Wesfarmers Analysis of Forecasting

In Wesfarmers, the forecasting next five year chart shows that sales revenue in 2011 will be 8% and it will keep the growth rate at 4% from 2013 to 2015. Because the assets turnover is rarely changed, the report estimate the rate as 1. 69, which is the same record as the Wesfarmers 2010 annual report. The profit margin is change largely these years. So the report takes 7. 5%, which is the average rate of five year accounting numbers. This report will use the forecasting numbers above, so it can analysis the future performance of Wesfarmers and estimate value per share of common stock for shareholders by following four valuation methods. . Discount dividend model 2. Discounted abnormal earnings model 3. Discounted cash flow valuation 4. Discounted abnormal operating earnings model In 30 June, 2010, the market per share of Wesfarmers is $27. 8. Currently, the market share price of common stock is $33. 08 in 27 May, 2011. The share price rise about 19%. The current market price is quite close to the results of four valuation models, which use WACC and CAPM to evaluate total value in the Wesfarmers. From the forecasting date, it seems that the common stock is slightly undervalued.

The report will choose the most suitable valuation models and give reasonable recommendation for the common shareholders at the end. Discount dividend model is the foundation of others popular valuation models and the usage is widespread in most firms. In Figure 1, the chart use discount dividend model valued the firm per share at $40. 88, which is trading at a $7. 8 discount in the market. However, Discount dividend model is not the perfect measure because it not link to value added. Although the firm value will seem to be higher, there is no actual value create into the wealth.

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In other words, this model is focus on creation of capital, instead of division of capital. Discounted abnormal earnings model forecasts residual income which measures the value added in Wesfarmers. The model requires high experience accountants who can deal with complex accounting records and understand the principal of accounting. The common shareholders may think that accounting numbers can be doubtful and hard to find the truth. However, this is one of models which close to the real total value of Wesfarmers. In Figure 2, the value of firm per share is $33. 75, which is slightly above market share price.

It shows that Wesfarmers is trading at $0. 67 discount. Opposite to Discount dividend model, it treats investment as asset and recognize value added into abnormal earnings. It more cares about the whole creation of capital in the Wesfarmers. For discounted cash flow valuation, the value per share of common stock is $40. 33 (Figure 3). Compared to the market value, the result shows that the share price of Wesfarmers is largely undervalued at $7. 2 discount. Although cash flows are ‘real’ number and people can easily understand the outcomes, the discounted cash flow valuation is not suitable to Wesfarmers.

According to the five years annual reports, the investment pattern is growth 4. 2% in 2010 and -23. 6% in 2009, which are not growing at a constant rate like free cash flow. Moreover, cash flow does not include any value added in the short-term investment. As a consequence, the investments are treated as value loss. In the figure 4, the chart shows that discounted abnormal operating earnings model value of the firm per share at $33. 88. The market share price of Wesfarmers is undervalued by $0. 8. The model is based on WACC to calculate the total value of Wesfarmers.

Compare to other models, the cost of capital only adjusted when the leverage changes each time. As a consequence, it is easy to use and less complex than discounted abnormal earnings model. The model is the most suitable for recommendation of Wesfarmers because it focuses on the growth pattern of NOPAT and net operating assets which are the important factors to the company. Based on the result of discounted abnormal operating earnings model, the recommendation of Wesfarmers is Hold. In the early of May, the spread of Wesfarmers between bids and asks range between $0. 01 and $0. 06.

The share market of Wesfarmers tends to be stable and investors are more rational to make fairly reliable forecasts of Wesfarmers’ share price. According to the ASX announcement of Wesfarmers, the company got strong investors’ support in bond and may acquisition the interests in Burrup Holdings Ltd and/or Burrup Fertilisers Pty Ltd. It shows that the business of Wesfarmers is doing well and the company structures will growth largely. In the short-term, the share price would not rise very largely and it may drop down a little bit if the Wesfarmers actually get the interests in Burrup.

However, if people treat Wesfarmers as a long-term investment, the share price will rise eventually because the market value is currently lower than evaluation value of discounted abnormal operating earnings model. Wesfarmers is suitable for the investors who willing to wait for a little longer investment return. Sensitivity analysis From the recommendation above, the common shareholders of Wesfarmers should be treated as a suggestion and think about it carefully. The share price may change any time when the managers of Wesfarmers change their business strategy or contribute different growth rates in the future.

