Introduction to Corporate Finance
Corporate finance deals with undertaking monetary decisions concerning optimization of finance in order to maximize the wealth of capital contributors. Unless, appropriate financial planning is ensured at various operational levels functioning in the organization, the business profitability will be reluctant to show its positive attitude towards prospects of business. Poor finance management is analyzed and interpreted using established mechanisms to assess financial performance of the company (Brealey, 2012).In this report, we have assessed the financial performance and standing of the renowned UK based real estate development firm Barratt Developments Plc in context with its current valuation and future prospects of the company in the industry. A recent issue reported by company’s issue reveals that some shareholders of the company have been contacted by ‘brokers’ from overseas, mainly from the USA, who are offering very high prices for shares in the company. These offers are a form of Boiler Room Scam which is well explained by statements marked by FSA. Such unsolicited offers lead to over pricing of company’s shares in the stock market and distorting company’s financial picture. Also, how the company has marked appreciation in the funds of investors will be discussed by referring to company’s market capitalization as per recognized stock exchange on which it is listed. Concern will be placed on assessing financial performance of the company through financial indicators involving working out company’s current and forward PE multiple, interpreting financial ratios using reported results (Laih, Lai and Li, 2014).
Barratt Development-Business Description Overview
Barratt development plc has been successfully operating in the real estate industry more than 50 years, becoming Britain’s one of the largest house builders with more than 5000 direct employees and operating in 27 divisions throughout the nation. Their principles and policies drive the organization to place customers at the heart of the organization aiming to keep people safe and serve as a trusted partner while building homes for the clients.
It is demonstrated that company has been consistently able to mark appreciation in the value of shareholder’s fund since 2009 till date. Graph even demonstrates index of other listed house builders and reflect outer performance by the company in comparison to other established brands. Above chart has been prepared in compliance with BIS regulations, showing TSR performance which does not include company’s investment trusts over the last five years against the FTSE 250. Hence, it can be said that company has successfully added value to owner’s fund. As of today, Barratt Development Plc’s enterprise value is £4500 million (EV/EBIT, 2014). As per London stock exchange, BDEV’s EV/EBIT is ranked higher than 82% of the 540 companies in the global residential construction industry.
Economic Value Added Analysis
In general terms, economic value added analysis is a internal management performance measure that helps in comparing net operating to total cost of capital. The formula of economic value added is net operating profit after tax – capital invested * weighted average cost of capital.
Current Valuation of the company
Valuation of the company is assessed using following below mentioned methods:
Net Assets value method: Net asset value method is used to determine the value of share by dividing net assets of the company by outstanding shares of the company, determining their share in the properties of the company (Fernandez, 2007). Value of net assets of the company is assessed through determining and individual market values to assets and liabilities under the control of the company. This approach also aims to determine firm’s value on account of Goodwill which is determined under various approaches of super profit and capitalization methods and applying them on future maintainable profits. However our calculations are based on book values of assets including Goodwill and liabilities. Book values of assets and liabilities have been used to ascertain current value per share of the company, in absence of market value of company’s assets and liabilities.
Valuation of share using PE multiple
Share value of the company can be assessed by using PE multiple and earnings per share of the company. PE multiple of the company is taken as 14 against the industry average of 13.9. Mathematical formula to ascertain market value of share with reference to PE multiple is laid below:
Market price per share= Earnings per share of equity shareholders x PE multiple
Note: If company’s PE multiple is not available, then reliance is placed on other companies’ PE multiple operating in the similar line of business (De Franco, Kothari and Verdi, 2011).
Market Price per share = 31.2pence (E.P.S) x 14 (PE Multiple)
= 436.8 pence per share or 4.37 £ per share
Note: Current Price of company’s stock is 4.54£ per share (Investors: Share Price, 2014)
Working Note: Company has generated operating income for the year ended 30the June, 2014 worth 410 million £ reflected in company’s income statement. EV/EBIT ratio is calculated as enterprise value divided by its EBIT for the reporting period. EV/EBITDA is calculated as enterprise value divided by its EBITDA which is nothing but EBIT before depreciation and amortization.
Referring to above stated comparative figures of income from operations for the two reporting periods, it can be concluded that company’s has been able to improve its operational performance at higher rate in 2014, thereby showing its positive attitude towards profitability. As far as PE multiple is concerned, company’s current PE is almost equivalent to what is prevailing in the industry, thereby performance of the company can be said to be at par with the industry performance.
