Forum Archive Index - February 2001

["Peter Maiden" <pmaiden@xtra.co.nz>]

Taking the concept of enterprise values a bit little further here is some thinking about assessing company valuations, which also takes into account levels of borrowing.

On the premise that a firms Market Value (market capitalisation) is equal to the Invested Capital (shareholder equity plus net borrowings) plus the value of the current and future cash flows (generated from the invested capital) we can easily calculate what the market has valued this cash flow as.

The value of these cash flows is then the firms market capitalisation less invested capital. Reviewing the value of these cash flows can lead to some judgement as to whether any particular share is 'undervalued' (or 'overvalued'). The alternative argument is the efficient market theory saying that the share price is fair and a real reflection of the company.

Contributors have talked about Ebos, Tourism Holdings and Frucor a lot recently. These three stocks actually show three different degrees of market expectations, and as such worth while taking a look at.

Consider Tourism Holdings THL - market value of $166M less equity and net borrowing’s of $284M gives a NPV of current and future cash flows of a negative $182M (equivalent to $1.98 a share). The return on invested capital is less than THL's cost of capital - the market is saying that THL is not creating value. If anybody believes that THL is adding value to this invested capital then jump in boots and all because the THL share price should be $1.98 more than it is now. At $3.80 the market would be saying that it is at least making a return equal to its cost of capital.

How about Frucor FRU - market value of $237M less invested capital of $80M gives a NPV of current and future cash flows of $157M (about $1,24 a share). To put in perspective forecast earning s this year are 16 cents per share. The market is recognising that FRU is likely to return increasing earnings at a return in excess of it's cost of capital. Current price for FRU seems pretty reasonable. One DCF I have seen for FRU does suggest that there is a potential 40cents a share upside - as long as high earnings growth continue for some time. Again how to assess what growth FRU can achieve and for how long is with each individual investor. When the forecasted results start coming through in future years the share price should follow as well.

Now to Ebos EBO - market value of $79M less invested capital of $47M gives a NPV of current and future cash flows of $32M ($1,20 a share). In perspective forecasted earnings this year forecast to be 20 cents/share. Again the market recognises that EBO is going to grow its profit at a return in excess of its cost of capital. One broker's DCF I have seen indicates that another $1.00 share could be added to the NPV without making these calculations look unreal.

Three different companies which the market has just happened to put three different perspectives on. Up to each of us to make our own assessments as to how the market valuation stack up.

There is a one ratio that summaries the above data - the market to book ratio (being market value (capitalisation) to book value (shareholder equity)). The market to book ratio of THL is 1.0, FRU 7.6 and EBO 2.1. Follow the relationships?

Must go now - another plane to catch

Cheers

Peter