CFA Presentation Slides Final

CFA Institute Research Challenge

Hosted by

CFA Society of Chicago

Blue Team/University of Illinois at Chicago

Investment Summary• We currently issue a HOLD recommendation on MJN, despite their mixed 4th

Quarter and 2015 earnings• Our intrinsic value estimate has changed to $76.02 per share, which is 4.8%

above the current market price

• In spite of low earnings we still have confidence in MJN’s management, leading to our high price target• Their push into the Toddler section of

the child nutrition market is promising because of their large amount of free cash

Investment Summary & Business Description

Industry Overview & Investment Risks Financial Analysis Valuation Conclusion

Market Profile Column1Closing Price (2/3/2016)

52-Week High / Low

Average Volume

Diluted Shares Outstanding

Market Cap

Dividend Yield

Beta

EV / Revenue

EV / EBITDA

P / FFO Share

Instituational Holdings

Insider Holdings

Business Description• MJN is a worldwide leader in the pediatric nutrition market with 2015 annual

sales of approximately $4.1 billion• MJN offers over 70 products in 50 countries, while 76% of their annual sales

are outside of the US, mainly concentrated in Asia• Infant products account for over half of MJN’s 2014 net sales



Asia52%

Latin America20%

North Amer-ica/Europe

28%

2014 Net Sales Routine Infant Formula 38%Solutions Products 11%Specialty Products 8%Total Infant 57%

Children's Nutrition Products 41%Total Children's 41%

Other 2%Total Other 2%

Product % of 2014 Net Sales

Industry Overview & Competitive PositionPediatric nutritional products: Demand for these products arise from parents need to properly feed their children with required nutrients in the form of infant formula, products targeting specialized nutritional deficiencies, and children nutritional supplements.

Source: Statista & Team Figures



Source: Statista & Team Figures

Demand Drivers

China2-Child policy:

1.5 – 2 Mil more births/year

E-Commerce: 32% growth rate

Input Costs

Dairy: Main production cost

USDA: Expects Dairy costs to decrease thru

2018

Currency Exchange

Dollar vs. Yuan: Expected to strengthen

Euro vs. Yuan: Expected to Strengthen



Porter’s Five Forces Analysis

• Bargaining Power of Customers (Low)

• Intensity of Competition (High)

• Bargaining Power of Suppliers

(Insignificant)

• Threat of Substitutes (Moderate)

• Barriers to Entry (Significant)



Bargaining Power of Customers

Intensity of Competitive Rivalry

Baragining Power of SuppliersThreat of Substitutes

Barriers to Entry

0

5

Porter's Five Forces

0 = No threat to MJN1 = Insignificant threat to MJN2 = Low threat to MJN3 = Moderate threat to MJN4 = Significant threat to MJN5 = High threat to MJN



Consumer Brand Preference

• I buy whatever brand I want, regardless off price41%

• I have a limited set of baby food brands I am willing to buy, and I choose the least expensive out of that set46%

• I always seek out baby food with the lowest price, regardless of what the brand is13%

Source: Nielsen Global Baby Care Survey

S.W.O.T. AnalysisStrengths: Product Quality/R&D, Brand Loyalty

Weakness: Emerging Markets, Dependence on Commodities

Opportunities: China, Emerging Markets

Threats: Competition, Foreign Currency Exchange

2012 2013 2014 2015(Projected)10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

22.00%

24.00%

Operating Margin

MJN Abbott Nestle Danone



Strength

Weakness

Opportunity

Threats 0

20

40

MJN SWOT Analysis

Investment Risks



Regulatory

Government and International Agencies:

Pricing, Sanctions, Health

No Material Litigation pending at this time.

Market

Foreign Currency Exchange: 76% of

sales outside of US.

Input Prices: Dairy costs declining thru

2018

Economic

Middle Class in Emerging Markets

Birth Rates: Directly related to economic

condition.

Operational

R & D: No guarantee of ROI

Significant exposure to China as a

portion of sales

Derivatives / Hedges

(in millions) Hedge Designation Sept. 30, 2015

Dec. 31,

2014

Foreign exhange contracts Cash Flow 13.3 13.0

Interest rate forward swaps Fair Value 13.7 0.0

Commodity contracts Cash Flow 0.7 0.0

Foreign exhange contracts Cash Flow 0.0 (0.2)Commodity contracts Cash Flow (0.3) (0.8)Interest rate forward swaps Fair Value 0.0 (0.9)Net asset/(liability) of derivatives designated as hedging items

27.4 11.1

Earnings Before Interest and Income Taxes (EBIT)Nine Months Ended September 30, 2015 % of

