Valuation And Forecasting Analysis Of Boral Limited

Forecasting Analysis

Question:

Describe about the Prospective analysis, valuation and application of the Boral Limited company ASX:BTL?

This prospective analysis of Boral Limited can be divided into two sections. These sections are forecasting and valuation. Initial forecasting analysis of the Boral’s performance will be based upon the past and current financial performance of the company. After initial analysis, four valuation models which are Dividend Discount model, Discounted Abnormal Earnings model, Discounted Abnormal Operating Earning model and Discounted Cash Flow model are used for assessing the company’s value.  

Through analyzing the current and future macroeconomic conditions as well as Boral’s competitive strategy it is predicted that sales will increase by 2% in FY15 and FY16, 3% in FY17, 4% in FY18 and 6% in FY19. As the company invests in the Joint venture, it sales will gradually increase in upcoming years. At present the sales growth rate for last five years is a mixed one. The sales of company showed increasing trend except for the year ended 2013, which showed a decline. However the construction industry is developing one and Boral is having strong position in this industry thus a good sales growth in future can be expected.

It may be noted that the changes in revenue and net operating asset (NOA) directly affect the movement of ATO (Bragg 2012). In the case of Boral, NOA is expected to keep stable.  Recently Boral has restructured its business, it has established joint venture. Now the company is focusing on managing the costs and expenses. Hence it is not expected that there will be noticeable growth in NOA in coming future, though some small projects may be initiated.

 Thus the ATO of Boral is expected to constant at 0.80.  

It can be safely assumed that profit margin will remain constant at 3.5% which is relatively low but in line with the average profit of “building material industry” (Yahoo 2015). In the next five years sales revenue of the company will increase as it has set up joint venture and Boral is merging its brick business with CSR (AFR 2014). However the cost of raw material will also increased and there is not much scope in the building material industry to boost the profit ratio beyond a limit.  Thus the profit margin is taken as constant at 3.88%.  

A constant dividend payout ratio of 33% has been forecasted for the next 5 years, based on Boral’s current dividend policy. It has been little lower in the past five years but as now Boral has restructured most of its business it is expected that the directors will be able to maintain at least this dividend payout ratio.

Boral has paid a major portion of tis debt in the year 2013. Hence the cost of debt after tax is expected to be slightly diminishable. As a result, cost of debt after tax of Boral for the next 5 years is predicted around 4%.

There are several valuation models; however for the purpose of this assignment focus will be made only for few major models. Dividend discount model is one of such model.  Under this method the valuation part is done of by forecasting the net dividends and than discounting the stream of dividends (Brigham & Ehhardt 2010).  It is assumed that after restructuring of the business Boral limited will be able to pay a fixed series of dividends in coming years, thus this model is used.

Forecasts	Value	Forecast	Forecast	Forecast	Forecast	Forecast
1.Forecast net dividend pay-out		$ 58.15	$ 59.31	$ 61.09	$ 63.53	$ 67.35
2. estimate cost of capital for equity	10%	1.1	1.210	1.331	1.464	1.611
3. Calculate forecast dividend growth patterns			2%	3%	4%	6%
Estimate TV method – perpetuity with growth of 6%
4. Calculate TV (div from next year / cost capital – growth)						$ 1,122
5. Discount dividend stream to TV year		$ 53	$ 49	$ 46	$ 43	$ 42
Discount TV						$ 697
Total value =	$ 930
Number of shares	583
Share price	$ 1.60

Valuation Models

The second valuation model used to value a company and its stock is DAE model. This DAE model is basically a theoretical framework for valuation of equity shares, which is based on the information extracted from the financial reports (Palepu 2013). This model heavily relies upon the accounting information. The accounting information can be manipulated by the management, thus this model may not give accurate valuation which reflects market expectation.  

Cost of capital (firm)	9%
Cost of capital (equity)	10%
Growth	2%
Number of shares outstanding (million)	779
Year	2014	2015	2016	2017	2018	2019
NOA	$ 5,559	$ 5,670	$ 5,784	$ 5,957	$ 6,195	$ 6,567
NFO	$ 886	$ 21	$ 15	$ 65	$ 177	$ 419
BV	$ 4,673	$ 5,649	$ 5,768	$ 5,892	$ 6,018	$ 6,148
CSP	$ 159	$ 175	$ 179	$ 185	$ 190	$ 197
Residual earnings = CSP1 – (CSE0*CoC(e))		$ 159	$ 161	$ 167	$ 172	$ 178
Growth patterns			1.30%	3.16%	2.82%	3.68%
Terminal value (growth rate 3%)						$ 4,847
Discounted terminal value						$ 3,009
Discounted residual earnings		$ 145	$ 133	$ 125	$ 117	$ 111
Present value of residual earnings	$ 3,641
NOA	$ 5,559
Intrinsic value of the firm	$ 9,200
NFO	$ 886
Intrinsic value of equity	$ 8,314
Price per share	$ 10.67

The third valuation method used is discounted abnormal operating earnings (DAOE). This model can be seen as an alternative model for the valuation of the stock prices of the Boral Limited.

