Comprehensive Valuation Report: Sab Miller's Financial Analysis

This report presents a valuation analysis of Sab Miller, employing several financial models to assess its economic value. The analysis includes the application of the Price-Earnings (P/E) ratio, a Dividend Growth Model (specifically the Gordon Growth Model), and Free Cash Flow forecasting. T...Read More

VALUATION FOR SAB MILLER

TABLE OF CONTENTS
Introduction..........................................................................................................................................
1. Presenting the valuation of Sab Miller....................................................................................1
2. Comparing the valuations with the actual market value of the company................................3
A). Price earnings ratio................................................................................................................3
B). Dividend growth model.........................................................................................................4
C) Forecast free cash flows..........................................................................................................5
3) Advantages and Disadvantages of methods selected..............................................................7
Conclusion..........................................................................................................................................
References..........................................................................................................................................
Appendix............................................................................................................................................
Discounted Cash flow method...................................................................................................13
Gordon Dividend Growth Model...............................................................................................14

INTRODUCTION
Valuation of business can be defined as the process or a set of procedures that is used to
estimate the economic value of company’s economic position. The main use of valuation is made
by financial market participants to determine the price they are willing to pay or receive to effect
a sale of business. In the present report researcher focuses on the valuation of Sab Miller through
different methods that consist of prospective price earnings ratio analysis, forecast dividend
growth model and forecast free cash flow. By the means of all these approaches researcher
focusing on assessing the economic position of business on the basis of share price so that value
of shares can be assess either under or over.
1. Presenting the valuation of Sab Miller
A). Price earnings ratio analysis: It is also termed as P/E ratio which clearly indicates the
market value of stock in relation to their earnings. Investors usually makes use of this ratio to
assess the the fair value of stock price. One can easily assess this ratio by dividing the market
value price per share by earning per share. Moreover, business organization offers high level of
dividend who has high level of earnings. It is the measure which clearly reflects the extent to
which stock will appreciate in the near future (Engsted and Pedersen, 2010). Thus, market value
of the stock is usually based on the predicted future earnings. This ratio can be calculated by the
investors on a quarterly basis when quarterly financial statements are issued by the business
organization.
Price earnings ratio is one of the most effectual factor which closely influence the
investment decision of the investors. Usually, capitalist prefer to invest money in share or
securities of the firm who has high P/E ratio. Moreover, company who has high P/E ratio
presents that business unit will grow in the near future in a positive manner. On the contrary to it,
low P/E ratio indicates that financial health and performance of the firm is poor. In this, investors
are hesitate to invest money in the shares of the corporation (Ghosh and Constantinides, 2010).
Moreover, investors have desire to earn high through dividend. Moreover, company is unable to
offer high dividend to the shareholders if their financial performance is poor in the financial
terms. This ratio assists investor in making comparison of the growth and other aspects of the
firms who operate in the similar industries. Besides this, high P/E ratio entails that investors are
expecting high earning growth in the future in comparison to the companies who have low P/E
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ratio.
However, on the critical note, valuation and growth rates of the varied companies or
industries highly differs. If investors may comparison of the price earnings ratio of food and
beverages with the energy sector then they not abler to make suitable investment decisions
(Golez, 2014). Further, the calculation of P/E ratio is highly based on the earning per share which
is the subject of high risk. Management can easily manipulate the earnings by taking into
consideration the specific accounting techniques. All these aspects limit the significance of P/E
ratio to some extent.
b). Forecasted dividend growth model: In the present era, investment decision of the existing
and potential shareholders are highly influenced by the dividend aspect. Due to this, now
companies make competent strategic framework which helps them in enhance their profitability.
Dividend growth model establishes relationship between the value of firm's equity and market
cost of equity (CAI, 2010). This model is used by the business enterprise for determining the
intrinsic value of stock by taking into consideration the future series of dividend which grow at a
constant rate.
There are mainly three key inputs on which dividend growth policy is based. Three key
elements include dividend per share, growth rate in dividend per share bad required rate of
return. In this, dividend per share reflects the amount which Sab Miller pays to their common
equity shareholders. Besides this, dividend growth aspect presents the level or possibility to
which dividend will grow from one year to another. Whereas, required rate of return entails the
amount which investors are willing to earn by purchasing the stock of a particular company
(Kung and Schmid, 2015). By taking into account all these aspects, investors are able to estimate
the rate of dividend in an appropriate manner.
