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Universal Corporation
Equity Valuation and Analysis
As of June 2, 2008
Analysis Group
Cas Hughes [email protected]
Mark Young [email protected]
Jonathan Krebbs [email protected]
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Table of Contents Executive Summary………………………………………………………………………………………………8
Business and Industry Analysis…………………………………………………………………………….13
Business Overview…………………………………………………………………………...........13
Industry Overview…………………………………………………………………………………….15
Five Forces Model……………………………………………………………………………………….........16
Rivalry of Existing Firms…………………………………………………………………………….17
Industry Growth Rate………………………………………………………………………17
Concentration and Balance of Competitors…………………………………………18
Degree of Differentiation………………………………………………………………….18
Switching Costs……………………………………………………………………………….18
Economies of Scale………………………………………………………………………….19
Learning Economies of Scale…………………………………………………………….19
Excess Capacity……………………………………………………………………………….19
Exit Barriers…………………………………………………………………………………….20
Conclusion………………………………………………………………………………………20
Threat of New Entrants………………………………………………………………………………21
Economies of Scale………………………………………………………………………….21
First Mover Advantage……………………………………………………………………..21
Access to Channels of Distribution …………………….. …………………………..22
Relationships………………………………………………………………………………….22
Legal Barriers………………………………………………………………………………….23
Conclusion………………………………………………………………………………………23
Threat of Substitute Products……………………………………………………………………..24
Buyers Willingness to Switch…………………………………………………………….24
Relative Price and Performance…………………………………………………………25
Conclusion………………………………………………………………………………………25
Bargaining Power of Customers…………………………………………………………………..26
Price Sensitivity……………………………………………………………………………….26
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Relative Bargaining Power……………………………………………………………….27
Conclusion………………………………………………………………………………………27
Bargaining Power of Suppliers…………………………………………………………………….28
Price Sensitivity……………………………………………………………………………….28
Bargaining Power…………………………………………………………………………….29
Conclusion………………………………………………………………………………………29
Value Creation Analysis………………………………………………………………………………………..31
Competitive Strategy…………….……………………………………………………………………31
Economies of Scale…………….……………………………………………………………………..31
Efficient Production……………….…….……………………………………………………………31
Low Input Costs…………………………………………………………..…………………………..32
Low R&D………………………………………………………………………………………………….32
Tight Cost Control System….………………………….…………………………………………..32
Firm Competitive Advantage Analysis……………………………………………………………………33
Economies of Scale……………………………………………………………………………………33
Efficient Production…………………………………………………….……………..……………..34
Low Input Costs…………………………………………….………………….……………………..34
Low R&D…………………………………………………….…………………………………………..35
Tight Cost Control System…………….…………………………………………………………..35
Accounting Analysis…………………………………………………………………………………………….36
Key Accounting Policies……………………………………………………………………………………….37
Goodwill……………………………………………………….………………………………………….38
Operating Leases………………………………….…………………………………………………..39
Pension Plan………………………………………..…………………………………………………..41
Conclusion………………………………………………………………………………………………..43
Accounting Flexibility………………………………………………………………………………………..…43
Goodwill……………………………………………………………………………………………………44
Operating Leases……………………………….………………………………………………………45
Pension Plans…………………………………………………………………………………………...47
Conclusion………………………………………………………………………………………………..48
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Accounting Strategy………………………………………………………………………………….………...49
Goodwill……………………………………………………………………………………………………49
Operating Leases…………………………………………………………………………….………..50
Pension Plan……………………………………………………………………………………………..51
Conclusion………………………………………………………………………………………………..52
Qualitative Analysis……………………………………………………………………………………………..52
Quantitative Analysis……………………………………………………….…………………………………..53
Sales Manipulation Diagnostics……………………………………………………………………………..54
Net Sales / Cash from Sales………………………………………………………………………..55
Net Sales / Accounts Receivables………………………………………………………………..56
Net Sales / Unearned revenue…………… ………………………………………………………57
Net Sales / Inventory…………………………………………………………………………………58
Net Sales / Warranty Liabilities……………………………………………………………….....59
Conclusion………………………………………………………………………………………………..59
Expense Manipulation Diagnostics…………………………………………………………………………59
Asset Turnover………………………………………………………………………………………….60
Cash Flow from Operations / Operating Income……………………………………………61
Pension Expense / SG&A…………………………………………………………………………….62
Conclusion………………………………………………………………………………………………..62
Potential Red Flags……………………………………………………………………………………………..63
Undoing Accounting Distortions……………………………………………………………………………63
Financial Analysis………………………………………………………………………………………………..64
Liquidity Ratios……….. …………………………………………………………………………………………65
Current Ratio…………………………………………………………………………………………….66
Quick Asset Ratio………………………………………………………………………………….....67
Inventory Turnover……………………………………………………………………………………68
Days in Inventory………………………………………………………………………………………69
Accounts Receivable Turnover…………………………………………………………………….70
Days in Accounts Receivable……………………………………………………………………….71
Cash to Cash Cycle…………………………………………………………………………………..72
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Working Capital Turnover…………………………………………………………………………..73
Conclusion…………………………………………………….…………………………………………74
Profitability Ratios……………………………………………………………………………………………..75
Gross Profit Margin………………………………………………………………………………....76
Operating Expense…………………………………………………………………………………..77
Operating Profit Margin…………………………………………………………………………….78
Net Profit Margin……………………………………………………………………………………..79
Asset Turnover………………………………………………………………………………………..80
Return on Assets……………………………………………………………………………………..81
Return on Equity……………………………………………………………………………………..82
Conclusion………………………………………………………………………………………………82
Capital Structure Ratios……………………………………………………………………………………..83
Z-Score…………………………………………………………………………………………………..83
Debt to Equity Ratio…………………………………………………………………………………85
Times Interest Earned………………………………………………………………………………86
Debt Service Margin…………………………………………………………………………………87
Conclusion………………………………………………………………………………………………87
IGR/SGR Analysis………………………………………………………………………………………………88
Internal Growth Rate……………………………………………………………………………….88
Sustainable Growth Rate………………………………………………………………………....89
Financial Statement Forecasting………………………………………………………………………….90
Income Statement……………………………………………………………………………………91
Balance Sheet………………………………………………………………………………………….93
Statement of Cash Flows………………………………………………………………………….97
Estimating Cost of Capital…………………………………………………………………………………..99
Cost of Equity………………………………………………………………………………………….99
Regression Analysis Results………………………………………………………………………101
Cost of Debt……………………………………………………………………………………………102
Weighted Average Cost of Capital……………………………………………………………..104
Conclusion……………………………………………………………………………………………...104
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Analysis of Valuations………………………………………………………………………………………..105
Methods of Comparables…………………………………………………………………………………...105
Price/Earnings Trailing……………………………………………………………………………..106
Price/Earnings Forecast…………………………………………………………………………….107
Price/Book……………………………………………………………………………………………...108
Dividend Yield………………………………………………………………………………………….109
Price Earnings Growth (P.E.G.)………………………………………………………………….110
Price/EBITDA…………………………………………………………………………………………..111
Price/Free Cash Flows………………………………………………………………………………112
Enterprise Value/EBITDA………………………………………………………………………….113
Conclusion………………………………………………………………………………………………114
Intrinsic Valuation Models…………………………………………………………………………………..115
Discounted Dividends Model……………………………………………………………………..115
Discounted Free Cash Flows Model…………………………………………………………...117
Residual Income Model…………………………………………………………………………….118
Long Run Residual Income Model……………………………………………………………..120
Abnormal Earnings Growth Model (A.E.G)………………………………………………….123
Conclusion……………………………………………………………………………………..……….125
Appendices……………………………………………………………………………………………………….127
References………………………………………………………………………………………………………..148
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Executive Summary
Investment Recommendation: Fairly Valued – Hold or Buy (6/2/2008)
$50.16 Altman Z Scores52 week range 2003 2004 2005 2006 2007 2008Revenue $2.15 B 2.54 2.38 2.42 2.32 2.71 3.39
$1.21 B26.98 M Market Price (6/2/2008)
Comparables Based Valuations$33.23 Trailing P/E $72.35
ROE 11.60% Forward P/E N/AROA 5.10% P.E.G. N/A
P/B $77.76P/EBITDA $9.33P/FCF $1.72
R- Squared Beta Ke EV/EBITDA 32.953-month 0.034 0.48 6.39% Divident Yield N/A6-month 0.0343 0.49 6.4%2-year 0.0352 0.49 6.4% Intrinsic Valuations5-year 0.0352 0.49 6.4% Discounted Dividends $39.3210-year 0.035 0.49 6.4% Free Cash Flows N/A
Residual Income $48.28LR ROE RI $52.19.
9.70% A.E.G. 49.970.56
5.04%7.47%
WACC (AT) 6.62%
UVV - NYSE(6/2/2007):
Market CapitalizationShares Ourstanding
Book Value Per Share
Cost of Capital
Backdoor KePublished BetaCost of DebtWACC (BT)
$68.04 - $41.23
Estimated
http://moneycentral.msn.com
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Industry Analysis
Universal Corporation was founded in 1918 by Jacquelin P. Taylor. The company
was formed by combining six tobacco leaf dealers into one. Universal Corporation is
now one of the world’s leading tobacco leaf merchants and processors. Universal has
over 25,000 permanent and seasonal workers in over 35 countries. Universal previously
owned a lumber and building products and agri-products operation. The company sold
off these operations in pieces for each of the last 3 years.
Universal is involved in selecting, buying, processing, packing, storing, shipping,
and financing leaf tobacco. They sell their tobacco to manufacturers of consumer
tobacco products worldwide. They grow and process many different types of tobacco
which help manufacturers produce cigarettes, cigars, pipe tobacco, and smokeless
tobacco products.
A direct competitor with Universal is Alliance One International Inc. British
American Tobacco plc is also a competitor but only with their tobacco merchant
segment of their business. Smaller companies have been competing with these larger
companies because they can afford to sell their tobacco for cheap with their lack of
overhead costs. This industry is highly competitive while growing at the same time.
Firms must differentiate products, create economies of scale, and utilize capacity to
gain new market share in this highly competitive industry.
The key success factors in this industry greatly affect a firm’s chance of gaining a
competitive advantage. Universal Corporation uses a cost leadership strategy in their
attempt to gain a competitive advantage. Universal uses several techniques to gain this
competitive advantage which include: economies of scale, efficient production, lower
input costs, little research and developments, and a tight cost controls system.
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Accounting Analysis
The main purpose of an accounting analysis is to determine how well a
company’s accounting policies reflect an accurate view of the company. It is vital for a
company to disclose as much information as possible so the financial statements can be
examined for any possible distortions. Often times a company will manipulate their
financial statements by only disclosing what is required by GAAP. Manipulating financial
statements makes it difficult for shareholders to have an accurate view of the company.
Distorted financial statements also make it hard for an analyst to fairly value the
company.
Universal did a fair job overall of disclosing information in their 10-K. They
vaguely explain how to calculate goodwill when they purchase other businesses, but
they explain in detail why they wrote off goodwill in years that it was impaired. But
there were no explanation as to why goodwill wasn’t written off in 2008. It was a
decent disclosure of information that could use more explanation. The disclosure
Universal uses for operating leases in their 10-K is good. They explain how much their
leases are and how much they are expected to be in the future. This breakdown of
operating lease expenses is why their disclosure is considered good. The disclosures
that Universal utilizes for pension plans with the 10-K is excellent. They discuss all the
estimates used when calculating the pension plans. They also explain how each
estimate is calculated and who does the calculation. The only flaw is that they do not
provide future growth rates of expected pension plans. Overall the accounting
disclosures are fair, but could be improved with further disclosure regarding accounting
for goodwill.
Financial Analysis, Forecast Financials, and Cost of Capital Estimation
Thorough financial analysis is necessary to make a recommendation regarding
the current value of a firm. Analysts use ratios to compare a firm to its past
performance and against its competitors. We looked at five years of Universal’s financial
statements and calculated liquidity, profitability, and capital structure ratios. We used
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these ratios to forecast Universal’s financial statements for the next ten years and
calculated the companies cost of equity, cost of debt, and weighted average cost of
capital.
Universals liquidity ratios were close to the industry average for tobacco
manufacturers. Universal has shown overall improvement in its current ratio, inventory
turnover, and days sales outstanding ratios in the last five years. Universal’s
weaknesses in liquidity were receivables turnover, and working capital turnover. Overall
Universal liquidity position seemed favorable. Universal’s profitability ratios indicated
that Universal was maintaining its profitability. The company fairly has been over the
last five years in return on assets, return on equity, and net profit margin. Universals
capital structure has been changing over the last five years. Universal has improved its
debt coverage ratio and debt to equity ratio. By decreasing its dependence on debt
financing the company is able to fund more opportunities internally.
After analyzing the ratios for Universal we made predictions about the growth
and profitability over the next ten years. We estimated net income to grow smoothly at
4.5% per year. We then used our forecasted income growth and Universal’s ratios to
determine the effect on assets, liabilities, and equity over the next ten years.
To determine Universal’s cost of debt we took a weighted average of all the
interest rates paid on liabilities. The information was available in the 10-K and gave us a
cost of debt of 5.04%. To determine cost of equity we used regression analysis to
estimate beta based on Universals returns, treasury returns, and returns on the market.
After running 25 regressions we found no explanatory power and were forced to use an
alternative method based on forecasted return on equity and forecasted growth and net
income. This gave us an estimated cost of equity of 9.6%. We found our before tax
weighted average cost of capital to be 7.47% and after tax to be 6.62%.
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Valuations
Valuations are estimates of the price of an equity based on models. To determine
if Universal Corporation was overvalued, undervalued, or fairly valued we used the
method of comparables and intrinsic valuation models and analyzed the sensitivity of
each model.
The method of comparables is a quick way to assess the value of a company
compared to the industry. We valued Universal using six ratios; P/E trailing and
Forecasted, P.E.G., P/B, P/EBITDA, EV/EBITDA, and P/FCF. These ratios proved to be
unreliable for valuing Universal. Three of the ratios used could not be used to value
Universal. This is because of the nature of the ratios, they are based on industry
averages and the tobacco manufacturing industry is dominated by only two firms,
Universal and Alliance.
The intrinsic valuation models were much more beneficial when valuing
Universal’s stock. The models we used were the discounted dividend model, discounted
free cash flows, residual income, abnormal earnings growth, long run residual income.
The discounted dividend model valued Universal’s shares at $39.95 which meant that
Universal was overvalued. The discounted free cash flow model value was $-84.43
which we throughout because Universal typically has negative free cash flows. The
most accurate models, the residual income, abnormal earnings growth model, and long
run residual income model all fairly valued Universal’s stock. We looked at the
sensitivity of the models we found that Universal was fairly valued according to the
Residual income model and AEG model. The long run residual income model was
sensitive to growth rates and cost of equity and tended to undervalue Universal’s stock.
Our conclusion was that Universal was a fairly valued stock. Fairly valued meant
that the price we got from the models fell within 15% of the observed price. The only
model that did not indicate a fairly valued stock was the free cash flow model which we
threw out because it was impractical for valuing the firm.
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Business & Industry Analysis
Company Overview Universal Corporation (UVV) is one of the world’s leading leaf tobacco merchants
and processors. The company was founded By Jacquelin P. Taylor in 1918 by
combining six leaf dealers into one, which was named Universal Leaf Tobacco
Company. Universal Leaf Tobacco Company still remains as the primary subsidiary to
Universal Corporation. From the day it was founded, Universal Corporation quickly rose
to become one of the premier leaf tobacco merchants in the world with over 25,000
permanent and seasonal workers in more than 35 countries. Universal Corporation
previously had a lumber and building products and agri-products operation. The lumber
and building products and a portion of the agri-products operation were sold in
September, 2006 with the remainder of the agri-products operation being sold during
both 2007 and 2008. The company is presently located in Richmond, Virginia (10-k
Universal Corporation).
Universal Corporation is involved in selecting, buying, processing, packing, storing,
shipping, and financing leaf tobacco. They sell to manufacturers of consumer tobacco
products produced throughout the world. Universal Tobacco does not manufacture any
consumer tobacco products. They process and/or sell flue-cured and burley tobaccos,
dark air-cured tobaccos, and oriental tobaccos through many operating subsidiaries and
unconsolidated affiliates that are in tobacco growing countries throughout the world. In
addition, they provide customers with blending and chemical and physical testing of
their tobacco. The flue-cured, burley, and oriental tobaccos are primarily used to
manufacture cigarettes while the dark air-cured tobacco is used to manufacture cigars,
pipe tobacco, and smokeless tobacco products.
There is very high competition in the tobacco leaf merchant industry. It varies
depending on the market or the country that is involved and is derived from the ability
of merchants to be able to meet customer specifications when it comes to buying,
processing, and financing of tobacco. The price charged is also a major contributor to
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this industry’s competitiveness. British American Tobacco plc (BTI) is the industry
leader with sales totaling 5.74 billion pounds in 2007, or 11.41 billion in U.S. dollars.
This high sales volume is mainly due to the fact the British American sells leaf tobacco
as well as actual consumer tobacco products. Universal tobacco comes in second with
2.01 billion in sales for 2007. This is not much higher than the 1.98 billion in sales that
Universal’s main competitor, Alliance One International Inc. (AOI) had for 2007. They
compete in many of the same countries where Universal Corporation operates.
Universal believes that they hold a larger worldwide market share based on the volume
that is handled by their subsidiaries and affiliates, but based on recent evidence does
not believe this difference to be significant. Universal is also seeing an increase in
competition from smaller companies in some of the markets where they operate. Net
income for the past two years has been really low when comparing these years to the
previous three. From 2003 to 2005 Universal saw net income around 100 million for
each of those years. In 2006 Universal Corporation saw a significant downfall in net
income to 7,940,000(www.finance.yahoo.com). “Net income for the fiscal year 2008,
which includes results from discontinued operations, was $119.2 million” (wall street
journal).
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Industry Overview
The tobacco industry can be broken down into two parts, merchants and
manufacturers. The companies who are leaf tobacco merchants, like Universal
Corporation and Alliance one, sell tobacco to companies that manufacture cigarettes
and other tobacco products. The tobacco products manufacturers themselves actually
produce the products that consumers can buy. The tobacco products manufacturers of
the world leave the selecting, buying, and processing of the tobacco to the leaf dealers.
The merchant segment of the tobacco industry consists of thousands of growers
in over 35 countries. Although there are a couple top players in the industry who
possess the majority of the market share, the smaller competitors are starting to
compete more because they can charge a cheaper price to the manufacturers. Because
all of the tobacco merchants produce roughly the same product, they are forced to
compete on the quality of their product they produce as well as the price. Tobacco
manufactures, “will continue to face higher costs in most of the major producing areas
of the world, the weak U.S. dollar continues to exacerbate this trend in many areas”
(Wall Street Journal, May 22nd 2008). Universal Corporation, as well as the other top
players in the industry, can afford to provide manufacturers with low cost services due
to their large economies of scale. As mentioned above the smaller competitors are
competing on price as a competitive strategy against the bigger companies. They can
afford to do this because of their small amount of overhead costs and their lack of
financial support to tobacco farmers. A lot of the time the small competitors purchase
their leaf tobacco in auctions for cheap and then sell to manufacturers. This often turns
out to be only slightly profitable because it is also possible for manufacturers
themselves to purchase the same tobacco in the warehouse auctions as well. Even
though the smaller merchants can provide a lower price to manufacturers, Universal
Corporation provides a quality product in extremely large quantities that keeps their
tobacco extremely competitive.
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The major competitors with Universal in this industry are British American
Tobacco plc and Alliance One International, Inc. Although smaller companies may have
a chance to make an impact in the future, their market share is not significant enough
to severely affect Universal Corporation as of yet. Universal Corporation and Alliance
One have combined total revenues of 3.99 billion in 2007. Although the annual
revenues for each firm were nearly identical, Alliance One lost about 21.6 million last
year while Universal Corporation gained nearly 44.4 million (www.finance.yahoo.com).
Five Forces Model
When analyzing an industry there are many forces that can affect the profitability
of firms. The five forces model is a reference tool that allows an analyst to look at the
structure of the industry in order to assess the level of competition and strategies of
firms competing in an industry. The components of the model are rivalry among
existing firms, threat of new entrants, threat of substitute products, bargaining power
of buyers, and the bargaining power of suppliers. The first part of the model assesses
the degree of actual competition in an industry while the last part two focuses on the
bargaining power of firms over their customers and their suppliers. We will look at how
each of these five forces affects profitability in the tobacco manufacturing industry.
Tobacco Manufacturing Industry
Rivalry Among Existing Firms High
Threats of New Entrants Low
Threat of Substitute Products Low
Bargaining Power of customers High
Bargaining Power of Suppliers Low
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Rivalry Among Existing Firms
Rivalry among existing firms affects the profitability of an industry. Highly
competitive industries with low concentration of firms compete on price while firms
competing in a high concentration industry compete how well they differentiate their
products. The number and size of competitors, differences in products, economies of
scale, installed capacity, and exit barriers all affect profit potential. Rivalry among
existing firms in the tobacco manufacturing industry is high. The tobacco manufacturing
industry is growing, however, in order for firms to gain new market share they must
successfully differentiate products, create economies of scale, and utilize capacity.
Industry Growth
The level of competition in an industry depends on how much or how little the
industry as a whole is growing. Industries that are growing steadily allow firms to take
on new market share; firms in industries that are not growing must attract business
away from other firms in order to grow. The tobacco manufacturing industry is one of
high growth. High growth in the industry makes it possible for large and small firms to
grow steadily over the last few years. The following graph shows the net sales of the
two largest competitors over the last five years. We can see that the industry has been
steadily growing over the last five years. There have also been years of significant
growth. From 2005 to 2006 the industry experienced a 30 percent increase in sales.
Sales Growth in Tobacco Manufacturing Industry
Net Sales 2003 2004 2005 2006 2007
Universal 2,636,776 2,271,152 1,667,193 1,781,312 2,007,272
Alliance 1,268,752 832,291 1,311,388 2,112,685 1,979,078
Total % Growth
in sales
-2% -4% %30.7 %2.37
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Concentration and Balance of Competitors
The degree of completion in any industry is affected by how many firms are
competing for market share. Industries with a few large competitors can have high
price competition. In tobacco manufacturing Universal Corporation, Alliance One
International, and British American Tobacco P.L.C make up the majority of the industry.
Smaller companies make around 5% of the industry. These smaller companies can
compete because of low overhead expense. Companies like Universal and Alliance One
charge slightly higher price but offer more quality to the customer. Overall the
concentration of the tobacco manufacturing industry is low because the industry is
dominated by three large firms.
Degree of Differentiation
Firms differentiate their products in order to gain a competitive advantage. Firms
competing in the tobacco manufacturing industry can do little to differentiate their
product from the competitors. Therefore, companies focus on differentiating services.
Large manufacturers of tobacco provide shipping services that small companies cannot.
They also keep inventory on hand to consistently meet customer demands. This gives
companies selling identical products a way to differentiate themselves from the
competition by providing services that have value.
Switching Costs
Switching costs are low in the tobacco manufacturing industry. Large cigarette
manufacturers can easily switch from one company’s product to another. This leads to
high price competition amount existing firms.
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Economies of Scale
While small companies can sometimes have an advantage large companies
sometimes have an advantage over smaller companies because of economies of scale.
Economies of scale are cost advantages associated with large scale production. The
majority of business done in the tobacco manufacturing industry is done by three firms.
Universal has a huge advantage when dealing with its suppliers, the growers of the
tobacco leaves. Because of the amount of tobacco Universal buys the company has
power over its suppliers that smaller firms do not. For example, Universal bought 45%
of the tobacco produced in Africa in 2007. The company also bought 30% of the
tobacco grown in Brazil. This is very important because of the seasonal nature of the
business. When tobacco crops fail in one part of the world Universal is better equipped
than small firms because it buys tobacco from several different countries.
Learning Economies
Learning economies exist where firms have special knowledge, research, or
patents. Knowledge is a valuable asset in any industry. Knowledge can give firms a
competitive advantage through patents, or perfecting a process. Firms in the tobacco
industry do not invest in research and development or patents. The knowledge for
these firms comes from the tobacco curing process which Universal has been doing
since 1918. This experience companies like universal a competitive advantage over
firms who might be entering the industry for the first time. The process of curing
tobacco is complicated. Firms without the expertise would be less efficient than
Universal and be at a disadvantage.