Discounted Cash Flow Approach
Valuation of share of company using discounted cash flow approach will involve using past 6-7 years data regarding free cash flow of the company, growth multiple and total equity capital outstanding as on date i.e. June 30, 2014. Projected Intrinsic value based on Discounted cash flow IV or Discounted Earnings IV cannot be applied to the companies if their revenue, earnings and free cash flows are not and have not been consistent during the past years of operations. Hence, their projected intrinsic value is based on normalized Discounted Cash Flow and Book Value of the company.
Interpretation: Based on above calculations for ascertaining value of the company it is concluded that company current value of share price ranges from 3.414.79£ per share to 4.79£ per share. Maximum value which company can get against its share under above different approaches discussed and analyzed, will be worth 4.79£ per share. In addition to it, after forecasting the cash flow it can be stated that, revenue figures are showing positive results as at the initial stage during 2005-07 BDEV generated constantly increasing revenues which indeed assisted top level management in enhancing profit margin. Furthermore, according to forecast it has been evaluated that there are certain point of time between 2009-11 when company's revenue is showing declining results but in coming years revenues are showing hike in figures which indeed can be fruitful for firm in attaining sustainability for future contingency.
Adopting appropriate method for company’s Valuation
Choosing appropriate method for share valuation of the company will require detailed analysis and assessment regarding inherent limitations with which the method is developed. A brief to such limitations is explained below:
Net Assets Value/Book Value: Ascertaining net assets value of the company will require obtaining market value of all the assets under control and liabilities incurred by the company, which is a difficult task. Using book values to the extent, when market value is not determinable may even not reflect true value of the company as book value of various assets held by the company may be based historical cost of acquiring them. Even Goodwill needs to be correctly valued using various approaches (Tsai, Lu and Yen, 2012). It is hard to determine future maintainable profits for working out super profits and the years to which such profit will be maintained, in the cases when the company has maintained trend of inconsistency in its revenue, profits and cash flows for the past years. However, as a matter of regulatory requirement companies is required to the extent reflect fair value of assets and liabilities while preparing and presenting their financial statements.
P/E multiple: P/E ratio demonstrates the number of years it takes for the company to earn back the price investors paid or are willing to pay. As earnings never remains constant PE multiple changes. PE ratio to the extent can mislead investors a lot of times, especially when the business concern is cyclical and unpredictable. But for concerns that project their earnings with consistency in growth PE is more suitable to value their business.
Discounted Cash Flow Projection approach: Free cash flow is the money generated in a year which can be used to grow the business while reinvesting and paying dividends (Ruback, 2011). Formula mentioned under this approach, translated free cash flow assumptions into the Growth multiple. The reason for using the 6 years average of cash flows is to smooth the up and downs that can occur in any particular year of reported year, thereby using average serve as a means to normalize the FCF data.
Analysis: Referring to above inherent limitations of the methods under impression for valuing company’s stock, it can be concluded that valuing share using PE is most suited to work out worth of the company as it is based on current earnings of the company and demonstrated the relationship of company’s current earnings per share with that of market price (Napolnov, 2012). As a fundamental assumption, it determines how long the company will take to pay back the money invested by shareholders by generating return on assets. Hence using PE multiple and earnings per share of the company, value of company’s stock stands for 4.37 £ per share.
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Based on above discussions and interpretations, it can be concluded that valuation of shares can be made using various approaches and different approaches may reflect different value due to different mathematical formulas stated under different approaches and varying under lying assumptions based on which such formula is derived. Prospective investors will tend to pay for acquiring company’s stock different prices based on their assessment of value of firm under such approaches. In this context, we applied various share valuation techniques in working out valuation of renowned company of household products, being Barratt Developments Plc. Also we identified growth and sustainability prospects of the company along with past analysis of company’s rate of return to shareholders.
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- Gu, F and Lev, B., 2011. Overpriced shares, ill-advised acquisitions, and goodwill impairment. The Accounting Review.
- Laih, Y. W., Lai, H. N and Li, C. A., 2014. Analyst valuation and corporate value discovery. International Review of Economics & Finance.
- Ruback, R. S., 2011. Downsides and DCF: valuing biased cash flow forecasts. Journal of Applied Corporate Finance.
- Tsai, C. F., Lu, Y. H and Yen, D. C. 2012. Determinants of intangible assets value: The data mining approach. Knowledge-Based Systems.
- De Franco, G., Kothari, S. P and Verdi, R. S., 2011. The benefits of financial statement comparability. Journal of Accounting Research.