This model is based on the assumption that business organization exists for the infinite
time period. Further, it also assumes that company will offer dividend to the shareholders at an
increasing rate. For this purpose, this model undertakes the infinite series of the dividend per
share and thereby discounts it by taking into consideration the required rate of return. However,
it is to be critically evaluated that the assumption of increasing dividend is not highly realistic in
the present time. Moreover, dividend decision of the firm is highly influenced by their growth
and profitability aspects (Hein, 2012). In addition to this, business environment is not static
rather it is highly dynamic in nature. Business cycle and financial difficulties are one of the main
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aspects which closely affect the profitability and thereby dividend decision of the firm. Thus,
investors can use this model for the firms who constantly enjoys the stable growth rates. Besides
this, when required rate of return is less than the growth rate of dividend then it offers negative
solution or outcome.
Gordon dividend growth model: P = D / K-G
p = Security’s price
D = dividend pay-out ratio
K = required rate of return
G = growth rate
c). forecast free cash flow: It refers to the cash flow which company has after performing its
operations. The remaining cash flow offers opportunity to the business organization to maximize
the shareholder's value by offering high dividend to them. Besides this, higher cash flow means
that company is able to expand their business operations and functions by developing the new
products or services. Investors make assessment of the free cash flow which helps them in
assessing the reward which company will offer in the near future in the form of dividend
(Garrett and Priestley, 2012). Moreover, when sales revenue of the firm is continuously
increasing, cots are reduced then cash flow of the business unit rises. Cash flow is one of the
main aspects which have high level of impact on the growth and financial performance of the
firm. When cash position of the business enterprise is sound then they are able to develop new
products or services in an effectual manner (Cuaresma, Lutz and Sanderson, 2014). Furthermore,
dividend decision of the business unit is also highly dependent on their cash position and
performance to the significant level.
2. Comparing the valuations with the actual market value of the company
A). Price earnings ratio
Price earnings ratio of Sab Miller: 32.98
Earnings per share: 1.85
P/E ratio of the food and beverage industry = 51.8
On the basis of above mentioned aspect it has been assessed that price earnings ratio of
Sab miller is lower than the average industry ratio. This aspect reflects that financial health and
performance of Sab miller is good to some extent. There is the difference of 18% between the
price earnings ratio of industry and Sab Miller. By taking into consideration this aspect, it can be
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said that shares of Sab miller are undervalued according to the industry average. There are
several reasons due to the price earnings ratio of the firm is below the average industry level.
Price earnings ratio of the business unit is lower when it is suffered from the problem of high
debt. Thus, it might be one of the reason behind the lower P/E ratio. Moreover, when debt aspect
of the business unit is high then it is unable to offer high level of dividend to their shareholders.
Moreover, in debt corporation has obligation to make payment of interest to the debt holders.
This aspect closely influence the earning or profitability of the company and thereby affects their
dividend decision.
In addition to this, Sab Miller operates in the food and beverage industry in which taste
and preference of the customers are change with the very high pace. In this, company prefers to
take keep more money with itself rather than offering high dividend to the shareholders.
Moreover, in order to enhance the profitability business unit requires to comply with the latest
technological aspects. This activity requires huge investment, so business enterprise prefers to
maintain the lower P/E ratio to fulfil their future needs or requirements. Further, companies who
are facing threat in relation to the future survival also maintains lower P/E ratio (Constantinides
and Ghosh, 2011). Fierce competition takes place in the food and beverages sector. In order to
cope up with the situation of Competition Company maintains high level of liquidity within the
business unit rather than offering high dividend to the investors. Further, not only the
performance but also the rules and regulations closely affect the price earnings ratio of the
business enterprise.
