Hormel Foods Corporation
Equity Valuation and Analysis
Chris Atten
[email protected]
Jacob Blain
[email protected]
Shana Hartford
[email protected]
Jordan Isbell
[email protected]
Brian Milliken
[email protected]
Table of Contents
Executive Summary
3
Business & Industry Analysis
9
Company Overview
9
Industry Overview
13
Five Forces Model
14
Rivalry Among Existing Firms
14
Threat of New Entrants
18
Threat of Substitutes
20
Bargaining Power of Customer’s
23
Bargaining Power of Suppliers
24
Value Chain Analysis
26
Firm Competitive Advantage Analysis
30
Accounting Analysis
35
Key Accounting Policies
36
Assess Accounting Flexibility
39
Actual Accounting Strategy
42
Quality of Disclosure
44
Qualitative Analysis
44
Quantitative Analysis
48
Identify Potential “Red Flags”
55
Undo Accounting Distortions
56
Financial Analysis
58
Liquidity Ratios
58
Capital Structure Ratios
66
Profitability Analysis
74
Financial Statement Forecasting
82
Income Statement
82
Balance Sheet
86
1
Statement of Cash Flows
91
Cost of Equity
94
Cost of Debt
97
Weighted Average Cost of Capital
99
Valuation Analysis
Method of Comparables
Intrinsic Valuations
100
100
109
Discounted Dividends Model
109
Discounted Free Cash Flows Model
111
Residual Income Model
114
Long Run Return on Equity Residual Income Model
116
Abnormal Earnings Growth Model
121
Credit Analysis
126
Appendix
128
References
150
2
Executive Summary
Investment Recommendation: Overvalued, Sell November 1, 2007
HRL - NYSE (11/1/07)
$35.80
52 Week Range
$30.04 - $40.34
Revenue (2006)
$5,745,481,000
Market Capitalization
$4,926,080
Shares Outstanding
$137,600
Percent Institutional Ownership
27.3%
Book Value Per share
$13.10
ROE
16.00%
ROA
10.00%
Cost of Capital est.
Estimated:
72 month @ 3-Month rate
72 month @ 1-Year rate
72 month @ 2-Year rate
72 month @ 5-Year rate
72 month @ 7-Year rate
72 month @ 10-Year rate
Kd(bt)
WACC(bt)
WACC(at)
Published Beta
Altman's Z-score
2002
4.93
Ratio Comparison
Trailing P/E
Forward P/E
P.E.G.
P/B
R2
Beta
Ke
0.0884
0.0884
0.0883
0.0879
0.0877
0.0876
6.36%
8.16%
7.73%
0.28
0.4123
0.4122
0.4115
0.4103
0.4099
0.4096
Ke
7.22%
7.31%
7.18%
7.40%
7.53%
7.73%
8.6%
2003
5.07
2004
5.66
(www.moneycentral.msn.com)
Valuations Estimates
Actual Price 11/1/07
Ratio Based Valuations
Trailing P/E
Forward P/E
P.E.G.
P/B
P/EBITDA
P/FCF per share
EV/EBITDA
Intrinsic Valuations
Discounted Dividends
Discounted Free cash flows
Residual Income
Long-run Residual Income
2005 2006 Abnormal Earnings Growth (AEG)
5.57
5.9
TSN
$ 20.33
$ 14.62
$ 2.99
$ 1.16
SFD
$ 16.73
$ 14.17
$ 2.05
$ 1.30
CAG
$ 15.12
$ 16.91
$ 2.00
$ 2.47
$ 35.80
$
$
$
$
$
$
$
17.21
16.05
2.46
2.73
0.06
31.68
10.28
Actual Revised
$ 10.28
$ 25.85 $ 0.49
$ 17.19 $ 10.29
$ 6.93 $ 16.17
$ 13.78 $ 5.50
(www.moneycentral.msn.com)
3
Industry Analysis
Hormel Foods Corporation was founded by George A. Hormel in 1891.
Since its opening Hormel has expanded into six sales branches which distribute
nationally and has acquired several subsidiaries including Jennie-O Turkey Store
and Hormel Foods International Corporation. Hormel strives to produce
convenient, healthy products with high quality for consumers. Hormel operates in
five different segments within the meat products industry: Grocery products,
Jennie-O Turkey Store, Refrigerated foods, Specialty foods, and other. Within
these segments a variety of products are manufactured such as turkey, ham,
meat spreads, salsas, canned luncheon meats, etc. Along with expansion
throughout the United States, Hormel sells its products to wholesale, retailers,
and other food services under 27 trademarks.
In the meat products industry Hormel has few competitors. Its main
competitors consist of ConAgra Foods, Smithfield Foods, and Tyson Foods. The
threat of new entrants in this industry is extremely low due to a tight cost control
system and the small amount of differentiation among products. Having low
differentiation causes high rivalry among existing firms and forces firms to
compete more on gaining market share from one another by competing highly
on price. Due to the low switching costs and price sensitivity, customers have a
moderately high bargaining power over firms. Firms in this industry also have a
high bargaining power over their suppliers due to the fact that there is high price
sensitivity and competition among existing firms.
In order to achieve a level of profitability within the industry firms must
implement a set of key success factors. Competitors in the meat products
industry have key success factors of economies of scale, product quality and
variety, investment in brand image and tight cost control system. Firms buy
products in bulk in order to keep costs low which in turn allows for low product
prices. With low differentiation among products, companies must invest in
building a brand image to succeed over their competitors.
It is also important
within the meat products industry to keep a substantial level of quality for
4
products. Without a variety of quality products a firm cannot increase their
customer base and therefore will not succeed in the meat products industry.
Keeping low costs without reducing the quality of products is key to gaining
market share from competitors in the meat products industry.
Accounting Analysis
In order to gain market share over competitors it is important for a firm to
assess their key success factors in relation to key accounting policies. Hormel’s
key success factors are economies of scale, product quality and variety,
investment in brand image, tight cost control system, and efficient production.
When valuing a firm flexibility over accounting strategies must be taken into
consideration. This is because managers have the ability to manipulate financial
statements and may do so to make the firm seem greater in value.
One key success factor is having a tight cost control system. To
implement this Hormel uses an accounting strategy called a hedging program.
Hedging programs allow a firm to avoid the rising costs in the market. In
Hormel’s 10-K there is a high degree of disclosure regarding the hedge programs
used and how it is beneficial to the company in the future.
Another key success factor for Hormel is product quality and variation.
Hormel uses research and development to improve the quality and variation of
their products. Research and development is also used to improve the brand
image of all of Hormel’s products. Brand image within the industry is a key
success factor for all firms, and thus is important to disclose this information
within the 10-K.
The accounting strategies mentioned above have clear and concise
information disclosed for investors. This shows a moderate degree of
transparency in the financial statements. On the other hand there are many
generally accepted accounting principles that allow for more flexibility to
manipulate statements. One such example is reporting goodwill. Although it may
seem as though there is some degree of manipulation, Hormel provides full
5
disclosure on the accounting policies used and is to be in line with the industry
standard. Within our analysis we were unable to observe any potential “red
flags”. The disclosure Hormel provides in their 10-K is substantial and shows that
overall Hormel has a high level of transparency when reporting financial
statements.
Financial Analysis, Forecasted Financials, and Cost of Equity Estimation
Financial ratios have been developed to measure profitability, liquidity,
and capital structure within a firm. When valuing a firm, these ratios can be used
to compare a firm against its competitors and find any instability within the
industry.
The liquidity ratios consist of the current ratio, acid test ratio, receivables
turnover, inventory turnover, and working capital turnover. Hormel is more liquid
than its competitors in the industry according to the liquidity ratios.
The capital structure ratios measure how the firm’s assets are financed.
These ratios include: debt to equity, time interest earned, debt service margin, zscore, internal growth rate, and sustainable growth rate. Hormel has a less debt
for financing projects compared to the industry which in turn will increase profits
in the future.
The profitability ratios consist of four ratios including operating efficiency,
asset productivity, return on assets, and return on equity. Hormel seems to be in
line with the industry and at times more profitable than its competitors.
The financial statements for Hormel were forecasted out for ten years by
using the trends found in the common size statements and any stability found in
the previously mentioned financial ratios. We started our forecasting with net
sales on the income statement. We used our knowledge of the history of net
sales in the past five years in order to determine a sales growth rate of seven
percent a year. The asset turnover ratio was then used to link the balance sheet
and the income statement together to ensure they’re talking to each other
properly. This number not only gave us total assets, but total shareholder’s
6
equity and liabilities as well. This factor was important in assessing the right side
of the A=L+OE equation; thus resulting in a balancing balance sheet. In order to
create a statement of cash flows forecasting, the CFFO/NI ratio had the best
historical stability, and was used to forecast the cash flows from operations in
the statement of cash flows. The only other important line forecasted on the
statement of cash flows was the cash flows from investing activities. The method
used was simply taking the changes in long-term assets from year to year and
inserting those results into the CFFI line on the statement of cash flows.
We started out our cost of equity estimation by running regression
analysis at different points on the yield curve. The overall winner in this analysis
using the CAPM equation gave us a cost of equity of 7.31%. In an attempt to get
a more accurate estimation a second method was used by manipulating the
long-run residual income perpetuity, which gave us a cost of capital of 10.6%.
After further review we took a number in between those two numbers of 8.6%
and ran sensitivity analysis above and below that number throughout our
valuation models to test the sensitivity of each model to the cost of equity.
Valuations
Upon finishing the analyzing of the industry, accounting policies, and the
forecasted financials, it becomes time to make a valuation of the company
assessing the previously acquired knowledge. When valuing a company, there
are several methods available to use in order to come up with an estimated
share price of a company. When all the calculations are prepared, they are
reviewed and weighted based on their respected explanatory power or accuracy.
Method of comparables calculates a share price for a company by
comparing a firm’s ratios to the industry average. We used an industry average
based on Hormel’s three main competitors: Tyson, Smithfield and ConAgra. All of
the ratio valuations, except for P/E trailing, that we calculated for Hormel
indicated that our market share price is overvalued or fairly valued compared to
the observed share price of $35.80. These methods are rather inaccurate
7
because they are simply ratio based valuations which contain no theory or insight
to a company. These methods should not be heavily considered when valuing a
company due to their lack of explanatory power.
The last and most accurate valuations are computed by implementing
intrinsic valuations that use theory and insight into the firm. The first and least
accurate model used was the discounted dividends model. The model estimated
the price per share to be $10.28. The next model applied to our valuation was
the discounted free cash flows model that also carries a low explanatory power.
This model gave us an estimated share price of $25.85, which was only $9.95
less than the observed share price and the closest out of any of our models. The
residual income model, which is the most accurate model used in our valuation
gave us an estimated share price of $17.90. A long-run residual income
perpetuity was used next and conveyed an estimated share price of $6.93. The
last model implemented in our valuation was the abnormal earnings growth
model, which gave an estimated price per share of $13.78. As one can see, since
all these models gave us an estimated share price below the current share price,
it was safe to assume that Hormel is an overvalued firm.
After running an in-depth analysis and valuation of Hormel Foods
Corporation, it was concluded that Hormel, along with its competitors, are
overvalued firms as of November 1, 2007. We feel comfortable stating that even
though Hormel appears overvalued, they did seem to outperform their
competitors in many of the key success factors throughout the industry. Our
analyst recommendation would be to sell this company’s stock. Another
recommendation would be to look into the futures markets and feel safe about
investing in the short position on a call or a long position on a put, considering
our overvalue, we would expect the market price of the stock to decrease in the
future. Compared to the industry, if one must invest in the meat products
industry, Hormel looks to be the most stable and attractive investment.
8
Business & Industry Analysis
Company Overview
Hormel Foods Corporation (HRL) is committed to “providing high quality
products that are convenient, healthy, and flavorful to consumers.”
(www.hormel.com) Hormel was founded by George A. Hormel in 1891 in Austin,
Minnesota. Austin also serves as the company’s headquarters. Hormel has
divided their company into six sales branches which are distributed throughout
the entire United States. Along with the six sales branches Hormel owns several
subsidiaries which include Jennie-O Turkey Store, Dan’s Prize, Inc. and Hormel
Foods International Corporation which distributes all international products.
“Hormel Foods Corporation is a multinational manufacturer and marketer
of consumer-branded meat and food products.” (www.hormel.com) Hormel sells
to retail, wholesale, and other food services under twenty-seven different
trademarks. Hams, bacon, sausages, franks, canned luncheon meats, stews,
chilies, hash, meat spreads, salsas, and frozen processed foods are among the
products manufactured by Hormel, which are separated into five segments:
Grocery products, Jenny-O Turkey Store, Refrigerated foods, Specialty foods,
and other. The products produced by Hormel within these segments have
distribution centers located in several different states across the U.S. including:
Minnesota, Ohio, Iowa, California, and Georgia.
Hormel’s major competitors consist of Tyson (TSN), Smithfield Foods, Inc.
(SFD), and ConAgra Foods, Inc. (CAG). Hormel Foods has a market cap of $4.83
billion, but falls behind ConAgra Foods and Tyson with $12.73 and $6.6 billion,
respectively. Smithfield Foods comes in a close fourth with a market cap of $4.41
billion. Despite competition within the industry, Hormel has been steadily
increasing over the past five years with a sales growth of 6.12% in 2006 and a
net income of $286 thousand. Excluding ConAgra, with a $534 billion net
9
income, Hormel’s net income is substantially higher than the other leading
competitors in the industry. The competitor following close behind Hormel is
Smithfield reaching just under $167 thousand. The total assets and net sales
have increased steadily over the past five years and in return causing the sales
growth to increase year-after-year.
Hormel’s
Total Assets, Net Sales, & Sales Growth
Total
2002
2003
2004
2005
2006
$2,220,196
$2,393,121
$2,533,968
$2,846,560
$3,060,306
$3,910,314
$4,200,328
$4,779,875
$5,413,997
$5,745,481
.65%
7.42%
13.8%
13.27%
6.12%
Assets
Net
Sales
Sales
Growth
*in thousands
Over the past five years Hormel’s stock prices have risen 60 percent.
Besides Smithfield, Hormel’s stock price percentage has increased the most
compared to its competitors. The reason for the stock price increase is due to
total assets and net sales increasing steadily over the past five years.
10
www.moneycentral.msn.com
Since 2002 Hormel is up 60 percent and has just underperformed the Dow
Jones Industrial Average and S&P 500 Index. Over the past five years Hormel’s
stock price have mirrored the indexes. Unfortunately, Hormel’s prices fall
considerably below the NASDAQ and the Amex index.
http://www.moneycentral.msn.com
Hormel continually tries to diversify itself from the competitors in the
industry by creating different subsidiaries and trademarks within the corporation.
11
These include Jennie-O Turkey Store, Dan’s Prize, Inc. and Hormel Foods
International Co. Among the many well known trademarks are SPAM, Chi-Chi’s,
Old Smokehouse, and Fast ‘N Easy. Recently, Hormel purchased Burke
Corporation which is a privately owned company that manufactures and markets
pizza-toppings and other fully-cooked meat products. Net sales on the purchase
are expected to reach $125 million. Jennie-O, a subsidiary of Hormel, is teaming
up with “The Biggest Loser”, one of the highest rated shows. Jennie-O is offering
healthier options for the competitors of the NBC show. They are improving
customer value and building an admirable reputation of brand image by offering
recipes aimed toward a healthier lifestyle. Forbes magazine named Hormel as
“Best 400 Big Companies in America”
In the meat product industry Tyson has the biggest cut of the market
share owning nearly half of the market share. An important note to consider is
that the companies only compete with ConAgra in the grocery, refrigerated
products, and shelf stable products segment of the industry. Hormel, Tyson, and
Smithfield are gaining a percentage of the market share at the expense of
ConAgra. Hormel and Smithfield Foods are the only companies that gained
market share in each of the five years. Despite a three percent loss in 2005,
Tyson still leads the competitors in market share.
Market Share
Company
2002
2003
2004
2005
2006
%Change
Hormel
7%
8%
9%
9%
11%
4%
Tyson
41%
47%
48%
45%
47%
6%
Smithfield
13%
14%
17%
20%
21%
8%
ConAgra
39%
31%
26%
26%
21%
(18)%
12
Industry Overview
There are approximately 3000 meat product companies in the United
States with combined annual revenues of $85 billion. The main companies in the
meat products industry are Hormel, Tyson, ConAgra, and Smithfield.
The meat product industry is divided into two products. The wholesale
product consists of packaged meat that is cut, processed, and sold to retailers.
The next product is “case ready” meat, such as ground beef or fresh chicken
packaged ready for supermarkets. Approximately 40 billion pounds of beef and
30 billion pounds of pork are produced in the industry. Another segment of the
industry is slaughtering which has a high concentration. The high concentration
causes a low competition within this segment of the industry. Animals are bred
on farms until a certain size and weight is reached. Once a FDA approved size is
attained the animals are shipped to the individual company’s slaughtering
facilities. Some corporations raise their own livestock while others contract it out.
For example, Tyson does not raise their own cattle for slaughtering; they hire
“cattle buyers” to evaluate and purchase the cattle. Tyson mostly uses
independent contract growers to supply their chicken operations. Even though
the livestock is sometimes purchased from outside sources, corporations must
house and care for the animals for a short period prior to slaughtering. On the
other hand companies may choose to raise their livestock on their own. Hormel
raises 57 percent of their turkey for the Jennie-O Turkey Store. For the most
part, the industry norm is a mixture between raising their own livestock and
contracting it out, but corporations primarily look to outside sources for the
purchase of their livestock.