Excess Capacity
Excess capacity is when firms in an industry produce more goods or services
than there is a demand for. In the tobacco manufacturing industry there are two
aspects of competition between firms. Large firms as well as small firms compete on
the price of products and services but they also compete on buying the available
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tobacco. Because the firms buy the tobacco before processing there is not a material
problem with excess capacity.
Exit Barriers
Exit barriers are costs associated with leaving the industry. Exit barriers that
companies face in the tobacco manufacturing industry are the potential loss of
investments located in countries abroad. Large firms such as Alliance, Universal, and
British American have warehouses throughout the world where they store and process
tobacco. These large investments would make it difficult for the companies to change
industries. Firms in the tobacco manufacturing industry also finance farmers who grow
tobacco. Exit barrier exists because these companies have money invested in tobacco
farms that they stand to lose if they discontinue operations.
Conclusion
Rivalry exists in the tobacco manufacturing industry because tobacco is a
commodity and the industry is growing. The concentration of firms, their ability to
differentiate products, and economies of scale and learning create a highly competitive
environment. In addition, significant barriers to exiting the industry force firms to
constantly work to build and maintain their competitive advantage. Firms can analyze
competition in the industry to understand what competitive advantages they have and
how to keep those advantages. By looking at the structure of the tobacco
manufacturing industry an analyst can assess the nature of competition and better
determine what drives profitability.
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Threat of New Entrants
Competition is affected by the threat of new firms to the industry. Tobacco
manufacturing has a moderate threat of new entrants. This is because the industry is
dominated by Universal Corporation and Alliance One International. Small companies
enter the industry but have trouble competing with the large manufactures. In tobacco
manufacturing there are five factors that make it difficult for new firms compete.
Economies of scale, first mover advantage, channels of distribution, existing
relationships, and legal barriers.
Economies of Scale
In the tobacco manufacturing industry firms such as Universal have invested in
warehouses around the world. It would require a significant investment for a new firm
to match the two major firms (Universal and Alliance) presence. For example, Universal
has over 2.1 billion dollars worth of total assets, while Alliance One has over 1.6 billion
(www.yahoo.com). Another economy of scale is the purchase of tobacco. Universal has
relationships with suppliers and consistently buys all or most of their inventory. For
example, Universal typically buys between 20 and 30 percent of all tobacco produced in
Brazil. New entrants would have to establish themselves as a consistent purchaser of
tobacco in addition to attract large cigarette manufacturers away from the two major
tobacco manufacturing firms.
First Mover Advantage
Large firms already operating in an industry have first mover advantages. For
example, Universal tobacco has already established itself throughout the world market.
Companies like Universal, and Alliance One have created an industry standard of
financing farmers who grow tobacco. This makes it difficult for new entrants because
larger tobacco companies have already invested in future tobacco. New entrants would
be at a disadvantage because they would have to finance new equipment and buy land
for farmers to grow tobacco.
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Access to Channels of Distribution
Developing distribution channels can be expensive to firms wanting to enter the
tobacco manufacturing industry. Existing firms who buy wholesale tobacco and sell
cured tobacco operate all over the world. In order for a new entrant to compete with
large firms they would have to invest significantly in warehouses, shipping, and
processing plants in many different countries. For example, Universal Corporation has
seven hundred and ninety million dollars invested in buildings and machinery in 33
different countries (Universal 10-K).In addition, a new competitor would have to be
familiar with shipping and customs regulations in different countries.
Relationships
Success in any industry depends largely on a company’s ability to build and
maintain strong relationships. Firm’s existing relationships with its customers and
suppliers can deter new entrants from entering the industry. In the tobacco
manufacturing industry relationships with are extremely important. Most large
manufactures in the industry have a few large customers. For example, according to
Universal Corporations 10-K “over 80% of our volume is derived from sales to a limited
number of large multinational cigarette manufacturers.” (p. 6). It is obvious these
customer contracts are very important to Universal’s business because they amounted
to over 1.5 billion dollars in 2008. Universal’s relationship with its suppliers is another
important aspect of their business. Universal is the major purchaser of tobacco in the
tobacco exporting regions of the world. According to their 10-K “We usually purchase
between 20% and 30% of the annual production of such tobaccos in Brazil” (p. 6).
Farmers in Brazil and other tobacco exporters are dependent on tobacco manufacturing
companies to buy their products. This long term, mutually beneficial relationship makes
it difficult for new firms to enter the industry.
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Legal Barriers
The legal realm of tobacco manufacturing is probably the biggest obstacle facing
firms wanting to enter the tobacco manufacturing industry. The industry is facing heavy
pressure from the federal, state, and local governments to reduce the consumption of
tobacco products. In addition, political climates in other countries affect the tobacco
industry as well. The U.S Federal government is attempting to restrict tobacco
advertising and the use of tobacco in public places. There are proposed increases in
taxes on cigarettes and other tobacco products. Also, there is pressure from the Master
Settlement Agreement which is used to make tobacco product manufactures pay for
health care for tobacco related illnesses. This legislation affects the customers of
tobacco manufacturing companies. These companies are forced to change or
discounting aspects of their business. This in turn could will a negative effect on
companies in the tobacco manufacturing industry. Another legal barrier comes from
governments in other countries. Following in the footsteps of the U.S countries around
the world are prohibiting the advertising of tobacco products. This makes it difficult for
cigarette companies to sell their products which reduce demand for tobacco. There is
also political and economic risk in developing countries who export tobacco. For
example, according to Universal Corporations 10-K “government actions in Zimbabwe
have reduced the tobacco crop there.” Tobacco manufacturers have to be aware of
these political changes and respond to them effectively. When a country cuts
production on tobacco manufactures must either buy it from another source, or do
without. This harsh political and legal climate makes it difficult for new firms to enter
the industry. Firms who chose to enter the industry will want to be aware of the
changes in law, proposed changes in law, and governmental changes abroad.
Conclusion
As discussed earlier, they are several hurdles facing new entrants into the
tobacco manufacturing industry. First off, since tobacco is a worldwide industry small
firms would need an abundance of capital just to get started. Also, the two biggest
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firms hold a strong first mover advantage over the industry, making it tough for new
smaller firms to develop relationships with the major distributors of tobacco. Finally, the
legal barriers to enter the tobacco manufacturing industry are significant, with several
government regulations. There are many deterrents for firms wanting to enter tobacco
manufacturing. Therefore, the threat of new entrants has little effect on competition.
Large firms must instead focus on existing competitors.
Threat of Substitute Products
In any industry understanding the threat of substitute products is essential to be
competitive. According to Business Analysis and Valuation, “relevant substitutes are not
necessarily those that have the same form as the existing products but those that
perform the same function (Palepu and Healy pg. 2-4).” The tobacco industry is no
different from any other industry, so substitute products are obviously going to exist.
These products include nicotine gum, nicotine patches, and even caffeine for those
trying to quit tobacco products. But what is different about the tobacco industry, is that
tobacco contains nicotine which is highly addictive drug. Therefore, in the tobacco
industry the threat of substitute products is extremely low.
Buyers’ Willingness to Switch
The tobacco industry differs vastly from most industries in which the threats of
substitute products are a major concern. This is due to the fact that nicotine (which is
highly addictive) is in all tobacco products. According to quitsmoking.pharmacyrx.com,
“of the 44.5 million smokers in the world 70 percent say they want to quit smoking,”
but the majority of them are unable to because of the addictiveness of nicotine. This
fact usually deters customers from switching to other substitute products. But in some
cases when the customer decides to switch to substitute products they can run into
some high switching costs. For example, if a customer where to switch from a tobacco
product such as cigarettes or chewing tobacco to an alternative such nicotine gum or a
nicotine patch, the customer must be willing to pay a price difference up forty-five
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dollars. Therefore, because of the addictiveness of nicotine and the switching costs of
alternative products, the buyers’ willingness to switch is relatively low.
Relative Price and Performance
“Customer’s perception of whether two products are substitutes depends to
some extent on whether they perform the same function for a similar price (Palepu and
Healy pg. 2-4).” When customers are comparing substitute products of the tobacco
industry with actual tobacco, they are likely to find that these substitute products don’t
fulfill the same desired need as tobacco itself. For example, nicotine gum is not likely
going to give the customer the same “high” (performance) as smoking a cigarette or
dipping tobacco. Especially since the price of nicotine gum and the patch are sometimes
ten times the price of most tobacco products. Furthermore, this results in low relative
price and performance for customers switching to substitute products.
Conclusion
In today’s society the use of tobacco products is viewed negatively, which
therefore creates a big market for substitute products. These products include nicotine
gum, nicotine patches, nicotine lozenges, and even coffee and other caffeine products.
But because of the addictiveness of nicotine, most of these products pose little threat to
tobacco products. Also, most of these substitute products are ten times more expensive
than tobacco, resulting in high switching costs for the customers. In conclusion, even
though the market for substitute tobacco products is growing rapidly, the threat of
these products are extremely low to the tobacco industry.
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Bargaining Power of Customers
The bargaining power of customers determines the power customers have over
an industry. The more bargaining power a customer has determines how much
pressure is on the industry to lower their prices. When a customer has less bargaining
power, the industry can control and basically sell their product for any price they feel
necessary.
The tobacco manufacturing industry is composed of two major competitors
(Universal and Alliance), and several smaller competitors such as British America
Tobacco. These companies are all competing for the business of a few large tobacco
distributing companies such as Phillip Morris, Imperial Tobacco, Reynolds American, and
etc. This makes the bargaining power of these buyers extremely high. This is because if
either Universal or Alliance chooses to raise their prices, these companies could easily
switch suppliers which would result in a huge loss of sales for either of these
manufacturing firms.
Price sensitivity
“Price sensitivity is the extent to which price is an important criterion in the
customer's decision- making process (www.dictionary.com).” In an industry where the
products are similar and undifferentiated, such as the tobacco manufacturing industry,
customers will become more price sensitive and will switch suppliers if the
manufacturer’s prices are too high. Also, when the product is the major component of
the buyers business, they are more likely use a significant amount of resources to look
for the lowest possible price of their desired product.
Since the Tobacco Manufacturing industry is composed of two large companies
and several smaller companies’ price competition will be severe and will be dictated by
the few large tobacco distributing companies. Also, since the product that is being sold
is similar to the competitor’s product and switching costs are low, tobacco distributers
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will be able to regulate the prices of the product. This is because the tobacco
manufactures will be fearful of losing the business of one of the major companies,
which would result in a huge loss of revenue. Therefore, price sensitivity plays an
important role when determining the bargaining power of buyers.
Relative Bargaining Power
“The buyers’ bargaining power is determined by the number of buyers relative to
the number of suppliers, volume of purchases by a single buyer, number of alternative
products available to the buyer, buyers’ costs of switching form one product to another,
and the threat of backward integration (Palepu &Healy 2-5).” This results in several
problems for the tobacco manufacturing industry. First off, switching costs are low for
the customers so they are able to change buyers without it affecting their business.
Also, since there are only a few large buyers losing market share to a competitor could
be devastating to the business. Therefore the bargaining power of the buyers in this
industry is high.
Conclusion
There are several factors that contribute to how much bargaining power
customer’s have over an industry. The two most important are price sensitivity and
bargaining power. In an industry where there are only a few large customers and
where there is little product differentiation, the industry is going to be dominated by the
customers. This is the case in the tobacco manufacturing industry, where price
competition is highly competitive between the two major suppliers (Universal and
Alliance) and the several other small firms. For example, according to Universal’s 10-k,
“A material part of our business is dependent upon a few customers, the Altria Group
and Japan Tobacco including their affiliates accounted for more than 10% of the
revenues in the fiscal year 2008.” Also, “over 80% of our volume is derived from sales
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to a limited number of large, multination cigarette manufactures (10-k Universal).” In
conclusion, the bargaining power of customers is extremely high in the tobacco
manufacturing industry, because of the fear of losing market share to its competitors.
Bargaining Power of Suppliers
The bargaining power of suppliers is essential when analyzing an industry. In an
industry where there are many suppliers compared to customers, the bargaining power
of the supplier is low. This is because customers can switch suppliers easily at relatively
low prices if the products are similar and there are no substitutes. This results in
customers being able to demand lower prices, in fear that the supplier might lose their
partnership with the customer. In contrast, when an industry has few suppliers and
many customers, the bargaining power of the supplier is high. When this occurs
suppliers can set prices, because they know that the customers will have to buy their
product in order for the customers business’ to succeed.
Price Sensitivity
The price sensitivity of suppliers in the tobacco manufacturing industry is usually
low. The price sensitivity in this industry is low because tobacco is not a differentiated
product, meaning that there is hardly any difference between different crops of
tobacco. The price sensitivity is also low because there is thousands of suppliers
worldwide selling to only two major customers (Universal, Alliance) and to some other
small customers such as British American Tobacco. Since tobacco is grown worldwide
thousands of farmers contract with the buyers through yearly contracts to buy the
farmers entire production. Also, in some countries such as Canada tobacco is auctioned
off at public auctions. This results in customers being able to change suppliers with low
cost.
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Relative Bargaining Power
In the tobacco manufacturing industry, there are several thousand suppliers
worldwide producing the same commodity. Therefore, tobacco manufactures
(customers) such as Universal, Alliance, and British America Tobacco can pick and
choose between thousands of suppliers to get their desired product. Because of this,
suppliers to these huge manufacturing companies have very little bargaining power. If
they disagree with the manufacturers, then the companies can simply contract with
different farmers (suppliers) in over thirty-five different countries to achieve the same
product at the same or lower price.
Conclusion
The bargaining power of suppliers is important to firms when trying to gain
market share in an industry. In the tobacco manufacturing industry, the bargaining
power of suppliers is relatively low. This results from industry having thousands of
suppliers and only three major customers. For example, “in the tobacco manufacturing
companies provide agronomy services and season crop advances of seed, fertilizer and
other supplies to farmers (suppliers) (10-k Universal).” This results in the customers
being able to regulate the prices of the suppliers because of low switching costs and the
ease of access to new suppliers producing the same undifferentiated product.
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Value Chain Analysis
To summarize, the tobacco merchant industry in which Universal Tobacco
competes has the following characteristics: high rivalry among existing firms, a low
threat of new entrants, and a low threat of substitute products, high bargaining power
of customers, and low bargaining power of suppliers over the firm. Important factors a
low concentrated industry with strong growth, high economies of scale, established
supplier relationships through the financing of farms, established manufacturers
relationships, and low switching costs for customers. Firms that want to compete in
this industry must identify and focus on several factors if they want to succeed and be
profitable in this industry.
As discussed, there are many factors that contribute to a successful company.
Firms in this industry must focus their attention on cost leadership rather than on
differentiation. Although cost leadership is the main objective of the firm, it must also
differentiate its product slightly in terms of quality. Yes it is good to be the price leader.
But if another company has a superior product that is barely more expensive than your
terrible product, they will get the business. Most industries require either the cost
leadership approach or the differentiated product approach, which is true with this one,
but with a tiny bit of differentiation thrown in.
In order to compete in an industry, companies must go through activities that
add some type of value to the product they are selling. Companies must add a level of
value to its customers that exceeds their costs of adding the value. By looking at how
well a firm manages its value chain, people can see what factors play an important role
in an industry. By understanding these factors, they can tell whether or not the
competitive strategies are needed or not.
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Competitive Strategies
To be successful in the tobacco merchant industry, merchants must take
significant advantage of economies of scale, efficient production, low input costs, low
investment in research and development, and have tight cost controls while adhering to
the cost leadership approach. Being efficient in these factors will help a company to
ensure its success and profitability.
Economies of Scale
The highly competitive nature of the tobacco merchant industry demands that
each firm focus on its cost of production. Economies of scale are when firms reduce
their costs of selling a good by increasing purchases of their product. A firm must have
many factories and warehouses throughout the world in order to benefit from an
economy of scale. A firm must be able to produce a lot of tobacco in order to be able
to package and ship its tobacco at a lower cost to the firm. Also making their product
available at more than one warehouse or factory is a factor that can play an important
part in the company’s success.
Efficient Production
Efficiency in the production process is important tool that companies should if
they hope to be successful. Carrying excess goods in the warehouses has proven to be
costly because of the rate that tobacco becomes useless. If firms implement a just-in-
time inventory system it would greatly increase their production efficiency. There
would be no more wasted money on tobacco that they end up not being able to sell.
Also, a company can make their production process more efficient by financing the
farmers from which they buy the majority of their tobacco from. By financing these
farmers a company can have a guaranteed product when it comes time to process it.
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Low Input Costs
In order for a firm to be profitable, one of the most important aspects it can
focus on is maintaining low input costs. Some of the ways a company can do this in
this industry is by: keeping just in time inventory, maintaining a positive relationship
with the farmers that the firm finances, and by buying tobacco in large quantities.
Just-in-time inventory refers to keeping just enough tobacco in the firms’
inventory to take care of your manufacturers needs. By using this method for an
inventory strategy it eliminates unnecessary losses a company would experience from
possessing a product that is unsellable due to rotting of the tobacco.
Maintaining a positive relationship with the farmers a company finances is
another way to help lower input costs. By financing these tobacco farms with the firms’
money the farmers will sell the firm their product at a discount. This proves to be way
cheaper than buying the bulk of the tobacco out of warehouse auctions. Also, by
purchasing the product in bulk a firm can cut the costs of purchasing their tobacco that
will later be sold to many tobacco product manufacturers.
Low Investment in Research and Development
Little or no investment in research in development can prove to help firms be
successful by eliminating the unnecessary costs that come with it.
Tight Cost Control
Firms that have tight cost controls are generally very successful. By eliminating
unnecessary costs for the firm it will increase their gross profit. Outsourcing is a major
component that contributes to eliminating these costs in the tobacco merchant industry.
As mentioned earlier, companies can finance farmers to grow their product. Most of
the leaf tobacco produced comes from other countries so outsourcing is a good way to
lower the cost of goods bought from suppliers. Just in time inventory also helps with
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maintaining these cost controls. Firms that keep inventory only to the extent that is
needed to run their business will be profitable businesses. Also as previously
mentioned, having numerous warehouses and factories worldwide will help to cut down
on the expensive shipping costs associated with transporting tobacco. If firms in this
industry can maintain these three cost saving strategies they will have a good
foundation for having a tight cost control system.
Firm Competitive Advantage Analysis
When firms are trying to gain a competitive advantage within an industry they
use one of two different strategies. First, they could use a differentiation strategy in
which a firm tries to be unique in its industry with some dimension that is highly valued
by customers (Palepu and Healy pg. 2-9). They could also use the cost leadership
strategy, where a firm focuses on supplying the same product at a lower cost than its
competitors. This strategy is often the easiest way for a firm to gain a competitive
advantage in an industry where the product is similar to other competitor’s products.
Universal Corporation has adopted a cost leadership strategy to gain a competitive
advantage in the highly competitive tobacco manufacturing industry. Universal utilizes
several techniques such as economies of scale, efficient production, lower input costs,
little research and development, and a tight cost control systems to achieve a
competitive advantage over its competitors.
Economies of Scale
Universal company has invested in plants and machinery around the world. According
to Universal’s 2008 10-K, the company has 519 million dollars worth of equipment in 33
countries. This gives the company the ability to buy and process more tobacco than its
competition. Universal typically buys between 20 and 30 percent of the tobacco
produced in Brazil and 45 percent in Africa. Buying tobacco at this scale allows
Universal to fully utilize its plants and equipment. Universal has over 750 million dollars
worth of buildings and equipment on the balance sheet. Producing, packing and
shipping in large quantities allow Universal to save money on shipping costs and
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packing supplies. “Operating income of the Other Regions segment increased by $12
million, primarily due to increased volumes shipped from Europe and Asia.” (Universal
10-K p. 22) By having a presence around the world Universal increased its operating
income in 2008. Because of its size, infrastructure, and scale of production universal
has an advantage over other firms in the tobacco manufacturing industry.
Efficient Production
The processing of tobacco can be a complicated process. Universal Corporation
has been in the business since 1918 and utilizes new and efficient methods of curing
tobacco. The company also utilizes a just in time inventory system. The just in time
system keeps Universal from having to have a great deal of inventory on hand and
working capital tied up in inventory. Financing farmers is another method Universal
uses to produce products efficiently. This allows Universal to not be involved directly
with farming the tobacco but gives the company access to an alternative tobacco
inventory and reduces the risk of loss during market downtowns.
Lower Input Costs
Universal keeps its input costs low by financing farmers, and buying in bulk. By
financing farmers directly Universal has some control over their price of tobacco. “The
company provides agronomy services and seasonal advances of seed, fertilizer, and
other supplies to tobacco farmers.” (Universal’s 10-K p. 41) The company offers
financing in exchange for low prices and exclusive buying power. Advances to suppliers
made up 7% of total assets in 2008. This allows the company to have greater access to
cheap tobacco. Buying tobacco on a large scale is another way Universal lowers input
costs. Buy buying in bulk Universal gets a better price on fresh tobacco than smaller
competitors. Suppliers know that by giving Universal a good price they will have a
guaranteed buyer for their product.
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Research and Development
Universal has not invested in research and development in the last three years.
This allows the company to use its resources to invest in other projects.
Tight Cost Control System
Universal balances its inventories around the world by outsourcing their inputs.
Rather than buying all of the tobacco from one market Universal buys tobacco from
markets around the world. The company is able to do this because it owns or leases
tobacco storage facilities in 35 different countries. This allows for universal to minimize
loss when crops in a given geographic region. But sometimes this can lead to problems.
According to Wall Street Journal, “A reduction in the area of cropland worked by its
suppliers in places such as Mozambique, Malawi, and Canada declined, led to lower
tobacco yield, and shipments of processed tobacco came in sooner than expected in
prior quarters, leaving a shortfall (WSJ May 23rd, 2008).” Also, According to CEO
George Freeman, “Farmer leaf production costs, and therefore the prices we pay for
green tobacco, are increasing with the price of most other agricultural products (WSJ
May 22nd, 2008).” When costs go up in one area Universal can access suppliers
somewhere else. This forces suppliers to compete internationally which drives the price
of tobacco down and increases Universals control over its costs.
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Accounting Analysis
In the United States companies are required to present financial information
according to generally accepted accounting principles or GAAP. The principles are
flexible because different industries account for transactions in different ways. This
flexibility makes it possible for managers to use accounting methods to distort financial
statements and thus distort the value of the firm. The goal of accounting analysis is to
understand specific firms accounting policies and how these policies effect information
presented in the financial statements. It is then necessary for financial analysts to
carefully evaluate whether or not managers have used accounting to manipulate the
financial statements and thus the value of the firm. There are six steps to analyzing the
quality of accounting information presented in financial statements.
The first step is to identify principal accounting policies associated with the firm.
According to Palepu and Healy, “in accounting analysis the analyst should identify and
evaluate the policies and estimates the firms uses to measure its critical factors and
risks.”
The second step in the accounting analysis process is to assess the accounting
flexibility of the firm. There are several ways a firm can manipulate their financial
statements, by using accounting flexibility. For example, when a firm is deciding how
big the pension plans are going to be, they could change the discount rate, which could
result in lower expenses for the company therefore causing higher net incomes for the
year. Therefore accounting flexibility is important to review when analyzing a firm.
The third step in the accounting analysis is evaluating the accounting strategy.
For example, “when mangers have accounting flexibility, they can use it either to
communicate their firm’s economic situation or to hide true performance (Palepu and
Healy 3-8).” This can result in managers (who are under a lot of pressure for the firm to
post higher profits) distorting information to reach profit targets. This is why it is
essential to evaluate the accounting strategy.
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The fourth step is to evaluate the quality of disclosures. Today in business,
companies have the right to disclose as much or as little information as they choose to.
This is why it is important to evaluate the quality of the disclosure to get a better
understanding of the firms accounting policies.
The fifth step is to identify potential red flags. Unexplained changes in
accounting policies and/or financial numbers could mislead the public about the value of
the firm. This is why it is important to identify these red flags when evaluating a firm.
This leads to the final step of accounting analysis which is undo accounting distortions.
When a red flag is identified it is important for a firm to analyze these red flags and
change their financial statements to adjust for the red flags.
Accounting analysis is important when analyzing a firm because it can point out
the errors in accounting associated with the firm. This can therefore, lead to a better
and more accurate valuation of the firm.