Cost of capital (equity)	10%
Cost of capital (firm)	11%
Number of shares outstanding	779
Year	2014	2015	2016	2017	2018	2019
NOA	$ 5,559	$ 5,670	$ 5,784	$ 5,957	$ 6,195	$ 6,567
Free cash flow	$ 930	$ 65	$ 66	$ 12	-$ 46	-$ 168
change in NOA	-$ 757	$ 111	$ 113	$ 174	$ 238	$ 372
NOPAT = FCF + ∆NOA	$ 173	$ 176	$ 180	$ 185	$ 193	$ 204
AOI = NOPAT1 – (NOA0*CoC(f))		$ 157	$ 160	$ 165	$ 172	$ 183
Growth patterns			1.96%	3.03%	3.96%	5.87%
Terminal value (growth rate 4%)						4575
Discounted terminal value						2715
Discounted abnormal operating income		$ 142	$ 130	$ 121	$ 113	$ 109
Present value of AOI	$ 3,330
NOA	$ 5,559
Intrinsic value of the firm	$ 8,889
NFO	$ 886
Intrinsic value of equity	$ 8,003
Price per share	$ 10.27

Under discounted cash flow model, the future free cash flows are discounted to the present value. (Coyle 1999).  Thus first of all the FCF of the Boral limited are calculated and there after these cash flows are discounted by taking an appropriate discounting factor. The disadvantage of this model is that not every company’s shares can be valued by predicting the FCFs. Through this method, Boral’s share price is coming negative; this may be due to the reason that Boral has used most of its cash flows in restructuring business activities.

Cost of Capital (firm)		11%
Shares
Year	2014	2015	2016	2017	2018	2019
1. Forecast FCF		$ 65	$ 66	$ 12	-$ 46	-$ 168
2. Estimation of  cost of capital for the firm		1.11	1.23	1.37	1.52	1.69
3. Calculation of  forecast FCF growth patterns			0.02	-0.82	-4.89	2.67
4. Calculate TV (negative growth)						0
5. Discount fcf to TV year		$ 59	$ 54	$ 9	-$ 30	-$ 99
Discount TV						0
Intrinsic value of the firm		-$ 8
less NFO		$ 886
Equity		-$ 894
shares outstanding		779
share price		-$ 1.15

The market price of the share of Boral Limited as on 30th June 2014 is $ 5.25 (Boral 2014). The share price as per various models is very different from the market price of the share, or in other words the actual share prices it with just an approximate average of various models. The price of the share can be listed as under-

Model	Estimated Share Price	Actual Market Price	Deviation from Actual market price
Dividend Discount Model (DDM)	$ 1.60	$ 5.25	$ -3.65
Discounted Abnormal Earnings (DAE)	$ 10.67	$ 5.42
Discounted Abnormal Operating Income (DAOI)	$ 10.27	$ 5.02
Discounted Cash Flow (DCF)	$ -1.15	$ -6.40

As the dividend discount model provides most nearest value to the market price, sensitivity analysis will be applied to this model.

PM	% Δ in PM	Price Per Share	% Δ in Price		Div as % of NOPAT	% Δ in Div	Price Per Share	% Δ in Price
4.66%	20%	$ 1.43	19.79%		39.58%	20%	$ 1.43	19.79%
4.27%	10%	$ 1.31	9.74%		36.28%	10%	$ 1.31	9.74%
3.88%	0%	$ 1.19	0.00%		33%	0%	$ 1.19	0.00%
3.49%	-10%	$ 1.07	-10.37%		29.68%	-10%	$ 1.07	-10.37%
3.10%	-20%	$ 0.95	-20.42%		26.38%	-20%	$ 0.95	-20.42%
Cost of Debt	% Δ in Cost of Debt	Price Per Share	% Δ in Price		Cost of equity	% Δ in Cost of Equity	Price Per Share	% Δ in Price
6.00%	20%	$ 1.19	-0.31%		12.00%	20%	$ 1.10	-7.85%
5.50%	10%	$ 1.19	-0.31%		11.00%	10%	$ 1.15	-3.66%
5.00%	0%	$ 1.19	0.00%		10.00%	0%	$ 1.19	0.00%
4.50%	-10%	$ 1.19	-0.31%		9.00%	-10%	$ 1.24	3.88%
4.00%	-20%	$ 1.19	-0.31%		8.00%	-20%	$ 1.30	8.90%

The sensitivity analysis states that the key drivers of share price under DDM model are profit margin and dividend payout ratio, followed by cost of equity and cost of debt.  Under this valuation model, cost of debt has no effect on share price.