13
Five Forces Model
Firms within their particular industry can create profits according to the
degree of competition and the influence each firm has over its customers and
suppliers. A way to measure the profitability of an industry is analyzing and
evaluating five competitive forces. These forces include rivalry among existing
firms, threat of new entrants, threat of substitute products, bargaining power of
customers, and bargaining power of suppliers. Efficiently changing any one of
the five forces will give a firm an advantage over their competition which gives
the firm the ability to earn abnormal profits. Overall the five forces model allows
one to analyze aspects of an industry that can determine profitability.
Rivalry Among Existing Firms
High
Threat of New Entrants
Low
Threat of Substitute Products
Low
Bargaining Power of Buyers
Moderately High
Bargaining Power of Suppliers
Moderate
Rivalry Among Existing Firms: Competitive Force 1
(High)
Within the meat products industry many factors contribute to the high
competition. The main contributors are the low concentration and low
differentiation, as well as low switching costs, low learning economies, high
excess capacity, and high exit barriers.
14
Industry Growth
*percentages obtained from the average comparable sales growth for Hormel,
Tyson, Smithfield Foods, Inc., and ConAgra Foods.
Industry growth is a factor in determining rivalry among existing firms. In
industries with high levels of growth it is not necessary for a firm to take market
share from other competitors. On the other hand in an industry with little or no
growth a firm must gain market share from its competition in order to prosper.
Market share is calculated by the number of shares outstanding multiplied by the
price per share. Hormel has gained market share since 2002 with increasing
stock prices which rose 60 percent. There have been large fluctuations in growth
for the meat products industry over the past five years. Due to the overall
decline in the industry, a firm must acquire market share from their competitors
in order to maintain profits.
15
Concentration
The number of firms in an industry determines the level of concentration.
Having a high concentration allows firms to compete in other ways than on
pricing, such as brand marketing, product quality, and customer service. In
highly concentrated industries companies work with one another to determine a
set price for their products that are usually around or slightly below marginal
costs. In the meat products industry there is a low level of concentration due to
the number of firms competing. This low concentration causes rivalry among the
firms based on pricing which in turn keeps competition high.
Low concentration in an industry is the result of many firms competing on
price. The larger the industry, in terms of the number of competing firms, the
lower the concentration will be. In these lower concentrated industries, such as
the meat products industry, the larger firms can cooperate with each other to
avoid destructive price competition. In order to gain profitability over competitors
firms with low concentration compete highly on pricing. Profits can be increased
by gaining market share from its competitors. These firms will find it hard to
survive without an efficient and effective supply chain management. On the
other hand, industries with a dominant firm have high concentration. The
dominant firms in these industries have the upper hand and are able to set the
rules of competition.
Differentiation and Switching Costs
In highly competitive industries firms must rely on differentiation to gain
market share. The meat products industry also has a low level of differentiation
in that all products produced are similar. Having similar products within an
industry allows customers to switch brands easily, leading to low switching costs.
Low switching costs cause firms in an industry to compete more heavily on price.
16
Switching costs are determined based on the burden placed on the
consumer from switching from one brand to another. For example, Hormel Chili
and ConAgra’s Wolf Brand Chili are very similar products. This creates low
differentiation and in effect allows the customer to switch between products
based on price without compromising quality. Commodities have low
differentiation in the meat product industry; therefore, they must rely on other
ways to differentiate themselves such as quality, customer service, size of
product lines, and brand names. This is important to add value to the firm which
in turn increases market share.
Economies of Scale and Fixed/Variable Costs
According to Hoovers.com, there are approximately 3000 firms within the
meat products industry. Although a firm can succeed in this industry without
being large, only large corporations can compete on a national and international
scale. For instance, in fiscal 2006 Tyson Foods exported to more than 80
different countries such as: China, Japan, the European Union, and Russia. Small
companies can successfully operate within a small local area, but do not have
the total assets to compete internationally like Hormel and its competitors.
Hormel’s total assets in 2006 exceeded $3 billion. Competition in this industry is
high, so in order to be competitive companies must be able to cut costs
wherever possible. A way firms in the meat products industry cut costs is by
purchasing supplies in bulk. By buying in bulk firms gain bargaining power over
suppliers to reduce costs of raw materials.
Excess Capacity and Exit Barriers
At first glance it may seem easy to exit the meat product industry,
however further analysis shows that the exit barriers are very high. Hormel’s
balance sheet shows that total assets are $3.06 billion and of that $1.11 billion
17
are specialized equipment. Since the industry has low differentiation it would be
believed that selling equipment to existing firms would be fairly easy and thus
making exit barriers low. On the contrary, due to excess capacity in the industry
firms are not typically looking to expand, and without expansion it would be very
difficult to sell off such specialized equipment to other firms. If “demand in the
market for the product is below what the firm could potentially supply to the
market” then there is excess capacity (www.investopedia.com). Due to the size
of the dominant firms in the meat products industry, there is a greater supply of
meat than demand in the market. This causes firms to cut prices in order to
maintain profit over their competitors. Larger firms have more success than
smaller firms because they have more bargaining power over their suppliers
allowing for lower costs.
Threat of New Entrants: Competitive Force 2 (Low)
The threat of new entrants into the meat products industry is low. Rules
created by the FDA, USDA, EPA, and OSHA, cause a barrier that could make it
difficult to enter the industry. These regulations are administered by federal and
state laws. Since the meat industry is highly competitive, entering as a large firm
is nearly impossible. The already existing firms can work together to drive prices
down so the prospective firm cannot successfully compete.
Economies of Scale and First Mover Advantage
The economies of scale are the most important factor as to why threat of
new entrants in the meat industry is low. Entry into the industry on a local scale
is possible but not probable. Larger existing firms, such as Hormel Foods,
Smithfield Foods, Tyson, and ConAgra Foods, influence livestock suppliers to
lower prices. In turn this enables them to compete on a larger scale and
18
continue to grow successfully. Hormel, for example, is a large corporation in the
meat products industry having over $3 billion in total assets. Corporations of this
scale have a larger market opportunity and therefore increased bargaining
power. Smaller firms do not have this advantage due to their total asset size
which prevents them from purchasing supplies in large quantities.
Total Assets
2002
2003
2004
2005
2006
Hormel
$2,220.196
$2,393.121
$2,533.968
$2,846.560
$3,060.306
Tyson
$10,372
$10,486
$10,464
$10,504
$11,121
Smithfield
$3,907.1
$4,244.4
$4,828.1
$5,773.6
$6,177.3
ConAgra
$15,570.9
$15,071.4
$14,222.2
$13,042.8
$11,970.4
*in millions
Distribution Access and Supplier Relations
These large firms have been around for at least 70 years gaining more
experience each year. The experience gives the firms valuable information
pertaining to inventory control, channels of distribution, and relationships with
suppliers. For instance, Hormel has developed a Supply Quality Management
Team to determine the best suppliers. The information acquired in the Supply
Quality Management team allows for Hormel to develop relationships with high
quality suppliers. These long lasting relationships with suppliers enable them to
influence price and/or receive discounts for large quantity buying. New firms
have not yet had sufficient time to develop these loyal ties with the suppliers.
This further challenges new firms entering into the industry because of a lack of
information in these areas. Shelf space in grocery stores and supermarkets are
limited. The available space is almost “reserved” for reputable and familiar brand
names. Major companies such as Hormel, Smithfield, and ConAgra Foods have
19
developed relationships which allowed them to acquire well known brands such
as SPAM and Jennie-O, Butterball, and Peter Pan respectively.
Legal Barriers
Both federal and state laws cause a legal barrier in the industry. The FDA,
USDA, EPA, and OSHA monitor and enforce such laws. These laws regulate
antibiotics, pesticides, hormones, and protein supplements used by both
suppliers and each individual firm. The animals must also be treated humanely
during the maturing and slaughtering processes. International companies must
comply with the corresponding country’s laws. This includes both importing and
exporting laws. These rules and regulations eliminate threats such as bovine
spongiform encephalopathy otherwise known as mad cow disease.
Ultimately, it is difficult for new firms to enter into the meat product
industry. Economies of scale, channels of distribution, and government
regulations are difficult barriers for a new firm to overcome.
Threat of Substitute Products: Competitive Force 3
(Low)
Substitute products within an industry become a threat when there is a
similar product that achieves the same function of an existing product. In order
for a substitute product to be prominent over the other, relative price and
performance as well as the buyer’s willingness to switch must be taken into
consideration. If the substitute product is competitive on price and its
functionality meets that of the existing product a customer will be more likely to
switch. An example of a substitute product would be Splenda for sugar.
In
recent years there has been a health craze in the food industry. With Splenda
being low in carbohydrates and calories, customers have switched to this product
20
in order to be more health conscious. This substitute was successful in that it
provided the same sweet flavor at a comparable price. Without these two factors
customers would not have been as willing to switch products and thus there
would be no substitute product. In the meat products industry there are not
many products that fulfill the same function which causes the threat of substitute
products remain low. However, a minimal portion of Hormel’s products consist of
spices which may be susceptible to substitution.
21
Customer’s Willingness to Switch
The success of a substitute product depends heavily on the customer’s
willingness to switch. The customer’s motivation to switch products is based on
the substitute’s ability to execute the functions of the existing products.
Customers do not only rely on performance of substitute products; pricing also
determines the buyer’s willingness to switch. Many customers in the meat
products industry have been turning to healthier choices when choosing
products. In most industries this situation would increase the threat of
substitutes; however, in the meat products industry this allows for expansion.
For example, one of Hormel’s primary products is bacon which is high in calories
and saturated fat. Therefore, Hormel uses research and development to provide
a healthier product in order to satisfy health conscious consumers. Due to the
development of new products within the firm substitution threats not only remain
low but also provide opportunities for expansion. The possibility of customers
switching products is not the only threat firms must face. They also have to
consider customers who choose to go without their products. While this is
something to take into account, the percentage of customers making this
decision is considerably low.
Relative Price and Performance
Customer’s willingness to switch to substitute products can be determined
by price as well as performance. In terms of substitute products relative price is
the price at which a customer is willing to switch to the substitute. If a price
appears too low a buyer may view the product as less valuable. On the contrary,
if the price is too high the customer is less inclined to purchase the substitute
product. Given that price can determine a buyer’s willingness to switch,
substitute products prices must be set competitively in relation to that of the
existing product. In the meat products industry there are not a large variety of
22
substitute products. While some firms have created healthier substitute products,
price differences are insignificant and thus do not influence a customer’s decision
to switch. Performance is another key factor in the success of substitute
products. Substitute products must function in same manner as the existing
product. Without functionality customers have no reason to switch to the
substitute product. Turkey bacon, for example, is a substitute for bacon. This
product was created with the health conscious consumer in mind. While turkey
bacon might not be exact in taste the difference is minimal enough that
customers are willing to sacrifice and switch.
Bargaining Power of Customers: Competitive Force 4
(Moderately High)
Two major factors contribute to the bargaining power of customers, price
sensitivity and relative bargaining power. In this industry products are sometimes
sold directly to consumers but more often to stores that sell meat products.
Companies sell to grocery stores, supermarkets, restaurants, and even the
military. Price sensitivity refers to the buyer’s willingness to negotiate on price,
while relative bargaining power deals with how much impact the buyer will have
on lowering prices.
Price Sensitivity
The meat products industry is highly price sensitive. There is such low
differentiation, caused by large firms all producing similar products, which also
keeps switching costs low, and therefore causes firms to strongly compete on
price. Meat products are a large part of a grocery store’s income. Therefore they
will do whatever they can to receive the best price possible, in order to be more
profitable. Considering this and the low switching costs of the industry a buyer
23
can chose to purchase products from whatever company has the lowest prices.
Due to the fact that meat products are a large commodity, vendors can stock
almost any brand and it will sell, consequently firms must keep prices low to
ensure that their products are being offered in stores.
Relative Bargaining Power
The relative bargaining power has to do with the buyer and how much
power they have in causing a firm to lower prices. For example, in the meat
products industry with such high price sensitivity, if a buyer isn’t large or
powerful enough a firm will not lower prices for them. For example, a large, well
known grocery chain like Albertson’s would have high bargaining power, because
the firm will benefit from having its product in their store, therefore they hold
more power as far as bargaining on price. On the other hand, a small local store
would have much less relative bargaining power, because a company would not
benefit near as much by them carrying their products.
Bargaining Power of Suppliers: Competitive Force 5
(Moderate)
The bargaining power of the supplier refers to how much power a supplier
has to set their prices where they will be most profitable. In the meat products
industry suppliers mainly consist of those who supply the chickens, cattle, and
pork. The low concentration and low differentiation of this industry applies to the
suppliers as well. There are many farmers and ranchers raising chickens, cattle,
and pigs that they will be ready to sell to any firm, as well as the fact that they
are all generally raising the same kinds of animals. This gives the buyer low
switching costs, allowing them to buy from any supplier that offers them the best
price, and therefore creating stiff competition for price among suppliers. Not only
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does this create competition among prices, it also lowers the suppliers bargaining
power. The supplier’s low bargaining power is created because they have to
compete for the lowest price in order to sell their animals. They hold very little
power to set their prices in a way that would be most profitable.
However, suppliers to the meat products industry do have some
bargaining power in that there is no substitute for real chicken, beef or pork.
Therefore for a firm to sell their products and make money they will have to
purchase the animals from a supplier in the industry.
25
Value Chain Analysis
The components of the five forces model create a better understanding of
a certain industry, and reveal the strategies to use in order to gain the upper
hand on your competitors. The conclusion of the five forces model showed us
that in the meat products industry: the rivalry amongst existing firms is high, the
threat of new entrants is low, the threat of substitute products is low, the
bargaining power of buyers is moderately high, and the bargaining power of
suppliers tends to be moderate. “The profitability of a firm is influenced not only
by its industry structure but also by the strategic choices it makes in positioning
itself in the industry” (Business Analysis & Evaluation). The competitive
strategies within an industry are generally broken down into two main strategies,
which consist of cost leadership and differentiation. With the meat products
industry having low differentiation, cost leadership is going to be the main
component of a firm’s competitive strategy. The cost leadership strategy relies
on supplying the same product as your competitors at a lower cost. A company
in this industry can do so through economies of scale, efficient production, lower
input costs and a tight cost control system. For optimum profitability in the meat
products industry a few of the differentiation strategies should be used as well.
Superior product quality and variety, along with investment in brand image,
should be used to ensure customer satisfaction.
Economies of Scale
Economies of scale are a situation in which a company reduces the cost of
selling a good in the long run through increasing the purchases. Purchases and
market share are directly related in the industry. Firms must effectively control
costs, while maintaining a large enough asset base to fulfill the demands of the
customers.
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Efficient Production
When a firm produces a product at the lowest possible cost efficient
production has been reached. In the meat products industry, efficient production
is a very key aspect. When dealing with fluctuating costs of raw materials, an
efficient company will see greater profits. Ideally, a firm’s goal is to get the raw
materials into a finished product as quickly as possible to ensure freshness and
quality, leading to satisfaction in the customer’s demands.
Lower Input Costs
In an industry where the cost of raw materials fluctuates frequently, a
company must take strategies to keep input costs low. In this industry where a
firm must buy chickens to produce poultry, the cost of those chickens cannot be
avoided. Grain prices directly affect the prices of these chickens, and in order to
handle the recent increase of grain prices, companies within the industry will use
certain strategies to control the increased costs like: forward pricing, futures
markets, laying off employees, and even automating certain lines in production.
These strategies will help the prices of a company’s product to remain low, and
therefore, maintaining a good customer relationship.
Tight Cost Control System
“Firms that achieve cost leadership focus on tight cost controls” (Business
analysis & valuation). The prior mentioned strategies all lead up to a tight cost
control system in order to achieve success. A firm must have a structure that
most benefits operations. This is the most important because without it, the
other strategies would fail. Since cost is a major part of the bottom line in this
industry, eliminating all unnecessary or even reducing prior costs will lead to
increased profit over time.
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Product Quality
Government regulations require manufacturing facilities and products to
be inspected by federal, state, and local authorities. This would lead one to think
that it would be difficult to differentiate your product on quality. To ensure
product quality companies in the meat products industry have implemented
quality improvement programs. These programs employ managers to oversee
manufacturing processes to make certain product quality is up to par. In this
industry it is important to constantly reassure the customer that a company is
producing or buying high quality raw materials and using very efficient
production to guarantee the quality of the product.
Product Variety
In the meat products industry firms must compete to gain market share
which can be accomplished by increasing customer base. This can be done by
providing a variety in their product line because not all consumers are going to
be looking for the same types of products. For example, a customer exercising a
healthy diet compared to one that is not. Therefore, in this industry it is
important to add variety in your product line, and in return gain a wider
customer base. Hormel and its competitors produce a wide range of products
such as refrigerated and frozen meats, spices, frozen dinners, pre-cooked meat
products, etc. The firms in the industry continuously research new product ideas
to improve and expand their product line. Constantly innovating and reaching out
to new customers will increase a company’s profits.
Investment in Brand Image
The firms within this industry must rely heavily on brand image. The
standard is set high to create an image that the product provided is of the
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utmost quality available. Due to the fact the products are not very differentiated
within the meat products industry it is important for a firm to build brand image
to create customer loyalty. In order to create this positive brand image,
companies use marketing and advertising in the form of commercials and print
ads. Research is conducted to identify target markets for value added products
and marketing and advertising are focused on these markets to prove their
products are better, increasing brand image. To further expand brand image,
firms in the industry have sales teams to promote to grocery stores, restaurants,
local distributers, and the military. A company’s brand image can easily be
demolished, for example, by selling a chicken product to a customer that is
contaminated with avian influenza, which can live indefinitely in frozen material,
the company will be all over the news internationally, and will devastate the
brand image. In order to cover negative effects from health violations, it is the
norm to set up press conferences to inform the public of the firm’s plan of action
to ensure the safety and quality of their product.