Key Accounting Policies
Looking at the key success factors and how Universal discloses these factors in
the accounting policies gives a clearer view of possible misrepresentations in Universal’s
financial statements. The company can distort figures to make the company look more
profitable to the stockholders. The company can choose to accurately disclose these
factors or it can choose to take aggressive accounting measures that distort figures to
obtain company and/or management objectives. As stated earlier, Universal’s key
success factors are economies of scale, efficient production, lower input costs, little
research and development, and a tight cost control system. These factors help show
where possible distortions may exist. Accounting policies that may distort the value of
the company by the way they are recorded include: goodwill, the application of
operating or capital leases, and disclosure of pension plans and other postretirement
benefits. GAAP has minimum requirements for disclosure on financial information which
allows for flexibility in the reporting of this information.
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Goodwill
By creating economies of scale, Universal Corporation has been able to acquire
companies and add their assets to Universal’s portfolio. Often the book value of these
assets is smaller than the price paid by Universal because of the potential for future
earnings. Universal accounts for these future cash flows with goodwill, an asset
reported on the balance sheet. According to Wikipedia “goodwill is an accounting term
used to reflect the portion of the market value of a business entity not directly
attributable to its assets and liabilities; it normally arises only in case of an acquisition.”
This means that acquired companies are often worth more than just the amount of
their physical assets. As a result of acquiring smaller companies, large corporations
such as Universal can have a substantial amount of goodwill on its balance sheet. This
can greatly affect the value of the firm because goodwill can represent a large portion
of firm’s assets. As shown below goodwill is not a major portion of Universal’s assets.
Universal’s Goodwill
**in thousands**
The reason this needs to be carefully considered is because goodwill is an
intangible asset, one that cannot be touched or measured. This naturally gives rise to
questions about the amount of value attached to these assets. Goodwill used to be
amortized over a maximum of 40 years. However, the Financial Accounting Standards
Board now requires that goodwill be valued and adjusted each year. The value of
goodwill is found by taking the present value of future cash flows. It is up to
management to determine an appropriate growth rate and discount rate when
2003 2004 2005 2006 2007 2008 Goodwill 132,903 134,664 138,053 136,130 104,284 106,647 % of LTA 15.31% 14.08% 12.59% 12.39% 13.31% 14.87% % of TA 5.93% 5.42% 4.78% 4.69% 4.48% 5%
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calculating present value. Thus, the policy of the management with respect to the
discount rate can materially affect the value of the firm.
Operating Leases
A lease is an agreement between two separate parties that allows one party to
possess an asset (lessee) that is owned by another party (the lessor) for an agreed
period of time. In one case, the lessee uses the asset provided by the lessor but pays
payments to use these assets. Once the term of the lease is agreed upon it cannot be
terminated. The Federal Accounting Standards Board (FASB) acknowledges two
separate types of leasing agreements. There are capital leases and operating leases. A
capital lease is when the lessee enters into a long term contract with a lessor that has
an end result of the lessee paying off the price of the asset and therefore becoming the
owner of that asset. Capital leases have the same structure as loans do, where the
lessee pays principal plus interest throughout the entire life of the lease. Unlike capital
leases, operating leases are more like rent payments on an apartment. No exchange of
ownership will take place with operating leases. Also because there isn’t an exchange
of assets, it is classified as rent expense and does not show up on the balance sheet. If
Universal were to record their operating leases as capital leases this would overstate
assets and liabilities on the balance sheet.
An operating lease is a lease that is relatively short-term compared to the useful
life of the asset being leased. Because they are short term, they are primarily used in
companies that are always replacing or updating equipment. However, if a firm uses
operating leases when a capital lease is more logical, then the firm’s assets and
liabilities will both be understated on the balance sheet. Universal Corporation uses
operating leases only when needing to find more resources to continue or expand
operations. Some of the leases have options to extend the lease term at the current
market rate. “Operating lease obligations represent minimum payments due under
leases for various production, storage, distribution, and other facilities, as well as
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vehicles and equipment.” (Universal Corporation 10K 2008) Future operating lease
expenses are in the graph below.
Operating Leases to Forecasted LTL and LTA
2009 2010 2011 2012 2013 % of LTL 2.15% 1.5% 1.17% .51% .11% % of LTA 1.95% 1.39% 1.12% .5% .12%
As shown in the chart above, Universals operating leases are not a significant
percentage of long term liabilities or assets when compared to forecasted future long
term liabilities and assets.
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Pension and Postretirement benefit plans
“A pension is a steady income given to a person usually after they retire.
Pensions are typically payments made in the form of a guaranteed annuity to a retired
or disabled employee (Wikipedia.com).” Pension plans are recorded as an expense and
are located in the liability section of the balance sheet for companies. Any small change
in the estimations of the pension plans can result in drastic changes throughout the
income statement and balance sheet.
Universal has made some drastic changes to its pension and postretirement plan
recently. Universal adopted the recognition and disclosure provision effective March 31,
2007. This changed the way in which the company reports its pension’s plans in the
balance sheet. “Under SFAS 158, actuarial gains and losses and prior service costs
continue to be deferred and recognized in expense over future periods, but the
overfunded or underfunded status of the defined benefit plan is now measured as the
difference between the fair value of plan assets and the projected benefit obligation.
This difference is recorded as an asset if overfunded and as a liability if underfunded,
with a corresponding adjustment to accumulate other comprehensive loss, net of tax
(Universal 10-k).”
The determination of our pension and postretirement benefit plans are
dependent on several assumptions made by the Universal Corporation. “These
assumptions include estimation the present value of projected future pension payments
to all plan participants, taking into consideration the likelihood of potential future events
such as salary increases and demographic experience (Universal 10-k).” The pension
and postretirement plans are calculated using a variety of assumptions such as the
salary scale, expected long-term on plan assets, retirement and mortality rates,
healthcare cost trend rates, and the discount rate. First off, salary scale is estimated
using the long-term actual experience of salary increases, and the expected growth of
inflation in the future. Secondly, the expected long-term return on plant assets is
determined by the asset allocations and investment strategy used by the Pension
41
Investment Committee. Morality and retirement rates are based on past experiences.
Furthermore, healthcare cost trend rates are made on assumptions of future inflation
rates in the medical field. Finally and most importantly are the discount rates, these are
“based on investment yields on a hypothetical portfolio of long-term corporate bonds
rated AA that align with the cash flows for our benefit obligations (universal 10-k).”
These assumptions used by Universal can be extremely difficult when estimating for the
future.
Changes in Assumptions of Pensions and Postretirement Plans
(in thousands of dollars)
Effect on 2008 Projected
Benefit Obligation Increase (Decrease)
Effect on Annual Expense
Increase (Decrease) Changes in Assumptions for Pension Benefits 1% increase in discount rate $ (25,287 ) $ (2,656 ) 1% decrease in discount rate 30,684 3,996
1% increase in salary scale 7,879 2,629 1% decrease in salary scale (8,258 ) (2,380 )
1% increase in long-term rate of return on assets N/A (3,022 ) 1% decrease in long-term rate of return on assets N/A 3,021
Changes in Assumptions for Other Postretirement Benefits 1% increase in discount rate (4,096 ) (246 ) 1% decrease in discount rate 4,861 (64 )
1% increase in healthcare cost trend rate 1,159 110 1% decrease in healthcare cost trend rate *Chart information received from universal 10-k*
As shown in the figure above a mistake in any of the calculations even by one
percentage point can results in huge differences for the company. For example, if the
company understates the discount rate the liabilities will be overstated; in contrast if
they overstate the discount rate the liabilities will be understated. This results in the
estimates of pension and postretirement to be a critical accounting policy of the tobacco
industry because any estimation mistake can result in huge changes that effect the
financial statements of a company. For example, if the discount rate is estimated at 5%
and in actuality it is only 4% then the liabilities for Universal will be understated by
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25.287 million dollars, and the expenses will be understated by 2.656 million. This
would result in net income being overstated by at least 2.656 million dollars.
Conclusion
After analyzing Universal’s key success factors (economies of scale, efficient
production, lower input costs, little research and development, and a tight cost control
system), we determined some of their key accounting policies go hand in hand with the
key success factors. These include goodwill, operating leases, and pension and other
postretirement plans. After reviewing the accounting policies used when recording
goodwill, operating leases, and pension and other postretirement benefit plans,
Universal uses proper accounting policies to record their financial statements.
Degree of Accounting Flexibility
Every company, when preparing its financial statements has to follow the
General Accepted Accounting Principles (GAAP) put out by Financial Accounting
Standards Board (FASB). These principles give each company guidelines to follow when
preparing their financial statements. But there is plenty of flexibility within these
principles that firms can use to their benefit when preparing the financial statements.
Since managers of the corporation get to decide how to use this flexibility, sometimes
they can use this in key account policies to distort their financial statements to make
their firm seem more profitable than it really is. Some areas in which Universal can use
this flexibility are discussed in further detail below.
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Goodwill Flexibility
Firms have significant flexibility when accounting for goodwill. The value of
goodwill is tested annually for impairment. Impairment occurs when the present value
of future cash flows is lower than the amount of goodwill currently carried on the
balance sheet. The management of Universal Corporation is in charge of valuing the
future cash flows of its acquired business units. In order to value future cash flows the
managers must make two very important estimates, the growth rate of the cash flows
and an appropriate discount rate. According to Universal’s 10-K “Neither a one-
percentage-point increase in the discount rate assumption nor a one-percentage-point
decline in the cash flow growth rate assumption would result in an impairment charge”
(p. 33). This means that if there was more than a one percent decrease in the growth
rate of the cash flows goodwill could be impaired and thus overstated on the balance
sheet.
Universal’s Goodwill
**in thousands**
As shown in the chart about Universal has seen their goodwill go down as a
percentage of assets from 2003-2007. The substantial decrease from 2006 to 2007
resulted from Universal selling off its agri-product and lumber companies. Universal
Corporation however, recorded no charge against goodwill in 2008.
2003 2004 2005 2006 2007 2008 Goodwill 132,903 134,664 138,053 136,130 104,284 106,647 % of LTA 15.31% 14.08% 12.59% 12.39% 13.31% 14.87% % of TA 5.93% 5.42% 4.78% 4.69% 4.48% 5%
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Degree of Operating Lease Flexibility
Operating and capital leases play a vital part in determining how accurate a
firm’s financial statements are. Assets and liabilities are seen in two separate ways on
the balance sheet depending on which type of lease a firm chooses to use. In an
operating lease, the lessee does not assume any of the risk of ownership so the lease
expense goes down as an operating expense on the income statement and has no
effect on the balance sheet. In a capital lease, the lessee assumes some of the risk of
ownership as well as some of the benefits. The lease is recognized both as an asset
and a liability on the balance sheet. Because of the little risk associated with operating
leases, they also pose less of a threat to the company than do capital leases.
The top firms in the tobacco merchant industry choose their leases in one of two
ways. The first way is by only having operating leases and no capital leases, like
Universal. The other way is by having both operating and capital leases, as do British
American and Alliance One. Alliance One uses operating leases for land, buildings,
automobiles, and equipment. They use capital leases for assets they believe to have
long-term continuing benefit and therefore should be purchased. As stated above,
Universal Corporation only uses operating leases for its operations. Rent expense on
Universal’s operating leases totaled $17 million in 2008, $12.3 million in 2007, and $8.9
million in 2006. “The company also has future minimum payments under non-
cancelable operating leases of $16.6 million in 2009, $12.7 million in 2010, and $10.9
million in 2011.” (Universal Corporation 10K 2008) Universal had total assets in 2007
equaling $2.33 billion. Universal Corporation’s two main competitors, British American
and Alliance One, had total assets of $36.85 billion (18.728 billion pounds) and $1.65
billion.
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Operating Leases to Total Liabilities and Total Assets
**numbers in millions except for percentages**
As shown in the chart above, rent expense on Universal’s operating leases have
historically been a small percentage of the firm’s long term liabilities and assets. As
shown in a previous chart, Universal’s operating lease expenses will continue to remain
constant as a low percentage of long term liabilities and assets.
Unlike Universal using only operating leases, both British American and Alliance
One use both capital and operating leases. Universal Corporation only uses operating
leases, so no expenses are recognized on the balance sheet. This causes the firm’s
assets and/or liabilities to be understated. When this happens it causes net income and
retained earnings to be overstated. When retained earnings are overstated it causes
the company to look more profitable than what it really is. This isn’t such a bad thing
when you know that investors are more inclined to invest in highly profitable firms.
Universal’s choice of only using operating leases gives them little flexibility when
choosing a lease to apply to their financial reports.
2003 2004 2005 2006 2007 2008
Lease Exp 11 9.5 13.3 8.9 12.3 17
% of LTL 1.38% .97% 1.26% .91% 2.05% 2.77%
% of LTA 1.27% .99% 1.21% .81% 1.57% 2.37%
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Pension and Post retirement plans
Pension and other postretirement benefit plans are reported as major liabilities
on a firm’s balance sheet. To determine the amount reported to be reported as a
liability an any given year, universal uses a variety of assumptions such as discount
rate, salary scale, expected long-term return on plan assets, retirement and mortality
rates, and healthcare cost trend rates. These assumptions are determined by universals
management team. Meaning management could determine the flexibility of these
numbers on a year to year basis, based on how the company is performing in any given
year. Below is a chart showing how a change in a simple percentage point in any of the
assumptions could affect the company’s balance sheet. For example, if universal was
having a terrible year, management could decide to overstate the discount rate. This
would result in liabilities being understated along with expenses, which therefore would
make the company look more profitable in the given years.
Changes in Assumptions of Pensions and Postretirement Plans
(in thousands of dollars)
Effect on 2008 Projected
Benefit Obligation Increase (Decrease)
Effect on Annual Expense
Increase (Decrease) Changes in Assumptions for Pension Benefits 1% increase in discount rate $ (25,287 ) $ (2,656 ) 1% decrease in discount rate 30,684 3,996
1% increase in salary scale 7,879 2,629 1% decrease in salary scale (8,258 ) (2,380 )
1% increase in long-term rate of return on assets N/A (3,022 ) 1% decrease in long-term rate of return on assets N/A 3,021
Changes in Assumptions for Other Postretirement Benefits 1% increase in discount rate (4,096 ) (246 ) 1% decrease in discount rate 4,861 (64 )
1% increase in healthcare cost trend rate 1,159 110 1% decrease in healthcare cost trend rate (1,025 ) (98 ) *Chart from Universals 10-k*
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When looking at prior discount rates, Universal seems to have little change in the
percentages of any of the assumptions in recent years. As shown in the charts below,
Universal has been using a smaller discount rate compared to Alliance resulting in more
liabilities and expenses in fiscal years for Universal. In conclusion, since the numbers of
the assumptions dealing with pension and postretirement plans are determined by
management, flexibility in these assumptions could possibly result in future problems.
Chart of Discount Rates for past 5 years of Tobacco Manufacturing Competitors
Discount
Rate
2003 2004 2005 2006 2007
Universal 6.25% 6% 5.75% 5.75% 5.5%
Alliance 6% 6% 5.75% 6.00% 5.9%
Conclusion
General Accepted Accounting Policies (GAAP), allow for firms in different
industries flexibility when reporting financial statements. This allows firms to give a
more in depth view of the firm for investors. But sometimes management will take
advantage of this flexibility to generate falsification of numbers to make their firm look
more profitable in down years and even sometimes less profitable in good years. But
overall, Universal’s seems to use its flexibility reasonably. For example, as stated
previously they have maintained steady rates when valuing the pension and other
postretirement plans, which helps maintain steady liabilities and expenses. Also, they
only use operating lease. Overall, they use their flexibility to illustrate a true value of
their firm.
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Accounting Strategy
The accounting strategy of a firm can vary significantly. An analyst must
determine the amount of disclosure in financial statements to successfully value a firm.
Firms can fully disclose all accounting information, conceal information, or use both to
manipulate the view of the company. A conservative accounting strategy can lead to
higher expenses, lower revenues and lower reported earnings while an aggressive
accounting strategy can have the opposite effects. GAAP requires a minimal level of
disclosure that all firms must have but it is up the analyst to determine the firms
accounting strategy and the subsequent effect on the value of the firm.
Goodwill
Goodwill as a percentage of assets has steadily declined over those six years as
well. In 2007 Universal wrote off almost 32 million dollars from goodwill. Other firms in
the industry have taken similar action. For example, Alliance One wrote off over 113
million dollars of goodwill in 2006. These indicate that companies in the tobacco
manufacturing industry are using a very conservative strategy to account for goodwill.
These large write downs understate the value of assets and overstate a firm’s
expenses. Using this strategy allows firms to show turnarounds in following years. For
example, in 2008, Universal did not right down any charge against goodwill. This shows
that the value charged against goodwill was too large in 2007 and assets were
understated. Firms do this to overstate expenses and understate net income allowing
them to show a turnaround when they hit their earning the following year.
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Changes in Goodwill 2003-2008
2003 2004 2005 2006 2007 2008 Change in GW 7,634 1,761 3,389 -1,923 -31,846 2,363
**in thousands**
The chart above shows the changes in goodwill for Universal for the past 6
years. The negative change in 2006 is the result of Universal selling their lumber and
building products operations and a portion of their agri-products operations. The
remainder of Universal’s agri-products operations was sold in 2007. This is the cause of
the negative change in goodwill for that year.
Operating Leases
A large amount of Universal’s cash flow is used to cover their operating lease
obligations. This limits the extra cash flow Universal has for numerous operations. The
lack of cash causes a reduction in the working capital that Universal could use to build
additional storage warehouses and processing facilities. It also limits the amount of
money Universal can use to finance farmers and fund other endeavors. This will cause
high leverage and limits Universal’s ability to adjust to economic and industry
conditions.
Managers often prefer to use operating leases rather than capital leases because
it keeps the leases off of the balance sheet. This is considered an aggressive
accounting strategy, which understates the assets and liabilities. Managers often record
leases as expenses instead of liabilities to make their current asset ratio more appealing
to investors in the company. Universal’s financial statements reflecting their leases are
inaccurate because they only deal with operating leases. This allows the company to
recognize these lease payments as a rent expense. Not recognizing these rent
expenses as a liability will cause an understatement of the firm’s liabilities and assets.
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Pension and Postretirement Plans
Some sort of pension or other postretirement benefit plan is provided to its
employees at almost all major corporations. These are funded by the company and are
a huge liability for the company in its balance sheet. Universal Corporation sponsors
several defined benefit plans covering all U.S. employees and certain employees in
foreign countries. As mentioned earlier several assumptions are calculated by
management in order to obtain the present value of these pension and other
postretirement benefit plans. One of the most important assumptions in garnishing the
value of these plans is the discount rate. The lower the discount rate the higher the
liability the firm recognizes each year. Therefore firms with a more aggressive
accounting policy could intentionally raise the discount rate, which therefore would
result in higher profits and less liabilities for a company in the given years.
As shown in the chart below, Universal’s discount rate has been steadily
decreasing over the past five years. Also, Universal’s discount rate has been lower than
its main competitor (Alliance) in all but one of the past five years. By using a lower
discount rate than its main competitor, Universal has recognized higher liabilities and
expenses in the given years, resulting in lower net income and less profitability. The
differences between the two company’s discount rates could result from either
aggressive account strategies by Alliance (or conservative accounting strategies by
Universal) or just different calculations of the present value of the pension plans. But
for whatever reason, Universal’s financial statements look less distorted than Alliance
when dealing with pension and postretirement benefit plans.
Chart of Discount Rates for past 5 years of Tobacco Manufacturing Competitors
Discount
Rate
2003 2004 2005 2006 2007
Universal 6.25% 6% 5.75% 5.75% 5.5%
Alliance 6% 6% 5.75% 6.00% 5.9%
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Conclusion
Accounting strategies are extremely important when valuing a firm. This is
because managers have incentives to distort financial statements to make their firm
look more profitable than it really is. When analyzing Universal, we discovered that they
tend to have a somewhat conservation accounting policy. For example, they utilize
smaller discount rates then competitors when calculating pension plans. This results in
higher liabilities and expenses for Universal. In conclusion, Universal uses fairly
conservative accounting policies when recording financial statements.
Qualitative Analysis
In order to effectively analyze financial statements the company must have a
certain level of transparency. A qualitative analysis is used to analyze how well
management discloses the business realities of the firm. As indicated above firms can
implement accounting strategies that can distort their true economic picture. Universal’s
Management gives quality insight into how goodwill, pensions, and operating leases are
estimated.
The quality of disclosure that Universal utilizes within its 10-k is decent for
goodwill. Universal explains in somewhat detail how to calculate goodwill when they
purchase other businesses. Universal, also explains in detail why they wrote off goodwill
in the years that it was impaired. But they fail to explain why no goodwill was written
off in 2008, which can be confusing when analyzing the financial statements. They also
don’t explain why goodwill is not impaired on a yearly basis. But overall, they provide
enough information to get a decent understanding of their impairments of goodwill.
The quality of disclosure that Universal uses for operating leases with in its 10-k
is good. They explain in detail how much their operating leases each year are and
provide information about future operating lease obligations and the cost of these
future operating leases. For example, Universal will incur non-cancelable operating
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leases of 16.6 million in 2009, 12.7 million in 2010, 10.9 million in 2011, 5.3 million in
2012, and 1.4 million in 2013. In, conclusion, Universal provides good qualitative
disclosures when dealing with operating leases, because it breaks down the amount of
rent expense on the leases per year and also provides future breakdowns of the leases.
Finally, the quality of disclosures that Universal utilizes for pension plans within
the 10-k is excellent. They discuss in-depth all the estimates used when calculating the
pension plans. Also, they explain how each of the estimates is calculated, and who
calculates these estimates. Furthermore, they explain how a 1% change in these
estimates would affect the liabilities and the expenses of the pension plans. The only
flaw is that they do not provide future rates at which they expect the pension plans to
grow.
Overall, Universal does a fair job when disclosing qualitative information. The
financial statements disclose the discount rate, how it is estimated, and what would
happen if the estimation was off. The company also goes into detail about assumptions
and estimates for valuing inventories, advances to farmers, and income tax liability.
Management also shares honest predictions about demand and supply conditions in the
future and the resulting effect on the tobacco manufacturing industry. When comparing
Universals 10-K to its primary competitors the amount of disclosure is almost identical.
Quantitative Analysis
Quantitative analysis helps financial analysts get a better understanding of a
firm’s value by looking at several ratios. These ratios’s can help indicate the actual
value of the firm, and also illustrate some of the accounting policies used by firms. In
different industries, firms use a variety of flexibilities in accounting to better illustrate
the financial status of the firm through their financial statements. Generally Accepted
Accounting Principles (GAAP), regulate the amount of flexibility allowed when preparing
these financial statements. But sometimes management of companies will take
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advantage of these principles to paint a better picture of their financial status to
investors. This makes it important to carefully analyze the numbers on the financial
statements, to determine if the information is accurate.
There are two diagnostic categories that help analyze a firm’s numbers on the
financial statements. The first category is the sales manipulation diagnostics. These
diagnostics compares net sales to several other factors including cash from sales,
accounts receivable, unearned revenue, and inventory to try to paint a better picture of
the firm. These ratios can help diagnose problems, and find areas in which
management manipulated some numbers in order to benefit the firm’s profitability. The
second category is expense diagnostics. These ratios will analyze expenses of the firms
and will point out suspicious changes in expenses that seem unrealistic and/or
manipulated. These diagnostics will help us determine the accuracy of numbers located
on the financial statements of the firms we are evaluating.
Sales Manipulation Diagnostics
Sales manipulation diagnostics are ratios that help to determine if the reported
revenues of the company are credible. These ratios will help to identify distortions in
the accounting numbers of the firm and will also reveal any flaws when looking at sales,
accounts receivable, and inventory for the past six years. Looking at these ratios for
only one year is not a clear representation of how well the company is performing. But,
comparing them over the past 6 years helps us to notice trends and abnormalities that
may raise some “red flags”. Universal’s sales manipulation diagnostics ratios will be
compared to those of its’ main competitor, Alliance One International Inc. This will
allow us to see if the ratios are company specific or if they are similar throughout the
tobacco merchant industry.
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Net sales/Cash from sales
The ratio of net sales to cash permits us to determine the amount of sales that
are supported by the cash that is collected from sales. Cash from sales is computed by
taking the difference in net sales and the change in accounts receivable. The net sales
is then divided by the cash from sales to get this ratio. This ratio is significant because
it shows how much cash a firm is getting from its sales. A (1:1) ratio is very good and
means that the firm is doing a great job of collecting on its accounts receivable. A ratio
of less than one is a sign that the company is having some difficulty collecting their
accounts receivable.