Sales 2014 % of Sales %

(in millions) ChangeAsia 542.1 35% 623.4 36% -13%Latin America 141 24% 152.6 23% -8%North America/Europe 264.9 28% 200.9 22% 32%Corporate and Other -207.6 -198.2 -5% EBIT as reported 740.4 24% 778.7 23% -5%Specified Items 20.8 20.9

Impact of F/X 42.4

EBIT as adjusted 803.6 799.6 1%



Profitability Ratios

• MJN is more efficiently deploying

its assets to generate its revenue

• With higher ROA, MJN is earning

more money on less investment



Profitability Ratios

• Low Profit Margin due to

low sales and realized

interest on additional

debt

• Gross Profit Margin

rose from 61% to 64%

• Operating Profit Margin

rose from 22% to 23%



Liquidity Ratios

• Considering interest on debt is paid by cash, Quick and Current ratio remained

same from 2014 to 2015.

• MJN can more easily pay its short term debt by quick cash.



Liquidity Ratios:

• Days in Payable dropped from 170 days

to 124 days

• MJN’s Cash-to-Cash Cycle dropped

significantly from -20 days to 39 days



Solvency Ratios

• Times Interest Earned dropped from 16

to 6 due to interest on additional debt

• MJN is more sufficient in paying its short term debt

• DSCR dropped from 12 to 6, due to increase in

interest on debt



Valuation

• Discounted Cash Flow Valuation• FCFF• Terminal Value• EBITDA Exit Multiple

• Relative (Comps) Analysis• P/E Multiples (TTM)• EV/EBITDA Multiples



Pro Forma Financial ForecastRevenue Growth Assumptions Margin Assumptions

GDP Forecast

Revenue Forecast Margin Assumptions2013 2014 2015 2016E 2017E 2018E 2019E 2020E

Asia 11% 5% -11% -5% 8% 10% 10% 10%L. Am 14% 1% -13% 3% 6% 8% 8% 8%N. Am/Eur -2% 9% 1% 3% 3% 3% 3% 3%Total 8% 5% -8% -1% 6% 7% 7% 7%

Margin Assumptions2016E 2017E 2018E 2019E 2020E

Gross Profit 64.0% 64.0% 64.0% 64.0% 64.0%SG&A 21.9% 20.9% 19.9% 18.9% 18.9%Advertising 15.0% 15.0% 15.0% 15.0% 15.0%R&D 2.5% 2.5% 2.5% 2.5% 2.5%

GDP Growth2012 2013 2014 2015 2016E 2017E

Asia 7.4% 7.1% 6.9% 6.7% 6.7% 6.6%Latin America 2.9% 2.7% 0.9% 0.4% 2.0% 2.8%N. Am/Europe 0.8% 0.9% 1.7% 2.1% 2.3% 2.0%Source: World Bank



Earnings ForecastIncome Statement

2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020ENet Sales 3,901.3 4,200.7 4,409.3 4,071.3 4,030.3 4,271.5 4,583.3 4,921.8 5,289.7Cost of Product Sold (1,503.8) (1,528.5) (1,700.6) (1,455.3) (1,450.9) (1,537.7) (1,650.0) (1,771.9) (1,904.3)Gross Profit 2,397.5 2,672.2 2,708.7 2,616.0 2,579.4 2,733.7 2,933.3 3,150.0 3,385.4Operating Expense (1,562.2) (1,697.3) (1,720.4) (1,679.8) (1,587.9) (1,640.2) (1,714.1) (1,791.5) (1,925.4)Operating Profit (EBIT) 835.3 974.9 988.3 936.2 991.5 1,093.5 1,219.1 1,358.4 1,459.9Interest Expense (65.0) (50.6) (60.3) (65.0) (149.1) (149.1) (149.1) (149.1) (149.1)Pretax Profit 770.3 924.3 928.0 871.2 842.4 944.4 1,070.1 1,209.4 1,310.9Income Tax Expense (182.0) (235.1) (199.2) (215.9) (200.5) (224.8) (254.7) (287.8) (312.0)Net Earnings Before Nonctrl. Int. 588.3 689.2 728.8 655.3 641.9 719.7 815.4 921.5 998.9Noncontrolling Interest (7.9) (5.4) (9.0) (1.8) (5.8) (6.5) (7.3) (8.3) (9.0)Net Earnings 580.4 683.8 719.8 653.5 636.1 713.2 808.1 913.2 989.9

Basic EPS $2.85 $3.38 $3.56 $3.28 $3.42 $3.84 $4.36 $4.94 $5.37Diluted EPS $2.84 $3.37 $3.55 $3.28 $3.41 $3.83 $4.35 $4.93 $5.35

