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CEYSU ERTURKFEIFEI XUSANDRA SERRASYED MOHAMMAD ASHIQULLAHJIANI LIUYI-SHU TSAIAKIHISA NAKAZAWA
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COMPANY OVERVIEW
American Eagle Outfitters is one of leading apparel retailers in US
Targeting age: 15-25Sell to US (1977), Canada (2001) and 41 foreign countries
In 2006: introduced 3 new brands–Martin + OSA– Aerie– 77kids
As of Jan 2011 it operated 1086 stores– 929 American Eagle Outfitters stores– 148 Aerie stand-alone stores– 9 77kids stores
• 1977: AEO is launched
• 1991: AEO grows to 153 stores
• 1992: The company focuses on private-label merchandise
• 1993: AEO is incorporated
• 1994: AEO goes public
• 2001: AEO generates record net income of $105.5 million
• 2010: AEO goes global
KEY DATES
AEO YEARLY STOCK PRICE
Date Open High Low Close Volume Change (%)
11/25/2011 $12.87 $13.15 $12.76 $12.89 13222 -11.89%
12/31/2010 $14.60 $14.75 $14.49 $14.63 41750 -13.84%
12/31/2009 $16.96 $17.21 $16.88 $16.98 24771 81.41%
12/31/2008 $9.11 $9.48 $8.90 $9.36 55991 -54.94%
12/31/2007 $20.65 $20.99 $20.35 $20.77 31469 0%
INDUSTRY COMPETITORS
Retail industry: • Has the second growth rate among all the U.S
industries
• Two-thirds of the U.S. GDP come from retail consumption
• Getting hit hard because of recession
• Experiencing downward sales in the first part of 2009
• Upward trend in 2010 and 2011
COMPETITORS
For the past Five Years Jeans Price
(Avg unit Retail Price)Gross
MarginOperating
Margin
Abercrombie & Fitch(ANF) $80-$90 $35 60.09% 19%
American eagle(AEO) $50-$60 $20 41.66% 16%
Aeropostale (ARO) $30-$50 Cheapest 36.66% 10-12%
FORCASTING PERFORMANCE
Difficult task to undertake. Competition and the weather can change projected sales.
Growth is looked at from sales from the past several years for expectations for the current year.
Growth is estimated based on revenue for daily, weekly, quarterly, and yearly sales profits.
FORCASTING PERFORMANCEYear Revenue Percent Change EBITDA
2008
Feb $905,713 $870,227 May $640,302 -29.30% $547,899 Aug $688,815 7.58% $624,806 Nov $754,036 9.47% $708,728 Total $2,988,866
2009
Jan $995,725 35.05% $936,065 May $611,986 -38.54% $550,507 Aug $646,798 5.69% $584,366 Oct $736,011 13.79% $683,823
Total $2,990,520
2010
Jan $916,088 24.47% $869,049 May $648,462 -29.21% $698,750July $651,502 0.47% $558,215Oct $751,507 15.35% $610,373
Total $2,967,559
2011
Jan $920,463 22.48% $872,404April $609,562 -33.78% $524,875July $675,703 10.85% $584,915Total $2,205,728
Arithmetic Mean 1.02%
RISK CHARACTERISTICS
Risk traditionally is portrayed to be negative.
Based on Historical ReturnDiversified RiskCAPM Model
Based on Historical Return
YearPrice end
(E)Price Beginning
(B)End - Beginning
(E-B)Dividend (D) D+(E-B)
Return on AEO
2011 13.97 14.09 -0.12 0.11 -0.01 -0.00070972
2010 14.26 14.58 -0.32 0.2325 -0.0875 -0.00600137
2009 15.58 8.04 7.54 0.1 7.64 0.95024876
2008 8.35 19.9 -11.55 0.1 -11.45 -0.57537688
2007 17.98 27.61 -9.63 0.09375 -9.53625 -0.34539116
2006 26.61 15.18 11.43 0.062665 11.492665 0.75709256
Average 0.12997703
YEAR Return on AEO [R (AEO) - Average R (AEO)]2
2011 -0.00070972 0.017079027
2010 -0.00600137 0.018490125
2009 0.95024876 0.672845708
2008 -0.57537688 0.497524142
2007 -0.34539116 0.225974917
2006 0.75709256 0.393273885
SUM 1.825187804
. .
Variance 0.36503756
Standard Deviation 0.60418338 60%
Diversified Risk
• Firm-specific risk can be reduced, if not eliminated, by increasing the number of investments in your portfolio.
• Each investment is a much smaller percentage of the portfolio, muting the effect (positive or negative) on the overall portfolio.
• Firm-specific actions can be either positive or negative. In a large portfolio, it is argued, these effects will average out to zero.
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RISK CHARACTERISTICS
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Capital Asset Pricing Model (CAPM)The CAPM Pricing model assumes that there are no transaction costs, all assets are traded, and investments are infinitely divisible.
