Cleanaway Share Valuation and Analysis

This assignment delves into a detailed analysis of Cleanaway's shares. It involves forecasting future earnings and dividends, applying various valuation models such as the Dividend Discount Model (DDM), and comparing them with market prices. The analysis also considers key financial ratios and industry trends to provide an informed investment recommendation for prospective and current investors.

Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
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Forecasting & Valuation: A Case Study Of Cleanaway
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
Table of Contents
1.0 Introduction................................................................................................................................3
2.0 Forecasting:................................................................................................................................4
2.1 Forecasting: An Overview.....................................................................................................4
2.2 Sales Growth..........................................................................................................................4
2.3 Asset Turnover Ratio (ATO).................................................................................................5
2.4 Profit Margin..........................................................................................................................5
2.5 Net Dividend Payout Ratio....................................................................................................5
2.6 Cost of Debt...........................................................................................................................5
2.7 Cost of Equity........................................................................................................................6
2.8 Free Cash Flow (FCF)............................................................................................................6
3.0 Valuation:..................................................................................................................................7
3.1 Valuation: An Overview........................................................................................................7
3.2 Dividend Discount Model (DDM).........................................................................................7
3.3 Residual Income Model (RIM)..............................................................................................8
3.4 Residual Operating Income Model (ROIM)..........................................................................8
3.5 Free Cash Flow Model (FCF)................................................................................................9
3.6 Sensitivity Analysis: Residual Operating Income Model....................................................10
3.7 Recommendation.................................................................................................................10
4.0 Conclusion...............................................................................................................................11
References......................................................................................................................................12
Appendices....................................................................................................................................13
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
1.0 Introduction
Forecasting and valuation may be considered to be one of the most success critical roles and
responsibilities of management. Efficient and effective forecasting provides the management an
overview of future the financial performance of the business in terms of the projection and also
contributes towards understanding a fair valuation of the stock of the firm floating in the market
(Damodaran, 2016). Based on the valuation, the management may get an idea about the stock
performance n the market and accordingly take the strategic decisions such as divestment, share
issue, acquisition and corporate investment etc. The instant report deals with one of such case
study of Cleanaway where the revenue and profit has been forecasted for next five years based
on various parameters and assumptions. The report presents the brief discussion on those
presumptive elements and provides an estimated revenue projection for next five years. In the
next part of the study, the report attempts to value the stock of the firm applying different
valuation models. In addition, the report also presents a concise sensitivity analysis on valuation
and finally recommends as to whether the stock of the firm is overvalued or undervalued. At the
last, the researcher wraps up the discussion by way of concluding note.
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
2.0 Forecasting:
2.1 Forecasting: An Overview
Forecasting is a process by which the historical data is used to identify the future trends. In the
business context, the process of forecasting includes the collection of past data related to revenue
or profit or any other key performance indicators (KPIs) of the business and recognize the inbuilt
trend in those data set to visualize the future data. Forecasting process employs several financial
tools for the purpose of such estimation. As a result, the forecasting and trend analysis may be
construed to be similar at times (Yermack, 1996). It is interesting to note that the forecasting
requires a lot of assumptions and the accuracy of prediction largely depends on relevance and
logic behind those assumptions. The subsequent sections of the report discuss about the various
assumptions behind the process of forecasting for Cleanaway.
Trend analysis may be defined to be dependent on the simple formula of change in the figures as
compared to previous period. For example, if the revenue is AUD 100 million in FY 2015 and
the same for FY 2016 is AUD 120 million, then the growth in revenue may be calculated to 20%
(i.e. excess of figures for FY 2016 over FY 2015, with reference to the figure for FY 2015).
Trend=Current yea r' s data – Previous yea r' s data
Previous yea r' s data
Based on such simple formula, trend for all the below mentioned parameters have been
calculated in the instant case study. In the case of multiple reporting periods, an average of all
trend percentage may be considered to be overall growth rate.
2.2 Sales Growth
As discussed previously, the sales growth has been calculated using the aforementioned formula.
The tables in appendices show the calculation in details. Sales growth may be construed to be the
combined effect of marketing strategy of the firm and market linked factors such as inflation,
national economy and also various externalities. In the given case, the average growth rate in
revenue is computed to be less than 1 %. This is because of the reason that the firm has
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
witnessed the fluctuations in the sales figure in last few years. As a result, the top line has not
been able to provide any specific growth trends and averaged to be 0.82% approximately.