% Growth - 18.5% 5.5% -7.7% 3.9% 12.4% 13.6% 13.3% 8.6%



Intrinsic ValuationDiscounted Cash Flow to Firm WACC: 9.5%

Free Cash Flow to Firm2016E 2017E 2018E 2019E 2020E

EBIT 991.5 1,093.5 1,219.1 1,358.4 1,459.9Tax Rate 23.8% 23.8% 23.8% 23.8% 23.8%NOPAT 755.5 833.2 929.0 1,035.1 1,112.5Depreciation & Amortization 52.9 52.3 47.6 48.8 52.4Stock-Based Compensation 27.4 27.7 28.3 28.8 31.0Working Capital 3.3 25.1 32.5 35.3 38.3Cash from Operations 839.1 938.3 1,037.4 1,148.1 1,234.2Capital Expenditures (173.3) (183.7) (197.1) (211.6) (227.5)Free Cash Flow to Firm 665.8 754.7 840.3 936.4 1,006.8

% Growth - 13.4% 11.3% 11.4% 7.5%

PV of FCFF 612.3 634.0 644.9 656.5 644.8Total 3,192.6

WACC w/ Taxes AssumptionsCost of Debt 5.0%Tax Rate 23.8%Debt and Equivalents 1,282.6Debt as % of Total Capital 18.6%

Risk Free Rate 2.1%Beta 1.44Market Risk Premium 6.0%Cost of Equity 10.8%Equity as % of Total Capital Structure 81.4%

Cost of Capital (WACC) 9.5%Sources: Yahoo! Finance, Federal Reserve



Terminal ValueGrowth in Perpetuity: 4% EBITDA Exit Multiple: 14.3

Perpetuity Approach Strong Case AssumptionsUnlevered FCF in last forecast period (2020) 1,006.8FCFF (2021) 1,047.1Long-Term Growth Rate 4.0%Terminal Value 19,143.9PV of Terminal Value 12,260.6PV of Stage 1 Cash Flows 3,192.6Enterprise Value 15,453.3Less: Net Debt 1,282.6Equity Value 14,170.7Shares Outstanding 186.4Equity Value Per Share $76.02

EBITDA Exit Multiple ApproachTerminal Year EBITDA 1,543.4Terminal Value EBITDA Multiple 14.3xTerminal Value 22,070.2PV of Terminal Value 14,134.8PV of Stage 1 Cash Flows 3,192.6Enterprise Value 17,327.4Less: Net Debt 1,282.6Equity Value 16,044.8Shares Outstanding 186.4Equity Value Per Share $86.08



Scenario AnalysisStrong Case Revenue Growth

• Estimate: $94.16

Weak Case Revenue Growth

• Estimate: $64.21



Relative Valuation• Peer Group: Abbott Laboratories, Mondelez International, Hain

Celestial GroupMultiples

MJN 13.8 20.4 14.4ABT 54.8 17.1 14.2MDLZ 66.0 23.3 13.4HAIN 3.6 18.1 15.2

Mean: 19.7 14.3

Implied Price: $67.87 $81.48

Market Cap ($B)

P/E Multiple

EV/EBITDA MJN Historical P/E MultiplesHigh Low33.8 19.8

Implied Price: $116.13 $68.04



Valuation Results• Target Price: $76.02



$76.02 – Target Price

Investment Summary• Recommendation: HOLD

• Investment Risks:• Continued Currency Headwinds

• Input Costs

• Target Price: $76.02

• Investment Opportunities:• High-Margin Products• Toddler Product Line



Appendix: S.W.O.T AnalysisThe Strength, Weakness, Opportunity, and Threat (SWOT) analysis was performed by listing the attributes attributable to each category, and then assigning a value from 1 to 3 to each attribute with 3 having the strongest effect on the company. The SWOT Graph shows the aggregate of each of the attributes.

Strength

Weakness

Opportunity

Threats 0

20

40

MJN SWOT AnalysisStrength Research & Development 3 Innovation 3 Gegraphic Diversity 2 Economies of Scale 3 Product Quality 3 Promotional Effectievness 2 Brand Recognition 2 Brand Loyalty 3 Dividend Increases 2 Share Buybacks 1 Profitability 1 Subtotal 25

Weakness Emerging Market Exposure 3 Capacity limitations 1 Dependence on Commodity Price 3

Alleged Violation of Foreign corrupt Practices Act 2

Subtotal 9

Opportunity Emerging Markets 3 China 3 New Product Introductions 2 Increased Capacity 1

Expanded Product Line (post childhood) 2

Forward Intigration (e-commerce/direct sales) 2

Backward Integration (Dairy Farms) 1 Subtotal 14

Threats Substitutes 2 Competition 3 Global Economic Downturn 3 China 3 Currency Fluctuations 3 Subtotal 14

Strength 25Weakness 9Opportunity 14Threats 14

Appendix: Porter’s Five Forces




Barriers to Entry

0

5

Porter's Five Forces Threat of Substitutes – (Moderate): Infant formula substitutes include breast milk, and homemade and store brand products. Infant formula is used to supplement breast milk, or replace it in the case where breast feeding is not a realistic option, as in the case when mothers return to work. As such, this poses a low threat to be substituted. Homemade and store brand formula does not have the research or testing that has accompanied the premium infant formula, which is what separates the two products. While these could be a substitutes, the larger threat is from competitors who are of similar quality. Brand loyalty keeps the threat of substitution to the moderate level.

