Valuation Report of Woolworths Limited: Corporate Finance Analysis

This report provides a valuation analysis of Woolworths Limited, an ASX-listed company. It begins with an executive summary and a company profile. The report calculates the beta of Woolworths using regression analysis and compares it with the beta from financial websites, discussing the reasons for any discrepancies. It then employs the Capital Asset Pricing Model (CAPM) to determine an appropriate discount rate. The report utilizes the constant dividend growth model (Gordon Growth Model) to calculate Woolworths' current stock price, considering a specific growth rate for an initial period and a long-term inflation rate. Finally, the report outlines the limitations of the constant dividend growth model. The report includes tables and references to support its analysis.

Running Head: Corporate Finance
Corporate Finance

Corporate Finance
Contents
Executive Summary............................................................................................................................2
Profile of the Company.......................................................................................................................2
Beta of Woolworths Limited...............................................................................................................3
Computation of Discount rate of Woolworth Limited using Capital Asset Pricing Model..........5
Calculation of Woolworth Limited’s Current Stock Price with Constant Dividend Growth
Model....................................................................................................................................................6
Limitations of the Constant Dividend Growth Model/Gordon Growth Model..............................8
References..........................................................................................................................................9
Appendix.............................................................................................................................................10
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Corporate Finance
Executive Summary
This report deals with the valuation of Woolworth Limited. Here, market risk of Woolworth
has been calculated by running the regression analysis on the returns of market and
Woolworth Limited daily return. After computing the beta of Woolworth Limited, it has been
compared with the beta calculated by the financial website. In this case, the beta is taken
from yahoofinance.com. Then the possible reasons of change in the beta values estimated
by us employing CAPM model and as per the yahoo finance are stated and explained. Also,
a constant dividend discount model is explained and is used for the calculation of current
stock price of Woolworth Limited. At the end, the drawbacks or limitations of using this model
is explained in detail.
Profile of the Company
Woolworth started its operations in the year 1924 in Woolworths Stupendous Bargain
Basement. The business was founded by Percy Christmas. At present it is headquartered in
Bella Vista, New South Wales. Presently it has generated revenue of $5.76K per employee.
At present, the competitor lists of Woolworth include Metro, Coles, Carrefour, Distributors,
Safeway, ALDI, Giant Eagle, Supermercato24 etc. Where the revenue of Woolworth Limited
is $1.28 Billion, the revenues of its competitors are; $2B (Coles), $99.8B (ALDI), $2B
(Distributors), $36.3B (Safeway), $8.9B (Giant Eagle), $4B (Carrefour), $80M (Metro) and
$5M (Supermercato24).
In 1929, the first store was opened in New Zealand. Then by 1930 there were six stores in
total which started in New South Wales, Queensland and Western Australia. Earlier the
company was operating with the name Woolworths Limited but then in 2017 it has changed
to Woolworths Group Limited (Woolworths Group Limited, 2019). The group deals in the BIG
W, Australian Food, New Zealand Food, and also in other segments. Australian food
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Corporate Finance
Segment is involved in the process of procuring and reselling the food products to customers
living in Australia. The Australian Food looks over the operation of 1008 Woolworth’s
supermarkets and metro stores. It also manages the operation of countdown supermarkets
and is even involved in the wholesale operations. The other segment of Woolworth is
endeavour drinks which is engaged in the obtaining and reselling of liquor products to the
Australian customers. There are 1545 liquor stores which are functioning under Dan Murphy
and BWS Brands, summer gate stores, Langtons, cellarmasters, and winemarket.com.au.
The BIG W segment is into procuring and reselling discount general merchandise products
in Australia. Presently, there are 183 BIG W stores. In Australia, Woolworth offers leisure
and hospitality services under Hotel segment which includes food drinks, accommodation,
gaming, entertainment etc. Hotel segment manages 323 hotels which include bars, gaming,
dining etc. The Woolworth is involved in the property leasing business too. Woolworth and
Caltex share a strategic alliance across wholesale food, loyalty, fuel supply, redemption etc.
(Yahoo Finance, 2019).
Beta of Woolworths Limited
Beta-
There are two types of risks, one is systematic risk and the other is unsystematic risk.