B). Dividend growth model
All the details are here under with is related to the accounting year 2015-2016
Dividend pay-out ratio of Sab Miller = 44.3%
K = 2.11%
G = 2%
Price of the security = .44 / (.21-.02)
= 400
According to the Gordon model of dividend growth it has been analysed that the share
price of Sab Miller is 440. It is based on the assumption that company pays dividend to their
shareholders on a constant rate. Beside this, investors who make use of Gordon model also
assumes that Sam Miller has indefinite time period. During the financial period of 2015-16
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closing share price of Sam miller was 61.33 at 31st March, 2016. On the basis of this aspect it
can be stared that share price of the business enterprise is highly overvalued by the investors.
Moreover, constant dividend rate is one of the main factors which affects the relevancy of this
method. Financial crisis and changing market conditions have high level of impact on the
dividend policy of the fir. On the basis ODF this aspect, it can be stated that share prices of Sam
Miller are highly overpriced which negatively affects the decision making aspect of the
shareholders. Moreover, if there is the possibility in relation to the hike in the share prices of firm
then individual prefers to purchase the more securities. There are several reasons which may lead
overvaluation of the shares to the large extent. Most of the time, when share price of the firm is
continuously grow then existing and potential investors invest more money with the aim to get
high return. This increasing buying tendency of the people may cause of overvaluation of the
shares. Further, if analysts fail to assess the value of Beta in the appropriate manner then, it may
also result into the overvaluation of shares to the significant level. Moreover, beta is the measure
which clearly represents the extent to which the security is risky in terms of dividend (Ma and
Wohar, 2014). Usually, investors calculate beta to assess the risk and return relationship between
the shares of the firm. Risk averse investors give more priority to the Beta factor while investing
money in the shares of firm. In this, inappropriate beta may also lead to overvaluation of shares.
Thus, business analyst need to take caution while making analysis of beta factor.
C) Forecast free cash flows
Cash flow forecast is an estimation of the amount of money that individual expect to flow
in and out of his/her business by considering all the projected income and expenses. On the basis
of CAPM model in evaluating the free cash flow for Sab Miller it has been identified that stock
price is undervalued by the company. However, looking at the current share price of at London
stock exchange is 61.39 per share (Sab Miller Plc, 2016). While using the discounted cash flow
method and analyzing the share price through intrinsic value it has been assessed that the worth
of each share of Sab Miller Ltd is of 109. Henceforth it can be said that company has
undervalued its stock price.
The cost of equity (Ke) = 2.11%
Risk free rate = 2.1%
Beta = 0.04
Growth rate (Rm) = 2%
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On the basis of above values of different elements of discounted cash flow method the
total enterprise value is 108456. Furthermore, at the discount rate of 2.18% the present cash
flows of Sab Miller Ltd is relatively showing positive outcomes. Furthermore, with the WACC
of 2.50% and the long term growth in revenues of 5%, terminal value has been computed i.e.
87% (SABMiller PLC ADR SBMRY Financial Valuation. 2016). Whereas table of intrinsic value
indicates that, with equity value of 175940 and diluted shares of 1621, Sab Miller intrinsic value
is 109 per share and current share price is 61.39 thus, it can be said that value of stock is
undervalued (SABMiller plc Stock Price, 2016).
In general, undervalued stock can be defined as a stock that is selling at a price
significantly below what it is assumed to be its intrinsic value. Furthermore, there are several
reasons behind which top level management of Sab Miller would have valued their stock under
the actual worth which are as follows:
 Bubbles and market crashes: Operating in such a competitive market it is important for
the senior authority to maintain their position in the market. However, market momentum
and crowd mentality run to extremes, market faces the situations of bubble crashes results
(LAN, 2014). Considering the current market condition, top level management of Sab
Miller Ltd has been focusing on retaining their position in the market and due to which
valued their stock relatively low than its actual worth.
 One part of the company is underperforming: Looking at the current portfolio of Sab
Miller ltd it can be said that management have to employ smart and effective strategies so
that sales and demand of each products can be maintained. But looking at the present
share price and comparing it to intrinsic value on the basis of discounted cash flow
method it can be said that the reason behind undervaluation of share price could be the
underperformance of one of its portfolio. However, operating in such a competitive
market, products are facing high rate of substitution which indeed affecting their sales
and demand in the target market. Thus, to maintain the position senior authority might
undervalued its stock price.