Intensity of Competitive Rivalry – (High): The super-premium infant formula industry is populated by four main companies that are in intense competition. This is especially true for emerging markets where there is the greatest opportunity for growth. The low dairy prices and weak economy in many emerging markets is strengthening the intensity of competition as each of the main firms tries to solidify their market share through marketing, advertising, and price point. It is important to secure this market share early in the infants life for the parents tend to be brand loyal for products targeting later childhood nutrition as well as products for subsequent children.

Appendix: Porter’s Five Forces




Barriers to Entry

0

5

Porter's Five Forces Bargaining Power of Customers – (Low): Customers are fragmented across multiple nations, and the product is highly differentiated from competition. This causes lowered negotiating power by individual retailers, since there are many avenues to distribute the product including e-commerce. Bargaining Power of Suppliers – (Insignificant): The largest cost of production for input costs is directly tied to dairy, which is a commodity. As such, the bargaining power is minimal as the suppliers can be substituted readily at inconsequential switching costs.

Barriers to Entry – (Significant): The global infant formula industry requires companies to have multinational manufacturing, distribution, and compliance systems in place, which requires a very large capital commitment. The research and testing necessary to bring products to market also requires large capital investment along with a prolonged timeline to meet regulatory and market acceptance.

Appendix: Operating Income ComparisonMJN In Millions (except Share Price, EPS, P/E) 2015E 2014 2013 2012Net Sales 4,138 4,409 4,201 3,901Operating Earnings 987 988 975 835Operating Margin 23.85% 22.41% 23.21% 21.41%Share Price (MJN in USD) 70.4 99.94 83.44 69.99Shares Outstanding (non-diluted) 201.7 202.1 202.4 203.6EPS - Total 4.89 4.89 4.82 4.10P/E 14.39 20.44 17.32 17.06

Abbott In Millions (except Share Price, EPS, P/E) 2015E 2014 2013 2012Net Sales, Nutritionals 6,898 6,953 6,740 6,461Aprox. 56% are non-adult related sales. Non-Adult 3,863 3,894 3,774 3,618Total 20,284 17,778 17,159 16,593Operating Earnings, Non-Adult 894 817 707 571Operating Margin 23.15% 20.98% 18.74% 15.79%Share Price (ABT in USD) 40.22 44.9 38.64 33.07Shares Outstanding (non-diluted) 1499 1516 1558 1575EPS Attributed to Non-Adult Nutritionals Sales 0.60 0.54 0.45 0.36EPS - Total 2.09 2.81 2.43 2.16P/E 19.22 16.00 15.91 15.34

Nestle In Millions (except Share Price, EPS, P/E) 2015E 2014 2013 2012Net Sales, Nutritionals 10,985 10,516 10,602 8,382

Non-Adult 6,152 5,889 5,937 4,694Total 95,263 100,206 99,434 95,704Operating Earnings, Nutritionals 1,413 1,223 1,185 901Operating Margin 22.96% 20.77% 19.96% 19.20%Share Price(NESN in USD) 77.52 79.85 71.32 65.01Shares Outstanding (non-diluted) 3,188 3,188 3,191 3,186EPS Attributed to Non-Adult Nutritionals Sales 0.44 0.38 0.37 0.28EPS - Total 4.57 4.81 4.75 4.51P/E 16.95 16.60 15.02 14.42

Danone In Millions (except Share Price, EPS, P/E) 2015E 2014 2013 2012Nutritionals 5,430 5,845 5,662 5,475Total 25,299 28,106 28,289 26,839Operating Earnings, ELN 896 1,101 1,111 1,068Opearting Margin, ELN 16.50% 18.83% 19.62% 19.51%Share Price(NESN in USD) 69.16 71.59 68.64 64.30Shares Outstanding (non-diluted) 604 594 594 604EPS Attributed to ELN 1.48 1.85 1.87 1.77EPS - Total 5.06 5.96 6.29 6.31P/E 13.65 12.00 10.92 10.19

Appendix: Operating Income Comparison

2012 2013 2014 2015(Projected)10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

22.00%

24.00%

Operating Margin


2012 2013 2014 2015(Projected)0.00

5.00

10.00

15.00

20.00

25.00

Price/OEPS


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CFA Presentation Slides Final