The ratio of net sales to cash from sales graph below shows that Universal has
been around one for the past six years. This is good for the company and means that
they are doing a great of collecting from sales made in a short amount of time. The
numbers more than one from 2003 to 2005 are made possible by collected on sales
made in a previous period. Being efficient in collecting from sales made appears to be
an industry-wide characteristic with Alliance also having a ratio at or close to one for
the past 5 years.
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Net Sales/Net Accounts Receivable
The net sales to accounts receivable ratio is also known as the accounts
receivable turnover ratio. This ratio allows us to tell if the company’s revenue from
sales is supported by their accounts receivable. If there is an increase in sales over
time then there should be an increase in accounts receivables over that same period.
By comparing Universal’s accounts receivable turnover ratio to that of the industry, you
notice that they have relatively similar numbers. There is also a noticeable trend when
comparing Universal’s ratios to Alliance’s ratio. Each of the firms had a decrease in
their accounts receivable turnover ratio in 2004 and have been steadily climbing since
then.
When comparing Universal’s sales and accounts receivables there is no direct
relationship. During the past six years there is a number of times when Universal’s
sales would increase or decrease without the accounts receivable doing the same. This
means that Universal’s sales are not supported by their accounts receivable and is a
“red flag” for the company.
2003 2004
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Net Sales/Unearned Revenue
The sales to unearned revenues ratio is used to determine how much of a
company’s sales are obtained through unearned revenue. The higher the value of this
ratio the better because this means that the company is earning most of its sales and is
not liable to provide its goods to customers who have already paid for it. In this
industry this would consist of a tobacco products manufacturer paying for the leaf
tobacco before actually receiving it.
Excluding 2007, this ratio has been consistently higher than the industry’s ratio.
This ratio has skyrocketed in the past year despite only a slight increase in sales. This
can be attributed to the fact that Universal decreased its unearned revenue by 112
million from 2007 to 2008. Because of the reason for this sudden increase in the ratio
there is no need for a “red flag” to be raised.
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Net Sales/Inventory
This ratio is significant in the tobacco merchant industry. The fast pace that the
tobacco spoils and the cost of storage make holding an excess amount of product very
costly to the company. In order to see whether or not the company’s inventory
supports its sales, you must compute the net sales to inventory ratio. An increase in
this ratio would be related to a firm increasing its sales, which would decrease
inventory. The past six years show no relationship between Universal’s and the
industry’s sales to inventory ratio.
With the exception of 2003, Universal’s sales and inventory have either increased
or decreased together. This means that if sales go up, so does the inventory, or vice
versa. Because this is an industry-wide characteristic of firms in the tobacco merchant
industry, there is no indication of a potential red flag when examining the inventory
turnover.
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Net Sales/Warranty Liabilities
Despite extensive research, no warranty liabilities were found for the company or
its competitors, therefore, it cannot be computed.
Conclusion
The revenue diagnostic ratios raised one “red flag” for Universal Tobacco. The
one red flag had to do with Universals sales to accounts receivable ratio. The problem
is that Universal’s revenue from sales is not supported by their accounts receivable.
Sales and accounts receivables should move in the same direction as one another as
well as in the same proportion to one another and Universal’s do not. Universal did
outperform the industry when comparing net sales to unearned revenues and net sales
to inventory. Universal does move with the industry in terms of the sales to cash from
sales ratio. Universal and the industry had a consistent ratio of about 1.
Core Expense Manipulation Diagnostics
The core expense manipulation diagnostics are ratios used by financial analysts
to determine the accuracy of business expenses recorded in the financial statements.
We will look at these ratios for the past six years for Universal and the past five years
for Alliance(because there 10-k has not been completed for 2008). Looking at these
ratios for only one year is not a clear representation of how well the company is
performing. But, comparing them over the past 5 to 6 years helps us to notice trends
and abnormalities that may raise some “red flags”. Universal’s core expense
manipulation diagnostics ratios will be compared to those of its’ main competitor,
Alliance One International Inc. This will allow us to see if the ratios are company
specific or if they are similar throughout the tobacco merchant industry.
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Asset Turnover
According to investopedia.com, “Asset turnover measures a firm's efficiency at using its
assets in generating sales or revenue - the higher the number the better.” Asset
turnover is derived by taking sales divided by total assets. The asset turnover over time
should remain constant. This is because the more sales a firm is generates the more
assets the firm should acquire. Universals asset turnover ratio has been fairly
inconsistent over the past six years. This could have resulted from Universal’s failure to
depreciate its long term assets appropriately.
Over the past six years Universal’s ratio has only remained fairly constant for one
period (between 2005 and 2006). In contrast, during the other four periods the ratio
has increased or decreased by at least .23. This could raise some potential red flags,
but most of these periods are explained by their 10-k. For example, between 2003 and
2004 the asset turnover dropped from 1.18 to .91, this resulted from sales decreasing.
But this can be explained because in 2004 Universal switched its fiscal year end to
March 31st, which resulted in 2004 only having nine months of sales calculated. Also
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between 2006 and 2007, the ratio dropped from 1.21 to .86, this resulted from sales
dropping 42.8% and assets only dropping 19.7%. But this can also be explained,
because in September 2006, Universal sold its lumber and agri-product companies.
Therefore, despite the irregular fluctuations in the asset turnover ratio, we conclude
that there were no inaccurate accounting policies, because these fluctuations can be
explained by Universals 10-k’s.
CFFO/OI
This ratio is derived by taking your cash flow from operations and dividing it by
your operating income. Ideally this ratio should be around one. But that is not the case
when analyzing the tobacco manufacturing industry. For example, between 2003 and
2005 Universal had three consecutive negative ratios. This resulted from negative cash
flow from operations in those three years. But Universal was quick to rebound and in
the following three years reach a high of 1.5 in 2007. This most likely resulted from
them selling their other businesses not related to tobacco, which resulted in 36.059
million dollars in net income from discontinued operations. Overall, despite being
consistent, most of the changes in the ratios are explained by the 10-k’s of Universal,
resulting in no red flags.
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Pension Expense/SG&A
The pension expense divided by selling general and administrative expenses
illustrates how much of the SG&A is composed of the pension expense. This is critical
because if there are drastic changes in this ratio from year to year it could result in the
understating pension expenses. If this were the case, then it would be a potential red
flag, because pension’s expenses are estimated by management (meaning that
management could understate the pension expense which would overstate net income).
But even if it did change drastically it would have hardly any effect on net income,
because the pension expense is extremely small compared to selling general and
administrative expenses. Overall, this ratio has remained constant and actually has
increased slightly over the last two years, resulting in no potential red flags.
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Conclusion
After reviewing the core expense manipulation diagnostics, no faulty accounting
policies were found to be used by Universal. After examining all the ratios carefully, we
found some suspicious numbers, such as the erratic movements in asset turnover. But
these movements can be explained because of Universals drastic changes over the past
five years (such as selling businesses and changing fiscal years). Also, most of the
erratic movements by Universal are also reflected by the industry. Therefore, no
potential red flags were identified when analyzing the expense ratios.
Potential Red Flags
Accounting policies vary across industries so it is important to compare firms who
compete in the same industry when comparing ratios. In a given industry any large
variance needs to be carefully considered. These “red flags” can often be attributed to
changes in accounting policy; however, red flags can also be evidence of manipulation.
It is important to distinguish between the two in order to accurately value a company.
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Based on the last five years of Universals financial statements we have identified
one possible red flag. The red flag that was found was net sales/ accounts receivable.
Net sales and accounts receivable are supposed to reflect each other and move
together. For example, if one decrease the other should decrease and visa versa. But in
Universal’s case accounts receivables did not follow the trend of sales. Whenever a red
flag appears it is important to analyze it and decide if it is a manipulation of accounting
policies (and if it is the financial statements need to be fixed immediately) or can it be
verified by disclosures. For Universal the red flag can be varied by the disclosures in the
10-k.
Undo Accounting Distortions
When reviewing the financial statements of a corporation, if a “red flag” is found,
the firm should review this red flag and determine if there financial statements need to
be changed to fix it. After reviewing the financial statements of Universal and
comparing it to its competitor, we believe that it is not necessary to undo any
accounting distortions. Even though some potential “red flags” were spotted, we believe
that they were explained thoroughly throughout the disclosures. For example, when
analyzing whether operating leases should be capitalized, we found that they only
account for an extremely small portion of Long-term Assets and Liabilities. Therefore
they do not need to be capitalized. Also, when analyzing goodwill we determined that it
was only 5% of our total assets. Furthermore, goodwill did not need to be impaired and
financial statements didn’t need to be corrected.
Operating Leases to Total Liabilities and Total Assets
2003 2004 2005 2006 2007 2008
Lease Exp 11 9.5 13.3 8.9 12.3 17
% of LTL 1.38% .97% 1.26% .91% 2.05% 2.77%
% of LTA 1.27% .99% 1.21% .81% 1.57% 2.37%
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**numbers in millions except for percentages**
Goodwill to Long-term Assets and Total Assets
Financial Analysis
Financial analysis is used to determine the overall financial strength of a firm. To
determine a firms potential for profitability and growth analysts have developed ratios
to compare companies across an industry. By comparing these ratios analysts can get
an idea of how a well a firm is doing relative to its competition. Three categories of
ratios that are commonly used are, liquidity, profitability, and capital structure. Liquidity
ratios examine how quickly a firm can access cash to meet its immediate obligations;
profitability ratios measure how efficiently a firm uses its assets to make profit, and
capital structure ratios, which look at whether companies use debt or equity to finance
their assets. After calculating these ratios for the tobacco manufacturing industry we
plotted the results on graphs and compared Universal Corporation with Alliance One
International.
Liquidity Ratios
Liquidity ratios are used to measure a firm’s access to cash or cash equivalents
to satisfy short term debts. Lenders commonly use liquidity ratios as a way to evaluate
credit risk. Firms who have more liquidity typically are seen as less risky and receive
better interest rates on financing. Additionally, some lenders require that a firm
maintain a certain level of liquidity to satisfy the conditions of the loan. For the tobacco
manufacturing industry we will examine the current ratio, quick asset ratio, accounts
2003 2004 2005 2006 2007 2008 Goodwill 132,903 134,664 138,053 136,130 104,284 106,647 % of LTA 15.31% 14.08% 12.59% 12.39% 13.31% 14.87% % of TA 5.93% 5.42% 4.78% 4.69% 4.48% 5%
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receivable turnover ratio, day’s receivables ratio, inventory turnover ratio, days
inventory ratio, and working capital turnover ratio to evaluate the liquidity of Universal
and Alliance One.
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Current Ratio
The current ratio is measure by current assets divided by current liabilities.
Current assets are cash, inventory, and accounts receivable. Current liabilities are notes
payable, accounts payable, and accruals. Put simply, this ratio is used to measure
whether or not the firm will be able to pay its short term liabilities (due in the next 12
months), with the resources (current assets) on hand. Most lenders prefer a current
ratio of 2, that way if a firm has trouble moving inventory or collecting receivables there
is some insulation. A firm with a current ratio of less than 1 will have to borrow money
to pay its obligations and could be in financial trouble.
Both Universal and Alliance One have current ratios close to 2 which are healthy.
Universals current ratio has improved from 2006- 2008 do a dramatic reduction in
current liabilities from selling off business segments.
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Quick Asset Ratio
The quick asset ratio is a derivative of the current ratio. The only difference
between the quick asset ratio and current ratio is that inventory is removed from the
numerator leaving only cash, marketable securities, and accounts receivable to cover
current liabilities. The reason for this is because inventory is less liquid. Inventory may
become, obsolete, impaired, or demand may decrease. Traditionally a quick asset ratio
of 1 is seen as healthy for a firm.
Firms in the tobacco manufacturing industry average significantly less than 1
over the last five years. This is due to these firms maintaining a large supply of
inventory. Once again Universals ratio has improved dramatically do to a reduction in
current liabilities from 2006-2008.
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Inventory Turnover
Inventory turnover is the ratio between the cost of goods sold and inventory.
The ratio is used to analyze how often the stock of inventory is sold and replaced
during a given year.
As mentioned above firms in the tobacco manufacturing industry keep a
considerable amount of inventory on hand. The sharp dip in 2004 was due to low cost
of goods do to shortages in fresh tobacco while maintaining the same amount of
inventory. The industry as a whole is has improved over the last five years. The
industry average is 2.4 and Universal has a slightly higher average at 2.57. This means
that Universal does a better job than Alliance One at managing their inventory.
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Days’ Supply of Inventory
Day’s supply of inventory is used to measure how many days it takes for a
company to completely sell its supply of inventory. This is calculated by dividing the
days in a year (365) by the inventory turnover ratio.
The graph below shows that Universal has a shorter day’s supply of inventory
than its competitor Alliance One. It appears that the industry as a whole is getting
better at managing its day’s supply of inventory. There is an inverse relationship
between inventory turnover and day’s supply of inventory. A higher inventory turnover
is better as opposed to a lower day’s supply inventory being better.
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Accounts Receivable Turnover
The accounts receivable turnover ratio is the accounts receivable divided by
sales. This ratio is used to measure how many times accounts are received in full in a
given year.
We see that Universal is out performing Alliance One currently. However
historically Alliance one has had the better ratio. Universal’s accounts receivable
turnover is normally around 7.25 while Alliance One typically has a ratio around 6.5.
Both of these companies have seen large increases recently, Universal in 2008 and
Alliance One in 2007. This indicates that the companies are keeping more accounts
receivable on the balance sheet and doing a less efficient job of collecting accounts
from their customers.
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Days Sales Outstanding
The day’s sales outstanding ratio measures average amount of days in the year it
takes to completely the accounts receivable balance. The ratio is calculated by dividing
the accounts receivable by 365. A lower ratio is better because that shows that
companies are doing an efficient job of collecting receivables. Collecting accounts faster
gives companies more flexibility because they have more cash on hand.
By looking at the graph below we can see that both Universal and Alliance One
have been doing a better job collecting payments. The companies have lowered their
day’s sales outstanding ratio over the last four years after slow collection periods in
2004.
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Cash to Cash Cycle
The cash to cash cycle is the summation of day’s sales outstanding and days’
supply of inventory. Put simply to cycle shows how long the company had cash tied up
in inventory and accounts receivable.
Until recently Universal had been leading the industry in the cash to cash cycle.
In the last year Alliance One has done a more efficient job of managing inventory and
collecting receivables from customers. The increasing accounts receivable turnover and
decreasing inventory turnover has led to a stable cash to cash cycle. This is important
to a company because the faster you receive your cash the more cash you can invest in
capital, which in turn leads to more growth for your company.
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Working Capital Turnover
Working capital is the difference between current assets and current liabilities. It
can be viewed as money not used for current obligations that can “work” to generate
sales. The working capital turnover ratio measures how many dollars of sales a
company is generating from one dollar of working capital. The ratio is calculated by
dividing working capital by sales.
Alliance One has done a better job of using working capital to generate sales
than Universal. Universals turnover ratio has been declining the last three years while
Alliance’s ratio has been steadily improving. The reason for this is that Universal has
seen drop in sales the last two years while maintaining a relatively constant amount of
working capital.
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Conclusion
Liquidity is an important characteristic of a firm. A firm’s ability to pay its debts is
closely monitored by creditors and investors. Liquidity ratios can tell us about the
overall liquidity of a firm relative to the industry in which it operates. By analyzing
Universal Corporations liquidity ratios we have determined that Universal is more liquid
than its competition. We believe that as a whole the tobacco manufacturing industry is
becoming more efficient at collecting accounts receivable and managing inventory
which increases liquidity. Universal has been inefficient in generating sales from its
working capital but this could be do to lower sales during the last two years.
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Profitability Ratios
Profitability is a major component of valuing a company. Profitability ratios allow
analyst to look at the returns a company is generating from its sales. The analyst can
look at a firm over several years or compare it to other firms in the industry. We will
look at seven profitability ratios in the tobacco manufacturing industry; gross profit
margin, operating expense ratio, operating profit margin, net profit margin, asset
turnover, return on assets, and return on equity.
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Gross Profit Margin
Gross Profit Margin is calculated by dividing gross profit by sales. Gross Profit is
equal to the total sales minus the cost of the goods sold. This ratio can be used to see
if a firm is doing a good job of keeping their costs down. If the cost of goods sold is
lower the gross profit margin will be higher. A higher gross profit margin leads to a
larger overall net income.
The average gross profit margin for Universal Corporation is one fifth. That
means that for every dollar of sales Universal grosses about twenty cents. This is
because the tobacco manufacturing industry has a very high cost of goods sold.
Universal is leading Alliance on in gross profit and both firms have seen their profit
increase from 2006 to 2007.
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Operating Expense Ratio
The operating expense ratio is operating expenses as a percentage of net sales.
The ratio is used to evaluate how efficiently a company is operating. A High operating
expense ratio means that management is doing an inefficient job of running operation.
A high operating ratio is not a good sign if a firm wants to be profitable.
Universal’s operating expenses are greater than Alliances as a percentage of net
sales. Universal consistently keeps a ratio of around .12. We see in the graph below
that Alliance has been improving its operating expense ratio. This means that Alliance is
doing a better job of keeping selling and administrative expenses down.
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Operating Profit Margin
Operating profit margin is the ratio of operating income to net sales. Deducting
the operating expenses from gross profit will leave operating income.
Universal has clearly outstripped Alliance One in operating profit margin despite
Universal having higher operating expenses. Universal has increased its profit margin
over the last two years indicating that that the company has been more profitable
because of lower operating expenses. Alliance One has shown an operating loss in
2004, 2006, and 2007 indicating high cost of goods sold impacting their profitability.
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Net Profit Margin
Net Profit Margin is the net profit divided by the net sales. Net profit, is
commonly referred to as net income or “the bottom line”. Net profit is the amount left
over after all expenses have been paid. This is one of the most popular profitability
ratios because of the strong indication of profit potential. Because of this investors put
great emphasizes on this ratio.
After dropping significantly in 2005 and being almost non-existent in 2006,
Universal’s net profit margin reached a five year high this year. This is due to a high
gross margin and low operating expenses. Alliance One has shown a negative net profit
margin in 2006 and 2007, meaning that the company took a loss. It is obvious that
Universal is leading the tobacco manufacturing industry and looks like it will continue to
do so.
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Asset Turnover
Asset Turnover is net sales divided by total assets. This ratio is used to measure
how efficiently a firm is using its asset to generate sales. A higher ratio is preferred
because that means more sales are being made using fewer assets. Firms with profit
margins typically have lower asset turnover while firms with lower profit margins have
higher asset turnover
We have seen some irregularity in the tobacco manufacturing industry. This is
due to sales volatility do to seasonality. Alliance One and Universal each have led the
industry at different times as indicated by the graphs crossing each other. The last two
years Alliance has had the better asset turnover ratio while Universal had the better
ratio the previous three years.
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Return on Assets
The return on assets percentage is calculated by dividing net income by total
assets. Return on assets shows how much profit a firm is earning on its existing assets.
A higher percentage indicated a high return which is better for the firm.
Universals return on assets fell when they sold assets related to other business
segments in 2006. The percentage has climbed back up to historical levels around five
percent. Alliance suffered a dramatic decrease in 2006 due low profits. Universal has led
the industry the last 5 years.
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Return on Equity
Return on equity measures the net income as a percentage of total equity. Once
again a firm would prefer to have a higher return on its equity.
The return on equity in the tobacco manufacturing industry is slightly higher than
return on assets because firms have more assets than they do equity. In 2006 Alliance
had a very low net income which accounts for the spike in the graph. Universal’s return
on equity was down in 2006 due to business segments being sold, however, the ratios
climbed back up slightly in 2007 and is now at 11.6%. Universal leads the industry in
returns on equity.
Conclusion
Profitability is very important when doing financial analysis. Profitability ratios
allow analysts to compare against themselves and their competitors. Universal
outperformed its competitor Alliance One in almost every ratio. Alliance one had a
better operating expense ratio but Universal was still able to show more operating
income. Sharp decreases in the graphs can be explained by the volatility of sales due to
the seasonal nature of the tobacco industry. Also, the sale of business segments in
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2006 by Universal decreased its return on assets and return on equity but they have
returned to historical levels.
Capital Structure Ratios
The capital structure ratios of a company illustrates how a company uses its
financing to acquire assets, and this is shown in the companies liabilities and owners
equity section of the balance sheet (Financial Statement Analysis Worksheet). When
analyzing a company there are two issues which are how much debt do they have
compared to owners equity and the ability to compensate for the principle and interest
rates on the debt. Ratios such as Altman z-score, Debt to Equity, Time interest earned,
and Debt service margin, emphasize how a company is fairing in these aspects of a
business.
Altman Z-Score
According to covercredit.com, “Altman's z-score is a statistical ratio model
developed by Edward I. Altman to predict the probability of bankruptcy within two
years.” This ratio is a helpful tool that financial analysts use this ratio to determine the
credit risks of firms. The Altman z-score is composed of five different ratios. These
ratios include 1.2 multiplied by (working capital/total assets), plus 1.4 multiplied by
(retained earnings/total assets), plus 3.3 multiplied by (EBIT/total assets), plus .6
multiplied by (market value of equity/book value of liabilities), plus (sales/total assets).
If the z-score is below 1.81 then a firm is considered to be in serious financial distress.
However, if the score is above 2.67 then the firm is in great financial standing and does
not need to worry about bankruptcy. Furthermore, if the score is in between 1.81 and
2.67, then the firm is in the grey area, which means the firm is doing mediocre but not
great.
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According to the graph above, between 2003 and 2006 Universal was located in
the grey area. But, in 2007 and 2008 they increased their z-score and are now
considered to be gold financially, with no chance of going bankrupt. The jump in 2007
and 2008, most likely resulted from Universal selling their lumber and agri-product
companies in September 2006. In contrast, Alliance has been in serious financial
distress over the last four years, and has a good possibility of going bankrupt in future
years.
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Debt to Equity
The debt to equity ratio shows the proportion of a company’s total debt relative
to equity. A high debt/equity ratio generally means that a company has been
aggressive in financing its growth with debt. (www.investopedia.com). A high debt to
equity ratio could generate more earnings for a company than it would have been able
to achieve if it didn’t finance through debt. The cost of debt financing may end up
being more than the additional earnings, which would cause financial distress for the
company. As you can see the tobacco merchant industry is capital intensive with debt
to equity ratios ranging from 1.25 to 7.89. Universal over the past 6 years has an
average ratio of 1.92, which outperforms Alliance by a long shot. The numbers for
Universal are not as volatile as the numbers of its main competitor, Alliance One. This
means that Universal requires less debt financing of its operating activities than that of
Alliance. Since the sale of Universal’s lumber and building products operation in 2006,
their debt to equity ratio has been slowly decreasing. This is a good thing for the
company because they will not have to borrow a significant amount to fund their future
operating activities.
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Times Interest Earned
Times interest earned tells how well a firm covers its interest expenses with its
income from operations. A high times interest earned ratio will also allow a company to
have a low interest rate. Universal has had an average times interest earned of 3.76
over the past 6 years and an average of 3.81 since the sale of their lumber and building
products operation. As shown by the graph, Universal outperforms its main competitor
in times interest earned by an extreme amount. Alliance’s low times interest earned
causes them to pay a high rate of interest on borrowed money. Universal has been
favorable with this ratio over the past 6 years despite a drop in 2006. This sudden drop
may be attributable to their sale of the lumber and building products operations. All in
all, Universal does an outstanding job of covering its interest expense with their
operating income and should continue to do so in the coming years.
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Debt Service Margin
The debt service margin ration explains how well I firm can cover its debt service
with its cash flows from operations. Both Alliance and Universal have demonstrated
inconsistent debt service margin ratios over the past 5 years. This volatility is not good
because it leaves the companies with little or even no cash after paying its notes
payable for the year. Maintaining a high debt service margin is proving to be a
relatively difficult feat as neither company has seemed to master this yet. Universal has
maintained a positive debt service margin for the past few years. Universal, along with
most other companies, hopes to grow this margin so it can better cover its debts.
Conclusion
Universal does much better than its competitor Alliance in the capital structure
ratios. This results in Universal being able to achieve lower interest rates, to finance its
debt, and also its debt to equity ratio helps the firm generate more profit compared to
the industry.