2.3 Asset Turnover Ratio (ATO)
Assets Turnover Ratio (ATO) may be defined to be the ratio that defines the capacity of asset
base of the firm to generate revenue. As the ratio suggests, ATO signifies the ability of per unit
assets to generate revenue (Koceska and Koceski, 2014). Therefore, an ATO of more than 1
denotes an efficient asset base of the company and vice versa. In the given scenario, ATO has
been computed with reference to the provided figures for past few years and computed to be
63.4% on an average. In this context, it may be noted that assets here mean the net operating
assets and revenue includes other income also. Since the Cleanaway has ATO of less than 1, it
may be asserted that the management has not been able to utilize the asset base effectively to
produce more sales for the business,
2.4 Profit Margin
Profit margin may be computed with reference to the gross profit, operating profit or net profit
after tax. Since the intention of the entire paper is to create a forecasting and valuation based on
such prediction, the after-tax figure may be considered as the same has direct bearing with the
various valuation models used for the intended purpose (Palepu et al. 2013). However, non-
operating items may be deducted to arrive at the net operating profit after tax (NOPAT). Average
margin, based on NOPAT, may be calculated to be at around 5.8% during last five years.
2.5 Net Dividend Payout Ratio
Net dividend payout ratio may be defined to be the ratio of dividend paid and total earnings
available to equity shareholders. In the instant case, the ratio suggests the proportion of EPS that
has been paid out as dividend. Since the payment of dividend is not a charge against profit but
appropriation of profit, dividend payout has significant implication on the share valuation for the
company (Richard, 2014). This is because of the fact that the dividend payout ratio will show the
strategy of the firm to satisfy the financial needs of the shareholders by way of paying dividends
and thus retaining rest portion of the EPS for the expansion and growth of the firm. Since the
stock price largely depends on the dividend announcement and lots of other market linked
factors, dividend payout may have considerable influence on the valuation process of the firm.
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
2.6 Cost of Debt
Cost of debt may be defined to the ratio of finance expenses and total debt. However, cost of
debt takes into consideration the tax effect as the interest payment is a tax deductible expense
and hence, usually cost of debt is calculated taking after tax figure into consideration (Bergevin
et al. 2015). Cost of debt usually considers the net finance costs for the business. Since in the
instant case, the net financial expense for the Cleanaway is more than total debt position, at
times, primarily because of the US Private placement borrowings, average net borrowing cost
(NBC) is averaged at lest than 100% (i.e. 96.1%). Cost is 378% of total debt for FY 2014. Since
the figure does not show the real financial obligation for the business in terms of interest
payment and also the loan repayment, the ratio of NBC has not been considered while computing
cost of debt.
2.7 Cost of Equity
Since the debt and related financial expense is a fixed obligation for the business and has to be
borne by the firm irrespective of profit position, cost of debt may be easily computed with
reference to the net financial obligations for the firm. However, in the case of equity, the
calculation may seem to be complex since the cost of the firm for the equity may not be easy to
calculate. Cost of equity, in simple terms, may be denoted by the cost implications of the firm
towards its equity shareholders (Bao and Feng, 2017). In other words, the dividend payment may
be construed to be the cost for the company in connection with the shareholders.
2.8 Free Cash Flow (FCF)
Free cash flow (FCF) may be treated to be one of the most significant and critical items in the
valuation process. FCF is the excess of operating cash flow over the capital expenditure (capex).
FCF represents the amount of cash or liquid assets the firm is able to generate after incurring all
its capital expenditure. Therefore, the business does not have any further obligations to use the
FCF either for the purpose of maintenance of its asset base or for the purpose of conducting
routine daily operations. The firm has positive operating cash flow suggesting a liquiidy position
and hence short term solvency of the business.
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
3.0 Valuation:
3.1 Valuation: An Overview
As discussed in the preceding sections of the report, forecasting process requires several
financial assumptions and these have been briefly discussed therein. However, based on the
forecasted revenue, profit and assets; effort has been made to apply four different types of
valuation model in the instant scenario to find out the stock price of the firm. The subsequent
parts of the paper will discuss these four models in brief in the context of the given case study of
Cleanaway.
3.2 Dividend Discount Model (DDM)
Dividend discount model (DDM) is one of the most used valuation models in the corporate
world. The model relies on the projected dividend streams of a company for future years. DDM
employs a discount rate to bring down the future dividend streams to their present value. Such
discount rate is the differential of the cost of equity and dividend growth rate (Lazzati and
Menichini, 2015). However, the model suffers from limitation where the dividend growth rate is
more than the cost of equity. Since, the stock price is exactly similar (when computed under
DDM) to that of the market pric as on the specified date, the method my be considered to be
ideal for the business.