Boral limited is in a phase of restructuring. It has set up joint venture, merging its brick business with another entity; it has sold its land fill business to another entity. Boral has paid a huge amount of debts in the last year, due to strong cash generation. Thus it is in a position to launch it to a paced business growth. For this it has to control its administrative cost and various other costs. The reduction is cost is possible due to business restructuring. In fact the company has already save $130 million of overhead and contractor cost due to this restructuring (Boral 2014). The construction markets have picked up and this can result in increased sales. Thus reduction in cost and increased sales will lead to increased profit. Company is having a strong balance sheet and the management can benefit from the improving housing conditions in Australia, USA and other markets.

Another option which is seen as an opportunity for the company is the expansion of business of the company to markets outside the country. Boral can achieve this goal by becoming a partner of local companies at Asian markets such as China or India. This will help the company in increasing stability and Boral can improve their sale and profit margin. Furthermore, if the company runs business internationally, few more markets will be opened and thus sale growth rate will be expect to increase and ultimately results in the increase for Boral’s value in the future.

Sales Growth

The performance of the company is improving, yet all is not well for the company. Some of the business units of the Boral limited are still delivering low returns. Company needs to improve the position of these units. The management is in the process of restructuring which has worked for the company and more benefits will accrue in future.

The USA business division has remained challenging for Boral Limited. The USA housing business has collapsed since the global financial crisis of year 2008. Boral has to focus on US business also in order to survive at global level.

Company has also recruited new CFO, which has to take more efforts on cutting cost. There is a heightened possibility of Boral’s management using accounting policies to achieve the accounting strategies of a newly appointed CEO because Boral’s current CEO, Mike Kane, has only been in his position for two years (since October 2012). Empirical accounting research has found that firms with a newly appointed CEO are more likely to implement accounting strategies that involve exercising greater scrutiny over the value of assets, that change the strategic focus of the firm or that place the blame for poor acquisitions on previous management

Besides that the company is facing certain issues over the injuries at work places. Boral is also facing certain issues from the labour unions. Boral is operating in an environment characterised by legal disputes with unions over access to construction sites (e.g. the dispute between Boral and the CFMEU over access to construction sites in Victoria). This has impacted on Boral’s current business and will likely impact on its future performance.

The construction industry does not have a high margin. The Australian brick business has shown a declining trend. A recent report by PWC has both highlighted that the construction industry is a perennial underperformer from a productivity perspective and that technology can be a driver of future productivity. [Reference: PWC Report]. The report recommends that there be significant improvements in the technologies used to produce and distribute construction materials [Reference: PWC Report]. Therefore, if Boral can improve its technological processes, future profits will be positively impacted.

The first target point of the Boral should be development of business process. As most of units of the company have been closed, may be due to the reason of poor business processes. The company should focus on the developing standard process of doing particular things. Company is expecting growth in revenue in coming years and it is able to control the cost and improve the process than it can earn good profit.   

The second target point of the company should be quality products. As the focus of the company on controlling cost, this aspect may hurt the quality of the products. Boral should pay special attention towards the quality of the products, which should not be suffered due to cost cutting and business restructuring.

AFR 2014, ACCC approves merger of Boral, CSR brick units, viewed 17 January 2015, <https://www.afr.com/p/business/companies/accc_approves_merger_of_boral_csr_kXZ1uX9Qk3RF9Ip0440urM>.

Boral 2014, ‘Annual Report 2014’, Annural Report, Boral, Boral, Boral, Australia.

Bragg, S 2012, Business Ratios and Formulas: A Comprehensive Guide, John Wiley $ Sons, NY.

Brigham, EF & Ehhardt, MC 2010, Financial Management Theory and Practice, Cengage Learning, NY.

Coyle, B 1999, Cash Flow Control, Global Professional Publishi, UK.

Palepu, KHPABV 2013, Business Analysis and Valuation using Financial Statements, 5th edn, Southwestern, Canada.

Yahoo 2015, Industry: General Building Materials, viewed 19 January 2015, <https://au.finance.yahoo.com/q/in?s=BLD.AX>.