 The stock is unnoticed: The main reason behind selling the shares at less than their actual
worth under rating of a company (Basu, 2015). However, an organisation which is not
popular or not highly followed in the stock market can value their share low to its actual
value so that they can attract large number of investors or buyers of the stock.
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 Missed expectations: This can be another major reason behind undervaluation of Sab
Miller Ltd. It is because of the fact that, dealing in offering different types of beverages to
varied markets but at times due to high level of competition, management is unable to
grab the better opportunities that indeed force them to under value their stock price in
listed market. In such situation social media technology companies are more vulnerable
to sharp price declines because market tend to have a high expectations for their future
earnings growth (SABMiller PLC ADR SBMRY Financial Valuation. 2016).
3) Advantages and Disadvantages of methods selected
There are various methods of valuating a company in effective and efficient manner.
However, in the present study two of its significant methods has been selected which discounted
cash flow and Gordon Dividend growth model. In general, discounted cash flow valuation
focuses on estimating intrinsic value of an asset/business based upon its fundamentals. However,
intrinsic value of a business is the present value of the cash that company is expected to pay its
shareholder. The discounted cash flow valuation method is the basic foundation upon which all
the other valuation methodologies are built (Griffin, Lont and Sun, 2010).
It is important for the analyst to understand the fundamentals of this model in order to
perform valuation relatively correct. The main advantage of this method is that if anyone
understand this approach can make use of any other valuation approach in effective and efficient
manner. In addition to this, discounted cash flow is based on expected future cash flow of the
company and its associated discount rate which is measure of the risk attached to the business. In
order to value assets or any business discounted cash flow is considered as the easiest approach
(Cui and et.al, 2012). Considering the increasing significance of this model in business valuation
following are the certain advantages and disadvantages.
Discounted Cash flow method:
Advantages:
One of the biggest pros of this DCF model is that it undertakes fundamental drivers of a
business i.e. cost of equity, weighted average cost of capital, growth rate, re-investment rate etc.
mainly it is because of the fact that these models are the closet that could help in estimating
intrinsic value of assets or business.
Furthermore, unlike other valuations, discounted cash flow relies on free cash flows to a
larger extent. The main purpose for the use of cash flows is that it is reliable measure that
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eliminate the subjective accounting policies. Therefore, irrespective of whether a cash outlay is
categorized as an operating expense in P&L or capitalized into an assets on balance sheet, future
cash flow is a true measure of the money left over for investors (Décamps and et.al, 2011).
Another major benefit of using discounted cash flow model is that it allows investors to
incorporate key changes in the business strategy in the valuation model. While on the other hand,
method like relative valuation are fairly easier to calculate as their reliability become
questionable when the entire sector or market is over-valued or under-valued. In this regard, this
approach constantly focuses on undertaking the reliable and valuable components regarding
computing intrinsic value.
Lastly, one of the importance of using DCF is that this model assist in checking the
sanity. However, instead of estimating the fair intrinsic value the current share price of the can be
indulged into this model and on the basis of which this model will assist in illustrating how much
company’s stock is over-valued or undervalued (Chen, Chen and Wei, 2011).
Disadvantage:
Every model possess its own advantages and disadvantages thus, after pointing out varied
pros it is important for the analysts to understand certain drawbacks of the method also that its
use can be done in the best possible manner. Discounted cash flow is extremely sensitive to
assumptions as it is related to perpetual growth rate and discount rate. With very little change
here and there may widely fluctuate the intrinsic value and that may affect the reliability of the
valuation process. Furthermore, one of the major drawback of this method is that it only works
best when there is high confidence about the future cash flows (Shuiying and Kui, 2010). But if
company’s operations are unable to predict or possess lack of visibility it becomes difficult to
predict sales, operating expenses and capital investment with certainty. Along with this,
forecasting cash flows becomes difficult for future. Discounted cash flow model is susceptible to
error if not properly accounted with the desired inputs. Apart from this, one of the major
criticism of DCF models is that the terminal value comprises far too much of the total value.
However, with the minor variation in assumptions on terminal year may lead to have significant
impact on the final valuation. Furthermore, cited valuation mode is an ever changing target that
demand constant vigilance and modification. In case if expectations of firm vary the fair value
will change accordingly. It is not reliable for the short term investing as it mainly focuses on long
term value creation.