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Firm Competitive Advantage Analysis
Like any firm in any industry, the main goal is to increase market share as
well as profitability. Since Hormel is in a commodity industry, they have to put a
great deal of emphasis on key success factors in order to gain market share.
Hormel utilizes the key success factors for the industry in the following ways.
Economies of Scale
A key way Hormel achieves economies of scale is through operating in five
different market segments. Refrigerated foods, Grocery products, Jennie-O
Turkey store, specialty foods, and other, which consists of selling cooked beef
products internationally. Hormel has 850 million dollars in new product sales
since the year 2000, and currently has thirty four products at number one or two
in market share for their categories. This is due to the acquisition of many small
companies over the past few years. Among these are Saag’s products Inc.,
Provena, and Valley Fresh all occurring in 2006. The most recent acquisition by
Hormel is Burke Corporation in August of 2007. With these acquisitions new
products are introduced in Hormel’s product line. Saag’s Product Inc. is a
manufacturer of gourmet sausage and smoked meats. Upon ownership of this
company Hormel anticipated opportunities to expand production capacity. When
purchasing Valley Fresh, Hormel expected to build value in the grocery products
segment because it is a leader in the canned chicken category. Expansion
throughout their product lines has lead to economies of scale by increasing their
market share in each of the last five years.
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Efficient Production
In a commodity industry where the basis is on cost, one of the easiest
ways to get ahead of your competitors is through efficient production. What
stands out the most, is that Hormel is the leader in return on assets among their
competitors with a five year average of 9.45%. Tyson, Smithfield, and ConAgra
follow with five year return on asset averages of 2.48%, 4.2%, and 4.73%,
respectively. Hormel also leads the industry in gross profit margin which also
shows production efficiency. Industry averages were 6.45% for Tyson, 11.2% for
Smithfield, 22.29% for ConAgra, and 24% for Hormel as the leader. Over the
past five years, Hormel has increased sales growth in each and every year as
well, which is another key factor in production efficiency. This shows efficient
production through a great team of management within the company.
Return on Assets
2002
2003
2004
2005
2006
Hormel
9%
8%
10%
10%
10%
Tyson
4%
3%
4%
4%
-2%
Smithfield
6%
1%
5%
6%
3%
ConAgra
5%
5%
5%
5%
4%
Average
6%
4.25%
6%
6.25%
3.75%
Tight Cost Control System
Like every firm within this industry, Hormel is expecting grain prices to be
high in 2007. In order to reduce the market risks of these raw materials, they
must come up with systems to effectively control these cost fluctuations. Hormel
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does so in a couple of ways. For Example, in the hog market, Hormel enters
contracts at formula-based prices up to fifteen years to control these costs.
“Contract formulas are based on hog production costs, hog futures, hog primal
values, or industry reported hog markets” (Hormel 10-K). Grain prices directly
affect the turkey market; therefore, Hormel must come up with a strategy to
control the increased price expectations. “To reduce the company’s exposure to
changes in grain prices, the company utilizes a hedge program to offset the
fluctuation in the company’s future direct grain purchases” (Hormel 10-K). As
you will see in most firms in this industry, this strategy is used frequently and not
just with the turkey market. The Hedging strategy is used with natural gas as
well. The company also uses sensitivity analysis to measure the risk of foreign
currency exchange rates, and locks into fixed interest rates to stabilize long-term
debt.
Product Quality and Variety
In order to achieve the highest quality products Hormel focuses on the
suppliers and the quality of the raw materials purchased. Due to the low
differentiation within the industry it is vital that the best possible supplies are
obtained. Hormel achieves this by implementing a supply quality management
team to ensure that supplies are up to standard. Hormel also strives to attain
optimal product quality through many safety procedures by the employees and
ensuring that they always treat and transport their animals in a humane manner.
“To this end, the corporation uses state-of-the-art facilities in conjunction with
cost-effective systems and science-based methods to ensure and enhance
humane animal welfare throughout the entire protein supply chain”
(www.hormel.com). As mentioned previously Hormel operates in a variety of
segments such as grocery products, refrigerated foods, specialty foods, Jennie-O
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Turkey Store, and others. By operating in all of these segments it allows Hormel
to diversify their product lines to increase customer base.
Investment in Brand Image
Creating a positive brand image is imperative to Hormel’s success. Hormel
uses a variety of approaches to increase the image of their brands. One example
is involves Jennie-O. They have teamed up with “The Biggest Loser” to offer
healthier options to contestants. Additional options that are offered are healthy
recipes to the health conscience consumers. This gives Hormel opportunities to
build a reputable brand image. Advertising contributes greatly to improving a
firm’s brand image. Hormel’s total expenses for 2006 were approximately $937
million, where $93.7 million of that was spent on advertising. Considering the
many expenses a company incurs, having 10% composed from advertising
shows that Hormel is willing to invest significantly into advertising in order to
increase brand image.
Hormel also strives to improve brand image by protecting the environment
that they occupy during every day use by protecting their soil, air, and water
through numerous programs. They try to limit packaging waste as well by
implementing a waste management system to protect their environment for the
future benefit of the firm and the customer’s of the firm. They have policies and
procedures to ensure they operate in an ethical manner. Hormel also makes
every effort to earn trust from their customers through delivering a wholesome
product.
Future Outlook
The company feels they are in a good financial position heading into 2007.
Their two latest acquisitions should help compliment the growing product lines
within the business. They plan on expanding through organic growth in strategic
33
locations internationally, and innovating products in order to stay on top of the
many different categories. Because of the financial stability of the company, one
can assume strategic acquisitions will continue to play a role into the future.
They’re hoping their well balanced portfolio will help straighten out the changes
in the protein cycle. “The company will continue to focus on new product
development, building brand awareness, and the expansion of value-added
product lines…” (Hormel 10-K). The emphasis on value-added products will
hopefully alleviate the pressure of having a pricing strategy that passes some
costs onto the customer.
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Accounting Analysis
Accounting analysis assesses a company’s operations by using financial
statements that evaluate a company at one given point or period in time.
Generally, a company creates and provides three main financial reports which
include a Balance Sheet, Income Statement and a Statement of Cash Flows.
These financial reports are important to not only managers, but owners and
shareholders as well. Since it is typical for a company to have different owners
and managers, these statements are used as an intermediary to show the
growth or loss of a firm. In order to comprehend these financial statements the
reader must understand accrual accounting, Generally Accepted Accounting
Principles (GAAP), management reporting, external auditing and legal liability.
Managers will face many situations where estimates and judgment are needed.
GAAP has evolved to try and keep managers honest in these accounting
situations. Accounting analysis summarizes and evaluates the three main
financial statements to review the judgment of the financial managers.
There are six steps in performing the accounting analysis. The first step is
to identify key accounting principles. It is important for the analyst to identify the
success factors and risk being practiced by the firm. Next, one must assess
accounting flexibility; that is, the limitation managers have in choosing
accounting policies and estimates; “When managers have accounting flexibility,
they can use it to either communicate their firm’s economic situation or to hide
true performance” (Business Analysis & Valuation, Palepu and Healy). The third
step is to evaluate the firm’s accounting strategy. The fourth item the accounting
analyst must evaluate is the quality of disclosure. These disclosures must explain
the policies and estimates used in the accounting judgment. While some
disclosure is required, managers have a fair amount of control over further
disclosure. In order to analyze accounting quality an analyst must look for certain
potential “red flags”. Identifying these “red flags” helps highlight dubious
35
accounting practices which should cause alarm for further investigation. This in
turn leads us to the sixth and final step of the accounting analysis. In the event
of finding a “red flag” that leads to any ambiguous information the analyst
should undo the accounting distortions. These distortions are disclosed in the
footnotes of the financial statements so that the corrected information is readily
available for the owners, shareholders, and future investors.
Key Accounting Policies
The key success factors need to be considered when a company
determines key accounting policies. The success factors give each company in
the industry a competitive advantage over the other firms. Firms can manipulate
financial documents, while still adhering to Generally Accepted Accounting
Principles, to make itself appear more financially sound than it really is. They
would do this for shareholders and potential investors. In the meat products
industry the key success factors are economies of scale, cost control, product
quality and variety, investment in brand image, and efficient production. The
goal of the managers of firms is to insure these success factors are administered
through key accounting policies. Some managers will doctor these factors to
benefit themselves.
Cost Control and Hedging
In Hormel’s case, as well as the rest of the industry, cost control is an
important success factor; however, there are some costs that companies have
little control over. The act of minimizing these costs gives a corporation a
competitive advantage over the others in the industry. For example, if the price
of grain increases, then the cost of chicken and turkey is going to rise. In order
to cover the increase in costs Hormel develops a hedge program to minimize
36
fluctuations in the costs. These hedge programs are accounted for under cash
flow hedge accounting. It is apparent that Hormel creates contracts with
suppliers on formula based pricing systems over long periods of time (usually
fifteen years). These contracts are based upon production costs, industry
reported hog markets, and/or hog primal values. These contracts offset rising
costs in the hog market which demonstrates tight cost control as a key success
factor.
Sales
2002
2003
2004
2005
2006
$3,910,314
$4,200,328
$4,779,875
$5,413,997
$5,745,481
$2,947,461
$3,187,175
$3,655,837
$4,129,549
$4,362,291
75.38%
75.88%
76.48%
76.28%
75.93%
Cost of
Goods
Sold
Cost of
Sales
%
Economies of Scale
Economies of scale is one of the main key success factors in the meat
product industry. In order to be successful and compete in the industry,
companies strive to grow. The main way to do this is by increasing sales and
gaining market share. Hormel recognizes sales when title passes at delivery.
According to Hormel’s 10-k, “the company was able to deliver on its growth
objectives to grow top-line sales by five percent and bottom-line net earnings by
ten percent.”
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Research and Development
With regard to product quality and variation Hormel was able to increase
product categories by introducing new value added and innovative products.
Research and development costs are included in the selling as well as the
general and administrative expense section of the income statement. Along with
research and development, advertising expenses as well are expensed when
incurred. Research and development of new products contributed to 14.8
percent of net sales since 2000. Advertising is an ideal way to gain brand
recognition. This shows that improving brand image is a key success factor.
Pension and Benefits
Generally accepted accounting principles allows for a certain degree of
flexibility for managers to make cost assumptions. Some assumptions managers
are forced to make are pensions and benefit plans. Death rate, discount rate,
and health care are factors deciding how much to allow for pension and benefit
expenses which are expensed as they are incurred. Hormel uses a third party to
determine estimates of benefit expenses. As disclosed in Note F of Hormel’s 10k, “the company offered early retirement packages to certain employees for a
onetime charge of 1.9 million dollars in 2004.” They plan to make at least
minimum annual payments on the remaining balance. Any adjustments in
pension plans are deferred and amortized up to fourteen years.
Goodwill and Intangibles
Almost a quarter of Hormel’s total assets come from goodwill and
intangibles. This is a large percentage that could certainly lead to distortions.
However, Hormel reviews these assets for impairment annually, or possibly more
38
often depending on changes, so that adjustments can be made. The asset is
impaired over its useful life. “The estimated fair value of each reporting unit is
determined on the basis of estimated discounted cash flow.” (Hormel 10-k)
As previously stated the key success factors of a company are closely
related to the key accounting policies and should be fairly similar. With the
flexibility in GAAP management can manipulate financial statements to make the
key success factors appear more appealing to investors. As one can tell Hormel’s
financial statements seem rather transparent.
Assess Accounting Flexibility
Financial statements are reported by firms to provide investors
information about the company. The financial statements of a firm must be
reliable and accurate in order for investors to make decisions about the firm. To
determine the accuracy of the firm’s financial statements, the degree of
accounting principles and flexibility used must be assessed. The flexibility a
manager uses when choosing accounting policies can affect the information
provided to understand the firm’s economics. For instance, if a manager is very
flexible in choosing the accounting policies, the financial statements have a
greater potential to be informative. Managers who use high degrees of flexibility
may sometimes manipulate the accounting numbers to make the financial
statements look more appealing to investors. On the contrary if a manager does
not have a high degree of flexibility when choosing accounting policies used, the
financial statements will not be very informative to the investor.
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Pensions and Benefits
One of Hormel’s main key accounting policies is their employee benefit
plans. Based on GAAP, managers within the company have the flexibility to make
assumptions and estimates on discount rates, mortality rates, and expected
return on plant assets. These assumptions are based on past trends and current
information. Since the assumptions are “people made” numbers managers have
the ability to influence the discount rates. One such possibility would be to
increase the discount rate which in turn decreases the company’s liabilities;
therefore, the company understates their expenses and overstates their net
income. If a company estimates too small of a discount rate the present value of
future service costs will be understated. For the past three years Hormel has
shown decreasing discount rates, from 2004 to 2006 it has dropped one percent.
With this observation one can tell that management has flexibility over the
discount rate they develop when estimating post-retirement benefit plans.
Goodwill and Intangibles
Another key accounting policy Hormel has flexibility over is goodwill and
Intangible assets. Hormel has the option to impair its intangibles annually or
anytime adjustments need to be made. Impairments are determined by
comparing an assets fair value to the book value listed. If the company’s listed
value of an asset is greater than the fair market value, then the difference is
written off as an impairment. This difference is the loss from the asset being
impaired because it was overvalued. These assets are impaired over its useful
life. If they choose not to impair, then assets will be overstated. In effect, equity
will be overstated on the financial statements. The net income will be overstated
because of an understatement in expenses. By overstating the net income,
40
earnings appear to be higher than they actually are which leads investors to
believe the total value of the firm is greater than it truly is.
41
Actual Accounting Strategy
Evaluating a firm’s accounting strategy considers the accounting flexibility
of the firm and in what way a manager chooses to use that flexibility. “When
managers have accounting flexibility, they can use it either to communicate their
firm’s economic situation or to hide true performance” (Palepu & Healy 3-8).
Although managers have flexibility in accounting, they must still adhere to the
generally accepted accounting principles. In reviewing Hormel’s financial
statements it seems to be that they abide by fairly conservative accounting
policies as does Tyson, Smithfield Foods, and ConAgra.
Research and Development
Without investing in research and development Hormel could not improve
the variation and brand image of their products. In 2006 alone Hormel invested
$18.63 million into research and development to improve and expand their
product line. Research is conducted by a team of 55 professionals. Among these
professionals 26 are devoted to improving product quality and 29 are devoted to
developing products. Although Hormel spends a significant amount on research
and development, they are sure to expense it when incurred which coincides
with their conservative accounting policies.
Pension and Benefits
Hormel has two different pension plans to cover hourly and salary
employees. Employees working on an hourly base receive benefits based on a
stated amount for each year. Benefits for salary employees are based on their
average total compensation. Discount rates used for pension plans are
determined by a third party. According to Hormel’s 10-K, estimates of future
42
performance, historical long-term rates of return, and the compensation of the
asset portfolio are determinants for the range of discount rates used. From 2001
to 2006 Hormel’s discount rates have been decreasing from 7.25% to 5.5%,
respectively. The effect of decreasing discount rates on pension plans causes
the cost of expenses to increase. This is shown by increasing costs associated
with pension and benefit plans. The average increase in pension costs over the
past three years is approximately $2.2 million. By recognizing the decreasing
discount rates provided, Hormel shows they use conservative accounting
methods when reporting pension costs.
Goodwill
In the meat products industry goodwill is not amortized. It seems to be
this way throughout the industry including Hormel. Of Hormel’s total assets
approximately 18% come from goodwill. While this is a large percentage of total
assets, it can be explained by the number of acquisitions made by Hormel since
2005. Some of these acquisitions include Farmer John, Mexican Accent, MarkLynn, Lloyds, and Valley Fresh. Over this time frame Hormel experienced the
biggest increase in goodwill, increasing from $417.73 million to $550.71 million.
Although goodwill is not amortized it is monitored for impairment annually, or
possibly more often depending on changes, so that adjustments can be made.
Due to these acquisitions and Hormel’s conservative accounting policies it does
not appear that distortions have been made regarding goodwill.
Changes in Accounting Principles
Recognizing changes in accounting policies is done regularly by firms in
this industry. Hormel recently changed from LIFO (last-in-first-out) to FIFO (firstin-first-out). This relates to Hormel’s key success factor of cost control. By
switching to FIFO, inventory is stated at a more current cost. When Hormel was
43
using the LIFO method net earnings were overstated which in turn increased
income tax. With this increased expense it is more difficult for Hormel to control
costs which may increase prices in the future.
As stated previously Hormel does not amortize goodwill. This is due to an
adoption of SFAS 142 in fiscal 2002. This policy stated that, “goodwill and other
indefinite-lived intangibles assets are no longer amortized but are reviewed
annually (or more frequently if impairment indicators arise) for impairment”
(Hormel 10-K). By implementing this policy Hormel’s net earnings are expected
to increase by approximately $9 million due to the reduction in amortization
expenses. This shows some aggression in accounting policies by Hormel;
however, it is in line with the industry norm seeing as Tyson, Smithfield, and
ConAgra do not amortize goodwill.
Hormel appears to be following similar accounting principles to others in
the meat products industry. These principles all appear to be rather conservative
with a moderately high level of disclosure.
Quality of Disclosure
Qualitative Analysis
After assessing Hormel’s key accounting policies, it is clear that their
financial statements show a high level of transparency. The amount of disclosure
a company provides to investors determines how transparent firm’s financial
statements are. Hormel provides an adequate amount of disclosure relating to
key success factors. For example, According to GAAP, for the most part Hormel’s
Managers have not used their flexibility to manipulate their earnings. This
means their financial reports are accurate and reliable for investors.