Variance of actual returns around an expected return as a measure of risk is used
Measures the non-diversifiable risk with beta, which is standardized around one and translates beta into expected return:
BIOTTOM-UP
Unlevered Beta = Average Beta/1+(1-Average Tax Rate)*Average Market
Debt Equity Ratio
Bottom-up Beta = Unleverd Beta [1 - AEO Tax Rate* AEO Market Debt
Equity Ratio]
Step 1
Step 2
Damodaran’s Website
Average Beta 1.35
Average Tax Rate 20.86%
Average Market Debt Equity Ratio 15.8%
10Q
AEO Tax Rate 38.35%
Long Term Debt $15,938,000
Current Portion of Long Term Debt $137,023,000
Yahoo Finance Market Value of Equity $2,610,000,000
Total Debt Unleverd Beta AEO's Debt Equity Ratio
$152,961,000 1.20 5.86%
Bottom Up Beta1.24
βETA
WHY BOTTOM-UP BETA?
• Eliminate Standard Error
• Eliminate Problem of a changing Product Mix
• Compute from the company’s current Financial Statement
• Computed from the company's current financial leverage
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ESTIMATE COST OF CAPITAL USING BOTTOM-UP BETA
• Allow a comparison of different ways of financing its operations.
• Permit a company to determine its value of operations and evaluate the effects of alternative strategies.
• Cost of capital = cost of debt * market value debt ratio + cost of equity * market value equity ratio
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COST OF EQUITY
Risk free rate:5.28%
Market risk premium:6.03%
Cost of equity = Risk free rate + Bottom-up Beta * Risk premium
Cost of equity=12.78%
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COST OF DEBT
Pre-tax cost of debt:5.78%
Why using marginal tax rate(35%)?
Cost of debt = Pre-tax cost of debt * (1 – marginal tax rate)
Cost of debt=3.76%
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DEVELOP COST OF CAPITAL
• Weighted approach• Why using market value of debt and equity ratios?• Cost of debt:3.76%• Cost of equity:12.76%• Market value debt ratio:5.54%• Market value equity ratio:94.46%
• Cost of capital = cost of debt * market value debt ratio + cost of equity * market value equity ratio
• Cost of capital=12.28%Take
Flight
VALUE OF FIRM
• What is Terminal value?
• Step 1: EBIT(1-t) = 182,952.08
Expected Growth rate = 9.065%
Stable growth rate = 1.02%
Expected operating income in year 6 =$285,214.59
• Step 2: Return on capital = 27.07%
Expected reinvestment rate from year 5 = g/ROC = 3.65%
• Step3 : Terminal Value in year 5 = $3,415,953.8
VALUE OF FIRM
Terminal Value = $3,415,953.8
Value of AEO today = $3,237,743.74
YEAR Cash Flow
Current $237,372.78
1 $258,890.62
2 $261,531.31
3 $264,198.93
4 $266,893.76
5 $269,616.07
VALUING THE AEOEB
IT (1
-T)
YEARSCURRENT YEAR AFTER 5 YEARS
Year
1 to 5
Beyond 5 Years
High Growth Period
• Cost of equity hg = Risk free rate+ bottom up beta*( Risk premium)
5.28+1.24*(6.03) = 12.76%
• Cost of capital hg = (cost of debt*weight of debt)+ (cost of equity*weight of debt)
0.0376*(0.0554) +0.1276*(0.9446) = 12.26%
• Growth rate hg=ROC 2011 *average reinvestment rate over past four years
27.90*21.46 = 6.002%
VALUE OF FIRM
HIGH GROWTH PERIOD
Year EBIT(1-t) Reinvestment Rate Reinvestment FCFF PV
Current $237,372,778.50
1 $251,620,751.96 21.46% 53,997,813.37 197,622,938.59 176,042,339.30
2 $266,723,940.35 21.46% 57,238,957.60 209,484,982.75 166,231,166.19
3 $282,733,676.80 21.46% 60,674,647.04 222,059,029.75 156,966,788.33
4 $299,704,375.57 21.46% 64,316,559.00 235,387,816.57 148,218,731.82
5 $317,693,717.12 21.46% 68,177,071.69 249,516,645.43 139,958,221.06
SUM OF PV CASH FLOWS 787,417,246.70
Cost of equity sg = 5.28+1*(6.03) = 11.31%
Cost of capital sg = 0.0376*(0.0554)+0.1131*(0.9446) =10.89 %
Growth rate sg= 1.02%
Reinvestment rate sg = growth rate sg/ROC 2011 1.02% / 27.97 = 3.65%
STABLE GROWTH PERIOD
STABLE GROWTH PERIOD
• FCFF year 6= EBIT after taxes in year 5*(1+gowth rate sg)*(1- reinvestment rate sg) 317,693,717.12*(1+1.02%)*(1-3.65%) = $309,230,479.17
• Terminal value = FCFF year 6 / (cost of capital sg-growth rate sg)309,230,479.17/ (10.89%-1.02%) = $3,132,485,179
• PV of terminal value = 3,132,485,179/(1+12.26%)^5=$1,757,065,354.94
COST OF CAPITAL hg
VALUATION
• Value of Operating Assets PV cash flow during hg+ PV of terminal value 1,757,065,354.94 +787,417,246 =$2,544,482,601
• Value of the Equity Value of operating assets + Cash and marketable securities – Debt 2,544,482,601 + 734,695,000.00 - 528,927,000.00 = $ 2,750,250,601.64
• Value of the equity =$ 2,750,250,601.64• Shares outstanding is 194,900,000 Stock price =$ 2,750,250,601.64/ 194,900,000
$14.11 $12.99
OUR VALUE LAST 3 MONTHS AVERAGE TODAY
VALUATION
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