# Essays on Company Profile - Origin Energy Limited Assignment

Generally, the paper "Company Profile - Origin Energy Limited" is a great example of a business assignment. Valuation of Origin Energy is done using various techniques and methods. Initially, the valuation is done using free cash flow to firm under constant growth model and multi-stage growth model. Then, valuation is done using several multiples such as Price-earning, price-book values and others. For valuation Weighted Average Cost of capital is used. WACC: Weighted Average Cost of Capital is the firm’ s average cost to employ its capital in running the business. A firm generates capital primarily from two sources, shareholder’ s capital and borrowed capital.

Different risks are attached with generating capital from both the sources which result in different expected return from employing the funds. These expected returns from the stakeholders become the cost for the firm. This cost for the firm is known as the average cost of capital employed in the business. Since the average cost of capital is a weighting of its cost of equity and its cost of debt, it is usually referred to as the weighted average cost of capital. WACC = (S/(S+B)) * rs + (B/(S+B)) * rb * (1 – Tc) Where S is shareholder’ s equity, B is borrowed capital, rs is the cost of equity, rb is the cost of debt and Tc is the effective tax rate. To calculate WACC for Origin Energy Limited following factors must be analyzed. Capital Structure of Origin Energy Limited: The capital structure of the firm estimates its gearing level, which shows how much the own fund and loan fund is employed in the business.

Three ratios are useful in assessing the capital structure of a firm namely Debt-to-Capital Ratio, Debt-to-Equity Ratio and Equity Multiplier. Debt-to-Capital Ratio: This reflects the ratio of total long term debt to total capital employed.

For Origin Energy (the Year 2008) it is calculated as following (Thomson One Banker): D-C Ratio = Total Debt/Total Capital = . 27 Debt-to-Equity Ratio: It reflects the total proportion of debt as a comparison to equity in the firm’ s capital.   D-E Ratio = Total Debt/Total Equity = . 37Equity Multiplier: It is the ratio of total assets to total equity. Equity Multiplier = Total Assets/ Total Equity = 1.34Analysis of these ratios for Origin Energy shows that the firm’ s debt level is on the lower side.

Hence the firm has a significant debt capacity unutilized. Only 28% of total capital employed is funded from debt activities. While debt is just 37% of total equity invested. Cost of Equity: From the firm’ s perspective, the expected return is the cost of equity capital. Under CAPM, the expected return on the stock is (Ross, Westerfield and Jaffe): rs = RF + β * (RM – RF)Where RF is the risk-free rate of return, β is the beta of the stock and RM is the market return. The beta value for Origin Energy is estimated to be. 66 which is calculated by regressing the past one year returns of stock over the market return (using index Australian Stock Exchange) for the same period.

In Australia, the risk premium is at a medium level which is estimated to be around 7.5%. The risk-free rate for the firm is assumed to be at a 5% level. This gives the value of the cost of equity for Origin Energy as following: rs = 5% + . 66 * (7.5%) = 9.95%Cost of Debt: The cost of debt for Origin Energy can be estimated by the yields on its long term debt, which is around 7-8% (Origin Energy Limited).

Hence cost of debt: rb = 8%Tax Rate: The effective tax rate for Origin Energy is 39.52%. Hence, a 40% tax rate can be considered. For Origin Energy; E/C Ratio = . 73 and D/C Ratio = . 27Hence, WACC = . 73 * 9.95% + . 27 * 8% * (1-. 40) = 8.56%Valuation Using Free Cash Flow to Firm (FCFF): There are two methods that can be used for valuation using FCFF: Constant Growth Model: In the constant growth model, it is assumed that the free cash flow to the firm would continue growing at a fixed rate infinitely, hence forming growing perpetuity.

The growth rate is estimated by analyzing past data. For Origin Energy the growth rate is calculated by taking comparing the industry growth for the past 5 years along with the extent of sustainability of growth in future, which is estimated to be 7.63%. Hence, g = 7.63%The value of firm under constant growth model is given by: Value = Current FCFF x (1 + growth rate)/ (WACC – growth rate)FCFF = EBIT * (1-Tax rate) + Depreciation & amortization – Capital Expenditure (or, change in gross block) – Change in Working CapitalFor Origin Energy; FCFF = 843.93 * (1-. 4) + 344.63 + 4143.79 – 66.18 = 4928.6Hence, Value = 4928.6 * (1+. 1863)/ (8.56% - 7.63%) = 628687.98 Millions AUDNumber of Origin’ s Shares Outstanding = 874328000Value per Share = 719.05 AUDCurrently, the share of Origin is trading at just 15.15 AUD hence this price seems to be undervalued comparing the value of the firm from the constant growth model is 719.05 AUD per share. Multi-Stage Growth Model: In the multistage model, the cash flows of the firm are divided into high growth periods and sustainable growth periods.

Generally, it is considered that a new firm or a firm in a growing industry would initially grow at a higher rate but after some times it will attain its maturity and the high growth rate would halt bringing the growth rate to a seemingly sustainable level (Palepu, Healy and Bernard).

This sustainable growth rate can be estimated to be equal to the growth rate of the economy. For valuation of Origin Energy, the initial 5 years are considered as high growth period and then onwards it is assumed that it will attain a sustainable growth rate. The high growth rate is estimated by analyzing past trends of the company’ s performance. Here, the compounded growth rate of net sales of Origin Energy for the past five years have been calculated to estimate the high growth, which is coming out to be 18.63%.

Sustainable growth is considered to be 4% which is a general trend of the Australian economy. Valuation Using Relative Valuation Techniques: The valuation using multiples can be done by mainly two multiples namely price earning multiple and price book value multiple. Price-Earning Ratio: P/E ratio shows that how much the market is ready to pay for the one AUD of the current earning of the firm. A forward Price Earning ratio shows that how much the market is ready to pay for the future on AUD earning of the firm (Chandra). P/E ratio = Current Price / Forward EPSForward EPS = Current EPS * (1 + Growth Rate)For Origin Energy, Current EPS = . 59 AUD & Growth Rate = 18.63% (Based on past data)Hence, Forward EPS = . 59 * (1.1863) = . 70 AUDHence, P/E Ratio = 15.15/. 70 = 21.61The industry P/E ratio is estimated to be 22.01, showing that the stock is undervalued. Price-Book Value Ratio: This ratio shows how much the market is valuing the current assets of the firm.

That means how much investors are expecting that the assets of the firm would be able to add value to their invested capital. P/B Ratio = Current Price / Current Book Value Per shareFor Origin Energy; Book Value per share = 10.57Hence, P/B Ratio = 15.15 / 10.57 = 1.44The Industry average P/B Ratio is estimated to be 1.76, implying that the stock is currently undervalued. Conclusions: As we have seen in the above valuation that all the models and methods depict that Origin Energy is currently underpriced at its price of AUD 15.15.

This underperformance might be because of the current slowdown in the market, however, looking at the prospects of the company and future demand for petrochemicals it is eminent that Origin Energy will be trading at its intrinsic value.

References

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1. Chandra, Prasanna. Investment Analysis and Portfolio Management. New Delhi: Tata McGraw-Hill, 2007.

2. Origin Energy Limited. Origin Energy. 2009. 28 May 2009 .

3. Palepu, Healy and Bernard. Business Analysis and Valuation. New Delhi: Cengage Learning India Private Ltd., 2004.

4. Ross, Stephen A., Randolph W. Wetserfield and Jefferey Jaffe. Corporate Finance. New York: McGraw-Hill, 2005.

5. Thomson One Banker. Thomson One Banker. 2009. 28 May 2009 .