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Pension and Benefits
Disclosure under pension and benefit plans show a high level of
transparency in Hormel’s financial statements. For example, labor negotiations in
2003 caused an increase in pension benefits. As a result benefit obligations for
Hormel increased approximately $3.5 million which in turn contributed to part of
Hormel’s general and administrative expense increase from 2003 to 2004. Not
only does Hormel provide a break down in how financials are affected by pension
and benefit obligations, they also disclose how benefits are applied to employees
based on the type of compensation received. By disclosing this type of
information, investors receive an accurate idea of Hormel’s current position.
When determining the discount rate used for pension and benefit plans
Hormel takes three factors into consideration: estimates of future performance,
historical long-term rates of return, and the compensation of the asset portfolio.
With this data assumptions have been made that pension and benefit discount
rates are expected to decrease by approximately 1% until 2008 where rates are
expected to remain at 5% (Hormel 10-K 2004). Hormel discusses these
assumptions in moderate detail within their footnotes. The disclosure of these
assumptions provides forward looking information for potential investors.
Product Segments
Hormel operates within five different segments of the meat products
industry including grocery products, refrigerated foods, specialty foods, Jennie-O
turkey store, and other. A detailed breakdown of sales and operating profits
within each of the five segments is disclosed in Hormel’s 10-K. Disclosing this
breakdown allows investors to review which segments are most profitable for
Hormel. Increases in different segments can be partially explained by
acquisitions made by Hormel. Hormel provides high disclosure to discuss
45
acquisitions made as well as their expectations in the future. For example, upon
acquisition of Lloyd’s Barbeque in 2005, Hormel expected market share to
increase in the refrigerated foods segment. The 2.6% increase from 2005 to
2006, shown in the chart below, reflects this expectation.
46
Segment Operating Profits
(in thousands)
%
2005
2006
$
$
132,047
137,580
$
$
Refrigerated Foods
129,831
133,212
Jennie-O Turkey
$
$
Store
136,071
128,734
$
$
27,310
48,579
$
$
22,384
33,222
$
$
447,673
481,327
Grocery Products
Specialty Foods
All Other
Total
Change
4.20%
2.60%
-5.40%
77.90%
48.40%
7.50%
(Hormel 10-K 2006)
As product variety is a key success factor for Hormel, they continue to
acquire companies in each segment to build variety. Due to the detailed
disclosure provided investors are able to determine which segment is most
valuable to the firm.
Conclusion
47
Overall Hormel provides a high level of disclosure in their financials.
Discussions within the footnotes include what causes changes in financials and
accounting policies. By disclosing detailed information in the footnotes it is clear
that Hormel’s financials are transparent which makes it easy for investors to
distinguish the true value of the company.
48
Quantitative Analysis
As mentioned before, Generally Accepted Accounting Principles (GAAP),
provide managers with the freedom of the quality of disclosure through
flexibility. Managers of a firm can go one of two ways with this flexibility. GAAP
requires a certain minimum of disclosure, which provides managers of a firm too
much free will in some cases; since they only have minimal requirements, they
can take advantage of this aspect in their disclosures to manipulate certain
numbers that pertain to their key success factors. At the same time, managers
can also take the time to thoroughly disclose any abnormal increase or decrease,
to provide prospective and current investors with the level of information
required to make an accurate evaluation of the firm. In pursuing a quantitative
analysis, we used selected ratios to attempt to find out the degree of accuracy in
the financial statements of the firms. The diagnostic ratios are divided into two
categories which measure both sales and core expense manipulation.
Throughout the analysis, we look for any distortions in the consistency of the
ratios that do not come with proper disclosure. The ratios used in order to assess
sales manipulation are net sales to cash from sales, net sales to accounts
receivable, and net sales to inventory. The ones used to evaluate expense
manipulation are as follows: asset turnover, change in cash flows from
operations to change in operating income, and total accruals to change in sales.
Sales Manipulation Diagnostics
Sales manipulation diagnostics are a set of five ratios that show how sales
are supported. For Hormel there are three out of the five ratios that provide
significant information. These ratios include net sales over cash from sales, net
sales over accounts receivable, and net sales over inventory. This section
provides an analysis of the sales manipulation diagnostics for Hormel, ConAgra,
49
Smithfield, and Tyson which will reveal any inconsistencies for Hormel or
competitors in the industry.
Net Sales/Cash from Sales
The first ratio we used in our analysis is net sales over cash from sales.
This ratio tells us the amount of cash from sales is collected that is or isn’t
supported by sales. One would look for this ratio to be at one or within two
hundredths of one. As you can see over the past five years Hormel’s net sales to
cash from sales ratio is inside this range, and their main competitors have
maintained a healthy ratio as well.
Net Sales/Account Recievables
25.00
20.00
Hormel
15.00
Tyson
Smithfield
10.00
ConAgra
5.00
0.00
2002
2003
2004
2005
2006
Year
Net Sales/Accounts Receivable
The second ratio, net sales to accounts receivable, tries to find out if sales
are supported by receivables. If there is an increase in sales that are not
supported by an increase in accounts receivable, then there is a cause for
50
concern. In Hormel’s case this ratio has been fairly across the last five years
along with Tyson and Smithfield. ConAgra, on the other hand, had a sharp
decline between 2003 and 2004 due to a decrease in sales of about 5.6 billion
dollars along with an increase in accounts receivable of about a half a billion
dollars. Their ratio has been consistent since 2004. ConAgra downsized their
company during this time period causing the inconsistency in this ratio.
Net Sales/Cash from Sales
1.01
1.01
1.00
Hormel
Tyson
1.00
Smithfield
0.99
ConAgra
0.99
0.98
2002
2003
2004
2005
2006
Year
Net Sales/Inventory
The last ratio that has to do with sales manipulation is net sales over
inventory. This ratio tells us how much sales are supported by the amount of
inventory. An increase in this ratio would create a bad image for our analysis
purposes. Hormel’s ratio is once again steady, leading us to believe that they
have not manipulated sales. Everyone else in the industry has kept a fairly firm
ratio as well, so the industry seems to have sales that are supported by their
inventories.
51
Net Sales / Inventory
14.00
12.00
10.00
Hormel
8.00
Tyson
6.00
Smithfield
ConAgra
4.00
2.00
0.00
2002
2003
2004
2005
2006
Year
Core Expense Manipulation Diagnostics
The core expense manipulation diagnostics are a set of ratios that
determine possible manipulation of expenses. Significant expense diagnostic
ratios for the meat packing industry include asset turnover, cash flow from
operations over the change in operating income, and total accruals over the
change in sales. The following section examines these ratios throughout the
industry to identify abnormalities.
Asset Turnover
Asset turnover is the relationship of sales over total assets. This ratio
measures how effectively a firm is using their assets to create sales. A firm with
a declining asset turnover shows the firm could be manipulating expenses to
increase net income. An example in the meat products industry would be not
52
expensing spoiled meat but rather recognizing it as finished goods, which in turn
increases assets. With the exception of ConAgra, Hormel and its main
competitors have solid asset turnover ratios which indicate that there is no
attempt at manipulation. As stated previously ConAgra downsized in 2004 which
explains the decline in asset turnover.
Asset Turnover
3.00
2.50
2.00
Hormel
Tyson
1.50
Smithfield
ConAgra
1.00
0.50
0.00
2002
2003
2004
2005
2006
Year
CFFO/Operating Income
This next ratio shows if the cash flows from operations are being
supported by operating income. This can be calculated by dividing the change in
cash flows from operations (CFFO) by the change in operating income (OI). It is
ideal to have a low CFFO/OI ratio because this shows that a company is
generating money through operations. Over the past five years firms in the meat
packing industry have seen some fluctuations with this ratio particularly with
ConAgra in 2003. This large increase for ConAgra can again be explained by the
restructuring of their company. The fluctuation of this ratio among firms in the
industry seems to be standard therefore indicating no suspicion of manipulation.
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CFFO / Operating Income
90.00
80.00
70.00
60.00
Hormel
50.00
Tyson
40.00
Smithfield
30.00
ConAgra
20.00
10.00
(10.00)
2002
2003
2004
2005
2006
Year
Accruals/Change in Sales
The last ratio in expense manipulation is total accruals over change in
sales. Total accruals are computed by subtracting CFFO from net income. One
reason a firm may have a low accruals/change in sales ratio is due to the fact
that the firm is receiving more cash from sales rather than on credit. Over the
past five years Hormel and Tyson have had ratios between 0.5 and -0.5 while
ConAgra and Smithfield have experienced a deep decline. From 2005 to 2006,
Smithfield’s sales increased from $151.1 million to $964.5 million, respectively.
This increase is reflected by the decline in their ratio from 2005 to 2006 which
can be grounds for possible manipulation of expenses.
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Accruals / Change in Sales
1.00
0.50
(0.50)
2002
2003
2004
2005
2006
Hormel
(1.00)
Tyson
(1.50)
Smithfield
(2.00)
ConAgra
(2.50)
(3.00)
(3.50)
(4.00)
Year
Conclusion
Overall Hormel seems to be practicing truthful accounting policies which
are reflected by the expense and sales diagnostic ratios. Hormel has maintained
consistent ratios in comparison with their competitors. Although there are some
suspicions of manipulation because of large increases or decreases in ratios,
most seem to be reasonable with respect to the firm’s activities during a
particular time period.
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Identify Potential “Red Flags”
Through the expense and revenue manipulation ratios, one can easily
identify a potential “red flag”. These “red flags” are causes for concern for an
outside investor. Managers can manipulate earnings in many ways, and the
integrity of the financial statements is valued through assessing the ratios
mentioned above. Any sharp decline in any of the expense manipulation ratios
would be a potential “red flag”. At the same time, any increase in a revenue
manipulation ratio would also be a potential “red flag”. These accounting
distortions need to be further evaluated in the disclosure to find out the cause of
one of these concerns. If one cannot locate a “red flag” in the disclosures of the
financial statements, then it would be hard to trust the accuracy of the
accounting of that firm.
Goodwill to Assets Ratio
2002
2003
2004
2005
2006
Hormel
13.97% 17.31% 16.49% 17.64% 18.00%
Tyson
25.39% 25.29% 24.45% 23.82% 22.59%
Smithfield 11.56% 9.97%
ConAgra
10.38% 10.47% 11.67%
25.05% 25.26% 26.64% 26.46% 28.78%
In the quantitative analysis we were able to assume that Hormel had not
distorted any aspects of their financial statements. When arriving at goodwill, the
chart above shows that the industry as a whole has a consistent goodwill to total
assets ratio. This means that Hormel, along with its competitors, do not impair
goodwill. As a whole they do follow the accounting rules and run tests for
impairment annually or when needed. “The impairment test is a two-step
process, starting with the fair value of each reporting unit is compared with the
carrying amount of the reporting unit, including goodwill. This fair value is
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another “man made” number, so it is just an estimation on the basis of
discounted cash flow. If the carrying value is larger than the fair value, then the
second step of the process comes into play, in order to establish the amount of
goodwill impairment that should be recorded” (Hormel 10-K). The reason we
see a consistent goodwill to total assets ratio is because everyone within the
industry is going to treat goodwill the same. They do this to ensure that one of
the competitors does not get an unfair advantage in the accounting process. If
goodwill was impaired, then the expenses in the year it was amortized would
increase, causing net income to decrease. The chart below shows adjusted
earnings for the past five years if goodwill were to be amortized by 20%.
Earnings Adjusted for Goodwill Impairments
Net Earnings
Goodwill
Amortization
Adjusted Earnings
2002
$189,322
2003
$185,779
2004
$233,550
2005
$254,603
2006
$286,139
$(62,041)
$127,308
$(82,852)
$102,927
$(83,546)
$150,004
$(100,421)
$154,182
$(110,141)
$175,998
While no firms within the industry amortized goodwill, this is a significant
difference in earnings that should be taken into account when valuing a firm.
Undo Accounting Distortions
The last step of the accounting analysis process is to undo accounting
distortions. If this analysis leads one to believe that the reported numbers are
inaccurate, then it is crucial to seek for the correct numbers to the best of your
ability. Since the numbers are already wrong, the best estimation you can come
up with is the only way to get closer to the actual numbers. One can further look
through the financial statements and cash flows to attempt to restate a more
accurate number. “For example, if an analyst is concerned that the firm is
aggressively capitalizing certain costs that should be expensed, the information
in the cash flow statement provides a basis to make the necessary adjustment”
57
(Business Analysis and Valuation). In our evaluation of Hormel, we did not
encounter any potential “red flags”, therefore there is no accounting distortions
to undo. One would get a more accurate view of the value of the firm if you
were to amortize goodwill. Since the other firms in the industry do not impair
goodwill, Hormel is forced to use this approach to keep up with the industry and
does not concern us in our accounting analysis.
58
Financial Analysis
This section will closely examine the financial standing of Hormel.
“Financial statements of a business must be analyzed and interpreted in order to
evaluate the financial condition of the company and the results of its operations”
(Financial Statement Analysis Handout). In order to truly understand a firm, the
financials must be analyzed from three major viewpoints: liquidity, profitability,
and capital structure. Based on these three areas, ratios are constructed that
allow one to evaluate the financial position of the firm, both historically and
currently. These ratios also provide a reasonable basis to forecast out future
performance of the firm.
Liquidity Ratios
Liquidity of a firm is a measurement of the ability to convert current
assets to cash to finance short-term liabilities. In order to analyze the liquidity of
a firm five ratios are used as determinants. The ratios include: current ratio, acid
test ratio, receivables turnover, inventory turnover, and working capital turnover.
Perhaps the most important part of evaluating a firm’s liquidity is to find the time
table of the cash-to-cash cycle, which is explained further in the analysis. The
cash to cash cycle is calculated by using two additional ratios: days supply of
inventory and days sales outstanding. In this section an evaluation of Hormel
and its competitors will be conducted to find the efficiency each company uses to
meet daily operations of the firm.
Current Ratio
The current ratio is a coverage ratio of short term liabilities. By taking a
ratio of current assets over current liabilities one can determine a firm’s ability to
59
cover short term financial responsibilities. In general a current ratio that is
greater than one is ideal. A ratio that is larger than one allows for a higher
capacity to pay off current liabilities in a fast manner. As an example, a ratio of
2:1 shows that for every dollar of current liabilities a firm has, two dollars are
available to pay off these liabilities. As a current ratio increases you can
determine that the firm is more liquid; and thus able to pay off current liabilities
in a time of need.
Hormel has maintained an average current ratio of 2.04:1 for the past five
years, with the most recent ratio being 1.95:1 in 2006. This appears to be
unfavorable for Hormel; however, when comparing the current ratio to 2005 of
1.85:1, it can be said that Hormel’s current ratio has obtained a favorable
increase in the past year. This shows that Hormel is able to cover all current
liabilities. By looking at the trend in the industry you can see that Tyson,
ConAgra Foods Inc., and Smith Fields Foods maintained average current ratios of
1.5, 1.66, and 2.1 for the past five years, respectively. Hormel’s competitors
have maintained positive current ratios and therefore are able to cover their
current financial obligations with assurance. Alike its competitors, Hormel’s
current ratio has remained positive which, in turn allows for assurance in
covering short-term liabilities as well.
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Acid Test
Acid test, or in other words, the quick asset ratio is also a measurement of
coverage. Current assets consist of cash, cash equivalents, accounts receivable,
and inventory; however the quick asset ratio takes inventory into consideration
when determining the liquidity of the firm. Inventory is not as liquid as other
current assets, so if all sales were to come to an immediate halt the acid test
ratio would be a better indicator of the firm’s ability to cover short-term debts.
The ratio is the relationship of cash, accounts receivables, and securities to
current liabilities. The current assets exclude inventory in this ratio.
Hormel has an average quick ratio of 1.04:1; however, an average of this
ratio is not a good indicator for the firm’s liquidity. In 2006, Hormel had a quick
asset ratio of 0.88:1 which means that if coverage of short-term liabilities arises
in a hurry, the firm could run into some issues. Hormel is above the industry
average in means of liquidity. In 2006, the industry had an acid test ratio of
0.6:1. Subsequently, for every one dollar of short-term debt the firm has only
sixty cents are available to cover the current liabilities. With an acid test of less
than one a firm can seem less favorable to an investor. Despite that, is it
common in this industry to have a quick asset ratio of less than one due to
inventory being a large portion of current assets.
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Inventory Turnover
The inventory turnover ratio shows how many times a company is able to
replenish their inventory within an accounting period. It is measured by taking
the relationship of cost of goods sold to inventory. Inventory in this case is
measured in cost. Generally, a firm with a high inventory turnover is considered
a cost leader. This is due to a firm’s ability to replenish inventory at lower costs.
This allows for firm’s to make a lower investment in inventory and thus
assume less risk. If a firm’s inventory turnover decreases or increases
dramatically from year to year, this may be due to lack of inventory efficiency.
Hormel’s five year average inventory turnover is 8.03:1 which means that
the firm is able to restore its inventory about eight times per year. Tyson Foods,
Hormel’s number one competitor, leads the industry in inventory turnover rates
with a five year average of 11.70:1. This shows that while Hormel can turnover
its inventory every month and a half, Tyson Foods replenishes their inventory
every month. In the meat packing industry it is standard to have a high
inventory turnover to keep products fresh. Overall the industry average of
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inventory turnover is 8.33, which shows that Hormel in line with the industry in
that they have good operating efficiency.