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Gordon Dividend Growth model:
The Gordon growth model is also defined as dividend discount model which assist in
measuring the value of a publically traded stock by summing up values of the expected future
dividends payments, discounted back to the present value (Ma and Wohar, 2014). Furthermore,
this model assist in valuing the stock on the basis net present value of its future expected
dividends.
Advantages:
One of the main advantage of Gordon growth model is that is the most commonly
employed technique to compute the share price and therefore easy to understand. Furthermore, it
value a company without considering the market conditions which is indeed easier to make
comparison between the companies of different sizes and in different industries.
In addition to this, this dividend growth model is extremely east to explain and
understand. It is because of the fact that it does not take too much intelligence to assume that the
dividends are expected to go and increase at constant rate (Gordon Growth Model: Pros and
Cons, 2015). However, the simplicity of this model is what makes this dividend growth model so
popular and widely understood. There are several complex models that have been proposed
against this approach but still analyst uses this model to make appropriate valuations on the
stock.
Gordon discounted model considers reverse logic in which it does not find correct
intrinsic value rather than focuses on conducting reverse analysis in which growth rate is being
implied and current market price is calculated. Apart from this, another pros of this model is that
is applicable to most of the companies. Especially to those companies which have relatively
mature and stable business position (Constantinides and Ghosh, 2011). This model is also widely
used to find out if the indices are valued correctly or whether the market is amidst a bubble.
Disadvantages:
The main drawback of this method is that it requires precision to carry out the valuation.
However, it is because of the fact that, it is highly sensitive to changes in inputs. For instance, if
there is change in required rate of return or constant growth rate than there will be huge different
in terminal value and leads to major alteration in stock value. Therefore, the accuracy of model
highly depends upon the accuracy of forecasted inputs (Garrett and Priestley, 2012). In other
words, even if slight change in assumptions may affect the result in huge manner.
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In addition to this, Gordon growth model assumes a constant growth rate which indeed
makes the growth rate of company dividends look linear. However, in reality it has been proven
that dividend growth is rarely linear. Furthermore, there is no future changes considered in this
model which indeed makes this model as less preferred model of dividend growth (Cuaresma,
Lutz and Sanderson, 2014). On the basis of rapid changes in dividend pattern, this model is less
favorable for market and companies.
CONCLUSION
By summing up this report, it can be articulated that P/E ratio, dividend growth model
and free cash flow technique assists analyst in evaluating the return and performance of the firm.
It can be seen in the report that share prices of Sab miller is undervalued on the basis of free cash
flow technique. Whereas according to the Gordon growth model prices of the securities are
highly overvalued. This difference occurs between the share prices due to varied assumptions of
the technique. On the basis of the above analysis, it can be concluded free cash flow analysis is
the best method which offers highly realistic solution or framework to the investors. Moreover,
the aspects or assumptions of the Gordon model have less importance in the dynamic business
arena.
Further, it can be inferred that Sab Miller has undervalued the price of its firm. It can be
revealed from the report that P/E ratio of the food and beverage industry is higher as compared to
Sab miller. Thus, business unit needs to frame competent strategic framework which helps them
in improving their financial health and performance. This in turn, helps business enterprise in
build or sustain distinct image in the mind of stakeholders or investors.
10

REFERENCES
Journals and Books
Cai, F., 2010. Demographic transition, demographic dividend, and Lewis turning point in
China. China Economic Journal. 3(2). pp.107-119.
Chen, K.C., Chen, Z. and Wei, K.J., 2011. Agency costs of free cash flow and the effect of
shareholder rights on the implied cost of equity capital.Journal of Financial and
Quantitative Analysis. 46(01). pp.171-207.
Constantinides, G.M. and Ghosh, A., 2011. Asset pricing tests with long-run risks in
consumption growth. Review of Asset Pricing Studies. 1(1). pp.96-136.
Cuaresma, J.C., Lutz, W. and Sanderson, W., 2014. Is the demographic dividend an education
dividend?. Demography. 51(1). pp.299.
Cui, X. and et.al., 2012. Better than Dynamic Mean‐Variance: Time Inconsistency and Free Cash
Flow Stream. Mathematical Finance. 22(2). pp.346-378.
