AGL Energy Company - Business Valuation and Financial Analysis - Case Study Example

AGL Energy Company Report on business valuation and financial analysis Prospect Analysis a) Forecasting In determining the forecast of AGL Energy Company, it is very important to study the trend of the financial performance of the previous five years. This will outline the outlook of future performance of the company. Just focusing on the stability of the company, after demerging of AGL and Alinta in 2006, AGL Company remained to own 33% interest of AlintaAGL Company. The company recorded a value of $601.8 million net cash provided by operating activities at the beginning of the year 2013 compared to $569.3 and $466. 5 in 2011 and 2012 respectively (Appendix 3). The outlook of this seems to define the company at its mature state in the market. However, the profit margins on the other hand perhaps may not be expected to be much since acquisitions are to be made as tax burden on the debtors. Growth assumptions implicated by financial analysis of AGL between 2009 and 2013; Profitability assumptions Basing on ratio analysis, returns on equity basically determines the growth rate of AGL Limited Company. For example, in 2011 the company’s return on equity dropped from 8.81% to 1.61% in 2012. This directly affected the profit of AGL Limited Company from $559.00 million in 2011 to $115.00 in 2012 (Appendix 2). It is important to understand that the performance of investment at this period was poor that called for the company to reinvest dividends back to the capital. The reinvestment done in 2012 shifted the growth by 2.68% (refer to Appendix 2) and more importantly to note is that it brought the company to stability. This was the normal level of the growth rate and due to the competitive edge the company has created then the forecasted growth by the end of financial year 2014 would be 4.2%. There is a decreasing rate of investment by the company which means that in coming years the revenue from investment (other income) would be driving towards 0. Apparently, high investment rate on the capital rather than on equity perhaps forecast on the stability of the company. However, the challenge will still be on how to manage return on equity in order to stabilize the operations. Assets turnover assumptions In 2012, the low performance of the company leads to a decline in asset turn over. However, change in business strategy enhanced a significant increase in operating assets by 1.7%. This implies that company’s operating assets is expected to grow slowly. For this to be understood as a business valuation, assets turn over ratio in the year 2011 was 1.08% while in 2012 was 0.87%. In 2013, the turn-over ratio was 0.94%. Before it reached the terminal (0.94%), the turn-over rate of the company dropped first, and then comes to the present. Therefore, the future turn-over ration is expected to be consistent at 0.94% before shifting perhaps after 5 years of operation. Generally, a lot of investment has been done therefore there is possibly no foreseeable expending by the company. Capital structure As mentioned earlier, the performance of the company is realized by comparing the changes in capital within a specific span of time. In this regard, changes in the working capital perhaps would help forecast the stability of AGL Limited Company over the coming years. There is an increase in financial control in AGL Company. Besides the absent of other income in 2011, the capital structure remained to be strong. Net financial obligation between 2010 and 2011 (before acquisition) was between $448 and $553 million while after acquisition (between 2012 and 2013) it increased significantly to $3,157 million in 2012 and $3, 132 million in 2013. On the other side, net operating asset ranged between $6,353 and $6,790 million in 2010 and 2011 respectively. After acquisition, net operating asset shifted to $10,290 million in 2012 and $10,471 million in 2013. What does this imply? The ratio of the net financial obligation to the total net operating asset is expected to be a consistent figure with the 2013 ratio, which is 3%. (Refer to appendix 1). Figure 1. Table showing optimal capital structure of capital of AGL Company 2010 2011 2012 2013 2014 Cost of equity at each level of debt 5801 6342 7133 7339 7574 Value of equity 5801 6342 7133 7339 7574 value of debt 553 448 3157 3132 3319 Value of the firm (Value of equity+ value of debt) 6353 6790 10290 10741 10893 Another aspect that will shape the capital structure of AGL Company in the coming years is the revenue obtained from the sales. As realized from 2009 to 2013, sales have been in an increasing trend though with the respective high cost on operating expense. Profit in this case has been on the same trend (increasing). Therefore, profit margin will increase by 2.68% until it reaches its best. (Appendix 3). The competition in the market would hold back the capital structure to reach its maturity. Cash flow performance figure, 2: grahp showing cash flow forecast. From the above graph, total cash inflows look to be increasing every year. This means that in the next year (2014) inflows are expected to be high compared to the previous year. On the other side, cash outflows will take the same trend but