Days Supply of Inventory
Days Supply of Inventory is the amount of time in days before inventory is
replenished. In other words inventory is left in stock during this period. Days
supply of inventory is the first half of the cash-to-cash cycle. The cash-to-cash
cycle is a determinant of how many days it takes for a company to make money
from the time money is put into inventory to the time the firm receives money
from short term receivables. The second half of the cash-to-cash cycle is days
sales outstanding which will be mentioned later. The way we determine the days
supply of Inventory is to take the relationship of days per year (365) to the
inventory turnover. In this case Hormel’s days supply of inventory is about 45.46
days, or one and a half months. This may seem like a fast inventory turnover
rate; yet, when compared to the industry average of 47.27 it is clear that days
supply of inventory for Hormel is standard.
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Receivables Turnover
Receivables turnover establishes the amount of cash that is collected from
outstanding receivables. This ratio can be measured by the relationship of net
sales to accounts receivable. Accounts receivables are a current asset of the firm
that is awaiting payment from consumers. The higher the account receivables
turnover is, the more money a firm has tied up into the account receivables. A
significant change in the account receivables turnover could result from changes
in credit policies of a firm. From 2003 to 2004 Hormel experienced a dramatic
increase in the account receivables turnover from 14.41:1 to 17.53:1,
respectively. The accounts receivable accounts decreased in fiscal year 2004
causing an increase in the account receivables turnover. Such an increase,
results in higher net earnings. Hormel’s average turnover rate is 16.18:1, which
is almost in sync with its competitor Smith Fields at 16.71:1. Unlike Hormel,
Tyson Foods and ConAgra Foods Inc. have obtained a steady receivables
turnover for the past five years. This shows that both companies have had been
consistent in their credit policies and sales efficiency.
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Days Receivables Outstanding
As mentioned before, days sales outstanding defines the remainder of the
cash-to-cash cycle. Days sales outstanding shows the amount of days it takes a
firm to collect on receivables. For instance, in 2006 Hormel had a receivables
turnover of 16.8. To convert to days we divide 365 by 16.8 (A/R turnover) to get
a days sales outstanding of 21.72. This tells us that in that year Hormel could
collect on receivables approximately every 22 days.
This ratio is more significant when related to the days supply of
inventory. In 2006, days supply of inventory was 47.77 days. By this observation
we can see that the cash-to-cash cycle in 2006 was complete every 69.49 days
(days sales outstanding + days supply of inventory: 21.72 + 47.77). The
significance of this cycle to determine how long it takes for a firm to receive
money from the time inventory is purchased to the time collections are made on
receivables.
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Working Capital Turnover
Working capital turnover is calculated by dividing net sales by working
capital (current assets less current liabilities). In other words, “A company uses
working capital to fund operations and purchase inventory. These operations and
inventory are then converted into sales revenue for the company.”
(www.investopedia.com) If a company has a low working capital turnover, then
working capital is not being used efficiently to generate sales.
The industry has a range of average working capital turnovers from 6.9221.92. Hormel sits in the middle with a five year average working capital
turnover of 9.62. This means that one dollar of working capital the company has
they are generating $9.62 in sales. The working capital for Hormel has decreased
by one dollar each year for the past two years. This has been a result of either
increased current liabilities or current assets within the firm.
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Conclusion
According to the liquidity ratios Hormel is a fairy liquid firm. The
current ratio average over the past five years is 2.04. This indicates that they
have enough resources to cover liabilities in the previous year. The quick ratio
shows that Hormel is more liquid than the rest of the industry. The cash to cash
cycle is calculated by adding the days supply inventory and the day’s sales
outstanding. Hormel has a cash to cash cycle of 70 days. That is, the time from
when raw materials are purchased to the payment from the sales of inventory
are received.
Capital Structure Ratios
Capital structure ratios are a tool to measure how a company finances its
asset in relation to liabilities and owner’s equity. The more equity that is used to
finance these assets the lower the company’s default risk. There are two main
components to consider in this evaluation process. The first is debt in relative to
equity and the second is the ability to service the principal and interest
requirements on debt. There are three ratios used in the evaluation process
which consist of debt to equity, times interest earned, and debt service margin.
Debt to Equity
Debt to equity is a leverage ratio that measures the risk exposure of a
company. The relationship of debt to equity indicates how a firm is financed and
can determine the ability for repayment of liabilities. A high ratio means that the
firm is more risky. The debt to equity ratio can vary from industry to industry. If
your debt to equity ratio is higher than the segment standard this may cause you
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to lose earnings due to the interest expense incurred with debt financing. A long
run result from too much debt financing could lead to bankruptcy.
In this industry Hormel is at the lowest of its competitors with a debt to
equity ratio of 0.84:1 (five-year average). This means that Hormel uses equity to
finance its assets more than it does debt. Hormel’s competitors have a five year
D/E average of 1.85:1. Such a high ratio can indicate that there is not enough
equity to finance the firm’s liabilities. Hormel is not aligned with the industry
standard; however, its low debt to equity ratio keeps a low risk for Hormel.
Times Interest Earned
Times interest earned signifies a firm’s ability to finance the interest
expense incurred from current and long-term liabilities. This is measured by
evaluating the relationship of operating income to the interest expense. The
operating income is the earnings before interest and taxes and must be larger
than the interest expense in order to make a profit. Without a positive ratio stock
holders will not gain a profit. A company whose operating income is 2000 with
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an interest expense of 800, has a times interest earned ratio of 2.5. This means
the company made 2.5 times more income from operations than were they
charged in interest expenses.
In comparison to the industry Hormel has a very high ratio of times
interest earned at 13.36. Tyson Foods, Smith Field Foods, and ConAgra Foods
Inc. have ratios of 2.38, 2.65, and 3.42, respectively. The reasoning behind the
large gap in times interest earned between competitors can be explained by
looking back at the debt to equity ratios. Hormel was the only company within
this industry who finances their assets more with equity than liabilities leading to
lower interest rates. Conversely, Tyson Foods, Smith Field Foods, and ConAgra
Foods Inc. all financed their assets with more debt than equity; resulting in
higher interest rates for those companies. With higher interest rates the times
interest earned is lower; and thus lower profits are earned for stock holders.
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Debt Service Margin
The Debt Service Margin measures the ability of a firm to cover
installments of long term liabilities. Debt service margin is calculated by dividing
cash from operations by installment due on long-term debt. Debt service margin
for Tyson and Smith Field Foods are fairly low in the industry. Conversely Hormel
along with ConAgra Foods Inc. has high debt service margins at 13.34 and
18.53, respectively. This means that these companies are able to finance longterm liabilities, such as notes payable, with certainty. A debt service margin is
grounds for worry due to uncertainty of cash flows in the future.
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Z-Score
Altman’s Z-score is a measure of credibility of a firm. In this case,
credibility of the firm can determine whether a company will go bankrupt in the
near future. The z-score has 70-95% accuracy rate within one to two years.
According to www.valuebasedmanagement.net, “If the score is above 3.0bankruptcy is not likely. If the score is 1.8 or less then bankruptcy is likely. A
score between 1.8-3.0 is the grey area.” Altman’s Z-Score is calculated using five
ratios. The formula is as follows:
⎡ Working Capital ⎤
⎡ Retained Earnings ⎤
Z − score = 1.2 ⎢
+
1.4
⎢⎣ Total Assets ⎥⎦
⎣ Total Assets ⎥⎦
⎡ Earnings Before Interest and Taxes ⎤
+ 3.3⎢
⎥
Total Assets
⎦
⎣
⎡ Market Value of Equity ⎤
+ 0.6 ⎢
⎥
⎣ Book Value of Liabilities ⎦
⎡ Sales
⎤
+ 1.0 ⎢
⎣ Total Assets ⎥⎦
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Hormel is above the industry standard of z-scores with a score of 5.9 in
2006. Although Hormel is much higher than competitors, the industry has an
average z-score of about 3.7. This means that there is not much likely hood of a
competitor in this industry to go bankrupt within two years.
Internal Growth Rate (IGR)
The internal growth rate is the growth within a firm without using outside
sources for financing purposes. The return on assets is a key factor for
determining this growth rate. Hormel has an average IGR of 6.04% which is the
highest in the industry. Following Hormel, Smith Field Foods has an internal
growth rate of 4.2%. Tyson and ConAgra Foods Inc. has a much lower IGR due
to borrowing from outside of the corporation.
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Sustainable Growth Rate (SGR)
The sustainable growth rate shows how much a firm can grow internally
by using retained earnings for financing. The greater profit a company received
the greater the retained earnings will be. In turn the sustainable growth rate will
be larger. In order to increase the SGR, a company can do one of three things:
increase return on assets, eliminate dividends, or increase leverage. Hormel and
Smith Field Foods have almost identical average SGR of 12.45% and 12.46%,
respectively; whereas, ConAgra Foods Inc. and Tyson Foods have average SGR
of 3.66% and 5.35%, respectively.
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Conclusion
In order to finance future projects, the internal growth rate and the
sustainable growth rate are used to determine the amount of debt Hormel needs
to undertake the projects. These ratios are significant because they forecast
profitability for a company. After analyzing the IGR and SGR for the industry, it is
apparent that Hormel has a relatively higher IGR and SGR than its competitors.
This means that Hormel acquires less debt to finance projects, thus, increasing
future profitability.
74
Profitability Analysis
One major way to evaluate a firm’s performance is to determine their
profitability. A profitability analysis is done by creating profitability ratios that
look at four aspects pertaining to profits: 1. operating efficiency, 2. asset
productivity, 3. return on assets, 4. return on equity. The evaluation of these
ratios allows one to better understand the profitability of a firm as well as that of
its competitors.
Gross Profit Margin
Gross profit margin is the remaining percentage of sales after deducting
cost of goods sold. Based on 10-K’s from the past five years, Hormel’s gross
profit margin remained steady while their competitor’s were full of fluctuation.
Smithfield’s profit margin declined from 15% to 10%, Tyson fell from 8% to 4%,
while ConAgra increased their profit margin from 16% to 25%. This shows that
Hormel is able to maintain a balance between fluctuating prices and costs. Due
to the fact that the meat products industry has to compete so heavily on price a
firm must be able to adjust their costs in relation to price to maintain their gross
profit margin. Tyson and Smithfield’s drop in profit margin could be do to a drop
in sales, or their inability to control costs. ConAgra on the other hand has had a
steady growth over the past five years, which could be due growth in the firm
and increased sales.
75
Operating Expense Ratio
The operating expense ratio for a firm shows what percentage of a firm’s
sales go to selling and administrative expenses. Given that the meat products
industry is so driven by price, the ability of the firm to manage cost is extremely
important. Over the past five years Hormel has maintained their operating
expense ratio at 16% to 17%. This is a fairly high percentage when compared to
that of competitors. Tyson kept their ratio low averaging around 3% and 4%,
Smithfield at about 6%, and ConAgra growing from 9% to 16%. While Hormel’s
ratio is significantly higher than that of Tyson and Smithfield, the fact that they
kept a consistent ratio is a good thing. ConAgra on the other hand had a
consistent growth in their operating expense ratio. This illustrates that ConAgra
is consistently having to spend more money to try and make money.
76
Operating Profit Margin
Operating profit margin shows the firm’s operating income as a
percentage of revenue. Hormel’s operating profit margin averaged around 8%
over the past five years. The fact that they maintained a steady operating profit
margin shows that Hormel was consistently profitable with regard to operations.
Other companies in the industry such as Tyson and Smithfield had operating
profit margins that progressively declined, Tyson from 4% to 0% and Smithfield
from 6% to 2%. These companies inability to maintain an operating income can
have a very negative effect. ConAgra on the other hand increased their operating
profit margin from 3% to 8%, which shows they were consistently increasing
their operating income.
77
Net Profit Margin
The net profit margin ratio of a firm shows what percentage of a firm’s
sales make up net income. Net profit margin can provide some of the best
information regarding a firms profitability, because it let’s you know how much of
each sales dollar goes to net income. Hormel had a consistent net profit margin
of 5%, meaning that $.05 of every sales dollar is held as net income. Tyson’s
pattern continued, and their net profit margin declined from 2% to -1%. This
means that Tyson paid $.01 for every dollar of revenue. Smithfield averaged
between 2% and 3%, except for in 2003 when they fell to 0%. ConAgra
remained fairly steady, 4% in 2002, increased to 7% in 2004, and then down to
5% in 2006. There doesn’t seem to be a trend in the industry regarding net
profit margin, however Hormel appears to be at the top of the industry with a
consistent 5% net profit margin.
78
Asset Turnover
Asset turnover measures asset productivity. “The basic concept of asset
productivity is that resources are used to generate or support sales volume”
(Financial Statement Analysis Handout). Asset turnover is calculated by dividing
sales by total assets. In comparison to their competitors, Hormel’s asset turnover
is pretty average, ranging from 1.76 to 1.90 over the past five years. This means
that for every dollar of Hormel’s assets, $1.76 to $1.90 was earned in sales.
Tyson and Smithfield have a slightly higher asset turnover. The industry trend
seems to be that the lower the profit margin the higher the asset turnover. With
ConAgra’s growing profit margin, they have an asset turnover that is lower than
that of their competitors.
79
Return on Assets
Developing a return on assets ratio is a way to comprehensively measure
the profitability of a firm. Return on assets is computed by dividing net income
by the previous year’s assets. By calculating this ratio with assets from the
previous year the ratio will be more accurate, because the firm used the assets
they already had to earn revenue, not what was acquired during the period.
Hormel has a considerably higher rate of return on assets than its competitors.
They keep their return on assets at 8% to 10%, while Smithfield and ConAgra
average around 5%, and Tyson is even lower fluctuating from 4% in 2002 down
to -2% in 2006. Hormel is earning significantly more off their assets than others
in the industry.
80
Return on Equity
A firm’s return on equity is calculated by dividing net income by the
owner’s equity from the previous year. This ratio measures profitability by
evaluating the profitability of the owner’s interest in total assets. Hormel seems
to have similar rates of return on equity in comparison with their competitors,
except for Tyson. The overall rate for Hormel, Smithfield, and ConAgra seems to
be around 16% to 17%, except for Smithfield’s significant drop to 2% in 2003.
Tyson is considerably lower, starting out at 11% in 2002 and dropping to -4% in
2006. Hormel’s ratios are overall consistent and their profitability appears to
generally follow the trends of the industry.
81
Conclusion
After analyzing the profitability ratios, Hormel tends to perform at or
above the industry average. Whether or not Hormel increases or decreases in
each area, they have less volatility than the rest of the firms. The industry trend
seems to be that the lower the profit margin the higher the asset turnover.
Therefore, since Hormel has a high profit margin this explains a low asset
turnover ratio relative to the industry.
82
Financial Statement Forecasting
When coming to a valuation of a firm, the forecasting of the three major
financial statements (Income Statement, Balance Sheet, and Statement of Cash
Flows) is an important tool to use. These forecasts are not only used by
Managers and prospective investors, but for debt markets and bankers as well.
Historical data is used to collect ratio analysis and trends in averages to create a
basis for your forecasting. In our case we used five years of historical data, but
to quite possibly get a more accurate number, one could go with ten to fifteen
years of historical data if available. These historical numbers are found in a firm’s
annual filings, 10-k reports. After gathering the three key financial statements it
is best to get those into consolidated statements. Once consolidated, the next
step is to convert them into common size statements, which just converts the
current numbers into a percentage of an important bottom line number. Since
some aspects of these statements are almost impossible to predict, one puts
emphasis only on the numbers where there was stability in the ratio analysis or
the averages of common size statements. In the forecasting of Hormel’s
financials we chose to attempt to forecast the next ten years.
Income Statement
The first step in the process of forecasting is to start with the income
statement. The common size income statement puts all the line items as a
percentage of net sales. The first number forecasted is net sales. Taking a look
at the average trends, Hormel maintained a steady growth in sales, while the
only other main competitor to do so was Smithfield. Tyson experienced a
decrease in sales in 2005 and 2006 along with ConAgra in 2003. As one can see,
there does not seem to be stability within this industry in the last five years. We
83
chose to focus more on what Hormel had been doing historically instead of the
industry average, because while some struggled in select years, they did not
struggle in the same years, so therefore Hormel’s sales do not show any signs of
correlating with the industry as a whole. The overall five year average for
Hormel’s sales was 8.25%. Starting slow in 2002 at .26% growth they were able
to bump up to 7.42% in 2003, and even up to over 13% in the following two
years. It eventually dropped in 2006 to 6.12%. We chose 7% for our sales
growth rate in the forecasting process which could possibly be a little high due to
the fifty percent drop in the last year, but we felt that it could just as easily go
up looking at historical data. Therefore, we consider 7% a moderately
conservative number which was the approach taken throughout the forecasting.
When comparing to yahoo finance, they predict next years sales growth to be
7.3% which is not an extremely reliable number due to the amount paid for the
information, but we wanted to do outside research to make sure that,
individually, we were in the ballpark of other’s opinions.
Due to the nature of a commodity industry, the cost of goods sold is
usually a high percentage of sales at a pretty steady rate, from firms locking in
prices in futures markets, hedges, and contracts. The five year average for
Hormel’s cost of goods sold came out to be 75.99%. Therefore, we chose 75%
because it fluctuated slightly above and below this number throughout the
historical data gathered. This percentage of cost of goods sold is actually smaller
than the industry average. Gross profit is easily forecasted by taking the
difference between the two previously forecasted numbers to arrive at a gross
profit of $1,536,916 in 2007.
