0% 4.0%
  4.0% $24.57 $29.70 $38.26
  5.0% $19.34 $22.48 $27.19 $35.04
  6.0% $15.63 $17.69 $20.57 $24.89
  7.0% $12.87 $14.29 $16.18 $18.83
  8.0% $10.74 $11.75 $13.05 $14.79

Multiples analysis

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
 Industry P/E   21.54   21.54
 Projected 2012 earnings   $1.35  $0.75
 Price estimate   $29.07   $16.15

TEV/EBITDA

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
Market Capitalization $17,270,261,700 $10,321,605,900 $13,499,010,000 $12,535,031,000 $7,548,787,000
Preferred Stock $- $- $- $- $-
Total Debt $2,098,000,000 $2,656,000,000 $2,445,000,000 $3,136,200,000 $3,308,400,000
Cash $963,000,000 $1,105,000,000 $1,312,000,000 $1,180,000,000 $1,245,000,000
Total Enterprise Value $18,405,261,700 $11,872,605,900 $14,632,010,000 $14,491,231,000 $9,612,187,000
EBITDA $1,957,000,000 $2,435,000,000 $2,188,000,000 $2,197,000,000 $1,992,000,000
TEV/EBITDA Multiple 9.405 4.876 6.687 6.596 4.825 6.478

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
Revlon 8.5
Ulta Salon Cosmetics & Fragrances 18.45
Industry Average 12.073

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.

TEV/EBITDA Valuation
Present Value of Forecast Period Cash Flows 3,525,534,000
Projected 2021 EBITDA 1,984,234,000
Terminal Value 12,853,610,424
Discounted Terminal Value 7,683,628,702
PV of Cash Flows 11,209,162,702
Less: Debt 3,308,000,000
Less: Underfunded Pensions -
FCF Available to Equity 7,901,162,702
Diluted Shares Outstanding 432,100,000
Intrinsic Value $18.29

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.

Value Measure Value
Current Stock Price $13.95
DCF IV $15.55
Sensitivity IV (range) $15.63 -$24.89
P/E IV based analysis' est. per share $16.15
TEV/EBITDA IV $18.29

Grades
2.55/3

No discussion of peer PE ratios. MV debt differs on DCF analysis from WACC analysis. Discussion of sensitivity analysis is required

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