Value of stock= Dividend per share
cost of equity – Dividend growth rate
In the given scenario, the present value of all future dividend streams has been calculated to be
around AUD 0.80, which is exactly same to the market price of the stock of the company in ASX
as on 30th June 2017 (i.e. the closing date of FY 2017 for the firm). The table below shows the
calculation in details.
Dividend Discount Model (DDM)
Particulars 2017 2018 2019 2020 2021 2022 2023
Dividend 30.20 51.45 57.92 64.56 71.37 78.35 0.00
No. of Shares 1592.89 1592.89 1592.89 1592.89 1592.89 1592.89 0.00
DPS 0.0190 0.0323 0.0364 0.0405 0.0448 0.0492 0.0503
Cost of Capital 7.70%
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
Terminal growth rate 2.25%
Dividend Forecast 0.16
Terminal Value 0.64
Share Price 0.80
Table 1: Share Valuation of Cleanaway under Dividend Discount Model (DDM)
3.3 Residual Income Model (RIM)
The method is similar to that of DDM, except for the case where the future residual earnings are
discounted as against the future dividend streams. The residual earnings are nothing but the
abnormal earnings over and above the standard rate of return as multiplied by the equity fund of
the business (Norman et al. 2013). Based on such calculation, stock is valued to be AUD 0.74. In
this context, it may be noted that the cost of capital and also the terminal growth rate have been
assumed to be 7.70% and 2.25% respectively. In addition, the residual income has consistently
increased during the given period exhibiting a sound growth trend. The table below shows the
calculation in details.
Residual Income Model (RIM)
Particulars 2017 2018 2019 2020 2021 2022 2023
Net profit 66.80 143.18 168.28 194.04 220.46 247.57
Shareholders’ Funds 1,825.00 1,916.73 1,891.36 1,884.48 2,209.09 2,177.22
Residual Income -4.40 22.65 48.93 50.36 79.93 81.72
Cost of Capital 7.70%
Terminal growth rate 2.25%
Book Value 1,825.00
Residual Income:
Forecast 147.20
Terminal 1,034.84
Market Value 1,182.04
No. of Shares 1,592.89
Share Price 0.74
Table 2: Share Valuation of Cleanaway under Residual Income Model (RIM)
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
3.4 Residual Operating Income Model (ROIM)
Residual operating income model is a slight variation from residual income model. In this case,
NOPAT is considered instead of net profit and net operating assets base is considered instead of
equity fund of the firm (Ahmed AL-Dhamari et al. 2014). Like in all previous cases, the total
equity value of the firm has been divided by the weighted average number of shares which is
1,593 approximately. The stock is valued as AUD 2.51 under this model. An increasing trend of
the aforesaid income depicts the operational efficiency to substantiate long term growth strategy
of the firm. The table below shows the calculation in details
Residual Operating Income Model (ROIM)
Particulars 2017 2018 2019 2020 2021 2022 2023
NOPAT 126.96 214.39 241.34 269.00 297.37 326.48 0.00
NOA 2186.5 2200.64 2257.85 2316.56 2376.79 2438.59 0
Residual Operating Income -41.4005 44.943 67.4896 90.6224 114.357 138.708 141.83
Cost of Capital 7.70%
Terminal growth rate 2.25%
NOA 2200.64
Residual Income:
Forecast 353.18
Terminal 1795.93
Firm Value 2149.11
Book Value of Debt -1857.00
Equity 4006.11
No. of Shares 1592.89
Share Price 2.51
Table 3: Share Valuation of Cleanaway under Residual Operating Income Model (ROIM)
3.5 Free Cash Flow Model (FCF)
Free cash flow (FCF) model is another most important and widely used method for stock
valuation. FCF model uses future free cash flow streams and discount the same to value today’s
stock. The method is also called discounted cash flow (DCF) model. However, in the instant
case, the model provides a negative stock value to the extent of AUD -6.77. This is because of
the reason that the terminal value is computed to be negative of AUD 11,125 approximately. The
table below shows the calculation in details
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
Free Cash Flow Model (FCF)
Particulars 2017 2018 2019 2020 2021 2022 2023
Net Profit 66.80 143.18 168.28 194.04 220.46 247.57 0.00
NOA 2186.50 2200.64 2257.85 2316.56 2376.79 2438.59 0.00
Change in NOA 14.14 57.22 58.70 60.23 61.80 0.00
Change in Debt -362 13 6 290 -992 1045 0
Free Cash Flow 116.05 105.07 -154.67 1,152.23 -859.23 -878.56
Cost of Capital 7.70%
Terminal growth rate 2.25%
FCF Forecast 337.96
Terminal Value -11,124.88
Equity Value -10,786.92
No. of Shares 1592.89
Share Price -6.77
Table 4: Share Valuation of Cleanaway under Free Cash Flow Model (FCF)
3.6 Sensitivity Analysis: Residual Operating Income Model
It has been previously discussed that the residual operating income model has provided a value
of AUD 2.51 approximately. However, an attempt has been made to perform a sensitivity
analysis based on the model. If the discount rate increases from 7.7% to 17.7% (i.e. by 10%), the
share value decreases to AUD 0.68. Hence, it may be concluded that the stock value is sensitive
to this model for the change of discount rate by 10%. Initially, the stock was valued much higher
than the current stock price of AUD 0.80. However, 10% increase in discount rate has made the
stock under performing in the market and hence, unattractive to the investors.