This report will find out that the key factors will largely influence the forecasting recommendation. The reason of sensitivity analysis is that managers can choose less sensitivity investment project when they need to make decision for the Wesfarmers. It makes the reasonable judgment for managers when future projects need to take some extent of risks. For Wesfarmers, the report chooses sales revenue, NOPAT and profit margin as the sensitivity factors and analysis the relationship between these factors and total value of the Wesfarmers.

In the figure 7, the chart divided sales revenue into three groups, which are 10% sales growth rate, constant sales growth rate and -2% sales growth rate to work out the total value of Wesfarmers. The change rates of discounted abnormal operating earnings model range are -17%, -11% and 13%. Also, if ATO increases from 1. 69 to 2, the forecasted share rate will rise by 13. 5%. However, it is hard to determine the sensitivity element when managers only adjust one factor and keep other factors not change. In the real life, two or more elements will change at one time when the manager bring new business activities into the Wesfarmers.

Take profit margin for example, It has strong relationship with sales revenue and NOPAT. The balance of these two factors is quite important to the company. The current forecasting profit margin is 7. 5% in Wesfarmers. If the manager increases the profit margin to 10%, the share price will increase by 43. 5%. The data shows that forecasting profit margin is significantly influence the share price of Wesfarmers and the manager need to keep the profit margin in a fix rate. The recommendation of Wesfarmers is actually based on the collection information and guesses the future growth pattern by some accounting models.

There is no perfect valuation model in the world. Application The opportunity of Wesfarmers is the increasing demand for coal. Australian is one of the largest coal export countries. The demand for coal is largely to the foreign customers. The improvement of coal production and find new mine are very important. Wesfarmers should optimize the operation line and decrease the usage of resources. It will increase the production of high-quality coals so that Wesfarmers can set a good price to sell. Currently, the foreign exchange rate brings great price benefit to Wesfarmers when they purchase material form other countries.

Because of the rising of currency, lots of international brand are vulnerable to the surging dollar. The retail stores can buy cheaper materials and sell them in a good price. Therefore, it can increase their margins in the financial statement. Wesfarmers need to improve the foreign network of suppliers and establish good reputation of them. As a consequence, the strong relationship will bring more price discounts of materials and make the production cost lower. The potential challenges for Wesfarmers are the low production of Curragh mine because of the wet weather during April and May.

It is significant influence to the coal sales. The manager forecasted the sales will be 5. 1 to 5. 4 million tones for 2011 financial year (ASX announcements). The forecasting price may set too high or too low based on forward contract and foreign exchange rate. The managers need evaluation the competitors’ prices and use valuation model to get reasonable profit margin which can get the maximum profit for Wesfarmers. From the five years historical data, the profit margin is decrease from 13. 1% to 3. 9%. As a result, the report shows that profit margin is the most sensitivity element for Wesfarmers.

It is necessary to keep profit margin in a stable environment when managers make a new business decision. Also, the rising of currency may bring the negative impact to Wesfarmers. The foreign customers will change their retail suppliers because of the higher price. Wesfarmers need to bring the price benefits to the customers, instead of increasing margin. The profit margin of products would decrease a little. However, more people would like to keep buy goods form Wesfarmers. Therefore, it increases customer satisfaction and reputation of company.

Another remedies recommendation of Wesfarmers is keeping acquisition the interests of other public and private companies, which are profitable in the future. Based on the Wesfarmers’ structure, the business covers supermarket, insurance, mining, chemical and energy. Because of the complex company structure, Wesfarmers can expand business activities in different fields and increase the widely sales network of customers. For example, Coles supply the car insurance to customers. Wesfarmers combine supermarket and insurance together so that insurance can depend on the customers of Coles to increase their sales revenue.

Also, it makes customers more convenient. Moreover, Wesfarmers can learn the technologies from new companies and improve their other business. However the acquisition decision is quite difficult because Wesfarmers need spend a lot of money to acquisition the interests and make the company structure more complex. The action may influence the share price in a short time and the management of companies is a big problem to Wesfarmers. The consult team may spend some time to analysis advantages and disadvantages. Then they can give a properly advise to managers in Wesfarmers.

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