Where structure was found in the historical data, we compared Hormel to
the industry averages and made educated assumptions to come up with our
forecasted numbers. The expenses are the next items that needed to be
forecasted in order to get from gross profit to operating income on the income
statement. An article from the Wall Street Journal on October 22, 2007, titled
“Ship Shortage Pushes Up Prices of Raw Materials”, discussed how raw materials
84
that are shipped across seas have hit record highs, which has drove up
commodity prices; resulting in higher costs that could possibly be passed on to
the consumer. Since, Hormel has a very small fraction of its business across
seas, consumers of Hormel products should not be worried about a price
increase due to this fact. On the other hand, with the state of the economy and
the record highs of crude oil and gas, we did predict for selling and delivery
expenses to rise in the future. Going with this assumption, we chose a 13.9%
rate of these expenses which was above the overall average of 13.42%. General
and Administrative expenses averaged out to 2.96%, but 3.18% in the last two
most recent years; Therefore, continuing with the theory of rising costs in the
economy today, we selected a 3.25% rate to try and compensate for this
assumption.
Since it is impossible to predict the future sales of businesses, we went
ahead and just subtracted off the two expenses from gross profit to arrive at an
operating income of $482,592; which compared nicely to the historical data
rising by $31,883 from $450,709. With stability in interest expense and income
taxes we were able to forecast those out to produce a net income. The overall
average of the interest expense was -.62% of sales, which had a trend of
decreasing over the five year period due to an increase in the firm’s z-score
credit rating. Following the increased z-score we put more focus on the last two
years and were able to come up with a hypothesis of -.4% of sales. Provisions
for income taxes seemed predictable; therefore, we went just slightly below the
overall average to continue the conservative approach which was predicted to be
2.6% of sales. Subtracting the interest expense and adding the provisions for
income taxes will lead you to a net income of $297,547 for 2007, which once
again looked to follow the historical trend rising from $286,139 in 2006.
Assessing the knowledge from the data available we were able to
reasonably forecast out the predictable line items of the income statement
through the firm’s five year averages compared to the industry as a whole’s five
year averages
85
Hormel Foods Corporation Income Statements
2002
Actual Financial Statements
2003
2004
2005
2006
Average Assume
(In Thousands, Except Per Share Amounts)
Net sales
$3,910,314 $4,200,328 $4,779,875 $5,413,997 $5,745,481
Cost of products sold
2,947,461 3,187,175 3,655,837 4,129,549 4,362,291
Gross Profit
962,853 1,013,153 1,124,038 1,284,448 1,383,190
Expenses:
Selling and delivery
558,354
583,964 621,694 691,792 754,143
Administrative and general
93,990
124,665 146,488 172,242 182,891
Gain on sale of business
0
0 (18,063)
0
0
Total Expenses and Gain on Sale of Business
652,344
708,629 750,119 864,034 937,034
Equity in earnings of affiliates
7,741
5,886
6,458
5,525
4,553
Operating Income
318,250
310,410 380,377 425,939 450,709
Other income and expense:
Interest and investment income
7,145
10,785
14,363
8,531
5,470
Interest expense
(31,425) (31,864) (27,142) (27,744) (25,636)
Earnings Before Income Taxes
293,970
289,331 367,598 406,726 430,543
Provision for income taxes
104,648
103,552 134,048 152,123 144,404
Net Earnings
$189,322 $185,779 $233,550 $254,603 $286,139
Goodwill amortization
($62,014) ($82,852) ($83,546) ($100,421) ($110,141)
Adjusted earnings
$127,308 $102,927 $150,004 $154,182 $175,998
Common Size Income Statement
Sales Growth Percent
Net sales
Cost of products sold
Gross Profit
Expenses:
Selling and delivery
A dministrative and general
Gain on sale of business
Total Expenses and Gain on Sale of Business
Equity in earnings of affiliates
Operating Income
Other income and expense:
Interest and investment income
Interest expense
Earnings Before Income Taxes
Provision for income taxes
Net Earnings
2007
Forecast Financial Statements
2008
2009
2010
2011
2012
2013
2014
2015
2016
$6,147,665 $6,578,001 $7,038,461 $7,531,154 $8,058,334 $8,622,418 $9,225,987 $9,871,806 $10,562,832 $11,302,231
$4,610,749 $4,933,501 $5,278,846 $5,648,365 $6,043,751 $6,466,813 $6,919,490 $7,403,855 $7,922,124 $8,476,673
$1,536,916 $1,644,500 $1,759,615 $1,882,788 $2,014,584 $2,155,604 $2,306,497 $2,467,952 $2,640,708 $2,825,558
$854,525
$199,799
$914,342
$213,785
$978,346 $1,046,830 $1,120,108 $1,198,516 $1,282,412 $1,372,181 $1,468,234 $1,571,010
$228,750 $244,762 $261,896 $280,229 $299,845 $320,834 $343,292 $367,322
$1,054,324 $1,128,127 $1,207,096 $1,291,593 $1,382,004 $1,478,745 $1,582,257 $1,693,015 $1,811,526 $1,938,333
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$482,592 $516,373
$552,519 $591,196 $632,579 $676,860 $724,240 $774,937 $829,182 $887,225
($25,205) ($26,970) ($28,858) ($30,878) ($33,039) ($35,352) ($37,827) ($40,474) ($43,308) ($46,339)
$457,386.25 $489,403.29 $523,661.52 $560,317.83 $599,540.07 $641,507.88 $686,413.43 $734,462.37 $785,874.74 $840,885.97
$159,839 $171,028
$183,000 $195,810 $209,517 $224,183 $239,876 $256,667 $274,634 $293,858
$297,547 $318,375
$340,662 $364,508 $390,023 $417,325 $446,538 $477,795 $511,241 $547,028
($119,718) ($128,098) ($137,065) ($146,659) ($156,925) ($167,910) ($179,664) ($192,240) ($205,697) ($220,096)
$177,829 $190,277
$203,597 $217,849 $233,098 $249,415 $266,874 $285,555 $305,544 $326,932
2002
0.65%
100.00%
75.38%
24.62%
Actual Financial Statements
2003
2004
2005
7.42%
13.80%
13.27%
100.00%
100.00%
100.00%
75.88%
76.48%
76.28%
24.12%
23.52%
23.72%
2006
Average Assume
6.12%
8.25%
7.00%
100.00%
75.93%
75.99% 75.00%
24.07%
24.01%
14.28%
2.40%
0.00%
16.68%
0.20%
8.14%
13.90%
2.97%
0.00%
16.87%
0.14%
7.39%
13.01%
3.06%
-0.38%
15.69%
0.14%
7.96%
12.78%
3.18%
0.00%
15.96%
0.10%
7.87%
13.13%
3.18%
0.00%
16.31%
0.08%
7.84%
13.42%
2.96%
-0.08%
16.30%
0.13%
7.84%
0.18%
-0.80%
7.52%
2.68%
4.84%
0.26%
-0.76%
6.89%
2.47%
4.42%
0.30%
-0.57%
7.69%
2.80%
4.89%
0.16%
-0.51%
7.51%
2.81%
4.70%
0.10%
-0.45%
7.49%
2.51%
4.98%
0.20%
-0.62%
7.42%
2.65%
4.77%
13.90%
3.25%
-0.41%
2.60%
86
Balance Sheet
When forecasting the balance sheet there are a few ratios to consider in
order to get started; the current ratio, receivables turnover, inventory turnover,
and asset turnover. The asset turnover ratio is a crucial factor in forecasting the
balance sheet, because it connects the income statement and the balance sheet.
Asset turnover= net sales/total assets, so as one can see, net sales from the
income statement over total assets from the balance sheet, is not only the most
important ratio but was found to be the most consistent throughout the industry
in our ratio analysis. Therefore, with the overall asset turnover approximated to
be 1.9 for Hormel, algebra is applied to derive at: Total assets = net sales/1.9,
giving Hormel a predicted 2007 total assets of $3,235,613,000.
Next is the forecasting of accounts receivable, which can be done in one
of two ways: The average over time or by using the receivables turnover ratio.
Accounts receivables turnover = sales/accounts receivable. The average on that
ratio fell at 16.18% for Hormel which would have forecasted accounts receivable
at $379,852 a jump of $37,936 which only in 2006 did the analysis show a
higher spread than that. Since this was such a jump, it was assumed that this
rate was not sustainable, therefore the average percentage of accounts
receivable over total assets was used. This number came out to be 11.42% so
we assumed 11.5% for the accounts receivable line forecast, with a 2007
forecast a little lower at $372,095. The same approach was applied to forecast
the inventories with the average amounting to 17.42%, but over 18% in the last
two years, therefore, 18% seemed like a reasonable assumption, forecasting
2007 inventories to be $582,410,000.
The next line item forecasted was the non-current assets. There just
seemed to be a slight advantage in stability when comparing the averages of
total current assets and total non-current assets; with that in mind, non-current
assets were assumed at 63% of total assets and subtracting the non-current
87
assets from the total assets will reveal the total current assets, which amounted
to a forecast of $1,197,177 for 2007. The last step is done to ensure that the
balance sheet actually does balance. One also wants to look at the forecasted
items and make sure that the two lines forecasted under total current assets are
not larger than total current assets, for example, in order to reinforce a more
accurate forecast.
Simple accounting will tell you that on a balance sheet the total assets
must equal total liabilities plus shareholder’s investments. With that in mind, we
transferred total assets to total liabilities plus shareholder’s investments to start
with the right side of the A=L+OE equation. In order to forecast retained
earnings, the following formula was used: RE = Ret-1 + Nit –Div payt. Using
yahoo finance and the company’s 10-k’s we were able to forecast dividends
payable to use in the formula just mentioned. Looking at the history of Hormel’s
dividends per share, we found a little stability in the last few years, and we felt
safe assuming the dividends per share to increase about four cents a year. This
gave Hormel a projected dividends payable on the statement of cash flows
totaling (88,320) for 2007. The next item forecasted was total shareholder’s
investments, which was computed by applying the subsequent formula: OE =
OEt-1 + (REt – Ret-1). When applying these formulas retained earnings turns
out to be somewhat larger than total owner’s equity, but in this case it actually
followed with the exact trend we were looking for.
With the hard part done, once again applying minimal knowledge will lead
you right to the total liabilities. It’s simply subtracting the owner’s equity from
the total liabilities and owner’s equity combined or of course the total assets.
After research it was concluded that the average current ratio lead us to a better
looking forecast than just taking the simple average percentage of total liabilities
over time. A safe assumed current ratio of 2 was applied in forecasting the
current liabilities; therefore, total assets over two, which was $598,588,000. This
created an easier path to compute long-term liabilities, total liabilities minus
current liabilities to maintain a balancing balance sheet. The last item forecasted
88
on the balance sheet was plant, property, and equipment which had an
estimated average of 60% of total assets, and for 2007 we were able to forecast
a PP&E of $1,941,368.
This forecasting will give a better understanding of the firm’s profitability
and by applying the methods mentioned above it will help reassure the most
educated forecasting. No matter how educated it is, there are slim to none
chances that the actual forecasted numbers will come true, but it gives a good
theory on what to possibly expect in the future, to the best of a person’s ability,
with the readily available sources and tools.
89
Balance Sheet
(in thousands)
Total Current Assets
Cash and Cash Equivalent
Short-term Marketable Securities
Account Receivables
Inventories
Deferred Income Taxes
Prepaid Expenses and Other Current Assets
Total Current Assets
Deferred Income Taxes
Goodwill
Construction in Progress
Net Pension Assets
Investments in and Receivables from Affiliates
Other Assets
PP&E
Land
Buildings
Equipment
Construction in Progress
Total PP&E
Less Allowance for Depreciation
Total LT Assets
Total Assets
Current Liabilities
Accounts Payable
Accrued Expenses
Accrued Employee Compensation
Accrued Marketable Expenses
Employee Compensation
Taxes, other than Federal Income Taxes
Dividends Payable
Federal Income Taxes
Current Maturities of Long Term Debt
Total Current Liabilities
Long Term Debt less current Maturities
Accumulated Post Retirement Benefit Obligation
Other Long Term Liabilities
Deferred Income Taxes
Total LT Liabilities
Total Liabilities
Stock Holders Investments
Preferred Stock
Common Stock
Additional Paid-in Capital
Accumulated other Comprehensive loss
Retained Earnings
Total SH Investments
Total Liabilities and SH Investments
2002
309,563
275,460
355,638
7,431
14,078
962,170
6,583
310,072
56,224
127,222
105,247
Actual Financial Statements
2003
2004
2005
97,976
291,481
403,213
14,732
16,572
823,974
414,258
95,728
67,037
138,357
154,172
288,881
272,738
425,655
29,254
12,875
1,029,403
417,728
95,214
65,290
55,632
165,117
131,046
38,500
301,001
534,572
39,428
20,691
1,065,238
1,253
502,107
139,579
30,676
68,027
162,004
2006
172,485
341,916
570,932
48,535
7,803
1,141,671
7,387
550,706
147,975
66,097
76,684
158,976
21,709
382,573
852,403
46,466
1,303,151
(650,473)
1,258,026
2,220,196
26,157
25,872
436,660
455,860
902,652
948,244
46,057
44,666
1,411,526 1,474,642
(710,184) (770,405)
1,569,147 1,504,565
2,393,121 2,533,968
49,281
46,854
548,044
562,949
1,059,328
110,315
66,326
123,608
1,722,979 1,843,726
(845,303) (932,916)
1,781,322 1,918,635
2,846,560 3,060,306
174,070
34,496
51,739
87,897
19,819
13,569
14,701
13,820
410,111
409,648
253,078
32,104
694,830
1,104,941
195,826
33,996
62,799
84,658
21,647
14,594
14,175
14,295
441,990
395,273
255,914
36,247
10,962
698,396
1,140,386
255,144
26,270
27,619
68,640
114,518
11,993
17,950
49,963
11,075
583,172
350,430
263,663
50,565
664,658
1,247,830
8,111
(32,959)
1,140,103
1,115,255
2,220,196
8,122
8,079
8,078
8,066
4,073
3,260
2,507
(25,144)
(23,534)
(24,923)
(17,996)
1,265,684 1,414,703 1,612,315 1,821,202
1,252,735 1,399,248 1,598,730 1,802,912
2,393,121 2,533,968 2,846,560 3,060,306
203,563
31,435
71,855
94,548
13,569
15,673
17,963
15,760
464,366
361,510
257,392
47,128
4,324
670,354
1,134,720
271,358
27,103
27,895
68,503
187,332
7,784
19,361
55,312
366
585,014
350,054
271,240
51,086
672,380
1,257,394
Average Assume
2007
Forecast Financial Statements
2008
2009
2010
2011
2012
2013
2014
372,095
582,410
398,142
623,179
426,012
666,802
455,833
713,478
487,741
763,421
521,883
816,861
558,415
874,041
1,197,177
1,280,979
1,370,648
1,466,593
1,569,255
1,679,102
$598,588
$640,490
$685,324
$733,297
$784,627
1,941,368
2,077,264
2,222,672
2,378,259
2,038,436
3,235,613
2,181,127
3,462,106
2,333,806
3,704,453
598,588
640,490
624,886
1,223,474
2,030,429
2,012,139
3,235,613
2015
2016
597,504
935,224
639,329
1,000,689
684,082
1,070,738
1,796,640
1,922,404
2,056,973
2,200,961
$839,551
$898,320
$961,202 $1,028,486 $1,100,480
2,544,737
2,722,869
2,913,470
3,117,412
3,335,631
3,569,125
2,497,172
3,963,765
2,671,974
4,241,229
2,859,012
4,538,115
3,059,143
4,855,783
3,273,283
5,195,687
3,502,413
5,559,386
3,747,582
5,948,542
685,324
733,297
784,627
839,551
898,320
961,202
1,028,486
1,100,480
584,942
1,225,432
541,154
1,226,478
492,865
1,226,161
439,374
1,224,002
379,931
1,219,483
313,733
1,212,053
239,920
1,201,122
157,573
1,186,059
65,708
1,166,188
2,254,964
2,236,674
3,462,106
2,496,266
2,477,976
3,704,453
2,755,894
2,737,604
3,963,765
3,035,517
3,017,227
4,241,229
3,336,922
3,318,632
4,538,115
3,662,020
3,643,730
4,855,783
4,012,855
3,994,565
5,195,687
4,391,616
4,373,326
5,559,386
4,800,644
4,782,354
5,948,542
90
Balance Sheet
Common Size
2002
Current Assets
Cash and Cash Equivalent
Short-term Marketable Securities
Account Receivables
Inventories
Deferred Income Taxes
Prepaid Expenses and Other Current Assets
Total Current Assets
Deferred Income Taxes
Goodwill
Construction in Progress
Net Pension Assets
Investments in and Receivables from Affiliates
Other Assets
PP&E
Land
Buildings
Equipment
Construction in Progress
Total PP&E
Less Allowance for Depreciation
Total LT Assets
Total Assets
Current Liabilities
Accounts Payable
Accrued Expenses
Accrued Employee Compensation
Accrued Marketable Expenses
Employee Compensation
Taxes, other than Federal Income Taxes
Dividends Payable
Federal Income Taxes
Current Maturities of Long Term Debt
Total Current Liabilities
Long Term Debt less current Maturities
Accumulated Post Retirement Benefit Obligation
Other Long Term Liabilities
Deferred Income Taxes
Total LT Liabilities
Total Liabilities
Stock Holders Investments
Preferred Stock
Common Stock
Additional Paid-in Capital
Accumulated other Comprehensive loss
Retained Earnings
Total SH Investments
Actual Financial Statements
2003
2004
2005
2006
Average Assume
13.94%
0.00%
12.41%
16.02%
0.33%
0.63%
43.34%
0.30%
13.97%
2.53%
0.00%
5.73%
4.74%
0.00%
0.98%
17.23%
38.39%
2.09%
58.70%
-29.30%
56.66%
100.00%
4.09%
0.00%
12.18%
16.85%
0.62%
0.69%
34.43%
0.00%
17.31%
4.00%
2.80%
5.78%
6.44%
0.00%
1.09%
18.25%
37.72%
1.92%
58.98%
-29.68%
65.57%
100.00%
11.40%
0.00%
10.76%
16.80%
1.15%
0.51%
40.62%
0.00%
16.49%
3.76%
2.58%
2.20%
6.52%
0.00%
1.02%
17.99%
37.42%
1.76%
58.19%
-30.40%
59.38%
100.00%
4.60%
1.35%
10.57%
18.78%
1.39%
0.73%
37.42%
0.04%
17.64%
4.90%
1.08%
2.39%
5.69%
0.00%
1.73%
19.25%
37.21%
2.33%
60.53%
-29.70%
62.58%
100.00%
5.64%
0.00%
11.17% 11.42%
18.66% 17.42%
1.59%
0.25%
37.31% 38.62%
0.24%
18.00% 16.68%
4.84%
2.16%
2.51%
5.19%
0.00%
1.53%
18.40%
3.60%
4.04%
60.25% 59.33%
-30.48%
62.69% 61.38%
100.00% 100.00%
15.75%
3.12%
0.00%
4.68%
7.95%
1.79%
1.23%
1.33%
1.25%
37.12%
37.07%
22.90%
2.91%
0.00%
62.88%
100.00%
17.17%
2.98%
0.00%
5.51%
7.42%
1.90%
1.28%
1.24%
1.25%
38.76%
34.66%
22.44%
3.18%
0.96%
61.24%
100.00%
17.94%
2.77%
0.00%
6.33%
8.33%
1.20%
1.38%
1.58%
1.39%
40.92%
31.86%
22.68%
4.15%
0.38%
59.08%
100.00%
20.45%
2.11%
2.21%
5.50%
9.18%
0.96%
1.44%
4.00%
0.89%
46.73%
28.08%
21.13%
4.05%
0.00%
53.27%
100.00%
21.58%
2.16%
2.22%
5.45%
14.90%
0.62%
1.54%
1.37% 1.60%
4.40%
0.03%
46.53% 42.01%
27.84%
21.57%
4.06%
0.00%
53.47% 57.99% 55.00%
100.00% 100.00%
0.00%
0.73%
0.00%
-2.96%
102.23%
100.00%
0.00%
0.65%
0.33%
-2.01%
101.03%
100.00%
0.00%
0.58%
0.00%
-1.68%
101.10%
100.00%
0.00%
0.51%
0.20%
-1.56%
100.85%
100.00%
0.00%
0.45%
0.14%
-1.00%
101.01%
100.00%
91
11.50%
18.00%
39.00%
18.50%
60.00%
63.00%
Statement of Cash Flows
The statement of cash flows acts a little different than the forecasting of
the previous two financial statements. This is the hardest statement to forecast
due to no stability in really any of the ratios and no trends in averages. When
attempting to forecast the statement of cash flows, it is best to start with trying
to find the cash flows from operating activities (CFFO), the first major line item in
this financial statement. A few ratios come into play in order to forecast this
number, CFFO/Sales, CFFO/OI, and CFFO/NI. The one that did show some
historical stability was the last one CFFO/NI, so it was implemented to forecast
the first major line item. The ratio averaged out at about 1.3, so by plainly taking
the forecasted net earnings numbers from the income statement and multiplying
it by 1.3 we arrived at a CFFO of $386,811 in 2007, which seemed acceptable to
the historical trend in our analysis.