3.7 Recommendation
Based on the discussion and analysis of stock value under four different models, it may be
construed that the stock price varies widely depending on the choice of the models used. DDM
shows that the stock is properly valued in the market, whereas the residual operating income
shows that the stock is undervalued and has the immense possibility to go up in future, thus,
making it attractive to the prospective investors. On the other hand, residual income model
denotes that the stock is slightly overvalued and hence will go down in future. Lastly, FCF model
tries to establish that the stock price will run negative in future and highly overvalued as of now.
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
Since the stock price cannot be negative, the value so derived under FCF model may be ignored
as not all the models are appropriate for all situations. Therefore, based on the results of rest
three models, the average price is calculated to be AUD 1.35, which is higher than the present
share price of AUD 0.80. In other words, it may be recommended that the share of the
Cleanaway is presently undervalued and the price of the share will increase in the near future.
Therefore, it may be advised to the prospective investors to buy the stock and present investors
to hold the same to get the benefit of dividend as well as capital appreciation.
4.0 Conclusion
From the detailed discussion, computation, analysis and recommendation, it may be observed
that the forecasting and valuation process is complex and involves lots of variables. It may not be
necessary that all the parameters and variables will be applicable to a given case, as explained
earlier. However, the management should be careful and vigilant enough to judiciously apply the
relevant theory and model into the practical situation to deduce and finalize the corporate
strategy. Finally, it may be concluded that the forecasting is futuristic and hence based on
uncertain factors and probability and the valuation is situational and market linked. Therefore,
the management should always plan accordingly to accommodate for alternative strategies.
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
References
Ahmed AL-Dhamari, R. and Nor Izah Ku Ismail, K., (2014). An investigation into the effect of
surplus free cash flow, corporate governance and firm size on earnings predictability.
nternational Journal of Accounting and Information Management, 22(2), pp.118-133.
Bao, G. and Feng, G., (2017). Testing the Dividend Discount Model in Housing Markets: the
Role of Risk. The Journal of Real Estate Finance and Economics, pp.1-25.
Bergevin, P., MacQueen, M. and Mitchell, L., (2015). Financial Statement Analysis: Content
and Context. BVT Publishing.
Damodaran, A., (2016). Damodaran on valuation: security analysis for investment and
corporate finance (Vol. 324). John Wiley & Sons.
Koceska, N. and Koceski, S., (2014). Financial-Economic Time Series Modeling and Prediction
Techniques–Review. Journal of Applied Economics and Business, 2(4), pp.28-33.
Lazzati, N. and Menichini, A.A., (2015). A dynamic approach to the dividend discount model.
Review of Pacific Basin Financial Markets and Policies, 18(03), p.1550018.
Norman, S., Schlaudraff, J., White, K. and Wills, D., (2013). Deriving the dividend discount
model in the intermediate microeconomics class. The Journal of Economic Education, 44(1),
pp.58-63.
Palepu, K.G., Healy, P.M. and Peek, E., (2013). Business analysis and valuation: IFRS edition.
Cengage Learning.
Richard, P., (2014). The Role of the Accounting Rate of Return in Financial Statement Analysis.
The Continuing Debate Over Depreciation, Capital and Income (RLE Accounting), 67(2), p.235.
Yermack, D., (1996). Higher market valuation of companies with a small board of directors.
Journal of financial economics, 40(2), pp.185-211.