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IGR/SGR Analysis
Having estimates of a firm’s growth rates helps someone valuing the firm
determine if they will be profitable in the future. Both these growth rates of a firm are
dependent on many other factors which include: dividend payout ratio, return on
assets, net income, and debt to equity ratio.
Internal Growth Rate
The internal growth rate of a firm determines how much the firm can grow its
asset base by only using internal financing. Internal financing refers to when a
company grows the assets it has without attaining any additional debt. They want to
fund their future projects only with the money already generated by the firm’s
operations without adding any additional funding from banks or financial institutions.
Universal has had a higher internal growth rate than its main competitor (Alliance) over
the past 5 years. The drop in internal growth in 2006 can be attributed to Universal
selling off some of their operations. Since the sale of their lumber and building
products operation, Universal has had a steady growth rate and is currently at 3.03%
for 2008. A continued increase in this rate will allow Universal to get rid of more debt
and allow them to finance future operations internally.
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Sustainable Growth Rate
The sustainable growth rate, as stated by investopedia.com, “is a measure of
how much a firm can grow without borrowing more money. After the firm has passed
this rate, it must borrow funds from another source to facilitate growth.” Because the
sustainable growth rate comes from the company’s internal growth rate, you can see
how both of the ratios for each of the firms resemble each other. The sustainable
growth rate for Universal decreases to its low of -4.3% in 2006 before rising over the
next 2 years. Even with some negative SGR ratios for Universal in the past, they have
outperformed Alliance each of the past 5 years of study. As talked about throughout
this section, the sharp decrease in 2006 may be the cause of selling the lumber and
building products operation in 2006.
The internal and sustainable growth rates for Universal determine the amount of
debt financing they will have to use to fund continuing and future operations. Both of
these ratios are very important because they will help determine the future level of
profitability for a firm. If a firm increases its financial leverage through the acquisition
of more debt financing then it will cause a reduction in future profitability because they
have increased the amount of their future obligations. When the IGR and SGR are
high, a company has few obligations and will be more profitable than a firm with low
IGR and SGR ratios. The low IGR and SGR ratios for the industry are explained by this
industry’s tendency to be capital intensive. This causes companies operating in this
industry to borrow a lot of money to finance their continuing and future operations.
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Financial Statement Forecasting
Financial statement forecasting is an important part of the valuation process.
Analysts use financial forecasts to help determine the present value of a firm. We have
forecasted Universal Corporation’s income statement, balance sheet, and statement of
cash flows for the next ten years. The forecasted financial statements were calculated
by examining growth rates, liquidity and profitability ratios, and capital structure ratios.
Our predictions are based on the previous five years of financial statements from
Universal’s 10-K reports as well as information from competitor’s 10-K reports (10-Q’s
were not used for Universal because their fiscal year end is March 31st, and they put out
there 10-k for 2008 at the end of May, because of this no 10-Q’s were available for use
when forecasting the financial statements). It should be noted that the future
profitability of these firms could be materially affected by a drastic change in regulation
of the tobacco industry. For the purpose of these financial forecasts, a drastic change is
considered unlikely and therefore not considered.
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Income Statement
Forecasting the income statement is the foundation for forecasting financial
statements. Determining future sales is the most critical part of forecasting the income
statement. Universal corporation’s sales have been erratic over the last five years. The
company experienced large increases in sales as in 2005 and a large decrease in 2007.
These dramatic changes in the volume of sales can be explained by the seasonality of
the agriculture business, and by Universal selling off its agri-business segments in 2005
and 2006. This meant that using an average to calculate the growth of future sales was
not an option. We chose to estimate sales growing at 7% per year based on sales
growth in the last year, 2007 to 2008, and the growth realized by the company from
2005 to 2006.
The next line items in the income statement were much more consistent over the
last five years. The cost of goods sold, selling and administrative expenses, and gross
profit were all very close to the same percentage of total sales. This allowed us to use
an average to forecast what we could expect them to be for the next ten years. Cost of
goods sold was estimated to be 80.5% of total sales; this was based on an average of
Cost of Goods Sold over the last five years. Then we estimated gross profit, which we
also calculated by taking the average over the past five years. Next, Selling and
administrative expenses were estimated at 11% based on the average over the past
two years. Furthermore, Income from operations was calculated to be 8.5% based on
averages over the past two years. We did this because Universal sold off its other
companies in September, 2006, which lead to drastic changes in Operating income from
the previous three years.
Finally, net income was estimated to be 4.5% of sales. This is based on averages
once again from the last five years excluding 2005 and 2006. Additionally, extra weight
was given to the latest year, 2008, because we felt that it was a more accurate
indication of future performance.
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Universal Income Statement Forcast 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Sales Growth ‐13.9% 44.2% 7.2% ‐42.8% 6.9% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0%Sales 2,636,776 2,271,152 3,276,057 3,511,332 2,007,272 2,145,822 2,296,030 2,456,752 2,628,724 2,812,735 3,009,626 3,220,300 3,445,721 3,686,922 3,945,006 4,221,157 Cost of Goods Sold 2,098,625 1,829,219 2,664,687 2,932,170 1,563,522 1,715,724 1,848,304 1,977,685 2,116,123 2,264,252 2,422,749 2,592,342 2,773,806 2,967,972 3,175,730 3,398,031 Gross Profit 538,151 441,933 611,370 579,162 443,750 430,098 447,726 479,067 512,601 548,483 586,877 627,959 671,916 718,950 769,276 823,126 SG&A Expense 297,335 250,307 387,906 417,346 249,269 225,670 250,494 278,048 308,633 342,583 380,267 422,096 468,527 520,065 577,272 640,772 European Commission Fines ‐ ‐ 14,908 ‐ ‐ ‐ Restructuring Costs 33,001 ‐ ‐ 57,463 30,890 12,915 Income from Operations 207,815 191,626 208,556 104,353 163,591 191,513 195,163 208,824 223,442 239,082 255,818 273,726 292,886 313,388 335,326 358,798 Equity in pretax Earning of Unconsolidated Affiliates 10,439 6,044 15,649 15,263 14,235 13,500 Interest Expense 45,270 35,032 58,252 81,293 53,794 41,908 Income Before Taxes 172984 162638 165953 38323 134877 180283Tax Expense 53,094 59,329 68,197 34,403 61,126 63,799
Minority Interests 9,296 3,673 1,743 (4,020) (6,660) (2,817)
Net Income 110,594 99,636 99,013 7,940 44,352 119,156 103,321 110,554 118,293 126,573 135,433 144,914 155,057 165,911 177,525 189,952
Common Size income Statement 2003 2004 2005 2006 2007 2008 Assume 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Sales Growth ‐13.9% 44.2% 7.2% ‐42.8% 6.9% 7.0%Net Sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Cost of Goods Sold 79.6% 80.5% 81.3% 83.5% 77.9% 80.0% 80.5% 80.5% 80.5% 80.5% 80.5% 80.5% 80.5% 80.5% 80.5% 80.5% 80.5%Gross Profit 20.4% 19.5% 18.7% 16.5% 22.1% 20.0% 19.5% 19.5% 19.5% 19.5% 19.5% 19.5% 19.5% 19.5% 19.5% 19.5% 19.5%SG&A Expenses 11.3% 11.0% 11.8% 11.9% 12.4% 10.5% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0%European Commission Fees 0.0% 0.0% 0.5% 0.0% 0.0% 0.0%Restructuring Costs 1.3% 0.0% 0.0% 1.6% 1.5% 0.6%Income From Operations 7.9% 8.4% 6.4% 3.0% 8.1% 8.9% 8.5% 8.5% 8.5% 8.5% 8.5% 8.5% 8.5% 8.5% 8.5% 8.5% 8.5%Equity in pretax earnings 0.4% 0.3% 0.5% 0.4% 0.7% 0.6%Interest Expense 1.7% 1.5% 1.8% 2.3% 2.7% 2.0%Income Before Taxes 6.6% 7.2% 5.1% 1.1% 6.7% 8.4%Minority Interests 0.4% 0.2% 0.1% ‐0.1% ‐0.3% ‐0.1%Tax Expense 2.0% 2.6% 2.1% 1.0% 3.0% 3.0%Net Income 4.2% 4.4% 3.0% 0.2% 2.2% 5.6% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5%
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Balance Sheet
Forecasting the balance sheet is a little trickier than forecasting the income
statement. This is because you have to link the income statement with the balance
sheet so your forecasts go hand and hand between the two. We first needed to find a
ratio that links these two financial statements together. We determined that the best
ratio to use was the asset turnover ratio. The asset turnover margin links the two by
comparing sales to total assets. When looking at our asset turnover ratio over the past
five years we determined that a 1.1 asset turnover ratio was the best place to start (this
is because it was the average over the past five years).
After determining the forecast of total assets, we needed to determine the
forecast for the rest of the assets. To do this we used the average of the past two years
to determine percentage of (Cash, Accounts Receivables, Inventory, Total current
assets, Total PP&E, Goodwill, other Non-current assets, and Total long-term assets)
assets compared to total assets. We used the percentage over the past two years,
because Universal has made some major changes over the past two years. These
changes included the selling of their lumber and agri-products businesses. This in turn
caused major changes in the portion of assets compared to the three previous years
before selling the two businesses.
Next, we forecasted the retained earnings. To do this you calculate the beginning
balance of retained earnings, add that number to net income, and then subtract
dividends paid. This will leave you with retained earnings for the year. But, before you
can do this you need to forecast the payment of dividends. This was somewhat difficult
to do because Universal has shown erratic dividend payouts over the past five years
(which averaged a growth of 14.6%). But, a 14.6% growth in dividends per year is an
unrealistic number because it would result in dividends paid growing at a higher rate
than sales. So this led us to choosing a 5.6% dividend growth rate because we figured
that they would keep on the same pace of growth from 2008.
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Finally, we forecasted the liabilities section of the balance sheet. We did this by
using the current ratio (CA/CL), which we calculated at 2.875 by using the average over
the past two years. After finding current liabilities, we found total equity by taking the
difference in current retained earnings and previous retained earnings and added it to
the previous year’s total equity. Then we calculated total liabilities, which was the
difference between total assets and total equity (A=L+E), and once we had total
liabilities we calculated long-term liabilities, by taking the difference in total liabilities
and current liabilities.
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Universal Balance Sheet 2003 2004 2005 2006 2007 2008 Assume 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018AssetsCurrentCash and Cash Equivalents 44,659 39,310 58,625 66,632 358,236 186,070 12% 303,076 324,291 346,992 371,281 397,271 425,080 454,835 486,674 520,741 557,193 short term investments 58,889 Accounts Receivables 370,784 432,546 494,963 466,013 261,106 231,107 11% 277,820 297,267 318,076 340,341 364,165 389,656 416,932 446,118 477,346 510,760 Advances to Suppliers 115,928 140,758 171,906 121,355 113,396 149,376 Accounts Receivable Unconsolidated Affiliates 7,595 6,156 4,759 19,215 37,290 43,718 Inventory 783,287 842,635 991,368 1,052,757 636,478 645,507 28.80% 727,382 778,299 832,780 891,074 953,450 1,020,191 1,091,604 1,168,017 1,249,778 1,337,263Prepaid Income Taxes 12,375 9,635 5,504 3,943 8,760 17,696 Deferred Income Taxes 6,168 16,908 6,875 22,078 25,182 22,737 Other Current Assets 34,201 38,721 54,808 50,605 62,480 61,960 current Assets of Discontinued op. 42,437 ‐ Total Current Assets 1,374,997 1,526,669 1,788,808 1,802,598 1,545,365 1,417,060 66.40% 1,677,020 1,794,412 1,920,020 2,054,422 2,198,231 2,352,107 2,516,755 2,692,928 2,881,432 3,083,133
Property Plant and Equip
Land 51,110 60,823 78,127 72,617 16,640 16,460 0.75% 18,942 20,268 21,687 23,205 24,829 26,567 28,427 30,417 32,546 34,825 Building 303,916 364,948 395,077 398,395 241,410 254,737 11.15% 281,608 301,321 322,413 344,982 369,131 394,970 422,618 452,201 483,855 517,725 Machinery 679,556 694,314 746,198 704,503 512,586 519,695 23.20% 585,947 626,963 670,850 717,810 768,057 821,821 879,348 940,902 1,006,766 1,077,239Total PP&E 1,034,582 1,120,085 1,219,402 1,175,515 770,636 790,892 35.10% 886,497 948,552 1,014,950 1,085,997 1,162,017 1,243,358 1,330,393 1,423,521 1,523,167 1,629,789Accumulated Depreciation (521,201) (559,217) (595,732) (593,418) (410,478) (456,059)
Other Assets
Goodwill and Other Intangible Assets 132,903 134,664 138,053 136,130 104,284 106,647 4.75% 119,968 128,365 137,351 146,965 157,253 168,261 180,039 192,642 206,127 220,555 Investments in consolidated affiliates 90,119 94,460 98,789 102,419 104,316 116,185 Deferred Income Taxes 45,466 62,489 85,014 95,183 81,003 49,632 Other noncurrent assets 86,208 103,623 150,990 182,914 133,696 109,755 5.40% 136,384 145,931 156,146 167,076 178,772 191,286 204,676 219,003 234,333 250,737
Long Term Assets 868,077 956,104 1,096,516 1,098,743 783,457 717,052 33.60% 848,613 908,016 971,576 1,039,587 1,112,358 1,190,223 1,273,538 1,362,686 1,458,074 1,560,140
Total Assets 2,243,074 2,482,773 2,885,324 2,901,341 2,328,822 2,134,112 2,525,633 2,702,427 2,891,596 3,094,009 3,310,589 3,542,330 3,790,293 4,055,614 4,339,507 4,643,273 asset to ratio 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1
Liabilities 2003 2004 2005 2006 2007 2008 assume 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
currentnotes payable and overdrafts 265,742 244,031 429,470 448,601 131,159 126,229 accounts payable 361,058 331,963 299,452 332,732 220,181 210,354 accounts payable ‐ unconsolidated 2,073 2,571 279 2,996 644 10,343 customer advances and deposits 42,093 59,894 48,634 98,871 133,608 21,030 accrued compensation 31,959 32,703 35,621 33,995 18,519 25,484 income tax payable 20,969 22,007 32,866 12,026 11,549 8,886 current portion of long‐term obligations 100,387 45,941 123,439 8,585 164,000 ‐ current liabilities of discontinued op 13,314 ‐ total current liabilities 824,281 739,110 969,761 937,806 692,974 402,326 583,311 624,143 667,833 714,581 764,602 818,124 875,393 936,671 1,002,237 1,072,394Current Ratio 2.875 2.875 2.875 2.875 2.875 2.875 2.875 2.875 2.875 2.875 2.875long term obligations 614,994 770,296 838,687 762,201 398,952 402,942 post retirement benefits other than pensions 40,305 41,721 43,459 45,560 100,004 88,278 other long‐term liabilities 96,522 93,739 131,885 136,082 70,528 84,958 deferred income taxes 12,348 43,691 43,899 37,022 29,809 36,795 minority interests 34,346 34,383
long term liabilities 798,515 983,830 1,057,930 980,865 599,293 612,973 769,178 845,777 929,999 1,022,471 1,123,864 1,234,900 1,356,355 1,489,067 1,633,930 1,791,911
total liabilities 1,622,796 1,722,940 2,027,691 1,918,671 1,292,267 1,015,299 1,352,489 1,469,920 1,597,832 1,737,053 1,888,466 2,053,024 2,231,748 2,425,737 2,636,168 2,864,305 minority interest 35,245 17,799 5,822 3,182
shareholders equitycommon stock 90,665 112,505 117,520 314,164 389,477 419,459 retained earnings 592,673 679,202 733,763 697,987 682,232 711,655 769,168 828,531 889,788 952,980 1,018,147 1,085,330 1,154,569 1,225,901 1,299,363 1,374,992accumulated other comprehensive loss (63,060) (31,874) (28,895) (47,280) (40,976) (15,483) total shareholders equity 620,278 759,833 822,388 964,871 1,030,733 1,115,631 1,173,144 1,232,507 1,293,764 1,356,956 1,422,123 1,489,306 1,558,545 1,629,877 1,703,339 1,778,968
total liabilities and shareholders equity 2,243,074 2,482,773 2,885,324 2,901,341 2,328,822 2,134,112 2,525,633 2,702,427 2,891,596 3,094,009 3,310,589 3,542,330 3,790,293 4,055,614 4,339,507 4,643,273
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Common Size Balance Sheet 2003 2004 2005 2006 2007 2008 assume 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018AssetsCurrentCash and Cash Equivalents 2.0% 1.6% 2.0% 2.3% 15.4% 8.7% 12% 12% 12% 12% 12% 12% 12% 12% 12% 12% 12%short term investments 0.0% 0.0% 0.0% 0.0% 0.0% 2.8%Accounts Receivables 16.5% 17.4% 17.2% 16.1% 11.2% 10.8% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11%Advances to Suppliers 5.2% 5.7% 6.0% 4.2% 4.9% 7.0%Accounts Receivable Unconsolidated Affiliates 0.3% 0.2% 0.2% 0.7% 1.6% 2.0%Inventory 34.9% 33.9% 34.4% 36.3% 27.3% 30.2% 28.8% 28.8% 28.8% 28.8% 28.8% 28.8% 28.8% 28.8% 28.8% 28.8% 28.8%Prepaid Income Taxes 0.6% 0.4% 0.2% 0.1% 0.4% 0.8%Deferred Income Taxes 0.3% 0.7% 0.2% 0.8% 1.1% 1.1%Other Current Assets 1.5% 1.6% 1.9% 1.7% 2.7% 2.9%current Assets of Discontinued op. 0.0% 0.0% 0.0% 0.0% 1.8% 0.0%Total Current Assets 61.3% 61.5% 62.0% 62.1% 66.4% 66.4% 66.4% 66.4% 66.4% 66.4% 66.4% 66.4% 66.4% 66.4% 66.4% 66.4% 66.4%
Property Plant and Equip
Land 2.3% 2.4% 2.7% 2.5% 0.7% 0.8% 0.75% 0.75% 0.75% 0.75% 0.75% 0.75% 0.75% 0.75% 0.75% 0.75% 0.75%Building 13.5% 14.7% 13.7% 13.7% 10.4% 11.9% 11.15% 11.15% 11.15% 11.15% 11.15% 11.15% 11.15% 11.15% 11.15% 11.15% 11.15%Machinery 30.3% 28.0% 25.9% 24.3% 22.0% 24.4% 23.2% 23.2% 23.2% 23.2% 23.2% 23.2% 23.2% 23.2% 23.2% 23.2% 23.2%Total PP&E 46.12% 45.11% 42.26% 40.52% 33.09% 37.06% 35.10% 35.10% 35.10% 35.10% 35.10% 35.10% 35.10% 35.10% 35.10% 35.10% 35.10%Accumulated Depreciation ‐23.2% ‐22.5% ‐20.6% ‐20.5% ‐17.6% ‐21.4%
Other Assets
Goodwill and Other Intangible Assets 5.9% 5.4% 4.8% 4.7% 4.5% 5.0% 4.75% 4.75% 4.75% 4.75% 4.75% 4.75% 4.75% 4.75% 4.75% 4.75% 4.75%Investments in consolidated affiliates 4.0% 3.8% 3.4% 3.5% 4.5% 5.4%Deferred Income Taxes 2.0% 2.5% 2.9% 3.3% 3.5% 2.3%Other noncurrent assets 3.8% 4.2% 5.2% 6.3% 5.7% 5.1% 5.4% 5.4% 5.4% 5.4% 5.4% 5.4% 5.4% 5.4% 5.4% 5.4% 5.4%
Long Term Assets 38.7% 38.5% 38.0% 37.9% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6% 33.6%
Total Assets 100% 100% 100% 100% 100% 100%
Liabilities 2003 2004 2005 2006 2007 2008 assume 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
currentnotes payable and overdrafts 16.4% 14.2% 21.2% 23.4% 10.1% 12.4%accounts payable 22.2% 19.3% 14.8% 17.3% 17.0% 20.7%accounts payable ‐ unconsolidated 0.1% 0.1% 0.0% 0.2% 0.0% 1.0%customer advances and deposits 2.6% 3.5% 2.4% 5.2% 10.3% 2.1%accrued compensation 2.0% 1.9% 1.8% 1.8% 1.4% 2.5%income tax payable 1.3% 1.3% 1.6% 0.6% 0.9% 0.9%current portion of long‐term obligations 6.2% 2.7% 6.1% 0.4% 12.7% 0.0%current liabilities of discontinued op 0.0% 0.0% 0.0% 0.0% 1.0% 0.0%total current liabilities 50.8% 42.9% 47.8% 48.9% 53.6% 39.6% 43.1% 42.5% 41.8% 41.1% 40.5% 39.8% 39.2% 38.6% 38.0% 37.4%
long term obligations 37.9% 44.7% 41.4% 39.7% 30.9% 39.7%post retirement benefits other than pensions 2.5% 2.4% 2.1% 2.4% 7.7% 8.7%other long‐term liabilities 5.9% 5.4% 6.5% 7.1% 5.5% 8.4%deferred income taxes 0.8% 2.5% 2.2% 1.9% 2.3% 3.6%minority interests 2.1% 2.0% 0.0% 0.0% 0.0% 0.0%
long term liabilities 49.2% 57.1% 52.2% 51.1% 46.4% 60.4% 56.9% 57.5% 58.2% 58.9% 59.5% 60.2% 60.8% 61.4% 62.0% 62.6%
total liabilities 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
minority interest 0.0% 0.0% 4.3% 1.8% 0.6% 0.3%
shareholders equitycommon stock 14.6% 14.8% 14.3% 32.6% 37.8% 37.6%
retained earnings 95.5% 89.4% 89.2% 72.3% 66.2% 63.8% 65.6% 67.2% 68.8% 70.2% 71.6% 72.9% 74.1% 75.2% 76.3% 77.3%accumulated other comprehensive loss ‐10.2% ‐4.2% ‐3.5% ‐4.9% ‐4.0% ‐1.4%
total shareholders equity 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
total liabilities and shareholders equity 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
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Statement of Cash Flows
The statement of cash flows is the hardest financial statement to forecast,
because it changes drastically from year to year. We determined the best way to do this
was to look at three ratios that link the statement of cash flows to the income
statement. These ratios include the CFFO/Sales, CFFO/OI, and CFFO/NI. We calculated
these three ratios to determine which was the most stable over the past five years. Are
results concluded that CFFO/Sales was the most consistent, which had an average of
.02 over the past five years, which we used to forecast CFFO. Next, we had to forecast
the CFFI, which was even more difficult. We determined the best measure to do this
was to take the change in total Property Plant and Equipment. This was used because it
was the most reasonable and constant figure in our balance sheet. Finally, we used our
calculations of dividend growth to forecast dividends pay in the financing activities.