The only other line item that can possibly be predicted in the statement of
cash flows is the cash flows from investing activities. The best solution to
forecasting the cash flows from investing activities is by taking the change in
long-term assets from year to year. Implying this method we forecasted the cash
flows from investing activities to be ($119,801) in 2007.
92
Statement of Cash Flows
(In Thousands)
Operating Activities
Net earnings
Adjusted earnings for goodwill impairment
Adjustments to reconcile to net cash provided
by operating activities:
Depreciation
Amortization of intangibles
Equity in earnings of affiliates
Provision for deferred income taxes
(Gain) loss on property/equipment sales
and plant facilities
Gain on sales of business and investment
Changes in operating assets and liabilities,
net of acquisitions:
(Increase) decrease in accounts receivable
Increase in inventories, prepaid expenses,
and other current assets
(Increase) decrease in net pension assets
Increase in accounts payable and accrued
expenses
Other
Net Cash Provided by Operating Activities
Adjusted net cash provided by operating activities
Investing Activities
Sale of available-for-sale securities
Purchase of available-for-sale securities
Acquisitions of businesses/intangibles
Purchases of property/equipment
Proceeds from sales of property/equipment
Proceeds from sales of business and investment
Decrease (increase) in investments, equity
in affiliates, and other assets
Dividends from affiliates
Net Cash Used in Investing Activities
Financing Activities
Proceeds from short-term debt
Principal payments on short-term debt
Proceeds from long-term debt
Principal payments on long-term debt
Dividends paid on common stock
Share repurchase
Other
Net Cash Used in Financing Activities
Increase (Decrease) in Cash and Cash Equivalents
Cash and cash equivalents at beginning
of year
Cash and Cash Equivalents at End of Year
Actual Financial Statements
2003
2004
2005
2002
$189,322
$127,308
0
2006
2007
Forecast Financial Statements
2008
2009
2010
$185,779 $233,550 $254,603 $286,139 $297,547 $318,375
$102,927 $150,004 $154,182 $175,998 $177,829 $190,277
0
0
0
0
82,240
998
(6,799)
3,052
619
83,374
4,646
(5,000)
(4,592)
2,519
87,675
7,070
(5,884)
(10,494)
(432)
105,774
9,415
(5,797)
(24,333)
149
109,360
11,741
(4,083)
(26,736)
(686)
0
0
0
0
(24,285)
0
0
0
0
0
32,655
9,250
(10,636)
(24,303)
14,803
(31,997)
6,463
(15,180)
(37,986)
(21,722)
15,524
17,697
(5,733)
22,644
23,478
93,078
(22,406)
14,899
0
326,861
264,847
3,766
253,250
170,398
4,557
291,474
207,928
6,069
453,719
353,298
18,054
326,574 $386,811 $413,888
216,433 231,178 247,361
20,000
(20,000)
(476)
(64,465)
9,800
0
(7,575)
275,941
86,470 188,800 174,960
(116,291) (195,600) (118,300) (136,460)
(240,970) (21,452) (366,496) (78,925)
(67,104) (80,363) (107,094) (141,516)
5,085
2,903
2,938
8,689
0 126,774
0
0
(91,291)
(3,680)
(5,060)
1,917
2,104
(60,612)
0
(234,630)
$0
$0
0
775
811
(84,948) (404,437) (170,524) (119,801)
(142,691)
395 0
0
0
3,263
(84,504)
(53,437)
(10,762)
2,478
(142,962)
123,287
186,276
60,000
0 115,000
70,000
(60,000)
0 (115,000) (70,000)
42
0
0
0
(13,942) (32,298) (15,765) (11,085)
(57,092) (61,343) (69,371) (75,840)
(6,119) (37,525) (22,977) (36,978)
6,554
6,545
9,996
9,292
(70,557) (124,621) (98,117) (114,611)
(51,937)
81,905 (48,835)
41,439
149,913
97,976 179,881 131,046
$309,563
$97,976 $179,881 $131,046 $172,485
(88,320)
(93,840)
2011
2012
2013
2014
2015
2016
$340,662 $364,508 $390,023 $417,325 $446,538 $477,795 $511,241 $547,028
$203,597 $217,849 $233,098 $249,415 $266,874 $285,555 $305,544 $326,932
$442,860 $473,860 $507,030 $542,523 $580,499 $621,134 $664,613 $711,136
264,676 283,203 303,027 324,239 346,936 371,221 397,207 425,011
$0
$0
$0
$0
$0
$0
$0
$0
(152,679) (163,366) (174,802) (187,038) (200,131) (214,140) (229,130) (245,169)
(99,360) (104,880) (110,400) (115,920) (121,440) (126,960) (132,480) (138,000)
93
Statement of Cash Flows
Common Size
2002
Operating Activities
Net earnings
Adjustments to reconcile to net cash provided
by operating activities:
Depreciation
Amortization of intangibles
Equity in earnings of affiliates
Provision for deferred income taxes
(Gain) loss on property/equipment sales
and plant facilities
Gain on sales of business and investment
Changes in operating assets and liabilities,
net of acquisitions:
(Increase) decrease in accounts receivable
Increase in inventories, prepaid expenses,
and other current assets
(Increase) decrease in net pension assets
Increase in accounts payable and accrued
expenses
Other
Net Cash Provided by Operating A ctivities
Investing Activities
Sale of available-for-sale securities
Purchase of available-for-sale securities
Acquisitions of businesses/intangibles
Purchases of property/equipment
Proceeds from sales of property/equipment
Proceeds from sales of business and investment
Decrease (increase) in investments, equity
in affiliates, and other assets
Dividends from affiliates
Net Cash Used in Investing A ctivities
Financing Activities
Proceeds from short-term debt
Principal payments on short-term debt
Proceeds from long-term debt
Principal payments on long-term debt
Dividends paid on common stock
Share repurchase
Other
Net Cash Used in Financing Activities
Increase (Decrease) in Cash and Cash Equivalents
Cash and cash equivalents at beginning
of year
Cash and Cash Equivalents at End of Year
57.92%
0.00%
0.00%
25.16%
0.31%
-2.08%
0.93%
0.19%
0.00%
0.00%
0.00%
0.00%
9.99%
2.83%
0.00%
0.00%
4.75%
0.00%
0.00%
100.00%
-33.00%
33.00%
0.79%
106.36%
-16.17%
0.00%
12.50%
0.00%
-3.47%
100.00%
Actual Financial Statements
2003
2004
2005
73.36%
0.00%
0.00%
32.92%
1.83%
-1.97%
-1.81%
0.99%
0.00%
0.00%
0.00%
0.00%
-4.20%
-9.60%
0.00%
0.00%
6.99%
0.00%
1.49%
100.00%
80.13%
56.11%
0.00%
0.00%
0.00%
0.00%
30.08%
23.31%
2.43%
2.08%
-2.02%
-1.28%
-3.60%
-5.36%
-0.15%
0.03%
0.00%
0.00%
-8.33%
0.00%
0.00%
0.00%
0.00%
0.00%
5.08%
1.42%
-10.98%
-3.35%
0.00%
0.00%
-1.97%
5.17%
7.77%
20.51%
0.00%
0.00%
1.56%
1.34%
100.00% 100.00%
2006
71.03%
87.62%
0.00%
0.00%
33.49%
3.60%
-1.25%
-8.19%
-0.21%
0.00%
0.00%
0.00%
0.00%
-11.63%
-6.65%
0.00%
-6.86%
4.56%
0.00%
5.53%
100.00%
-117.61% -101.79% -46.68% -102.60%
49.56% 230.26%
29.25%
80.02%
102.70%
25.25%
90.62%
46.28%
28.60%
94.60%
26.48%
82.99%
-2.17%
-3.42%
-0.73%
-5.10%
0.00% -149.24%
0.00%
0.00%
38.91%
4.33%
1.25%
-1.12%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
-0.19%
-0.48%
100.00% 100.00% 100.00% 100.00%
0.00%
0.00%
1.05%
-27.30%
-17.26%
-3.48%
0.80%
-46.18%
39.83%
60.17%
61.24%
-61.24%
0.04%
-14.23%
-58.27%
-6.25%
6.69%
-72.01%
-53.01%
153.01%
0.00%
87.76%
0.00% -87.76%
0.00%
0.00%
-17.96% -12.03%
-34.10% -52.94%
-20.86% -17.53%
3.64%
7.63%
-69.28% -74.87%
45.53% -37.27%
54.47% 137.27%
40.58%
-40.58%
0.00%
-6.43%
-43.97%
-21.44%
5.39%
-66.45%
24.02%
75.98%
100.00%
100.00%
100.00% 100.00%
100.00%
94
Cost of Equity
The cost of Equity or Ke is the first number researched in estimating a
WACC for the firm. In order to estimate this number, regression analysis was
used over the following time periods: 72 months, 60 months, 48 months, 36
months, and 24 months using the treasury bill rates for 3 months, 1 year, 2
years, 5,7, and 10 years. The St. Louis Fed Fred Data website allowed us to
come up with a risk-free rate (Rf) for the previously mentioned time periods. The
important statistics we were able to get out of the regression analysis were the
Beta, t-stat, and adjusted R^2. The t-stat shows the significance of this number
while the adjusted R^2 shows us the explanatory power of the stability of beta.
The Capital Asset Pricing Model (CAPM) is put into place to find the cost of equity
for Hormel. The model is computed as follows: Ke=Rf + B*(market risk
premium). Regression analysis showed us betas for the assorted time periods
and by using the highest adjusted R^2, we were able to assume a beta using
the risk-free rate for 3 months, 1 year, 2 years, 5 years, 7 years, 10 years. In all
of the six observations the 72 month time period ended up with the highest
explanatory power, therefore we chose an overall beta from that assumption.
The 72 month winner in all 6 observations shows that investors invest their
money in Hormel for long-term returns. The beta throughout this analysis came
out to be between .2845 and .4123. Yahoo Finance estimates the beta of Hormel
to be .28 currently which is slightly lower than in the recent past. Our overall
winning beta with the highest adj R^2 was .4122, which was based off of in
depth analysis so we are ok with this number since it is in the ball park. The only
other variable needed is the market risk premium which we were able to collect
from the Business Analysis & Valuation book. It estimated an average market
risk premium of 6.8%. Further research lead us to an adjusting factor according
to the size of the firm. According to table 8-1 in the book, we estimated a size
premium of .1 added to the 6.8%; all leading to an estimated cost of equity of
7.31%. We were looking for a number no less than seven percent for a cost of
95
equity for Hormel. We decided to use a back door approach to estimate the cost
of equity by using the following formula which is the long-run residual income
perpetuity: P/B=(1+((ROE-Ke)/(Ke-g))). We plugged in the variables needed and
solved for Ke. This model gave us a cost of equity of 10.6%. The difference
between the two numbers seemed rather large, so we went ahead and picked a
safe cost of equity at 8.6%.
96
Cost of Equity
3-month
72
60
48
36
24
1-year
Rf
4.00%
Beta
t-stat
adj R^2
Ke
0.4123
2.8247
0.0884
7.22%
0.3510
1.7247
0.0319
6.74%
0.3067
1.1994
0.0091
6.39%
0.2960
1.1128
0.0066
6.31%
0.3745
1.2214
0.0201
6.92%
5-year
72
60
48
36
24
7-year
72
60
48
36
24
Rf
4.10%
Beta
t-stat
adj R^2
Ke
0.4122
2.8258
0.0884
7.31%
0.3506
1.7244
0.0318
6.83%
0.3063
1.1987
0.0090
6.49%
0.2935
1.1042
0.0061
6.39%
0.3728
1.2170
0.0197
7.01%
10-year
72
60
48
36
24
Rf
3.97%
Beta
t-stat
adj R^2
Ke
0.4115
2.8243
0.0883
7.18%
0.3499
1.7206
0.0316
6.70%
0.3040
1.1897
0.0086
6.34%
0.2911
1.0958
0.0055
6.24%
0.3716
1.2147
0.0194
6.87%
2-year
Rf
4.20%
Beta
t-stat
adj R^2
Ke
0.4103
2.8177
0.0879
7.40%
0.3486
1.7106
0.0311
6.92%
0.2980
1.1636
0.0073
6.52%
0.2874
1.0812
0.0047
6.44%
0.3712
1.2137
0.0193
7.10%
72
60
48
36
24
Rf
4.33%
Beta
t-stat
adj R^2
Ke
0.4099
2.8151
0.0877
7.53%
0.3482
1.7066
0.0309
7.05%
0.2956
1.1532
0.0068
6.64%
0.2857
1.0740
0.0042
6.56%
0.3711
1.2135
0.0193
7.22%
72
60
48
36
24
Rf
4.53%
Beta
t-stat
adj R^2
Ke
0.4096
2.8123
0.0876
7.73%
0.3477
1.7027
0.0307
7.24%
0.2936
1.1442
0.0064
6.82%
0.2845
1.0690
0.0040
6.75%
0.3710
1.2125
0.0192
7.42%
Yahoo #'s
P/B
ROE
g
solve for K
2.88
0.1637
0.05
8.95%
Our #'s
P/B - 11/1/2007
ROE
g
solve for K
2.51
0.16
0.07
10.60%
MRP
7.8%
7.31%
Ke
Assumed Ke
8.6%
97
Cost of Debt
The cost of debt although not a piece of cake, is easier to compute than
the cost of equity. We started off with the liabilities section of the balance sheet
and computing an interest rate for each line item. Some companies may have
this provided in the annual 10-k reports. In Hormel’s case the disclosure of these
interest rates were not thoroughly discussed and consequently, it took using the
readily available tools with knowledge and assumptions to indicate each interest
rates. Assuming all tax related line items will be paid to the government
regardless of the firm’s performance, we used the current risk-free rate for the
interest rate on the three corresponding line items. In the 10-k a 7.35% rate was
for medium ranged debt, and it was inserted on the accounts payable, accrued
expenses, and accrued marketable expenses. A 5% rate was also located in the
10-k for employee compensation and as a result that rate was placed on the two
matching line items. The dividend yield for Hormel was 1.7%, so we used that
for the dividends payable line. The senior long-term debt rate stated in the 10-k
was 6.63% and was used for the three long-term debt line items. In order to
come up with the post retirement benefit obligation, we were unable to locate
this rate in the company’s 10-k. Looking at the competitors 10-k’s, we estimated
it to be about 6% and placed that interest rate to the last line item.