Systematic risk refers to those risks which is not specific to any industry or firm. It has an
impact on all the sectors. However, systematic risks can be controlled but cannot be
diversified. For example, a sudden increase by the Government in the tax burden by 1% on
stock market transactions. This is a risk which will affect all the sectors and the industries.
So, systematic risk are the common causes that have an impact on almost all the companies
like, inflation rate, political instability, interest rates, exchange rates, war etc. These risks
cannot be diversified through investing in different sectors or other strategies however; these
risks are diversified through derivatives. Unsystematic risks are the firm specific or industry
specific risk. These are the risk which occurs suddenly because of the disturbance in normal
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operations of the business. These risks could arise from strike by the company’s employees,
which could drop the share price of that stock and can have an impact on the industry in
which it is operating. These risks can be diversified by investing in the stocks belonging from
different industries. It is also called as specific risk, residual risk or diversifiable risk.
Beta refers to systematic risk associated with the stock of the company as compared with
the risk of market as a whole. It helps the investors to know about the level of risk they are
wishing to take to achieve a particular return on the said risk. The value of beta is not same
and varies across different sectors and industries. There exist two types of investors risk
averse investors and risk tolerant investors. Those investors who want a fixed or stable
return like retirees, they go for low beta stock. Low beta stocks are the ones that give a lower
rate of return to the investors for taking less amount of risk. There are other types of
investors who are focussed towards long- term growth and therefore they prefer investing in
stocks with high beta value. Such investors are known as risk-tolerant investors. High beta
value stocks are the ones that provide a higher return for taking high amount of risk. Using
the regression analysis the beta of a stock is calculated considering stock returns and
market returns. The beta is usually interpreted in the way that; if beta of a stock is equal to
one then it has an average risk (b=1; average risk associated with stock), if beta of stock is
greater than one then the stock has a higher risk than that of average risk (b>1; stock is
riskier than the average risk) and if beta of a stock is less than one then the stock has a
lower risk than the average risk (b<1; stock is less riskier than the average risk). Apart from
this, there are stocks with zero and negative beta. A stock with the beta amount of zero
means there are no risk associated with the stock. The return which an investor gets from
the stock with negative beta value is lower than the risk free rate of return. There are many
reasons behind the negative beta value like extended lawsuit or any other strange
happenings. Therefore, beta helps the investors to know about the volatility of the stock
compared with volatility of the market as a whole (Morning Star, 2016).
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Corporate Finance
Difference in the Woolworth’s calculated Beta value and Beta Value Given on Finance
Websites-
According to the finance website (Yahoo finance), the beta of the company is 0.61 (Table-1).
However, the value of beta calculated through regression model (Table 2) is coming to be
0.73 approx. Both the beta values are different because of the following reasons:
a. There might be a difference in the time interval considered by the finance website and the
time considered by us. For example- Possibilities are there that Yahoo finance had
considered daily return for calculating the beta value but here we considered monthly return
for the same beta calculation through regression analysis.
b. The period considered for the estimation by Yahoo finance and the estimation period
considered by us can also be held responsible for the difference in the beta values. It is
believed that, most of the time longer estimation period is biased and such values hardly
holds any significance for the readers looking at the finance domain (Daves, Ehrhardt and
Kunkel, 2000).
c. Also the possibility is there that yahoo finance has calculated discrete returns of market
and discrete returns of Woolworth and then had run the regression analysis on those
discrete returns. However, we considered continuous returns of market and Woolworth after
which the regression was run on those returns. This could also be the reason behind the
difference in the beta value.