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Statement of Cash Flows 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Cash Flows From Operating ActivitiesNet Income 110,594 99,636 96,013 7,940 44,352 119,156 124,518 130,121 135,977 142,096 148,490 155,172 162,155 169,452 177,077 185,046
Adjustments to reconcile net income to net cash
Net Income from discontinued operations 36,059 145
Depreciation 47,969 45,519 69,409 64,753 46,423 41,383
Amortization 5,535 3,348 4,724 3,386 1,882 1,857
Inventory valuation allowances 16,928
Provision for losses on advances to suppliers 28,486 31,822 22323
Translation (gain) loss, net (12,558) 100 1,473 9,342 (1,416) (15,168)
Accrued liability for European Commission fines 14,908
Restructuring costs net of cash paid 16,340 - -
Deferred taxes (11,901) (7,346) (10,577) (35,493) (654) 19,713
Minority interests 9,296 3,673 1,743 (4,020) (6,660) (2,816)
Equity in net income of unconsolidated affiliates (5,847) (4,062) (3,766) 10,871 (653) 607
Restructuring and impairment costs 57,463 30,890 12,915
Other (1,783) (3,121) (7,154) 3,542 7,837 5,257
Changes in operating assets and liabilities
Accounts and notes receivable (92,268) (61,885) (36,469) (11,066) (81,254) (25,980)
Inventories and other assets (85,958) (68,288) (155,876) (149,641) 97,115 39,934
Income taxes 12 10,886 4,131 (13,862) 6,474 (13,148)
Accounts payable and other accrued liabilities (24,284) (44,626) (65,682) 74,699 33,717 (3,028)
Customer advances and deposits (112,578)
Net cash provided by operating activities (44,853) (26,166) (87,123) 63,328 245,934 90,572 45,921 49,135 52,574 56,255 60,193 64,406 68,914 73,738 78,900 84,423
Cffo/Sales (0.02) (0.01) (0.03) 0.02 0.12 0.04 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02
Cash Flows From Investing Activities
Purchase of PP&E (115,396) (63,243) (105,757) (74,217) (25,178) (27,704)
Purchase of Short-term investments (58,889)
Proceeds from sale of businesses 26,556
Proceeds from sale of PP&E 23,206
Purchase of business, net of cash acquired (71,865) - (16,027) (14,339) -
Sales of PP&E 11,133 2,837 5,778 12,595 392,847
Other (12,347) 12,199 - 12,846
Net cash used in Investing activities (176,128) (60,406) (128,353) (63,762) 367,669 (23,985) (95,605) (62,055) (66,398) (71,047) (76,020) (81,341) (87,035) (93,128) (99,646) (106,622)
Cash Flows From Financing Activities
Issuance of short-term debt 142,875 (607) 139,440 56,684 (140,406) (19,957)
Issuance of long-term debt 273,655 202,967 294,958 - -
Repayment of long-term debt (120,400) (96,008) (159,150) (190,032) (208,530) (164,000)
Dividends to minority shareholders (3,654) (2,662) (3,500) (2,779) (1,893) -
Issuance of preferred stock 19,478 -
Issuance of common stock 3,923 22,028 4,867 3,098 50,958 24,372
Purchases of common stock (54,607) (3,456) - - (14,685) (16,700)
Dividends paid (35,788) (28,693) (41,452) (43,716) (45,423) (63,452) (67,005) (70,758) (74,720) (78,904) (83,323) (87,989) (92,916) (98,120) (103,615) (109,417)
Other - 2,500 (853) (973) 826 (981)
Net cash provided in Financing activities 206,004 96,069 234,310 15,828 (339,675) (240,718)
Common Size Statement of Cash Flows 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Cash Flows From Operating ActivitiesNet Income ‐247% ‐381% ‐110% 13% 18% 132% 271% 265% 259% 253% 247% 241% 235% 230% 224% 219%Adjustments to reconcile net income to net cashNet Income from discontinued operations 0% 0% 0% 0% 15% 0%Depreciation ‐107% ‐174% ‐80% 102% 19% 46%Amortization ‐12% ‐13% ‐5% 5% 1% 2%Inventory valuation allowances 0% 0% 0% 45% 13% 25%Provision for losses on advances to suppliers 0% 0% 0% 45% 13% 25%Translation (gain) loss, net 28% 0% ‐2% 15% ‐1% ‐17%Accrued liability for European Commission fines 0% 0% ‐17% 0% 0% 0%Restructuring costs net of cash paid ‐36% 0% 0% 0% 0% 0%Deferred taxes 27% 28% 12% ‐56% 0% 22%Minority interests ‐21% ‐14% ‐2% ‐6% ‐3% ‐3%Equity in net income of unconsolidated affiliates 13% 16% 4% 17% 0% 1%Restructuring and impairment costs 0% 0% 0% 91% 13% 14%Other 4% 12% 8% 6% 3% 6%Changes in operating assets and liabilities 0% 0% 0% 0% 0% 0%Accounts and notes receivable 206% 237% 42% ‐17% ‐33% ‐29%Inventories and other assets 192% 261% 179% ‐236% 39% 44%Income taxes 0% ‐42% ‐5% ‐22% 3% ‐15%Accounts payable and other accrued liabilities 54% 171% 75% 118% 14% ‐3%Customer advances and deposits 0% 0% 0% 0% 0% ‐124%Net cash provided by operating activities 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%Cffo/Sales (0.02) (0.01) (0.03) 0.02 0.12 0.04 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02
Cash Flows From Investing ActivitiesPurchase of PP&E 66% 105% 82% 116% ‐7% 116%Purchase of Short‐term investments 0% 0% 0% 0% 0% 246%Proceeds from sale of businesses 0% 0% 0% 0% 0% ‐111%Proceeds from sale of PP&E 0% 0% 0% 0% 0% ‐97%Purchase of business, net of cash acquired 41% 0% 12% 22% 0% 0%Sales of PP&E ‐6% ‐5% ‐5% ‐20% 107% 0%Other 0% 0% 10% ‐19% 0% ‐54%Net cash used in Investing activities 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
Cash Flows From Financing ActivitiesIssuance of short‐term debt 69.4% ‐0.6% 59.5% 358.1% 41.3% 8.3%Issuance of long‐term debt 132.8% 211.3% 125.9% 0.0% 0.0% 0.0%Repayment of long‐term debt ‐58.4% ‐99.9% ‐67.9% ‐1200.6% 61.4% 68.1%Dividends to minority shareholders ‐1.8% ‐2.8% ‐1.5% ‐17.6% 0.6% 0.0%Issuance of preferred stock 0.0% 0.0% 0.0% 0.0% ‐5.7% 0.0%Issuance of common stock 1.9% 22.9% 2.1% 19.6% ‐15.0% ‐10.1%Purchases of common stock ‐26.5% ‐3.6% 0.0% 0.0% 4.3% 6.9%Dividends paid ‐17.4% ‐29.9% ‐17.7% ‐276.2% 13.4% 26.4%Other 0.0% 2.6% ‐0.4% ‐6.1% ‐0.2% 0.4%Net cash provided in Financing activities 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
99
Cost of Capital Estimation
Cost of capital estimation is necessary for valuing a firm. The cost of capital is
equal to the average required return on the firm. Cost of capital is made up of a
weighted average of the cost of debt and cost of equity. Debt holders have less risk and
therefore require a lower return while equity investors have more risk and typically
require a higher return. The weighted average comes from a firms capital structure,
which is the percentage of a firms assets financed by debt the percentage financed by
equity. We will use information from Universal’s 10-K as well as our forecasts of future
performance to estimate Universal Corporations cost of capital.
Cost of Equity
The cost of equity is equal to the return an investor requires on a given stock.
For a company with high risk the cost of acquiring equity capital is greater because
investors require a greater rate of return. The capital asset pricing model or CAPM was
used to calculate Universal Corporations cost of equity. CAPM sets the cost of equity
equal to the rate of return required on a risk free asset plus the estimated beta
coefficient multiplied by the market risk premium. The risk free rate is considered to be
the return on a treasury bill. Beta is the measure of the relationship between the return
on Universal’s stock and the stock market as a whole. The market risk premium is the
difference between the market return and the risk free return. We also used a size
adjustment of +1.7% (Palepu & Healy 8-4). The reason for this was that Universal has
a market cap of 1.7 billion and companies of that size are less effected by fluctuations
in the market than smaller companies.
Cost of Equity = Risk free rate + Beta (Market return – Risk free rate)
To calculate Beta, we computed 25 statistical regressions to find the correlation
between the monthly return on Universal’s stock for the last six years and the monthly
return on the S&P 500 for the last six years minus the risk free rate. The risk free rate
100
was based on 3-month, 6-month, 2-year, 5-year, and 10-year Treasury bill rates found
at www.stlouisfed.org. We used multiple risk-free rates because investors have
different investment horizons and we wanted to see the effect of different risk-free
rates. The returns for the S&P 500 and Universal were found at www.yahoo.com. We
used investment periods of 24, 36, 48, 60, and 72 months in order to compare risk for
different investment periods. When deciding which regression had the best estimate of
beta we looked at the adjusted R-squared variable. The adjusted R-squared shows how
much variation in one variable can be explained by variation in another variable.
After analyzing the 25 different R-squared variables from our regressions we
found that beta was most stable using the 5-year Treasury bill and 72 months of
Universal’s returns and market returns. This regression had the highest R-squared value
of .035. The beta value was .49 with a 95% confidence interval of (-.025 – 1), this
meant that we could be 95% confident that beta was between these values. We
realized that this really did not have any significant explanatory power and that the
value of beta was unstable. Without significant explanatory power the CAPM model
would not provide a good estimate of Universal’s cost of equity. Therefore, it was
necessary to use a different method to calculate Universal’s cost of equity. This
alternative method was based on Universal’s price to book ratio, and forecasted returns
on equity and growth in earnings for the next ten years. Universal’s price to book ratio
was 1.14 which is the current market value of the equity divided by the current book
value of equity. The average return on equity for the next ten years was estimated at
10.46% and the forecasted growth of earnings was estimated at 4.5%. Based on this
model we estimated Universals cost of equity to be 9.7%
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Regression Analysis Results
3 Month Month Beta Adj R Square T Stat
72 0.4863 3.41% 1.87260 0.4337 0.06% 1.01648 0.3962 -0.89% 0.76636 0.2017 -2.66% 0.30724 0.3604 -3.54% 0.463
6 Month Month Beta Adj R Square T Stat
72 0.4876 3.43% 1.87760 0.4365 0.08% 1.02348 0.3992 -0.87% 0.77236 0.2050 -2.65% 0.31224 0.3573 -3.55% 0.459
2 Year Month Beta Adj R Square T Stat
72 0.4921 3.52% 1.89560 0.4475 0.16% 1.04748 0.4109 -0.79% 0.79436 0.2176 -2.61% 0.33124 0.3458 -3.62% 0.444
5 Year Month Beta Adj R Square T Stat
72 0.4921 3.53% 1.89660 0.4493 0.17% 1.05048 0.4123 -0.78% 0.79836 0.2189 -2.61% 0.33324 0.3397 -3.65% 0.437
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10 Year Month Beta Adj R Square T Stat
72 0.4911 3.51% 1.89260 0.4481 0.16% 1.04748 0.4109 -0.78% 0.79636 0.2170 -2.61% 0.33124 0.3361 -3.66% 0.433
Cost of Debt
The cost of debt to a firm is equal to the average interest rate paid on borrowed
money. Debt holders have priority over equity investors so debt is less risky and has a
lower return. Therefore the cost of debt is typically lower for a firm than the cost of
equity.
When averaging the cost of debt for Universal Corporation we used the 3-month
commercial paper return of 2.03%. This was the cost of debt we used to estimate
interest on accounts payable. The interest rate on short term notes and overdrafts was
disclosed in Universal’s 10-K at 4.7%. We also used this rate for accrued compensation
and customer advances and deposits because it was the highest of the short term
interest rates. For the interest paid on income taxes payable and deferred income taxes
we used the 10 year Treasury bond rate from www.stlouisfed.org of 3.88%. Interest on
long term notes and other long term liabilities was estimated at 6.5%. This average was
taken from Universal’s 10-K which stated “Interest rates on the notes range from
5.00% to 8.00%.” It should be noted that this was the only given disclosure. The
actual weighted rate could be higher or lower depending on the actual interest rate and
103
the amount of each loan. Finally, 5.75% was the rate Universal estimated for pensions
and other post-retirement benefits.
To find the weighted average cost of debt we found the amount of each liability
above as a percentage of total liabilities. We then multiplied the percentage associated
with each liability by the corresponding interest rate to come up with Universal’s before
tax weighted average cost of debt of 5.04%. In order to get an after tax cost of debt
we simply multiplied 5.04% by (1-tax rate). Universal’s tax rate as stated in their 10-K
was 37.4%. This gave us an adjusted after tax cost of debt of 3.16%.
Cost of Debt
Liabilities Debt Weight Rate WACD
Notes Payable 126,229 .1243 4.7% .058%
Accounts Payable 220,697 .2174 2.03% .42%
Customer Advances 21,030 .0207 4.7% .10%
Accrued Compensation 25,484 .0251 4.7% .12%
Income Taxes Payable 8,886 .0088 3.88% .03%
Long-term Obligations 402,942 .3969 6.5% 2.58%
Pensions and other
Benefits
88,278 .0869 5.75% .5%
Other long-term liabilities 84,958 .0837 6.5% .54%
Deferred income taxes 36,795 .0362 3.88% .14%
Total Liabilities 1,015,299 1 5.04%
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Weighted Average Cost of Capital
To calculate Universal’s weighted average cost of capital we found the
percentage of debt and equity used to finance the company’s assets. Another way to
look at it is the percentage of debt that makes up the total debt and equity, and the
percentage of equity that makes up the total debt and equity. We then multiplied the
percentage of debt by the before tax cost of debt and added that to the percentage of
equity multiplied by the cost of equity. The estimated cost of equity we used was from
our alternative method. Normally we would want to compute a 95% confidence interval
for the WACC using the cost of equity from the confidence interval in our regression.
Because our regressions produced unreliable results we decided that the confidence
interval was not useful. We computed our before tax weighted average cost of capital
at 7.47%. To find the after tax cost of capital we simply used the after tax cost of debt
in the formula which gave us an after tax weighted average cost of capital of 6.62%.
Cost of
Debt
D/(D+E) Tax Rate Cost of
Equity
E/(D+E) WACC
WACC bt 5.04% .4757 .097 .5227 7.47%
WACC at 5.04% .4757 .35 .097 .5227 6.62%
WACC = (Value of Debt/(Value of Debt + Value of Equity))(Cost of Debt) + Value of
Equity/(Value of Debt + Value of Equity))(Cost of Equity)
Conclusion
The total cost of capital to a firm is composed of the cost of debt and cost of
equity. In order to compute the cost of equity for Universal we used regression analysis
to estimate beta and calculated the cost of equity using the capital asset pricing model.
When the results for the regression were unstable we used an alternative method and
estimated Universal’s cost of equity to be 9.6%. To find Universal’s cost of debt we took
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a weighted average of the interest on all of Universal’s liabilities reported on their 10-K.
Universal’s cost of debt came out to 5.04%. We then calculated the before tax weighted
average cost of capital based on the capital structure of the firm to be 7.47%.
Multiplying by Universal’s tax rate of 37.4% gave us an estimated after tax cost of
capital of 6.22%.
Analysis of Valuations
In order to determine if a company is fairly valued an analyst can use two
different valuation methods. The first is the comparability method. This method
compares industry averages with the firm to see if the firm is price correctly relative to
the industry. The second method is the intrinsic valuation method. This method is
based on financial theory and forecasts and is normally a better indicator of the true
value of the firm. We will utilize both of these methods in order to determine if
Universal Corporation’s stock price is overvalued, undervalued, or fairly valued.
Method of Comparables
The method of comparables is used to compute a firm’s price relative to the
industry average on a per share basis. We will use Universal’s share price of $50.16 as
of June 2, 2008 and compare that to the price and corresponding ratios of Alliance One.
We will look at the ratios of price to earnings, price to book, dividend yield, PEG,
enterprise value to EBITDA, and enterprise value to free cash flow. These comparables
are generally not considered to be an effective way of valuing a firm because there is
no underlying theory. Because of the low concentration in the tobacco manufacturing
industry, the value of Universal based on the method of comparables will not be a true
indication of value.
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Price to Earnings Trailing
The price to earning trailing is a ratio that helps analyst’s value firms and
industries. We computed this ratio, by using the current price per share on June 2nd,
2008 and divided it by the current period’s earnings per share. The current price per
share was found using yahoo finance, and the current periods earnings per share was
found using the latest 10-k of the companies. Since the EPS for Alliance was negative,
we could not personally compute the P/E trailing, so we found there P/E trailing from
yahoo finance.
PPS EPS P/E Trailing Industry
Avg.
Comparable
PPS
Universal 50.16 3.82 13.13 18.94 72.35
Alliance 5.96 -.25 18.94
According to this measurable, Universal is considered undervalued. But there is many
flaws examining this measureable. First of all, since the tobacco manufacturing industry
consists of only two major competitors the industry average is derived from only
alliance. Therefore, you are comparing a smaller company such as Alliance to a much
larger company such as Universal, this results information that can be false leading and
distorted. Also, there is a flaw with this method of comparables, because both of the
inputs in this method are backwards looking, and not forward looking which is essential
to financial analysis. Finally, even though this ratio says that Universal is undervalued,
critics should be skeptical because there are not enough firms in this industry to
compute a reasonable industry average.
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Price to Earnings Forward
The forward looking price to earnings method is calculated by, first using the
forecasted earnings of 2009. Then you divide that number by the total number of
shares outstanding to get your earnings per share. The price per share from yahoo
finance for June 2, 2008 is then divided by your forecasted earnings per share to get
your ratio for Universal. Alliance on the other hand did not have a forward P/E ratio that
could be calculated according to yahoo finance. This is probably because there EPS was
forecasted as a negative number and therefore and P/E forward could not be derived.
This is unfortunate, because the forward P/E ratio solves some of the flaws associated
with trailing P/E ratio. The forward P/E ratio utilizes numbers associated with future
outcomes of firms and therefore helps analysts better analyze the future outcomes of
firms, instead of looking at past numbers to predict future outcomes. Therefore, since
the industry average is not computable it is not known if Universal is under or
overvalued.
PPS EPS P/E Forward Industry
Avg.
Comparable
PPS
Universal 50.16 4.584 10.94 N/A N/A
Alliance 18.94 N/A N/A
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Price to Book
The price to book ratio is computed by using the price per share in the current
period and divide it by the book value per share in the current period. The book value
per share is calculated by taking the book value of equity and dividing by the total
number of shares outstanding. The book value of equity and the total number of shares
outstanding were derived from the latest 10-k’s of Universal. Alliances book value per
share was derived from yahoo finance. After calculating Alliances price to book to find
the industry average, we then took the book value per share of universal and multiplied
by 2.34 to get a comparable price per share of universal of 77.76. According to this
ratio Universal is considered to be undervalued. But as stated earlier, flaws exists when
computing these ratios is the tobacco manufacturing industry because there are only
two main competitors and Universal is a larger company than Alliance. This results in
the numbers from these ratios to be false leading.
PPS BVPS P/B Industry
Avg.
Comparable
PPS
Universal 50.16 33.23 1.51 2.34 77.76
Alliance 5.96 2.55 2.34
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Dividend Yield
To calculate the dividend yield you first take the dividend price per share and
divide by the price per share. To get dividend price per share you take the dividends
paid in current period and divide it by shares outstanding. Once you get this number
you compare it to the industry average, to find a comparable price per share. This is a
problem in the tobacco manufacturing industry because there are only two competitors
and Alliance has not paid dividends since 2005. This makes it impossible to compare
Universal to the industry, and therefore to determine if it is under or overvalued.
PPS DPS D/P Industry
Avg.
Comparable
PPS
Universal 50.16 2.34 .036 0 N/A
Alliance 5.96 0 0
Alliance hasn’t paid dividends since 2005.
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Price Earnings Growth
The price earnings growth model uses a company’s price to earnings ratio and
then divides it by their expected earnings growth rate. To get the share price for
Universal, we would have to have an average P.E.G. ratio for the industry and then
multiply that number by our company’s estimated earnings growth rate of 4.5%. After
that we would then multiply that result by our earnings per share. However, Alliance
has negative earnings per share which makes it impossible to compute the P.E.G. ratio
because negative numbers cannot be used when comparing a company to the industry.
This makes it impossible to know how the company is valued. Even if the numbers
were there to compute the price, it would probably be inaccurate because of the lack of
competitors in the industry that is needed to get a fair industry average.
PPS EPS Growth P.E.G Industry Average
Comparable PPS
Universal 50.16 3.82 4.5 2.918 N/A N/A Alliance 5.96 -.25 N/A N/A
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Price to EBITDA
To get a price to EBITDA ratio you must take the current share price and divide
it by earnings before interest, taxes, depreciation, and amortization. The numbers used
in this calculation were taken from Universal’s and Alliances 10-k. Alliance’s price per
share and EBITDA came from yahoo finance. All of the EBITDA’s are stated in terms of
billions in order to get reasonable numbers to work with. As already stated the price to
EBITDA is computed by taking the price per share and dividing it by the company’s
EBITDA. Price to EBITDA for Universal is 213.67 in 2008. The EBITDA is multiplied by
the industry average P/EBITDA of 39.75 which was taken from yahoo finance. The
share price for Universal is $9.33 for 2008. This shows that Universal is extremely over
valued when compared to the reported share prices for Universal. This assumption of
being overvalued could be off because of the lack of competitors to get an industry
average.
PPS EBITDA(IN
BILLIONS)
PPS/EBITDA INDUSTRY
AVG.
Comparable
PPS
Universal 50.16 .234753 213.67 39.74 9.33
Alliance 5.96 .149993 39.74
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Price over Free Cash Flow
To calculate the price over free cash flow, you first must find the free cash flow.
To find this you take your cash flow from operations and add/subtract cash flow from
investing activities in the current period. Once you have this number you can find your
price over free cash flow. Then you find your comparable PPS which is the industry
average multiplied by your free cash flow, which was 1.72 for Universal. This indicates
that Universal is extremely overvalued according to this model.
PPS FCF PPS/FCF Industry
Avg.
Comparable
PPS
Universal 50.16 66.587 .7533 .0257 1.72
Alliance 5.96 231.784 .0257
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Enterprise Value over EBITDA
To calculate the enterprise value over EBITDA you first have to find the
enterprise value. The enterprise value is calculated by taking the market cap (pps *
number of shares outstanding) plus the book value of liabilities and subtracting that
number by cash and short term investments. The enterprise value of universal was
2.132793 in billions. Once you have this number you find EBITDA, which is operating
income added to depreciation expense and amortization. Next you take enterprise value
and divide it by EBITDA, for Universal this was 9.09. We then found Alliance’s
EV/EBITDA on yahoo finance to get the industry average which was 6.833. Then you
have to find the comparable PPS for Universal. To do this you use this equation,
PPS*(# of shares) + (book value of liabilities – cash and short term investments)/
(EBITDA) = Industry Avg. You use this equation to find the variable PPS. After
completing this equation we found that the comparable PPS was 32.95, meaning that
Universal is overvalued according to this ratio.
PPS
EV(billions) EBITDA(billions) EV/EBITDA Industry
Avg.
Comparable
PPS
Universal 50.16 2.132793 .234753 9.09 6.833 32.95
Alliance 5.96 N/A N/A 6.833
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Conclusion
After analyzing all of the method of comparables we came to an unsuccessful
conclusion on whether are firm is under or overvalued. This is because half of the
method of comparables shows that our firm is undervalued, while the other half
determined that our firm was overvalued. These financial ratios value a company
through the comparison to the industries competitors. This causes problems with the
tobacco manufacturing industry because it only has two competitors and these
competitors vary in size. For example, Universal has 25,000 employees and Alliance
only has 4,700 employees. Overall, these estimations give no accurate valuations when
comparing the actual stock price of Universal, because of the reason stated above.
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Intrinsic Valuation Model
Intrinsic valuation models are generally more accurate than the method of
comparables. This is because the intrinsic models take into account firm specific
information. The four models we will use to value Universal Corporation are discounted
dividend model, the free cash flows model, residual income model, and the long run
ROE residual income model. We will also analyze how changes in the growth rate and
WACC estimation could affect the value of Universal Corporations stock.
Discounted Dividends Model
The discounted dividends model attempts to derive the value of a stock by
valuing the future dividends. This model is based on the assumption that shareholders
value stock based on the dividends. The problem with this assumption is that
shareholders do not buy stock simply for the dividend return. Investors typically get
most of their return from the stocks appreciation. Another problem with the model is
that it assumes that dividends will continue indefinitely and increase at a constant rate.
This is inaccurate because dividends typically increase, remain constant for a period of
time, and then increase again.
To value Universal Corporation based on the dividend discount model we
forecasted dividends paid for the next ten years. We then discounted each dividend at
Universals cost of equity and added them together to find a present value of the year
by year dividends which was $18.79. We then used perpetuity to estimate the present
value of all dividends occurring after 2018. This was found by dividing the estimated
dividend in 2018 by the cost of equity minus a growth rate. We estimated the growth
rate to be 2% based on previous dividend growth. It was then necessary to discount
the perpetuity back to the present value. The result was a value of $20.53. We added
the present value of the dividends for the next ten years to the perpetuity value for an
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estimated stock price of $39.32 as of 3/31/08. In order to analyze the model value
relative to the current market price at 6/2/08 we grew the value by two months to a
price of $39.95.
This value was smaller than our observed share price on 6/2/08 of $50.16. The
reason for this is because the discounted dividends model only values the dividends of
the company. Over 50% of the value the model found for Universal came from the
perpetuity. This implies that most of the value in the model comes from dividends
occurring after ten years. This is one of the weaknesses of the discounted dividends
model. The value for the model is based on the assumption that future dividends will
continue forever.