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
Appendices
All values AUD Millions. 2,017 2,016 2,015 2,014 2,013
Cash Only 43 48 37 190 76
Short-Term Investments 8 11 9 - 9
Accounts Receivables, Gross 245 226 226 215 263
Bad Debt/Doubtful Accounts - 3 - 8 - 7 - 3 - 5
Other Receivables 6 6 12 21 25
Finished Goods 7 6 6 5 162
Work in Progress - - - - -
Raw Materials 4 11 10 6 12
Progress Payments & Other - - - - - 8
Prepaid Expenses - - - 11 13
Miscellaneous Current Assets 24 23 19 1 6
Total Current Assets 334 323 312 446 553
Buildings 150 165 159 151 219
Machinery & Equipment 1,435 1,363 1,344 1,238 1,385
Construction in Progress 61 59 89 110 104
Other Property, Plant & Equipment 616 515 412 335 418
Accumuldated Depreciation - Buildings - 7 - 5 - 5 - 2 - 9
Accumuldated Depreciation - Machinery & Equipment - 988 - 916 - 902 - 809 - 858
Accumuldated Depreciation - Other Property, Plant &
Equipment - 331 - 284 - 236 - 201 - 176
LT Investment - Affiliate Companies 12 11 12 12 30
Net Goodwill 1,229 1,220 1,196 1,191 1,778
Net Other Intangibles 356 324 344 81 85
Tangible Other Assets - - - 7 8
Deferred Taxes Assets 90 136 145 176 102
Total Non-Current Assets 2,623 2,588 2,558 2,289 3,086
Total Assets 2,957 2,911 2,870 2,735 3,639
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
Liabilities & Shareholders' Equity
Short Term Debt - 1 1 2 4
Current Portion of Long Term Debt 62 - - - 18
Accounts Payable 91 86 81 57 150
Income Tax Payable 17 11 - 2 7
Accrued Payroll 46 40 43 37 45
Miscellaneous Current Liabilities 164 176 203 197 239
Total Current Liabilities 380 314 328 295 463
Long-Term Debt excl. Capitalized Leases 308 359 351 51 990
Capitalized Lease Obligations - - - - 42
Provision for Risks & Charges 311 350 345 316 127
Other Liabilities (excl. Deferred Income) 133 107 91 13 9
Total Non-Current Liabilities 752 816 787 380 1,168
Total Liabilities 1,132 1,130 1,115 675 1,631
Preferred Stock (Carrying Value) - - - 250 250
Common Stock Par/Carry Value 2,083 2,076 2,072 2,072 2,072
Revaluation Reserves 29 35 32 30 33
Other Appropriated Reserves 11 8 7 4 60
Accumulated Minority Interest - 7 8 9 7
Total Equity 1,825 1,781 1,755 2,060 2,008
Liabilities & Shareholders' Equity 2,957 2,911 2,870 2,735 3,639
- 385Retained Earnings - 298 - 345 - 364 - 305
Cumulative Translation Adjustment/Unrealized For. Exch.
Gain - - - - - 28
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Running Head: Forecasting & Valuation: A Case Study Of Cleanaway
All values AUD Millions. 2017 2016 2015 2014 2013
Revenue 1,454 1,455 1,385 1,421 1,495.0
Other Gains or Losses 22 2 4.1 -16.2 - 17.7
Labour related expenses -589.4 -610.7 -552.6 -540 - 547.0
Collection, recycling and waste disposal expenses -359 -359 -340.1 -350.8 - 378.7
Fleet operating expenses -132 -142 -160 -154.6 - 145.2
Property expenses -40 -32 -32 -34.5 - 50.7
Other expenses -44 -57 -98 -97.0 - 88.2
Share of profits from equity accounted investments 1.2 1.3 1.4 1.7 1.0
Profit from operations before depreciation and amortisation 314.0 257.1 208.9 229.9 268.5
Depreciation and amortisation expense -166 -161 -135 -195 - 152.4
Impairment of assets 20-4 0 -78 -139 - 271.8
Change in fair value of non-landfill land and buildings -0.6 0.2 -0.5 -8.3 -
Change in fair value of derivative financial instruments -8.8 12.5
Rectification expense on landfill assets and operations -69.2 -
Profit/Loss from operations 143.1 96.5 -3.9 -190.9 - 143.2
Net finance costs -34.1 -34.5 -27.1 -94.6 - 116.6
Profit before income tax 109 61.6 -31.0 -285.5 - 259.8
Income tax expense/benefit -36.5 -18.5 7.4 76.9 56.6
Profit/Loss from Continuing operations after income
tax 72.5 43.1 -23.6 -208.6 - 203.2
Discontinued operations
Profit for the period from Discontinued operations after tax 8.2 237.5 2.8
Profit/Loss after income tax 72.5 43.1 -15.4 28.9 - 200.4
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