with a lower rate. This implies that the cash position of AGL Limited Company will stand at $189.9 million which marks the beginning of stability in its cash flow. b) Business valuation The report recognizes models that integrate accounting information, economic information as well as management policies of the company in order to properly estimate the value of the business in regard to the assumptions made in the above forecasting model. Accounting information Economic information Management policies Total forecast revenue relative to the growth assumption (4.2%)= $11,950 million. Capital structure=$10, 893 million. Expected profitability of the company (profit margin of 4.2%) Growth assumption of the company is 4.2%% based on the profit margin Operates in one geographical area, therefore derivative financial instruments + deferred tax assets in Australia is expected to be $9,663 million. Setting up standards to increase the returns on equity Share management policies Cash management policies (managers develop useful guidelines to manage operations transaction pressure. Figure 3: Table showing essential elements of valuation (information adopted from, AEG working paper 2007: Anderson, Geckil & Funari). In regard to the forecast model and the three elements of business valuation, the report uses the residual income valuation model.(NB: The case in AGL Limited Company is a stereotype, that is, the financial adjustment needs a close focus to determine the sustainability of the business at each level of investment). Residual income valuation (AGL Company Equity valuation) Economic profit + Abnormal earnings + Economic value added = Residual income 2014 2013 2012 2011 2010 Equity Capital 7647 7339 7133 6342 5801 Equity Charge 764.7 733.9 713.3 634.2 580 net income 405 389 115 559 356 Residual income -359.7 -223.8 -598.3 -75.2 -224 Figure 4: Table showing residual income of AGL over the past 4 years (figures in Million $) Cost of Capital (equity) 10% Market Value $11,819,040 Terminal value 0.1% Shares 769.9 Book Value 8476 Share Price $15.35 Assumptions: 1. The cost of equity charge is assumed to be 10% with the bank interest rate of 7% per annum. As seen from the residual income, this is a risk venture and the bank rate may rise to over 9%. 2. The terminal growth rate is assumed to be 0.1%. This is computed by dividing the expected cash flow for the next period by the difference between the cost of equity and expected growth rate. 3. Since the firm is trying to maintain its stability in the market, the share price is assumed to be consistent at $15.35. Firm’s value (residual operating income model) The current market price obtained from AGL report 2013 is $14 (share price). While on the other side, residual income valuation model compute a market price of $15.35 (share price). The difference comes as a result of different in forecasting assumptions. 2009 2010 2011 2012 2013 2014 NOPAT 828.41 375.96 576.45 143.05 531.54 544.3 NOA 6106 6353 6790 10290 10471 10,726 Residual operating income forecast 7800 5342 7133 7339 7774.5 From the above model, NOA stands at $6109 million with the terminal growth of 0.1%. Share price is valued at $15.35. Assuming that the cost of capital is expected to be 10%, then the firm will be valued at $443,510 in regard to the number of ordinary shares traded ($550,548,123) (AGL Financial Report 2013). 2009 2010 2011 2012 2013 2014 Forecast dividends 37.6 26.6 24.3 26.7 24.5 26.7 Forecast dividends growth pattern -9.40% 9% -9% 9% Discount TV 1661.4 Equity value 5,800 6,342 7,133 7,339 8,000 Figure 5; Firm valuation with dividends discount model Discounted cash flow model (Firm valuation with NOPAT based terminal value) 2009 2010 2011 2012 2013 2014 NOPAT 828.41 375.96 576.45 143.05 531.54 544.3 NOA 6106 6353 6790 10290 10471 10,726 Change in NOA 247 437 3500 181 FCF 327.41 182.96 139.45 -3,355.95 350.54 559.17 TV 544.31 Figure 6; Figures in the table are in million $. From the above table, the cost of capital (equity) remains to be 10% when the firm’s interest rate on equity stands at 7% per annum. Actually this is a more risk venture. The firm’s value stands at $10766 million. Sensitivity analysis with respect to key the assumptions Focus on equity value: Considering the assumptions made (terminal growth has been assumed to be 0.1% and the equity charge of 10%), the company will still maintain the normal profit margin. At the same time the assumed growth rate of 0% would definitely predict a competitive nature of the market. EPS value on the underlying profit would lower from $108.8 cents to $108.7 cents. Equity valuation model has quantifies the correct value of stock provided by the firm to the market at an assumed tax rate of 30% (AGL financial report 2012). Earnings per share at this rate stand at $15.35. This implies that when the Australian government slightly increases the tax rate for instance by 5%, share value would drop to 7.5%. A reduce of tax rate imposition would lead to an increase in share price to 21.5%. The firm is at high risk rate when it comes to investment. Basing on the assumptions made during valuation, 10% assumed cost of equity at the rates inclining to 7% means that the value of equity at the end of the day would be lowered. This would affect the