Décamps, J.P. and et.al., 2011. Free cash flow, issuance costs, and stock prices. The Journal of
Finance. 66(5). pp.1501-1544.
Engsted, T. and Pedersen, T.Q., 2010. The dividend–price ratio does predict dividend growth:
international evidence. Journal of Empirical Finance. 17(4). pp.585-605.
Garrett, I. and Priestley, R., 2012. Dividend growth, cash flow, and discount rate news. Journal
of Financial and Quantitative Analysis. 47(05). pp.1003-1028.
Ghosh, A. and Constantinides, G.M., 2010. The predictability of returns with regime shifts in
consumption and dividend growth (No. w16183). National Bureau of Economic
Research.
Golez, B., 2014. Expected returns and dividend growth rates implied by derivative
markets. Review of Financial Studies. 27(3). pp.790-822.
Griffin, P.A., Lont, D.H. and Sun, Y., 2010. Agency problems and audit fees: further tests of the
free cash flow hypothesis. Accounting & Finance. 50(2). pp.321-350.
Hein, E., 2012. Finance-dominated capitalism, re-distribution, household debt and financial
fragility in a Kaleckian distribution and growth model. PSL Quarterly Review. 65(260).
pp.11-51.
Kung, H. and Schmid, L., 2015. Innovation, growth, and asset prices. The Journal of
Finance. 70(3). pp.1001-1037.
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Ma, J. and Wohar, M.E., 2014. Expected returns and expected dividend growth: Time to rethink
an established empirical literature. Applied Economics. 46(21). pp.2462-2476.
Shuiying, Z. and Kui, L., 2010. The Population Dividend, the Spatial Spill-over and the
Provincial Economic Growth [J]. Management World. 4. pp.14-23.
Online
Basu, C., 2015. Reasons Stocks Become Undervalued. [Online]. Available through:
<http://finance.zacks.com/reasons-stocks-become-undervalued-1080.html>. [Accessed
on 13th May 2016].
Gordon Growth Model: Pros and Cons, 2015. [Online]. Available through:
<http://www.managementstudyguide.com/pros-and-cons-of-gordon-growth-model.htm>.
[Accessed on 13th May 2016].
Lan, J., 2014. Calculating Intrinsic Value with the Dividend Growth Model. [Online]. Available
through: <http://www.aaii.com/journal/article/calculating-intrinsic-value-with-the-
dividend-growth-model.touch>. [Accessed on 13th May 2016].
Sab Miller Plc, 2016. [Online]. Available through: <http://www.sabmiller.com/about-us>.
[Accessed on 13th May 2016].
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<http://financials.morningstar.com/ratios/r.html?
t=SBMRY&region=USA&culture=en_US>. [Accessed on 13th May 2016].
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2016].
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APPENDIX
Discounted Cash flow method
CAPM Assumptions
K(e) 2.11%
RFR 2.1%
Beta 0.04
R(m) 2%
Enterprise Value (EV)
Current Market Price 61
Diluted Shares 1,621
Market Capitalization 98,881
Long Term Liabilities 10,540
Less: Cash & Cash Equivalents 965
Enterprise Value (in lacks) 108,456
PV at 4% WACC
Present year 1 2 3 4 5
Discounting factor 0.978665 0.95778538 0.937351 0.91735283 0.8977812
PV of cash flows 4348.974 4256.72788 4166.615 4078.58204 3992.41059
Terminal Value
Sum of PV of FCF for explicit forecast 20,843
WACC 2.50%
Long term growth in Revenues 5%
Present Value of terminal value 143,591
Terminal Value as % of Total Value 87%
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Equity Value
Enterprise Value 164,435
- Debt 10,540
+ Cash 965
Net Debt 11,505
Equity Value 175,940
Intrinsic Value
Equity
Value
175,94
0
Diluted
Shares
1,62
1
Intrinsic
Value 109
Gordon Dividend Growth Model
Particulars Figures
Dividend pay-out ratio of Sab Miller 44.30%
K (Required rate of return) 2.11%
G (Growth rate) 2.00%
Price of the security .44 / (.21-.02)
= 400
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