Equity Valuation And Analysis (Pdf)

EQUITY VALUATION AND
ANALYSIS

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
Evaluate the strategy of the subject company, including its industry environment, competitive
position, corporate strategy and financial strategy..........................................................................1
Evaluate the company’s accounting policies and methods and identify red flags of inappropriate
accounting treatments......................................................................................................................2
Estimate the implications of accounting policies and perform accounting adjustments where
applicable.........................................................................................................................................2
CONCLUSION................................................................................................................................3
REFERENCES................................................................................................................................4
APPENDIX....................................................................................................................................................5
Table 1Free cash flow......................................................................................................................5
Table 2Percentage of sales...............................................................................................................5
Table 3Calculation of cost of equity................................................................................................5
Table 4WACC calculation...............................................................................................................6
Table 5Terminal value calculation..................................................................................................6
Table 6Equity value and intrinsic value of share.............................................................................7

INTRODUCTION
Rio Tinto is known for large mining operations and use of innovative technology across
globe. Firm is currently listed in Australia stock exchange. In current report equity valuation of
Rio Tinto shares is done. In this regard DCF method is used. Apart from this, in the report
strategy followed by company, industry environment, competitive position of the firm, corporate
strategy and financial strategy is also discussed in detail. All these are taken in to account in
order to justify current equity value which is higher then value identified in DCF approach. At
end of the report, accounting approach which is wrongly used by the firm is identified and point
where improvement need to be made is identified. In this way, entire research work is carried
out.
Evaluate the strategy of the subject company, including its industry
environment, competitive position, corporate strategy and financial
strategy
Rio Tinto is one of Australia largest mining company. In year 2018 and 2019 strong fluctuations
are observed in country economic condition and also across the world. Such kind of conditions
create challenge for Rio Tinto to maintain consistency in earning of profit in the business.
Mentioned firm is following strategy under which it is focusing on 4 p’s which stand for
portfolio, performance, people and partners (Martin-Izard and et.al., 2015). Its strategy is to
make investment in assets which are reach and are mostly unexplored till the date. It focused on
safety of its employees and providing good working environment so that more and more can be
retained in the business which ultimately lead to good business performance. Firm focus is on
developing its technical and commercial capability and it is done by focusing on making
investment on HR. Ultimately, skill development of employees happened which benefit both
employees and firm. Rio Tinto is consistently focusing on making its current partnership strong
with suppliers and also adding new one in its supply chain (Martin-Izard. and et.al., 2015). Thus,
it can be said that firm is focusing on multiple fronts to ensure consistent business growth.
Industry condition is not so good as GDP of Australia is growing at low rate of 7% and
unemployement rate is 5%. Demand for house also reduced. Moreover, economic condition
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globally is also not good, China which is main market for Rio Tinto also observe decline in its
GDP growth rate from past few years. Thus, mining industry is facing lots of problems in current
time period.
Rio Tinto is highly competitive relative to rivals as it can be observed that it is focusing
on cost cutting through technology advancement. Firm is having long term contracts which
ensure that firm will have customers on regular basis. This make firm competitive to its rivals.
Under corporate strategy business firm is adding new products in its portfolio so that
business can be expand at rapid pace (Thibeault, Mézin and Martin, 2016). On other hand, cost
control is another area where firm is currently focusing under its corporate strategy. Under
financial strategy firm is doing capital allocation policy whereby first of all capital is kept aside
for investment in the business and few portions is used to pay dividend to shareholders. If any
amount remain aside same is used to make debt payment. By doing so firm time to time meet all
its obligations.