share price of the company leading to low dividends to the shareholders. Management consulting Basically, valuation of AGL limited company has help in realizing the performance of sales, equity and income at different conditions in the market. AGL’S ROE has been performing very well since 2009 until 2012 where the terminal growth value was realized. A lot of challenges results to decline in the performance. For example, market entry has been increasing therefore it reduces the target customers and reduces the rate of investment. However, high equity value can be achieved under the prevailing conditions (tax value, bank interest rates and environmental policies) in the market. The profit growth of AGL Company is towards a risk future; therefore it is good for CEO to focus on; Accelerating profit and equity value growth: By looking at the residual income during valuation, the rate of change is not well defined. The pattern that would enhance a sustainable equity growth value would rely on a practical business plan, realistic valuation target, value optimization (Increasing ROE) and exit strategy for non-performers. The forecasted economic value of the firm is $764,700,000. Therefore, it is important to restructure shareholders to the company. Tracking history financial record for the business future; The track record for AGL Company is almost perfect. However, presentation of value with respect to economic conditions (tax rate and fluctuation of stock prices) and government policies (pollution) has led to poor investment proposition. A significant drop in ROA from 6.8% to 0.94% in 2012 perhaps may be as a result of poor acquisition strategy. Therefore, to avoid this in future, business valuation and market risk assessment should integrate factors affecting the business both in short-run and long-run and the process should take at least 7 months. Opportunities for improvements AGL Company have competent leaders at all department. Therefore, strengthening leadership practices in all roles would lead to growth development. The idea of training leaders as a CEO would segment the customers basing on their needs. Apparently, this would be enhanced by creating customer-focused strategies. The projected business value of the company is high. Therefore, the share price is expected to grow making it competitive in the market. This is a foundation of shaping the equity with in order to increase the investment. FCF is expected to be at high in 2014 and 2015. The growth rate at this time is also consistent. Therefore, stability is enhanced while cash inflow from operating activities is strengthened. This is a prerequisite state of AGL Company to work on improving its financial obligations. Appendix 1; Reformatted balance sheet AGL Limited Company Operating Assets & Liabilities 2013 2012 2011 2010 Total current Assets 2535 2563 1877 1545 Total current liabilities 1715 1552 1129 951 Total non-current assets 10157 10144 6561 6175 Total non-current liabilities 507 864 519 416 Net operating assets 10470 10291 6790 6353 Financial Activities Net financial obligations 3132 3157 448 553 Net assets (operating & financing) 7338 7134 6342 5800 Equity Total equity 7339 7133 6342 5801 Appendix 2; AGL P&L Account 2013 2012 2011 2010 Profit/net income 389 115 559 356 Total equity 7339 7133 6342 5800 ROE 5.30% 1.16% 8.81% 6.14% Total Assets 13,366 14,738 9,696 8,690 Return on Assets 2.77% 0.94% 6.08% 4.02% Revenue 9,716 7,456 7,072 6,611 Cost of sale 7,451 5,918 5,706 5,328 Gross profit 2,265 1,538 1,366 1,283 GP margin 23.31% 20.63% 19.32% 19.41% Current Financial liabilities Borrowing 45 616 887 Other financial liabilities 432 442 441 582 Borrowing 3,064 3,696 285 900 Other financial liabilities 264 436 94 42 Total liabilities 3,805 5,190 1,707 1,524 Total equity 7,339 7,133 6,342 5,800 FLAV 51.85% 72.76% 26.92% 26.28% Net Asset 7,339 7,133 6,342 5,800 Financial activity 3,132 3,157 448 553 Net operating asset 10,471 10,290 6,790 6,353 Asset Turn Over Ratio 1 1 1 1 Appendix 3 2009 2010 2011 2012 2013 Net cash provided by operating activities 235.4 390 569.3 466.5 601.8 Net cash used in investing activities 1,440.90 -91.7 -419.3 -531.3 -559.6 Net cash (used in)/provided by financial activities -1,154.10 -4,441 122.7 1,124.60 -1,584.10 Net decrease/increase in cash and cash equivalents 522.2 -142.7 272.7 1,059.80 -1,531.90 Cash and cash equivalents at the end of the financial year 623.1 480.4 753.1 1,812.90 281 Reference AGL Financial Report (2012). Expanding opportunities. Australia. AGL Financial Report (2013). Energy in Action. Australia, www.agl.com.au AGL Resources Management Discusses Q4 2012 Results - Earnings Call Transcript. (n.d.). AGL Resources Inc. (GAS):. Retrieved October 29, 2013, from http://seekingalpha.com/article/1160771-agl-resources-management-discusses-q4-2012-results-earnings-call-transcript Financial Statements for agl energy ltd (AGK). (n.d.). Businessweek.com. Retrieved October 29, 2013, from http://investing.businessweek.com/research/stocks/financials/financials.asp?ticker=AGK:AU Granger, C. W. (1980). Forecasting in business and economics. New York: Academic Press. Trugman, G. R. (2007). Understanding business valuation. Lewisville, Tex.: American Institute of Certified Public Accountants. Read More