Sensitivity Analysis Growth 0 0.02 0.04 0.06 0.08
Ke
0.08 45.94 54.27 70.92 120.89 0.09 40.27 46.07 56.50 80.84 202.540.1 35.78 39.95 46.90 60.81 102.53
0.11 32.13 35.22 40.06 48.79 69.140.12 29.12 31.45 34.94 40.77 52.42
Undervalued Fairly Valued within 15% of
$50.16 Overvalued
When we looked at the sensitivity for Universal we found that the model could
fairly value the stock (within 15% of the observed price) if we assumed a lower cost of
equity, or a higher growth rate, or a higher growth rate and higher cost of equity.
Universal could be fairly valued if the cost of equity was 8 or 9 percent at a growth rate
of 2%. If dividends grew at 4% then Universal would be fairly valued at a cost of equity
of 10% or 9%. The model showed that Universal could also be undervalued if the
growth rate was assumed to be 6 or 8%. Overall we felt like there were too many
assumptions in the discount dividends model to accurately value Universals stock price.
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Discounted Free Cash Flow
The discounted free cash flow model is an intrinsic valuation model that financial
analysts use to value a firm. To value the firm they first start out by taking the cash
flow from operations and either add them or subtract them by cash flow from investing
activities. This is a major problem when dealing with Universal because they have a
continuing trend of having negative free cash flows. This results in negative price per
share’s which are not possible in the real world. But anyway after finding your FCF, you
must find the present value factor by taking 1/(1+WACC)^T, then multiply this number
by the periods FCF to get the FCF in present value. Then you take the sum of all
present values and add it to Terminal Value perpetuity (FCF 2019/ WACC before tax-
growth, this number is then divided by the present value factor of 2018) to get your
market value of assets. Market value of assets is then subtracted by book value of debt
and preferred stock to get a market value of equity. Then you divide MVE by total
number of shares outstanding to get you a share price for March 31, 2008. You then
have to find the time consistent price by taking your share price at March 31, 2008 and
multiplying it by (1+Ke)^(2/12), to get the share price of -75.53 for June 2, 2008. As
stated earlier it is impossible in the real world to have a negative share price, but this is
the case for Universal in the model because of the consistent trend of negative free
cash flows. Therefore, according to this model Universal is highly overvalued.
Sensitivity Analysis Growth 0 0.01 0.02 0.03 0.04
WACC (bt)
0.05 -80.29 -87.47 -99.44 -123.38 -195.18 0.06 -77.76 -83.03 -90.93 -104.11 -130.47 0.07 -76.10 -80.24 -86.04 -94.74 -109.24 0.08 -75.01 -78.42 -82.98 -89.35 -98.91 0.09 -74.31 -77.23 -80.98 -85.98 -92.98
Undervalued Fairly Valued with 15% of
$50.16 Overvalued
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Residual Income Model
The residual income model has the most explanatory power of all the intrinsic
valuation models. The reason for this is that residual income is based on easily
forecasted numbers and is not sensitive to changes in cost of capital or growth rates.
The model is accounting based so the information grounded in financial theory.
Residual income is the difference between the forecasted net income and the normal
income which is the previous year’s book value of equity times the cost of equity.
To forecast the residual income we first found the book value of equity from
Universal’s 10-K report. We then took the cost of equity we computed for Universal and
multiplied it by the book value of equity. The product was the normal income or
benchmark income. We estimated the normal income for the next ten years based on
our forecasted book values of equity and Universal’s cost of capital. We then subtracted
the normal income from our forecasted net income to arrive at our annual residual
income.
Once we had these residual income figures we discounted them at by the cost of
equity to their present values and added them together, this gave us our year by year
present value of residual income of $106,901.19. Next it was necessary to estimate the
future value of all residual income. It was necessary to use a negative growth rate
when computing the perpetuity. This is because firm’s residual income will eventually
shrink to zero. The value for all future residual income past ten years was $16,848.48.
We discounted this amount at the cost of capital minus the growth rate back to its
present value of $68,821. We were then ready to add the present values of the residual
income for the next ten years to the present value of the perpetuity and derive an
estimated market value of equity of 1,291,353. We divided this by the number of
shares outstanding, 27,162. This gave us Universal’s stock price of $47.54 at 3/31/08
as estimated by the model. To get the price as of 6/2/08 we simply grew the estimated
by two months which gave us a time consistent price of $48.28.
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Sensitivity Analysis Growth 0 -0.1 -0.2 -0.3 -0.4 -0.5
Ke
0.08 60.63 55.66 54.24 53.57 53.17 52.920.09 52.79 50.3 49.52 49.15 48.92 48.780.1 46.55 45.65 45.35 45.2 45.11 45.05
0.11 41.49 41.6 41.64 41.66 41.67 41.680.12 37.3 38.06 38.34 38.49 38.58 38.64
Undervalued Fairly Valued within 15% of $50.16 Overvalued
We found this model to be very accurate. The sensitivity analysis revealed that
Universal was fairly valued at our estimated cost of capital of 10%, as well as at 8 and
9%. At these costs of capital the estimated price was fairly valued when the residual
income was growing at -.1 though -.5%. The sensitivity analysis indicated that the price
was overvalued at costs of capital over 10% at all growth rates. Overall this model
seems to indicate that Universal’s stock is fairly valued.
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Long Run Return on Equity Residual Income Model
The long run return on equity residual income model is used to calculate the
value of a firm using a perpetuity equation that can be derived from methods in the
residual income model. It is a very accurate perpetuity model because of the factors
that are used within this model to value the firm. This model uses the long run cost of
equity, long run return on equity, and the long run growth of return on equity in the
long run to value the firm. Below is Universal’s long run return on equity residual
income model.
Long Run Residual Income Sensitivity Analysis Growth
Return on Equity
0.02 0.03 0.04 0.05 0.06 0.070.08 32.00 30.65 28.82 26.22 22.20 15.210.09 37.34 36.78 36.03 34.96 33.30 30.420.1 42.67 42.91 43.23 43.69 44.40 45.64
0.11 48.01 49.04 50.44 52.43 55.50 60.850.12 53.34 55.17 57.65 61.17 66.60 76.06
**Cost of Equity is held constant at 9.7% Undervalued Fairly Valued within 15% of $50.16 Overvalued fair if more than 42.63 and less than 57.68
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Long Run Residual Income Sensitivity Analysis Cost of Equity
Return on Equity
0.05 0.055 0.060 0.065 0.070 0.0750.08 497.44 174.43 105.75 75.88 59.17 48.490.09 649.56 227.77 138.10 99.09 77.26 63.310.10 801.68 281.11 170.44 122.29 95.35 78.140.11 953.81 334.45 202.78 145.50 113.45 92.970.12 1105.93 334.45 202.78 145.50 113.45 92.97
**Growth Rate is held constant at 4.3% Undervalued Fairly Valued within 15% of $50.16 Overvalued fair if more than 42.63 and less than 57.68
Long Run Residual Income Sensitivity Analysis Growth Rates
Cost of Equity
0.02 0.03 0.04 0.05 0.06 0.070.06 91.80 108.71 142.52 243.97 N/A N/A 0.07 73.44 81.53 95.02 121.99 202.90 N/A 0.08 61.20 65.22 71.26 81.32 101.45 161.830.09 52.46 54.35 57.01 60.99 67.63 80.910.10 45.90 46.59 47.51 48.79 50.73 53.94
**Return on Equity is held constant at 10.94% Undervalued Fairly Valued within 15% of $50.16 Overvalued fair if more than 42.63 and less than 57.68
To find the long run return on equity for Universal we used our forecasted return
on equity for the next 10 years and the book value of equity. The book value of equity
was not previously forecasted but can be done so by using the following formula.
Ending BVE = Beginning BVE + Earnings - Dividends
After finding the BVE it is easy to find the ROE by using the equation below.
ROE = Net Income (current year) / BVE of the previous year
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By using this equation we were able to calculate the ROE for the next 10 years. We
then took the sum of those calculations and divided it by 10 to get our long run return
on equity of 10.94%.
The next step is to find the long run growth of ROE. We found our long run
growth of ROE to be 4.73%. The number was reached by taking the sum of all of the
percentages changes in book value of equity for the past 10 years and dividing that
number by 10. The percentage change for each year is computed by taking the current
years BVE and dividing it by the BVE in the previous year and then subtracting 1.
After the long run ROE and the long run growth of ROE have been calculated, all
we have to do is plug in the numbers to find the value of Universal. To find the value
of a firm using the long run ROE residual income model you must use this equation:
Value of firm = BVE (1 + ((LR ROE – Cost of Equity) / (Cost of Equity – LR Growth))
After using this equation we then divided this number by the number of shares
outstanding, which is 27,162.15, to get our share price on March 31, 2008 of $51.32.
We then grew this price for two months to June 2008 to the price of $52.19.
This model shows that Universal is fairly valued. In order to maintain this fair
value in the long run ROE residual income model, Universal must do the following: keep
the long run cost of equity between 9% and 11%; have relatively low levels of long run
growth of equity; and keep the long run return on equity relatively close to 10.94%.
This is very possible according to the forecasted out 10 years for Universal. To sum
this all up, the long run ROE residual income model states that Universal is fairly valued
when using the forecasted inputs in this models equation. This conclusion to the model
contradicts what some of the other models have said about the value of Universal.
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Abnormal Earnings Growth Model
The abnormal earnings growth model is an essential model when looking to
value a firm. This model is calculated by taking your forecasted net income and adding
it to your dividend reinvestment program (DRIP income) to get your cumulative
dividend income. But first you must calculate your DRIP income by taking your
dividends from your previous year and multiplying it by your cost of equity, which in our
case was 9.7%. Once you have your DRIP income you can calculate your cumulative
dividend income which was stated earlier. Then you must find the benchmark income
(or sometimes called normal income), to do this you take your previous periods net
income and multiply by one plus your cost of equity. After that you can calculate your
annual abnormal earnings growth by taken your cumulative dividends income and
subtracting it by your benchmark income. Then you must check the accuracy of your
annual abnormal earnings, by comparing them to your change in forecasted residual
income. If the annual AEG and the change in residual income do not equal each other
than an error was made. As shown in the table below the calculations were done
correctly, which varies our model.
Proof of Annual AEG and Change in Residual Income
2010 2011 2012 2013 2014 2015 2016 2017 2018
Annual
AEG
25 97 177 265 361 466 581 706 843
Change
in
Residual
Income
25 97 177 265 361 466 581 706 843
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After calculating the AEG, we had to bring it back to present value of money, by taking
1 dividing by 1 plus cost of equity which gave us the present value factors. Then you
multiply that number by the AEG to get the present value of AEG. Once you have the
present value AEG you add them all together to get the total present value of AEG,
which was 1,921. Then we had to find the value of perpetuity by forecasting the
eleventh year of annual AEG, (which was 716.21) and putting it into the perpetuity
equation which is AEG perpetuity= forecasted AEG (716.21)/KE(9.7%)-Growth(0%).
This gave us 7,384, which then had to be calculated back to year one, by multiplying
7,384 by the present value factor of year ten.
After those calculations we found the total adjusted earnings perpetuity(129,649)
by adding the value of perpetuity(Net income 2009), the present value of AEG, and
total value of AEG. We then divided the adjusted AEG by the cost of equity to get the
market value of equity for March 31, 2008, and then divided this number by total
shares outstanding to get a model share price of Universal for March 31, 2008. Finally,
we had to find the time consistent price for June 2, 2008, by taking the model share
price and multiplying by (1+cost of equity)^(2/12), which gave us a share price of
49.97.
Sensitivity Analysis Growth 0 -0.1 -0.2 -0.3 -0.4 -0.5
Ke
0.08 55.58 53.21 52.23 52.21 52.02 51.90.09 52.02 50.83 50.46 50.28 50.17 50.10.1 49.18 48.75 48.61 48.53 48.49 48.46
0.11 46.87 46.93 46.95 46.97 46.97 46.980.12 44.95 45.33 45.47 45.55 45.6 45.63
Undervalued Fairly Valued within 15% of $50.16 Overvalued
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As shown by the table above in the sensitivity analysis, Universal is fairly valued.
No matter which growth rates or cost equity used, Universal is fairly valued according to
the abnormal earnings growth model.
Conclusion
The intrinsic valuation models were a much better indicator of Universal’s share
price. We used the models to determine if Universal’s shares were overvalued,
undervalued, or fairly valued. Fairly valued meant that the model price was within 15%
of the Universals share price at June 2, 2008 of $50.16.
The discounted dividend model we found that was overvalued. The model gave
us a price of $39.95 using Universal’s cost of equity of 10% and a growth rate of 2%.
When we analyzed the sensitivity of the model we found that Universal’s price was fairly
valued or even undervalued if we assumed a lower cost of capital or higher growth rate.
We do not think this was an accurate indicator of Universal’s price because the dividend
model values a firm on the assumption that investors are only interested in dividends.
The free cash flow model valued Universal’s stock at a negative price. This
indicates that the model cannot be useful in determining value. The reason for this was
that the model is based on free cash flows and Universal has negative free cash flows.
The sensitivity analysis was not helpful because of the inherent problem with the
model.
The residual income model fairly valued Universals stock at its current cost of
equity. We felt like this was the most accurate model because of it relates accounting
theory to value. When we looked at the sensitivity of the model we found that it was
the least sensitive to changes in cost of equity and growth rates. The model did show
Universal as slightly overvalued when we assumed a higher cost of equity, but the
overall the effect was negligible.
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The long run residual model also showed that Universal was fairly valued at the
current cost of capital. The long run residual income model is based on the residual
income model so the results tend to be a good indicator of value. Universal was fairly
valued when the long run cost of equity between 9% and 11% the growth was low,
long run return on equity was relatively close to the forecast of 10.94%.
Finally, the abnormal earning growth model was used to value Universal. Like the
residual income model this model is believed to be an accurate indicator of value. The
AEG model overwhelmingly found that Universal is a fairly valued stock. The sensitivity
of the model showed that Universal was fairly valued at all growth rates, and all
estimated costs of equity.
Overall we feel that Universal Corporation is a fairly valued stock. This means
that the actual price of the shares is within 15% of the current share price of $50.16.
The residual income, long run residual income, and abnormal growth model all found
Universal to be fairly valued and these theory based models are thought to be the best
of all the models we used.
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Appendices
Liquidity Ratios
Current Ratio 2003 2004 2005 2006 2007 2008Universal 1.67 2.07 1.84 1.92 2.23 3.52Alliance 2.08 1.94 2.17 1.65 1.89
Quick Asset Ratio 2003 2004 2005 2006 2007 2008Universal 0.50 0.64 0.57 0.57 0.89 1.04Alliance 0.67 0.47 0.62 0.42 0.50
Inventory Turnover 2003 2004 2005 2006 2007 2008Universal 2.68 2.17 2.69 2.79 2.46 2.66Alliance 2.17 1.41 2.35 2.45 2.59
Days Supply Inventory 2003 2004 2005 2006 2007 2008Universal 136.23 168.14 135.79 131.05 148.58 137.32Alliance 168.22 259.76 155.64 149.27 141.18
Receivables Turnover 2003 2004 2005 2006 2007 2008Universal 7.11 5.25 6.62 7.53 7.69 9.28Alliance 6.67 4.16 5.92 6.58 9.09
Days Sales Outstanding 2003 2004 2005 2006 2007 2008Universal 51.33 69.52 55.15 48.44 47.48 39.31Alliance 54.71 87.71 61.70 55.43 40.16
128
Working Capital Turnover 2003 2004 2005 2006 2007 2008Universal 4.79 2.88 4.00 4.06 2.35 2.11Alliance 2.74 1.91 2.78 3.92 3.72
Days of Working Capital 2003 2004 2005 2006 2007 2008Universal 76.23 126.57 91.25 89.89 155.00 172.60Alliance 133.06 190.99 131.46 93.11 98.11
Cash to Cash Cycle 2003 2004 2005 2006 2007 2008Universal 187.56 237.65 190.94 179.49 196.06 176.63Alliance 222.93 347.47 217.34 204.71 181.34
Profitability Ratios
Gross Profit Margin 2003 2004 2005 2006 2007 2008Universal 20.41% 19.46% 18.66% 16.49% 22.11% 20.04%Alliance 11.37% 13.15% 14.97% 10.64% 14.94%
Operating Expense Ratio 2003 2004 2005 2006 2007 2008Universal 0.11 0.11 0.12 0.12 0.12 0.11Alliance 0.09 0.11 0.10 0.08 0.08
Operating Profit Margin 2003 2004 2005 2006 2007 2008Universal 7.88% 8.44% 6.37% 2.97% 8.15% 8.92%Alliance 2.24% ‐2.69% 1.88% ‐20.04% ‐0.13%
Net Profit Margin 2003 2004 2005 2006 2007 2008Universal 4.19% 4.39% 3.02% 0.23% 2.21% 5.55%Alliance 2.34% ‐4.10% 1.02% ‐21.18% ‐1.09%
129
Asset Turnover 2003 2004 2005 2006 2007 2008Universal 1.43 1.01 1.32 1.22 0.69 0.92Alliance 0.94 0.59 0.96 1.50 1.04
Return on Assets 2003 2004 2005 2006 2007 2008Universal 6.00% 4.44% 3.99% 0.28% 1.53% 5.12%Alliance 2.20% ‐2.43% 0.98% ‐31.87% ‐1.13%
Return on Equity 2003 2004 2005 2006 2007 2008Universal 18.81% 16.06% 13.03% 0.97% 4.60% 11.56%Alliance 6.45% ‐7.23% 3.20% ‐108.00% ‐10.08%
Capital Structure Ratios
Debt to Equity 2003 2004 2005 2006 2007 2008Universal 2.62 2.27 2.47 1.99 1.25 0.91Alliance 1.98 2.27 2.39 7.89 6.33
Times Interest Earned 2003 2004 2005 2006 2007 2008Universal 4.59 5.47 3.58 1.28 3.04 4.57Alliance 0.572 ‐0.670 0.463 ‐3.899 ‐0.025
Debt Service Margin 2003 2004 2005 2006 2007 2008Universal ‐0.36 ‐0.26 ‐1.90 0.51 28.65 0.55Alliance 8.61 ‐44.73 2.16 26.34 6.67
Z ‐ Scores 2003 2004 2005 2006 2007 2008Universal 2.54 2.38 2.42 2.32 2.71 3.39Alliance 1.84 1.36 1.79 0.72 1.75
130
IGR/SGR
Sustainable Growth Rate 2003 2004 2005 2006 2007 2008Universal 12.72% 11.44% 7.58% ‐4.30% ‐0.11% 6.83%Alliance 3.62% ‐9.46% ‐0.07% ‐110.19% ‐10.08%
Internal Growth Rate 2003 2004 2005 2006 2007 2008Universal 4.06% 3.16% 2.32% ‐1.24% ‐0.04% 3.03%Alliance 1.23% ‐3.18% ‐0.02% ‐32.52% ‐1.13%
Sales Diagnostic Ratios
Net Sales/Cash From Sales 2003 2004 2005 2006 2007 2008 Universal 1.03 1.03 1.02 0.99 0.91 0.99 Alliance 1.00 0.98 0.98 0.95 1.05
Net Sales/Accounts Receivable 2003 2004 2005 2006 2007 2008 Universal 7.11 5.25 6.62 7.53 7.69 9.28 Alliance 6.67 4.16 5.92 6.58 9.09
Net Sales/Unearned Revenue 2003 2004 2005 2006 2007 2008 Universal 62.64 37.92 67.36 35.51 15.02 102.04 Alliance 15.94 10.40 26.33 9.33 15.78
Net Sales/Inventory 2003 2004 2005 2006 2007 2008 Universal 3.37 2.70 3.30 3.34 3.15 3.32 Alliance 2.45 1.62 2.76 2.74 3.04
131
Expense Diagnostic Ratios
Asset Turnover 2003 2004 2005 2006 2007 2008 Universal 1.18 0.91 1.14 1.21 0.86 1.01 Alliance 0.88 0.59 0.93 1.11 1.20
CFFO/OI 2003 2004 2005 2006 2007 2008 Universal ‐0.22 ‐0.14 ‐0.42 0.61 1.50 0.47 Alliance 0.36 2.54 0.26 ‐0.22 ‐71.69
Pension Expense/SG&A 2003 2004 2005 2006 2007 2008 Universal 0.04 0.04 0.04 0.03 0.05 0.07 Alliance 0.04 0.05 0.05 0.06 0.05
Cost Of Debt
Cost of Debt
Liabilities Debt Weight Rate WACD
Notes Payable 126,229 .1243 4.7% .058%
Accounts Payable 220,697 .2174 2.03% .42%
Customer Advances 21,030 .0207 4.7% .10%
Accrued Compensation 25,484 .0251 4.7% .12%
Income Taxes Payable 8,886 .0088 3.88% .03%
Long-term Obligations 402,942 .3969 6.5% 2.58%
Pensions and other
Benefits
88,278 .0869 5.75% .5%
Other long-term liabilities 84,958 .0837 6.5% .54%
Deferred income taxes 36,795 .0362 3.88% .14%
Total Liabilities 1,015,299 1 5.04%
132
Weight Average Cost of Capital
Cost of
Debt
D/(D+E) Tax Rate Cost of
Equity
E/(D+E) WACC
WACC bt 5.04% .4757 .097 .5227 7.47%
WACC at 5.04% .4757 .35 .097 .5227 6.62%
Weighted Average Cost of Equity
3 Month
72 months
Regression Statistics
Multiple R 0.21830388
R Square 0.047656584
Adjusted R Square 0.034051678
Standard Error 0.075819185
Observations 72
ANOVAdf SS MS F Significance F
Regression 1 0.020136574 0.020136574 3.50289699 0.065440262Residual 70 0.402398412 0.005748549Total 71 0.422534986
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.00767008 0.008953815 0.856627021 0.39457414 ‐0.010187741 0.025527901 ‐0.010187741 0.025527901X Variable 1 0.486311834 0.259837096 1.871602787 0.065440262 ‐0.031916908 1.004540575 ‐0.031916908 1.004540575
60 monthsRegression Statistics
Multiple R 0.132287302R Square 0.01749993Adjusted R Square 0.000560274Standard Error 0.080800132Observations 60