Company fair value is AUD 5 and current market price is AUD 49. This reflect that firm
shares are overvalued. Investors have lot of confidence on Rio Tinto due to its innovative
business operations and because of this more and more investors are making purchase of
mentioned firm shares. Hence, price of security is overvalued in the market.
Evaluate the company’s accounting policies and methods and identify red flags of
inappropriate accounting treatments
Under accounting policy firm is using impairment methods to revalue its assets so that true
financial position can be assessed. Under this policy Rio Tinto is using discounted value
approach under which present value of asset is computed (Rio Tinto annual report., 2018). There
are number of approaches that can be used by the firm to revalue its asset and one of them is
discounting method. Use of this approach prove wrong as number of cases are filed against Rio
Tinto in Mozambique and other African nations. Thus, on this point Rio Tinto need to pay due
attention to improve its business accounting operation.
Estimate the implications of accounting policies and perform accounting
adjustments where applicable
As discussed above there is loophole in firm accounting policy and it is not using
impairment approaches in proper manner. Rio Tinto must regularly use discounted method but it
must ensure that cash flows are predicted accurately. If cash flow will be computed wrongly then
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wrong value of asset can be computed which lead to computation of wrong value of asset. All
these things lead to preparation of inaccurate financial statements and making of wrong business
decisions (Mavris and et.al., 2018). Thus, cash flows must be based on some solid assumptions
so that relevant approach can be used accurately and proper decisions can be made in respect to
business.
CONCLUSION
At end of the report, it is concluded that there is significant importance of the discounted
cash flow approach because it assists firm in identifying actual value of its shares which further
reflect whether firm shares are overvalued or undervalued in the market. It is also concluded that
there are some calculations in accounting which require judgement. In case of judgement firm
must make decision based on assumptions which have solid foundations. In absence such kind of
strong logic wrong cash flows are estimated which lead to computation of wrong value of assets.
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REFERENCES
Books and Journals
Kaplan, H.H. and et.al., 2016. Orbital evidence for clay and acidic sulfate assemblages on Mars
based on mineralogical analogs from Rio Tinto, Spain. Icarus. 275. pp.45-64.
Martin-Izard, A. and et.al., 2015. A new 3D geological model and interpretation of structural
evolution of the world-class Rio Tinto VMS deposit, Iberian Pyrite Belt (Spain). Ore
Geology Reviews. 71. pp.457-476.
Mavris, C. and et.al., 2018. Diverse mineral assemblages of acidic alteration in the Rio Tinto
area (southwest Spain): Implications for Mars. American Mineralogist. 103(12). pp.1877-
1890.
Thibeault, P., Mézin, H. and Martin, O., 2016. Rio Tinto AP44 cell technology development at
alma smelter. In Light Metals 2016 (pp. 295-300). Springer, Cham.
Online
Rio Tinto annual report., 2018. [Online]. Available through:<
http://www.riotinto.com/documents/RT_2018_annual_report.pdf>.
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APPENDIX
Table 1Free cash flow
2015 2016 2017 2018 2019 F 2020 F 2021 F 2022 F 2023 F
Revenue
3482
9
3378
1
4003
0
4052
2 41332 42159 43002 43862 44740
Operating costs
2791
9
2679
9
2698
3
2711
5 30360 30967 31587 32218 32863
Impairment charges 2791 249 796 132 1143 1166 1190 1213 1238
Exploration cost 576 497 445 488 1143 1166 1190 1213 1238
Operating profit or EBIT 3543 6236
1180
6
1278
7 8686 8859 9037 9217 9402
Finance cost 750 1111 848 552 922 940 959 978 998
Tax expense 993 1567 3965 4242 2879 2937 2995 3055 3116
Net operating profit after
tax 3786 6692
1492
3
1647
7 10643 10856 11073 11294 11520
CAPEX 4685 3012 4482 5430 4853 4950 5049 5150 5253
FCF -899 3680
1044
1
1104
7 5790 5906 6024 6144 6267
PV
5349.57
1
5041.50
5
4751.1
8
4477.57
3
4219.72
3
Table 2Percentage of sales
Assumptions Percentage of sales Average
Operating costs 80% 79% 67% 67% 73%
Impairment charges 8% 1% 2% 0% 3%
Exploration cost 2% 1% 1% 1% 1%
Finance cost 2% 3% 2% 1% 2%
Tax expense 3% 5% 10% 10% 7%
CAPEX 13% 9% 11% 13% 12%
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Table 3Calculation of cost of equity
Cost of equity
RFR 2.10%
Rm 14%
Beta 0.71
Ke 11%
Table 4WACC calculation
WACC calculation
Current Market Price 49.55
Diluted Shares 1,732,000
Market Capitalisation 85820600
Long Term Liabilities 12,847,000
Less: Cash & Cash Equivalents 10,773,000
Enterprise Value (in lacks) 87,894,600
E/(D+E) @ Enterprise Value 98%
D/(D+E) @ Enterprise Value 15%
Interest Rate (%) 7%
Tax Rate (@) 30%
WACC 8.23%
Table 5Terminal value calculation
Terminal Value
Sum of PV of FCF for explicit 23839.55146
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forecast
WACC 8.23%
Long term growth in Revenues 2%
Present Value of terminal value 45583.29614
Terminal Value as % of Total
Value 66%
Table 6Equity value and intrinsic value of share
Equity value
Enterprise Value 69422.84759
- Debt 1,073,000
+ Cash 10,773,000
Net Debt 9,700,000
Equity Value 9,769,423
Intrinsic Value
Equity Value 9,769,423
Diluted Shares 1,732,000
Intrinsic Value 5.640544369
7