Table 1: Beta of Woolworth Limited
Calculated Beta of Woolworth
Limited
0.725314682
0.61
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Corporate Finance
Beta of Woolworth given on
Yahoo Finance
Table 2: Beta of Woolworth Limited calculated through Regression
SUMMARY
OUTPUT
Regression
Statistics
Multiple R 0.48274
R Square 0.23304
Adjusted R
Square 0.2098
Standard
Error 0.03621
Observations 35
ANOVA
df SS MS F
Significance
F
Regression 1 0.013 0.01 10 0.003312412
Residual 33 0.043 0
Total 34 0.056
Coefficient
s
Standard
Error
t
Stat
P-
value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
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Corporate Finance
Intercept 0.00584 0.006 0.95 0.4
-
0.006712139 0.018399988
-
0.006712139 0.018399988
X Variable 1
(beta) 0.72531 0.229 3.17 0 0.25929773 1.191331634 0.25929773 1.191331634
Computation of Discount rate of Woolworth Limited using Capital Asset Pricing Model
Capital Asset Pricing Model (CAPM)-
CAPM helps in determining the bond established between expected return of the stock and
risk of investment in the stock. It is abbreviated as CAPM Model and its equation is given in
Table 3.There are two assumptions of Capital Asset Pricing Model which are:
1. Investors are holding only the diversified portfolio and wants the return only on their
systematic risk since the unsystematic risk has already being diversified by them
2. In order to make the returns received on different securities comparable a
standardised holding period is assumed
3. The borrowing and lending could be carried out a risk free rate of return
4. Valuations of every security are computed appropriately and their returns are capable
of being plotted on security market line (SML).
Still, the CAPM denotes the idealised world and not the real world. In reality, it is more
likely that a linear relationship actually exist between the required rate of return and the
systematic risk.
Table 3: CAPM Equation
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Corporate Finance
CAPITAL ASSET PRICING MODEL (Woolworths LTD.)
Formula for CAPM Model Ke = Rf + beta x (Rm – Rf)
where, Ke=Cost of Equity
Rf= Risk free rate of return
Rm= Market return
Determining Appropriate Discount Rate of Woolworth Limited Using Capital Asset
Pricing Model-
To estimate discount rate of Woolworth Limited, we employed CAPM model (Table 4).
Table 4: Woolworth’s Discount Rate
Rf (Risk Free Rate of Return) 2.54
Rm (Market Risk Premium) 9.91
beta 0.7253
Ke (Discount
rate/ Cost of
equity) 7.88 %
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Corporate Finance
The calculated annual return of the Woolworth stock is 10% and the cost of equity is 7.88%.
This shows that the stock of Woolworth is under-priced. From the investment point of view,
the stocks of Woolworth should be considered in spite of being under-priced because in
such cases the probability of the stocks’ worth going up in future is more.
Calculation of Woolworth Limited’s Current Stock Price with Constant Dividend
Growth Model
Constant Dividend Growth Model/ Gordon Growth Model –
The constant Dividend Growth Model is popularly known as Gordon growth model. This
model is a method used for stock valuation and it computes the intrinsic value of company’s
stock. In this way, it does not consider the current market conditions. There are few
assumptions attached with this model which includes:
1. The business model is stable and therefore, there are no changes taking place in the
operations of the organisation
2. Company is rising at a constant rate
3. Company’s financial leverage is stable
4. Company’s free cash flows are distributed as dividends
Mostly, the model is applicable to those firms which are steady in terms of dividends to be
grown at a steady growth rate forever. Gordon growth model employs the following formula
for computing intrinsic value of stock:
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Corporate Finance
Current Price of Stock= (Dividend to be paid in next period)/(Cost of equity- Dividend Growth
Rate)
Woolworth’s Current Stock Price-
As per constant dividend growth model, after considering 8% per annum growth rate for first
5 years and 2.50% per annum future long term inflation rate, the current price of Woolworth
Limited stock is $45.55 (Table 5). To arrive at this value, we calculated dividends for first five
years at 8% growth rate (given). From 6th year, this growth rate is supposed to become
constant till infinity years at long term inflation rate i.e., 2.50%. So, here the terminal value is
calculated at D5 using Gordon Growth Model. We considered D5 for the terminal value
calculation because from its next year the growth is supposed to become constant at 2.50%
inflation rate. Then, all the dividend values are discounted at 7.88% return calculated
through CAPM to arrive at present value of dividends for each year. Apart from this, we even
discounted the calculated terminal value at the same rate of return calculated through CAPM
model. Lastly, we took the summation of all the calculated present values of dividends plus
terminal value’s terminal value to arrive at current stock price of Woolworth which comes out
to be $45.55.
Table 5: Woolworth Limited’s Current Stock Price
1.