ANOVAdf SS MS F Significance F
Regression 1 0.006744595 0.006744595 1.033074693 0.313658851Residual 58 0.378662354 0.006528661Total 59 0.385406948
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007215663 0.01058198 0.681882079 0.498027552 ‐0.013966472 0.028397798 ‐0.013966472 0.028397798X Variable 1 0.433675362 0.426676661 1.01640282 0.313658851 ‐0.420410764 1.287761488 ‐0.420410764 1.287761488
133
48 monthsRegression Statistics
Multiple R 0.11219773R Square 0.012588331Adjusted R Square ‐0.008877141Standard Error 0.088495802Observations 48
ANOVAdf SS MS F Significance F
Regression 1 0.004592753 0.004592753 0.586445577 0.447708692Residual 46 0.36024932 0.007831507Total 47 0.364842073
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007088052 0.012823137 0.552754963 0.583107513 ‐0.018723582 0.032899687 ‐0.018723582 0.032899687X Variable 1 0.396190639 0.517357027 0.765797347 0.447708692 ‐0.645195028 1.437576306 ‐0.645195028 1.437576306
36 monthsRegression Statistics
Multiple R 0.052555126R Square 0.002762041Adjusted R Square ‐0.026568487Standard Error 0.098767485Observations 36
ANOVAdf SS MS F Significance F
Regression 1 0.000918625 0.000918625 0.094169503 0.760813564Residual 34 0.33167055 0.009755016Total 35 0.332589175
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.010487491 0.016498736 0.635654232 0.5292574 ‐0.023041974 0.044016956 ‐0.023041974 0.044016956X Variable 1 0.201699792 0.65727984 0.306870498 0.760813564 ‐1.134053547 1.537453131 ‐1.134053547 1.537453131
24 monthsRegression Statistics
Multiple R 0.098293199R Square 0.009661553Adjusted R Square ‐0.035353831Standard Error 0.104369388Observations 24
ANOVAdf SS MS F Significance F
Regression 1 0.002337934 0.002337934 0.214627803 0.647714565Residual 22 0.239645322 0.010892969Total 23 0.241983256
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.021010136 0.021332415 0.984892532 0.335385351 ‐0.023230584 0.065250856 ‐0.023230584 0.065250856X Variable 1 ‐0.360357699 0.777840973 ‐0.4632794 0.647714565 ‐1.973501136 1.252785738 ‐1.973501136 1.252785738
134
6 Month
6m 72 months
Regression Statistics
Multiple R 0.21886817
R Square 0.047903276
Adjusted R Square 0.034301894
Standard Error 0.075809364
Observations 72
ANOVAdf SS MS F Significance F
Regression 1 0.02024081 0.02024081 3.521941878 0.064729847Residual 70 0.402294176 0.00574706Total 71 0.422534986
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007714392 0.008951081 0.861839126 0.391718868 ‐0.010137976 0.02556676 ‐0.010137976 0.02556676X Variable 1 0.487609831 0.259825254 1.876683745 0.064729847 ‐0.030595292 1.005814954 ‐0.030595292 1.005814954
6m 60 monthsRegression Statistics
Multiple R 0.133138773R Square 0.017725933Adjusted R Square 0.000790173Standard Error 0.080790838Observations 60
ANOVAdf SS MS F Significance F
Regression 1 0.006831698 0.006831698 1.046657081 0.310526517Residual 58 0.378575251 0.006527159Total 59 0.385406948
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007253535 0.010572731 0.686060661 0.495408314 ‐0.013910086 0.028417155 ‐0.013910086 0.028417155X Variable 1 0.43646964 0.426630434 1.023062599 0.310526517 ‐0.417523952 1.290463232 ‐0.417523952 1.290463232
135
48 monthsRegression Statistics
Multiple R 0.113031299R Square 0.012776075Adjusted R Square ‐0.008685315Standard Error 0.088487388Observations 48
ANOVAdf SS MS F Significance F
Regression 1 0.00466125 0.00466125 0.595305094 0.444320599Residual 46 0.360180823 0.007830018Total 47 0.364842073
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007130466 0.012816495 0.556350713 0.580667649 ‐0.0186678 0.032928733 ‐0.0186678 0.032928733X Variable 1 0.399206487 0.517401628 0.771560169 0.444320599 ‐0.642268956 1.44068193 ‐0.642268956 1.44068193
36 monthsRegression Statistics
Multiple R 0.053388168R Square 0.002850296Adjusted R Square ‐0.026477636Standard Error 0.098763115Observations 36
ANOVAdf SS MS F Significance F
Regression 1 0.000947978 0.000947978 0.097187092 0.757135429Residual 34 0.331641197 0.009754153Total 35 0.332589175
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.010500885 0.016494052 0.636646749 0.528618316 ‐0.023019062 0.044020831 ‐0.023019062 0.044020831X Variable 1 0.204974466 0.657499567 0.311748443 0.757135429 ‐1.131225412 1.541174345 ‐1.131225412 1.541174345
24 monthsRegression Statistics
Multiple R 0.097405346R Square 0.009487801Adjusted R Square ‐0.03553548Standard Error 0.104378543Observations 24
ANOVAdf SS MS F Significance F
Regression 1 0.002295889 0.002295889 0.210731006 0.650698414Residual 22 0.239687367 0.01089488Total 23 0.241983256
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.020983068 0.021331828 0.983650722 0.335982158 ‐0.023256436 0.065222573 ‐0.023256436 0.065222573X Variable 1 ‐0.357254606 0.778240122 ‐0.459054469 0.650698414 ‐1.971225828 1.256716616 ‐1.971225828 1.256716616
136
2 Years
2 year 72 months
Regression Statistics
Multiple R 0.220947741
R Square 0.048817904
Adjusted R Square 0.035229588
Standard Error 0.075772942
Observations 72
ANOVAdf SS MS F Significance F
Regression 1 0.020627272 0.020627272 3.592638365 0.062165336Residual 70 0.401907714 0.005741539Total 71 0.422534986
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.00785949 0.008942139 0.878927295 0.382447875 ‐0.009975044 0.025694024 ‐0.009975044 0.025694024X Variable 1 0.492126119 0.259638842 1.895425642 0.062165336 ‐0.025707217 1.009959454 ‐0.025707217 1.009959454
2 year 60 monthsRegression Statistics
Multiple R 0.13622011R Square 0.018555918Adjusted R Square 0.001634469Standard Error 0.080756698Observations 60
ANOVAdf SS MS F Significance F
Regression 1 0.00715158 0.00715158 1.096591533 0.299359756Residual 58 0.378255369 0.006521644Total 59 0.385406948
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007335093 0.010549735 0.695286949 0.48965188 ‐0.013782495 0.028452681 ‐0.013782495 0.028452681X Variable 1 0.447478268 0.427316344 1.047182664 0.299359756 ‐0.407888323 1.302844858 ‐0.407888323 1.302844858
137
2 year 48 monthsRegression Statistics
Multiple R 0.116249117R Square 0.013513857Adjusted R Square ‐0.007931494Standard Error 0.088454318Observations 48
ANOVAdf SS MS F Significance F
Regression 1 0.004930424 0.004930424 0.63015323 0.431375195Residual 46 0.359911649 0.007824166Total 47 0.364842073
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007185035 0.012803905 0.561159626 0.577412343 ‐0.018587889 0.032957958 ‐0.018587889 0.032957958X Variable 1 0.41094642 0.517680872 0.793821914 0.431375195 ‐0.631091112 1.452983953 ‐0.631091112 1.452983953
2 year 36 monthsRegression Statistics
Multiple R 0.056599377R Square 0.003203489Adjusted R Square ‐0.026114055Standard Error 0.098745622Observations 36
ANOVAdf SS MS F Significance F
Regression 1 0.001065446 0.001065446 0.109268682 0.743006709Residual 34 0.331523729 0.009750698Total 35 0.332589175
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.010493798 0.016488741 0.636422034 0.528762974 ‐0.023015355 0.044002951 ‐0.023015355 0.044002951X Variable 1 0.217598162 0.658275013 0.330558137 0.743006709 ‐1.120177611 1.555373936 ‐1.120177611 1.555373936
2 year 24 monthsRegression Statistics
Multiple R 0.094140094R Square 0.008862357Adjusted R Square ‐0.036189354Standard Error 0.104411492Observations 24
ANOVAdf SS MS F Significance F
Regression 1 0.002144542 0.002144542 0.196715223 0.661716655Residual 22 0.239838714 0.01090176Total 23 0.241983256
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.020973199 0.021339255 0.982845908 0.336369338 ‐0.023281706 0.065228104 ‐0.023281706 0.065228104X Variable 1 ‐0.345799371 0.779659931 ‐0.443525898 0.661716655 ‐1.962715096 1.271116354 ‐1.962715096 1.271116354
138
5 Years
5 year 72 months
Regression Statistics
Multiple R 0.221007358
R Square 0.048844252
Adjusted R Square 0.035256313
Standard Error 0.075771893
Observations 72
ANOVAdf SS MS F Significance F
Regression 1 0.020638406 0.020638406 3.594676978 0.062093047Residual 70 0.401896581 0.00574138Total 71 0.422534986
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.008100173 0.008936277 0.90643709 0.367814219 ‐0.00972267 0.025923017 ‐0.00972267 0.025923017X Variable 1 0.492102261 0.259552625 1.895963338 0.062093047 ‐0.02555912 1.009763642 ‐0.02555912 1.009763642
5 year 60 monthsRegression Statistics
Multiple R 0.136615871R Square 0.018663896Adjusted R Square 0.001744308Standard Error 0.080752256Observations 60
ANOVAdf SS MS F Significance F
Regression 1 0.007193195 0.007193195 1.103094016 0.297944672Residual 58 0.378213753 0.006520927Total 59 0.385406948
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007503866 0.010525134 0.712947323 0.478737046 ‐0.013564479 0.028572211 ‐0.013564479 0.028572211X Variable 1 0.449285239 0.427775479 1.050282826 0.297944672 ‐0.407000409 1.305570887 ‐0.407000409 1.305570887
139
5 year 48 monthsRegression Statistics
Multiple R 0.116814059R Square 0.013645524Adjusted R Square ‐0.007796964Standard Error 0.088448414Observations 48
ANOVAdf SS MS F Significance F
Regression 1 0.004978461 0.004978461 0.636377832 0.429124442Residual 46 0.359863611 0.007823122Total 47 0.364842073
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007268536 0.01279525 0.568065141 0.572753364 ‐0.018486967 0.033024038 ‐0.018486967 0.033024038X Variable 1 0.412304612 0.516845419 0.797732933 0.429124442 ‐0.62805124 1.452660464 ‐0.62805124 1.452660464
5 year 36 monthsRegression Statistics
Multiple R 0.057048802R Square 0.003254566Adjusted R Square ‐0.026061476Standard Error 0.098743092Observations 36
ANOVAdf SS MS F Significance F
Regression 1 0.001082433 0.001082433 0.111016549 0.741035782Residual 34 0.331506741 0.009750198Total 35 0.332589175
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.010512543 0.016484497 0.637723019 0.527925767 ‐0.022987985 0.044013072 ‐0.022987985 0.044013072X Variable 1 0.218883522 0.65693017 0.33319146 0.741035782 ‐1.1161592 1.553926245 ‐1.1161592 1.553926245
5 year 24 monthsRegression Statistics
Multiple R 0.092700023R Square 0.008593294Adjusted R Square ‐0.036470647Standard Error 0.104425664Observations 24
ANOVAdf SS MS F Significance F
Regression 1 0.002079433 0.002079433 0.190691141 0.666597922Residual 22 0.239903823 0.010904719Total 23 0.241983256
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.020920632 0.021337241 0.980475011 0.337511711 ‐0.023330098 0.065171362 ‐0.023330098 0.065171362X Variable 1 ‐0.339665717 0.777833164 ‐0.436681967 0.666597922 ‐1.95279296 1.273461527 ‐1.95279296 1.273461527
140
10 Years
10 year 72 months
Regression Statistics
Multiple R 0.220583684
R Square 0.048657161
Adjusted R Square 0.035066549
Standard Error 0.075779344
Observations 72
ANOVAdf SS MS F Significance F
Regression 1 0.020559353 0.020559353 3.580203859 0.062608251Residual 70 0.401975633 0.005742509Total 71 0.422534986
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.00832564 0.008933431 0.931964425 0.354558237 ‐0.009491526 0.026142806 ‐0.009491526 0.026142806X Variable 1 0.491062465 0.259527188 1.892142663 0.062608251 ‐0.026548184 1.008673115 ‐0.026548184 1.008673115
10 year 60 monthsRegression Statistics
Multiple R 0.136244021R Square 0.018562433Adjusted R Square 0.001641096Standard Error 0.08075643Observations 60
ANOVAdf SS MS F Significance F
Regression 1 0.007154091 0.007154091 1.096983819 0.299274137Residual 58 0.378252858 0.006521601Total 59 0.385406948
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.007681246 0.010504202 0.731254606 0.467567777 ‐0.013345199 0.028707691 ‐0.013345199 0.028707691X Variable 1 0.448086377 0.427820539 1.047369953 0.299274137 ‐0.408289468 1.304462223 ‐0.408289468 1.304462223
141
10 year 48 monthsRegression Statistics
Multiple R 0.116594912R Square 0.013594374Adjusted R Square ‐0.007849227Standard Error 0.088450708Observations 48
ANOVAdf SS MS F Significance F
Regression 1 0.004959799 0.004959799 0.633959463 0.429996748Residual 46 0.359882273 0.007823528Total 47 0.364842073
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.00738142 0.012786944 0.577262251 0.566577065 ‐0.018357363 0.033120204 ‐0.018357363 0.033120204X Variable 1 0.410863093 0.516019825 0.796215714 0.429996748 ‐0.627830925 1.449557111 ‐0.627830925 1.449557111
10 year 36 monthsRegression Statistics
Multiple R 0.056700721R Square 0.003214972Adjusted R Square ‐0.026102235Standard Error 0.098745053Observations 36
ANOVAdf SS MS F Significance F
Regression 1 0.001069265 0.001069265 0.109661597 0.742562131Residual 34 0.33151991 0.009750586Total 35 0.332589175
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.010557358 0.016477879 0.640698839 0.526013431 ‐0.022929721 0.044044438 ‐0.022929721 0.044044438X Variable 1 0.217039183 0.65540668 0.331151924 0.742562131 ‐1.114907437 1.548985803 ‐1.114907437 1.548985803
10 year 24 monthsRegression Statistics
Multiple R 0.09199283R Square 0.008462681Adjusted R Square ‐0.036607197Standard Error 0.104432542Observations 24
ANOVAdf SS MS F Significance F
Regression 1 0.002047827 0.002047827 0.187767998 0.668999857Residual 22 0.239935429 0.010906156Total 23 0.241983256
Coefficients Standard Error t Stat P‐value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.02083386 0.021330872 0.976699905 0.339336173 ‐0.02340366 0.065071381 ‐0.02340366 0.065071381X Variable 1 ‐0.336103714 0.775644156 ‐0.433322048 0.668999857 ‐1.944691231 1.272483803 ‐1.944691231 1.272483803
142
Method of Comparables
PE Trailing
PPS EPS P/E Trailing Industry
Avg.
Comparable
PPS
Universal 50.16 3.82 13.13 18.94 72.35
Alliance 5.96 -.25 18.94
PE Forward
PPS EPS P/E Forward Industry
Avg.
Comparable
PPS
Universal 50.16 4.584 10.94 N/A N/A
Alliance 18.94 N/A N/A
Price to Book
PPS BVPS P/B Industry
Avg.
Comparable
PPS
Universal 50.16 33.23 1.51 2.34 77.76
Alliance 5.96 2.55 2.34
Dividend Yield
PPS DPS D/P Industry
Avg.
Comparable
PPS
Universal 50.16 2.34 .036 0 N/A
Alliance 5.96 0 0
143
P.E.G
PPS EPS Growth P.E.G Industry Average
Comparable PPS
Universal 50.16 3.82 4.5 2.918 N/A N/A Alliance 5.96 -.25 N/A N/A
Price/EBITDA
PPS EBITDA(IN
BILLIONS)
PPS/EBITDA INDUSTRY
AVG.
Comparable
PPS
Universal 50.16 .234753 213.67 39.74 9.33
Alliance 5.96 .149993 39.74
Price/FCF
PPS FCF PPS/FCF Industry
Avg.
Comparable
PPS
Universal 50.16 66.587 .7533 .0257 1.72
Alliance 5.96 231.784 .0257
Enterprise Value/EBITDA
PPS
EV(billions) EBITDA(billions) EV/EBITDA Industry
Avg.
Comparable
PPS
Universal 50.16 2.132793 .234753 9.09 6.833 32.95
Alliance 5.96 N/A N/A 6.833
144
Discounted Dividends Approachperp
Relevant Valuation Item 0 1 2 3 4 5 6 7 8 9 10 112008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
DPS (Dividends Per Share) 2.47 2.61 2.75 2.90 3.07 3.24 3.42 3.61 3.81 4.03 4.26PV Factor 0.91 0.83 0.76 0.69 0.63 0.57 0.52 0.48 0.43 0.40PV Annual Div 2.25 2.16 2.08 2.01 1.93 1.86 1.79 1.72 1.66 1.60
PV YBY div 19.06 43.92
TV Perp 17.40 0 0.02 0.04 0.06 0.080.08 45.94 54.27 70.92 120.89 fairly valued
03/31/2008 model price 36.46 0.09 40.27 46.07 56.50 80.84 202.54 overvalued
Time Consistent Price 37.03 0.1 35.78 39.95 46.90 60.81 102.53 undervalue
0.11 32.13 35.22 40.06 48.79 69.14 within 15% fairly valued
0.12 29.12 31.45 34.94 40.77 52.42 42.63<fair value<57.68
Observed Share Price 50.16
Initial Cost of Equity (You Derive) 0.1Perpetuity Growth Rate (g) 0
coe 0.097
GrowthSensitivity Analysis
Ke
Undervalued Fairly Valued within 15% of $50.16 Overvalued
Discounted Free Cash Flow
0 1 2 3 4 5 6 7 8 9 102008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Cash Flow From Operations (thousands) 45,920.59 49,135.03 52,574.48 56,254.70 60,192.53 64,406.00 68,914.42 73,738.43 78,900.12 84,423.13 90,332.75Cash Flow From Investing Activities (95,605.00) (62,054.76) (66,398.39) (71,046.65) (76,019.62) (81,341.23) (87,035.05) (93,127.71) (99,646.23) (106,621.90) (114,085.00) FCF Firm (49,684.41) (12,919.73) (13,823.90) (14,791.95) (15,827.09) (16,935.23) (18,120.62) (19,389.27) (20,746.11) (22,198.77) (23,752.25)
PV Factor 0.930 0.866 0.806 0.750 0.698 0.649 0.604 0.562 0.523 0.487PV FCF (46,230.96) (11,186.11) (11,137.02) (11,088.59) (11,039.89) (10,991.77) (10,943.66) (10,895.91) (10,848.04) (10,800.81)
PV YBY FCF (145,162.75) Terminal Value Perp (653,516.63) fairly valued (317,968.54) Market Value Assets (798,679.38) overvalued
undervaluedBook Value Debt & Preferred Stock 1228322 within 15% fairly valuedMVE per model at 12/31/87 (2,027,001.38) 42.63<fair value<57.68divide by shares (74.63)
WACC(BT) 0.0747G 0 0 0.01 0.02 0.03 0.04
0.05 -80.29 -87.47 -99.44 -123.38 -195.180.06 -77.76 -83.03 -90.93 -104.11 -130.47
Time consistent ‐75.53 0.07 -76.10 -80.24 -86.04 -94.74 -109.24Observed Share Price 50.16 0.08 -75.01 -78.42 -82.98 -89.35 -98.91Initial WACC 0.0504 0.09 -74.31 -77.23 -80.98 -85.98 -92.98Perpetuity Growth Rate (g) 0
shares 27162.15
WACC (bt)
Undervalued Fairly Valued with 15% of $50.16 Overvalued
Sensitivity AnalysisGrowth
145
0 1 2 3 4 5 6 7 8 9 10 112008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Net Income (thousands) 124,518 130,121 135,977 142,096 148,490 155,172 162,155 169,452 177,077 185,046 Total Dividends (thousands) (67,005) (70,758) (74,720) (78,904) (83,323) (87,989) (92,916) (98,120) (103,615) (109,417) Book Value Equity (thousands) 1,115,631 1,173,144 1,232,507 1,293,764 1,356,956 1,422,123 1,489,306 1,558,545 1,629,877 1,703,339 1,778,968
Annual Normal Income (Benchmark) 108,216 113,795 119,553 125,495 131,625 137,946 144,463 151,179 158,098 165,224 Annual Residual Income 16,302 16,326 16,424 16,601 16,865 17,226 17,692 18,273 18,979 19,822 16,848.48 pv factor 0.912 0.831 0.757 0.691 0.629 0.574 0.523 0.477 0.435 0.396YBY PV RI 14,860.36 13,566.76 12,440.81 11,463.00 10,616.02 9,884.37 9,254.11 8,712.76 8,249.27 7,853.72
Book Value Equity 1,115,631 0 -0.1 -0.2 -0.3 -0.4 -0.5Total PV of YBY RI 106,901.19 0.08 60.63 55.66 54.24 53.57 53.17 52.92Terminal Value Perpetuity 68,821 0.09 52.79 50.3 49.52 49.15 48.92 48.78 173,696
MVE 03/31/2008 1,291,353 0.1 46.55 45.65 45.35 45.2 45.11 45.05divde by shares 27,162.15 0.11 41.49 41.6 41.64 41.66 41.67 41.68Model Price on 03/31/2008 47.54 0.12 37.3 38.06 38.34 38.49 38.58 38.64time consistent Price 48.28
fairly valuedObserved Share Price (6/2/2008) 50.16 overvaluedInitial Cost of Equity (You Derive) 0.097 undervaluedPerpetuity Growth Rate (g) 0 within 15% fairly valued
42.63<fair value<57.68
shares 27162.15
GrowthSensitivity Analysis
Ke
Undervalued Fairly Valued within 15% of $50.16 Overvalued
0 1 2 3 4 5 6 7 8 9 102008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
net income 124,518 130,121 135,977 142,096 148,490 155,172 162,155 169,452 177,077 185,046 dividends 67,005 70,758 74,720 78,904 83,323 87,989 92,916 98,120 103,615 109,417 drip income 6,500 6,863 7,248 7,654 8,082 8,535 9,013 9,518 10,051 cumulative dividend income 136,621 142,840 149,344 156,144 163,254 170,690 178,465 186,595 195,096 normal benchmark income 136,596 142,743 149,167 155,879 162,894 170,224 177,884 185,889 194,254 annual aeg 25 97 177 265 361 466 581 706 843 716.21 pv factor 0.912 0.831 0.757 0.691 0.629 0.574 0.523 0.477 0.435 pv aeg 22 81 134 183 227 267 304 337 366 change in residual income 25 97 177 265 361 466 581 706 843
core to the perpetuity 124,518
total pv of aeg added to the core 1,921 0 -0.1 -0.2 -0.3 -0.4 -0.5aeg tv perp 3,209 0.08 55.58 53.21 52.23 52.21 52.02 51.9 7,384
total adjusted earnings perpetuiy 129,649 0.09 52.02 50.83 50.46 50.28 50.17 50.1capitalization rate (Ke) 0.097 0.1 49.18 48.75 48.61 48.53 48.49 48.46model mve 03/31/2008 1,336,583.96 0.11 46.87 46.93 46.95 46.97 46.97 46.98divided by shares 27,162.15 0.12 44.95 45.33 45.47 45.55 45.6 45.63model price at 03/31/2008 49.21
time consistent price 49.97 fairly valuedovervalued
Observed Share Price (6/2/2008) 50.16 undervaluedInitial Cost of Equity (You Derive) 0.097 within 15% fairly valuedPerpetuity Growth Rate (g) 0.00 42.63<fair value<57.68
GrowthSensitivity Analysis
Ke
Undervalued Fairly Valued within 15% of $50.16 Overvalued
146
Long Run Residual Income Model
long run roe 10.94%growth bve 4.73%cost of equity 9.70%
BV of equity 2008 1,115,631
shares 27162.15
MV of Equity 2008 1,393,978
new share price 51.32
Initial Share Price 50.16Time Consistent Price 52.12
147
0.02 0.03 0.04 0.05 0.06 0.070.08 32.00 30.65 28.82 26.22 22.20 15.210.09 37.34 36.78 36.03 34.96 33.30 30.42
0.1 42.67 42.91 43.23 43.69 44.40 45.640.11 48.01 49.04 50.44 52.43 55.50 60.850.12 53.34 55.17 57.65 61.17 66.60 76.06
0.05 0.055 0.060 0.065 0.070 0.0750.08 497.44 174.43 105.75 75.88 59.17 48.490.09 649.56 227.77 138.10 99.09 77.26 63.310.10 801.68 281.11 170.44 122.29 95.35 78.140.11 953.81 334.45 202.78 145.50 113.45 92.970.12 1105.93 334.45 202.78 145.50 113.45 92.97
0.02 0.03 0.04 0.05 0.06 0.070.06 91.80 108.71 142.52 243.97 N/A N/A0.07 73.44 81.53 95.02 121.99 202.90 N/A0.08 61.20 65.22 71.26 81.32 101.45 161.830.09 52.46 54.35 57.01 60.99 67.63 80.910.10 45.90 46.59 47.51 48.79 50.73 53.94
fair if more than 42.63 and less than 57.68
Return on
Equity
**Growth Rate is held constant at 4.3%Undervalued Fairly Valued within 15% of $50.16 Overvalued
Cost of Equity
Long Run Residual Income Sensitivity Analysis
Fairly Valued within 15% of $50.16Undervalued Overvalued
Long Run Residual Income Sensitivity Analysis
Growth
Return on
Equity
**Cost of Equity is held constant at 9.7%
fair if more than 42.63 and less than 57.68
fair if more than 42.63 and less than 57.68
Long Run Residual Income Sensitivity AnalysisGrowth Rates
Cost of Equity
**Return on Equity is held constant at 10.94%Undervalued Fairly Valued within 15% of $50.16 Overvalued
148
References
1. Universal Tobacco 10-k
2. Alliance One International inc. 10-k
3. British American Tobacco 10-k
4. www.wsj.com
5. www.finance.yahoo.com
6. www.investopedia.com
7. www.wikipedia.com
8. http://moneycentral.msn.com
9. Business Analysis and Valuation using financial statements
10. www.dictionary.com
