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American Eagle Apparel Stores. Module 9: Valuation of Equity By: Nick Cecero. Enterprise Value. Enterprise Value – This value belongs to both debt and equity holders.
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American EagleApparel Stores Module 9: Valuation of Equity By: Nick Cecero
Enterprise Value • Enterprise Value – This value belongs to both debt and equity holders. • Equity Value- This is the residual value left to equity holders after the creditors are paid, and to arrive at this value we have to subtract out Net Financial Liabilities (NFL), or add back Net Financial Assets (NFA). - When subtracting out the value of debt it is more often times than not found on the balance sheet, and if it is not here we can delve into the financial statement notes.
Included In NFL Calculation • Preferred Stock • Long Term Debt • Non-Controlling Interest - As a side note Long Term Debt’s book value and fair value may not equal one another and it will say so in the Financial Statement Footnotes. The difference between the two values should be added back into NFL assuming book value is less than fair value. In this case, this does not apply to American Eagle because they do not have any debt on their books.
AEO Equity Value Calculation This is added back into our enterprise value because it is a Net Financial Asset, and therefore American Eagle’s equity value is going to be larger than their enterprise value.
Three Different Ways to Value Equity • Dividend Discount Model - The dividends of the firm are equal to the earnings of the firm minus the change in book value of the firm; similar to the DCF Model. 2) Residual Earnings Model - For this equation to hold true earnings must be comprehensive which is net income plus any income items flowing directly to equity. 3) Abnormal Earnings Growth Model - “Other Comprehensive Income” (OCI) such as Financial Statement Translations, Foreign Currency Exchange Gains & Losses should be forecasted as $0 for future periods because it is impossible to be able to predict foreign currency changes. ($0 is our best estimate)
Problem With Equity Valuation Model & Formula • When using an enterprise value we use the cost of enterprise capital which would not be expected to change from period to period unless the risk of enterprise operating activities changes, • Utilizing an equity valuation model would require an assumption that equity risk will be constant in future periods. • In essence, we are assuming that leverage will be constant in the future since the cost of equity capital is dependent upon the leverage of the firm. • rEq = rEnt + VD/VEq (rEnt – rD)
Analysts Forecasts as a Shortcut to Valuation • Analysts often times quarterly come out with projections of earnings and dividends and from these forecasts we can attempt to derive an estimated value of the company on a per share basis. • We originally estimated the per share equity value of American Eagle by taking the enterprise value subtracting out NFL (or adding it back in), and then dividing by the total common shares outstanding.
Implied Forecasts from ValueLine AEO Earnings Per Share Growth Rate = 16.96% Dividends Per Share Growth Rate = 3.85%
Dividend Discount Model Formula: V0 = .5193/(1+.0889)1 + .5392/(1+.0889)2 + .560/(1+.0889)3 + .5816/(1+.0889)4 + .6040/(1+.0889)5 + $24.50/(1+.0889)5 = $18.82 This represents the share price or the target price of a stock. This is the amount an investor would get if they liquidated the investment at the forecast horizon. I took the average of a high estimate of $30 and the low estimate of $19 to arrive at $24.50.
Residual Earnings Model • Formula: V0 = 6.30 + .440/(1+.0889)1 + .567/(1+.0889)2 + .709/(1+.0889)3 + .869/(1+.0889)4 + 1.050/(1+.0889)5 + 1.050*(1+0.03)/(1+.0889)5*(.0889-0.03) = $21.04
Two Observations • By using analyst forecasts it is safe to assume that American Eagle is in a steady state at the horizon because of the small difference in share price by using both the dividend discount model and residual earnings model. • Dividend Discount Model = $18.82 • Residual Earnings Model = $21.04 2) Also, as compared to my own forecasts which I calculated to be around $15/share these estimates are fairly higher compared to my own projected valuation.
Fundamental Analysis • Disappointing Fourth Quarter Results • Decline in Earnings Per Share of $0.27 from $0.55 from PYQ. • 7% decrease in net revenue from PYQ • Sever Winter & Economic Conditions • New CEO as of Fiscal Year 2014 • Reinventing their Product Assortment to be more in line with what customers are looking for • Recommendation: Hold($15 Price Target FY 15)
Adjusting Valuation to the Valuation Date • Most investors want to know the valuation of a company as of the date they are producing the model. Often times than not B/S items are not reflective of the current value. This does not pertain to American Eagle as of right now because their year end financial statements have been released. • If this were not the case you would have roll forward the value estimate at the cost of enterprise capital for the amount of months post balance sheet date. • Could also use a mid-year adjustment which would require one to multiply the estimated value by a mid-year adjustment factor defined as (1 + [rEnt/ 2]).
The End Any Questions?