Dividend
(Woolworths Group Limited Annual
Report, 2018)
1.03
g(1) 8%
for 1st
5
years
g(2) = long term inflation estimate 2.50%
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Corporate Finance
(Reserve Bank Of Australia, 2019)
Required return (CAPM) 7.88%
2. Present Year 1 2 3 4 5 6
D0 D1 D2 D3 D4 D5 D6
1.03 1.112 1.201 1.3 1.4 1.513 1.55
3.
T5=D6/(r-
g(2))
52.23
4. Gordon growth model
Terminal value (T)= D1/(r-g(2))
V(0) = Value of shares at present
5. Present Value of dividends 1.055 1.08 1.11 1.13 1.16
Present value of terminal value 40.02
6.
V(0)= D1/(1+r) +
D2/(1+r)^2………….(D5+T5)/(1+r)^5 45.55
Limitations of the Constant Dividend Growth Model/Gordon Growth Model
Constant dividend growth model works with the assumption that the dividends of the
company would continue to grow at a constant rate for an infinity period of time. In reality, it
is not possible for the company to grow the dividends at a rate which is constant. There are
factors like market fluctuations, business cycle related fluctuations and uncertain problems
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related to finance or increased investment opportunities, all these could either affect the
company’s dividend to grow or fall.
This model works best to value the stock price of only those companies which have low to
moderate rate of growth. It is not appropriate to use this model for those companies who are
in their early stages of growth and are experiencing a high growth rate.
This model cannot be used in those cases where the companies are not paying dividend and
it is not applicable for those companies too where earnings are not linked with the dividend.
One of the limitation which we cannot ignore is this model does not consider the non-
financial factors affecting the dividend for stock price estimation like brand equity, patents,
goodwill, diversification etc. (Bizfluent, 2018). The model is hypersensitive to the inputs for
the growth rate of dividend (g). So, if the calculation of dividend growth rate (g) is calculated
incorrectly it can have a very big impact on the current price of the stock.
This model also takes on that the growth rate of dividend would always be lower or near to
the cost of equity. In real, it is not possible because the growth rates are not of a constant
nature and can change over a period of time. For example: in case of Woolworth limited we
saw that the amount of dividend was supposed to grow at 2.50% inflation rate for a long time
period. This value is below the cost of equity which stands at 7.88%. In case, this growth
rate was higher than 7.88% then the value of shares would have become negative.
In short, Gordon Growth model works best for the organizations which have a growth rate
closer or lower than nominal growth rate prevailing in economy. This model is a good fit for
those companies which have good dividend pay-out policies that they have plan to proceed
with in the future period of time as well. Also, this model is not a good choice for those firms
who prefer to distribute less in terms of dividend in spite of increase in the income figure and
accumulates more cash.
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References
Bizfluent. (2018). What is the Gordon Growth Model?. [Online]. Available 03 July, 2019
https://bizfluent.com/13709405/what-is-the-gordon-growth-model.
Daves, P.R., Ehrhardt, M.C. And Kunkel, R. A. (2000). Estimating Systematic Risk: The
Choice of Return Interval and Estimation Period. Journal of Financial and Strategic
Decisions.[Online]13(1), p. 7-13. Available 03 July, 2019
http://www.studyfinance.com/jfsd/pdffiles/v13n1/daves.pdf.
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Morning Star. (2016). Can beta be negative?. [Online]. Available 03 July, 2019
https://www.morningstar.in/posts/36419/can-beta-be-negative.aspx.
Reserve Bank of Australia. (2019). Inflation Target. [Online]. Available 03 July, 2019
https://www.rba.gov.au/inflation/inflation-target.html.
Woolworths Group Limited.(2018). Annual Report. [Online]. Available 03 July, 2019
https://www.woolworthsgroup.com.au/icms_docs/195396_annual-report-2018.pdf.
Woolworths Group Limited. (2019). The Woolworths Story. [Online]. Available 03 July, 2019
https://www.woolworthsgroup.com.au/page/about-us/The_Woolworths_Story/
How_We_Were_Founded/#timeline-1924.
Yahoo Finance. (2019). Woolworths Group Limited (WOW.AX). [Online]. Available 03 July,
2019 https://www.woolworthsgroup.com.au/page/about-us/The_Woolworths_Story/
How_We_Were_Founded/#timeline-1924.
Appendix
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