The next step in the cost of debt is to take all the above mentioned line
items and get them into a percentage of total liabilities, which was already done
on a common sized balance sheet. Those average weights multiplied by there
parallel interest rates will give you all your weighted averages. The sum of these
weighted averages will lead one to the cost of debt at 6.67%.
98
Cost of Debt
Current Liabilities
Accounts Payable
Accrued Expenses
Accrued Employee Compensation
Accrued Marketable Expenses
Employee Compensation
Taxes, other than Federal Income Taxes
Dividends Payable
Federal Income Taxes
Current Maturities of Long Term Debt
Total Current Liabilities
2002
174,070
34,496
51,739
87,897
19,819
13,569
14,701
13,820
410,111
2003
195,826
33,996
62,799
84,658
21,647
14,594
14,175
14,295
441,990
2004
203,563
31,435
71,855
94,548
13,569
15,673
17,963
15,760
464,366
2005
255,144
26,270
27,619
68,640
114,518
11,993
17,950
49,963
11,075
583,172
2006
271,358
27,103
27,895
68,503
187,332
7,784
19,361
55,312
366
585,014
Weight Interest Rate
Weighted Average
21.58%
7.35%
0.015862
2.16%
7.35%
0.001584
2.22%
5%
0.001109
5.45%
7.35%
0.004004
14.90%
5%
0.007449
0.62%
4.63%
0.000287
1.54%
1.70%
0.000262
4.40%
4.63%
0.002037
0.03%
5.66%
0.000016
27.84%
5.66%
0.015757
21.57%
6.00%
0.012943
4.06%
5.66%
0.002300
0.00%
4.63%
0.000000
53.47%
Kd =
6.36%
100.00% Cost of Debt used
6.4%
46.53%
0.00%
Long Term Debt less current Maturities
Accumulated Post Retirement Benefit Obligation
Other Long Term Liabilities
Deferred Income Taxes
Total LT Liabilities
Total Liabilities
409,648 395,273 361,510 350,430 350,054
253,078 255,914 257,392 263,663 271,240
32,104
36,247
47,128
50,565
51,086
10,962
4,324
694,830 698,396 670,354 664,658 672,380
1,104,941 1,140,386 1,134,720 1,247,830 1,257,394
99
Weighted Average Cost of Capital
After finding the two costs of capital and debt, one is ready to move into
the WACC formula. WACCat= BVL/Vf*(Kd)*(1-tax rate) + MVE/Vf*(Ke). Vf is
equal to BVL + MVE and the WACCat stands for the after-tax weighted average
cost of capital. This method of WACC causes a problem in the computed number
because it considers getting taxed twice, therefore the more accurate WACC is
the before-tax based. This number is brought about by eliminating (1-tax rate) in
the above formula. Hormel’s WACCat equaled 7.73% and the before tax
computed to 8.16%.
When using the CAPM equation it is sometimes considered “CRAPM” due
to the fact that the explanatory power of only 8% is not explaining a whole lot at
all. A good way to check the validity of CAPM is by making sure that the
following is true: Ke > WACCbt >Kd. In this case that was indeed true, but due
to the large gap between CAPM and the back door method, we combined the
two when estimating the cost of equity.
Weighted Average Cost of Capital
Total Debt Kd
MVE
Ke
MVE+BVL
1,257,394 6.4% 5,213,801 8.60%
WACC bt
6,471,195
8.16%
WACC after tax
7.73%
100
Valuation Analysis
Valuation methods are used to obtain a price per share for a company.
Method of comparables relates the share price to the industry average. Intrinsic
valuation models are a more accurate source to value the share price for a
company. The intrinsic models consist of discounted dividends, discounted free
cash flows, residual income, long-run residual income, and abnormal earnings
growth.
Method of Comparables
Price Comparables
P/E
P/B
D/P
PEG
P/EBITDA
P/FCF (per share)
EV/EBITDA
Trailing
$36.18
$21.53
$29.08
$34.22
$13.37
$14.43
$30.09
Forward
$33.97
The method of comparables calculates a share price for a company by
comparing certain ratios to the industry average. All of the information used to
calculate the ratios is found on each firm’s financial statements. We used an
industry average based on Hormel’s three main competitors (Tyson, Smithfield,
and ConAgra). Hormel is not included in the industry average for any
comparables model. For example, the price per share to earnings per share
industry average ratio is multiplied by Hormel’s earnings per share to find the
price per share for Hormel. The methods of comparables is not an accurate
measure for price per share of a company because there is no theory involved.
These are simple ratio based valuations of a company that do not use any
fundamental knowledge and give no insight to the value of a firm.
101
Price to Earnings (Forward)
PPS
EPS
P/E
Hormel
Share Price
Hormel
35.80
2.23
16.05
Tyson
15.45
1.06
14.62
Smithfield
28.11
1.98
14.17
ConAgra
23.29
1.38
16.91
Industry
15.23
$33.97
Avg.
We forecasted earnings per share to be 2.23 assuming a growth rate of 7
percent. We used Yahoo Finance to find the forward price to earnings ratio for
each of the competitors. We then took an average of the industry, excluding
Hormel, using these ratios. We set Hormel’s P/E ratio equal to the industry
average and solved for price. This gave us a price of $33.97 compared to the
actual price per share of $35.80 as of November 1st. This ratio states that
Hormel’s price per share is overvalued. However, the explanatory power of this
method is unreliable. Since the explanatory power is unreliable, one should not
expect an accurate conclusion drawn from this ratio.
102
Price to Earnings (Trailing)
PPS
EPS
P/E
Hormel
Share Price
Hormel
35.80
2.08
17.21
Tyson
15.45
.76
20.33
Smithfield
28.11
1.68
16.73
ConAgra
23.29
1.54
15.12
Industry
17.39
$36.18
Avg.
The trailing price to earnings is similar to the forecasted. We used the
current earnings per share for 2006 instead of forecasting an EPS. Again, we
used pre-calculated numbers for competitors from Yahoo as observed on
November 1, 2007. The industry average P/E ratio was multiplied by the
Hormel’s earnings per share. This solved for the price per share which was
$36.18. This is only $.38 away from the actual price per share. This, coincidently,
is a fair price per share value. Even though this is only 38 cents from the actual
share price this method should not be used to draw any conclusions.
103
Price to Book
PPS
BPS
P/B
Hormel
Share Price
Hormel
35.80
13.10
2.73
Tyson
15.45
13.29
1.16
Smithfield
28.11
21.66
1.30
ConAgra
23.29
9.43
2.47
Industry
1.64
$21.53
Avg.
The price to book ratio uses the book value of shareholders equity. The
shareholders equity is divided by the number of shares outstanding to get a book
value per share. The price per share is then divided by the book value per share
to get a price to book ratio. The price to book ratio from the competitors in the
industry is averaged and multiplied by Hormel’s BPS of 13.10. This calculates a
price per share of $21.53. This proves that this is not a very accurate
measurement considering the actual share price is $35.80. This method, once
again, shows that Hormel is overvalued.
104
Dividend to Price
PPS
DPS
D/P
Hormel
Share Price
Hormel
35.80
.60
.02
Tyson
15.45
.16
.01
Smithfield
28.11
N/A
N/A
ConAgra
23.29
.72
.03
Industry
.02
$29.08
Avg.
The dividend to price comparable model is calculated by dividing the
dividends per share by the industry average. Since Smithfield does not pay
dividends, they are not included in the industry average. The dividend to price
method gives Hormel a share price of $29.08, which still overvalues the
company. Again, this is not an accurate measurement of a firm. The industry
average is distorted because there are only two companies used. This does not
give us any insight on the value of Hormel.
105
Price to Earning to Growth
PPS
EPS
PEG
Hormel
Share Price
Hormel
35.80
2.08
2.46
Tyson
15.45
.76
2.99
Smithfield
28.11
1.68
2.05
ConAgra
23.29
1.54
2.00
Industry
2.35
$34.22
Avg.
The PEG ratio is calculated by dividing the P/E ratio by the estimated
earnings growth rate. We assumed an earnings growth rate for Hormel of 7
percent. We used Yahoo Finance for the competitors PEG ratios and calculated
an industry average of 2.35. The average is then multiplied by the assumed
growth rate and further multiplied by the earnings per share. This gave us a
share price of $34.22. This appears to be a fair valuation of the price per share.
Price to EBITDA
PPS
EBITDA
P/EBITDA
(millions)
Hormel
Share Price
Hormel
35.80
577.28
.06
Tyson
15.45
1140.00
.01
Smithfield
28.11
653.70
.04
ConAgra
23.29
1800.00
.01
Industry
.02
$13.37
Avg.
106
The P/EBITDA industry average was calculated according to the P/EBITDA
ratios given by Yahoo. The earnings before income taxes, depreciation, and
amortization for Hormel is $577.28 million. Hormel’s EBITDA is multiplied by the
industry average of approximately .02, which gives a price per share of $13.37.
Using this ratio extremely overvalues Hormel compared to the observed price per
share of $35.80.
Price to Free Cash Flows (per share)
PPS
FCF
P/FCF
Hormel
(per share)
(per share)
Share Price
$14.43
Hormel
35.80
1.13
31.68
Tyson
15.45
1.21
12.77
Smithfield
28.11
N/A
N/A
ConAgra
23.29
.04
N/A
Industry
12.77
Avg.
In order to calculate the price to free cash flows we first had to calculate
the total free cash flows. Free cash flows is the cash flows from operating
activities plus/minus cash flows from investing activities which are $326.574
million and <$170.524 million> respectively. This gave us $156.05 million of free
cash flows. The FCF is then divided by the shares outstanding, which gives us a
FCF on a per share basis of 1.13. We use the same steps as the previous models
by multiplying the industry average by Hormel’s free cash flows per share. When
determining the industry average we were only able to use Tyson’s price to free
cash flows. Since ConAgra had an extremely high P/FCF per share, we did not
include it in the industry average. If ConAgra’s P/FCF were included in the
industry average, it would cause a distortion in the average. Also, Smithfield had
107
a negative FCF; therefore, it was not included in the industry average as well.
We calculated a price of $14.43, which is substantially lower than the observed
share price on November 1st of $35.80. This should not be used as a reliable
comparison when valuing Hormel since the industry average only includes one
company.
Enterprise Value to EBITDA
EV
EBITDA
EV/EBITDA
(millions)
(millions)
Hormel
5,935.73
577.28
10.28
Tyson
7,990.00
1,140.00
7.01
Smithfield
7,330.00
653.70
11.21
ConAgra
15,360.00
1,800.00
8.53
Industry
8.92
Hormel
Share Price
$30.09
Avg.
We calculated an enterprise value of $5,935.73 million by adding the
market value of equity and the liabilities and subtracting the cash and
investments. The enterprise value is then divided by the earnings before interest,
taxes, depreciation, and amortization. We then calculated a share price for
Hormel compared to the EV/EBITDA industry average. This is done by first
multiplying the EBITDA by the average. Then add back the cash and investments
and subtract the liabilities. We took this total and divided it by the shares
outstanding, which solved for price. We came up with a share price of $30.09 for
Hormel. This model indicates that Hormel is once again overvalued.
108
Conclusion
Ultimately, after analyzing the methods of comparables one can tell that
Hormel is overvalued. In each ratio, excluding the P/E trailing, the price per
share was lower than the observed price per share on November 1st. Valuing a
company based on these methods is insignificant because they are not an
accurate unit of measurement. This is true because they are simply ratio based
valuations. A more meaningful way to value a firm would be to use the intrinsic
valuation models. Intrinsic valuations represent a true valuation of the stock.
109
Intrinsic Valuations
Methods of comparables are ratio based valuations that do not
incorporate any fundamental knowledge meaning there’s no theory involved. It
shows pricing mediocrity and no insight to the value of the firm. In order to
come up with a more accurate valuation of the firm we implemented five intrinsic
valuation models, which are grounded in theory based on hard work. The models
used in our valuation were the discounted dividends approach, discounted free
cash flows, residual income, long-run residual income, and abnormal earnings
growth (AEG). Sensitivity analysis is run on each of the models to show the
significance of the model in valuing Hormel. Within the sensitivity analysis we
used a range of twenty percent of the November 1, 2007 share price of $35.80
(ie $28.64 - $42.96). Also all numbers used from the financial statements are
stated in thousands. The following shows the computations and results of each
model.
Discounted Dividends Model
The discounted dividends model shows the present value of all expected
future dividends in order to come up with an equity value. “It forms the basis for
most of the popular theoretical approaches to stock valuation” (Business Analysis
& Valuation). With that said, it also does not have very high explanatory power
for the true value of the firm. In our analysis it was assumed for growth to be
seven percent a year on sales based on the last five years of data trend. In real
life this could not be the case, a company can lose profitability in any given year.
Dividends are paid out of net earnings and can change depending on the stability
of the firm. For example, if a firm for one year has negative earnings then they
are very likely to reduce or even not pay dividends for that year, depending on
110
the amount in retained earnings. With these factors in mind it is very difficult to
predict the future and that leads to an inaccurate valuation most likely. The
following data shows the results from the discounted dividends model.
ke
Overvalued
Fairly valued
Undervalued
0.07
0.08
0.086
0.11
0.13
0.15
Sensitivity Analysis
g
0
0.02
0.04
0.06
$ 12.87 $ 15.77 $ 22.55 $ 56.44
$ 11.12 $ 13.05 $ 16.91 $ 28.49
$ 10.28 $ 11.82 $ 14.71 $ 22.04
$ 7.83 $ 8.54 $ 9.66 $ 11.67
$ 6.50 $ 6.91 $ 7.51 $ 8.44
$ 5.54 $ 5.79 $ 6.14 $ 6.64
0.08
$ 78.22
$ 16.37
$ 10.13
$ 7.42
0.1
$ 39.85
$ 14.06
$ 8.83
When using this model we began our focus on the dividends paid per
share. First, we analyzed the past dividend payments data. In the last few years
they increased their dividends per share by $.04 a year, and it was decided to
keep this rate throughout the next ten years forecasted because they also
showed a steady growth rate in earnings. These forecasted dividends were then
multiplied by their respective present value factor in order to find the present
value of the year by year dividends per share. The sum of these year by year
dividends will give you the total present value of annual dividends of $5.18,
assuming a growth rate of 0 and a cost of equity of 8.6%. Next, we found the
continuing terminal value of the perpetuity in year ten dollars by taking the
dividend per share value divided by the cost of equity minus the growth rate.
This amount came out to be $11.63 in year ten dollars and we discounted it back
to the present value of this terminal value perpetuity of $5.10. To find the
estimated price per share the $5.10 and $5.18 were added together to come up
with a total of $10.28. Our share price on November 1, 2007, was $35.80. We
checked to make sure this number is time consistent with the November 1, 2007
price, and luckily our year end is October 31, 2007, so our numbers throughout
these models are already time consistent. As you can tell there is quite a gap in
between those numbers. Most of this gap can be explained by the fact that this
111
model is based on a perpetuity that is full of assumptions, thus showing how
ineffective this model is. The other small portion is explained by the flaws in the
market of uneducated investors.
The sensitivity analysis shows us that according to this model Hormel is
overvalued even when changing the growth and cost of equity rates. Hormel was
only undervalued with a six percent growth rate and a seven percent cost of
equity along with eight percent and 8.6 percent respectively. The only point that
Hormel would be fairly valued according to the model is with a ten percent
growth rate and an eleven percent cost of equity. Comparing to the past five
years Hormel could keep the six percent growth rate, but a seven percent cost of
equity is unlikely, therefore in the model where Hormel is undervalued using
these assumptions, it’s very improbable that the following would occur. In the
second point in which Hormel is undervalued it’s using an eight percent growth
rate which right there throws that out due to the fact that in Hormel’s past that
has never occurred. At the only point where they are fairly valued is at a ten
percent growth rate which once again is most likely too high for Hormel.
Discounted Free Cash Flows Model
The discounted free cash flows model is derived from the discounted
dividends model. With that in mind, it also compares the weighted average cost
of capital and growth rates on the perpetuity. The annual free cash flows to the
firm are found by taking the cash flows from operations and adding the cash
flows from investing activities. In this model the present value of the annual free
cash flows and the total present value of the perpetuity make up the total value
of the firm. These two numbers are almost equally weighted in the total value of
the firm. Due to this fact, this valuation model is considered to be inaccurate
because we’re relying on a little over half of our total value of the firm in a
112
perpetuity full of assumptions. The following shows the results of the discounted
free cash flows model
WACCbt
Overvalued
Fairly valued
Undervalued
WACCbt
Overvalued
Fairly valued
Undervalued
0.07
0.082
0.09
0.1
0.11
$
$
$
$
$
0.07 $
0.082 $
0.09
0.1
0.11
0
32.67
25.85
22.35
18.79
15.89
$
$
$
$
$
0
1.73 $
0.49 $
$
$
Sensitivity Analysis
Actual
g
0.02
0.04
42.47 $
65.36
31.89 $
43.69
26.88 $
35.03
22.04 $
27.46
18.30 $
22.07
Sensitivity Analysis
Adjusted for Goodwill
g
0.02
0.04
5.12 $
13.02
2.82 $
7.37
1.72 $
5.11
0.66 $
3.12
$
1.71
$
$
$
$
$
0.06
179.79
76.92
54.05
38.31
28.87
$
$
$
$
$
0.06
52.53
20.20
13.01
8.06
5.09
In this model we started with the annual free cash flows to equity which
was computed in the above paragraph. This number multiplied by the present
value factor gave us the present value of these cash flows. The sum of these
amounts gives us the first value needed in our valuation of $2,241,483 (in
thousands) which is the total present value of the annual free cash flows. The
second number needed comes from the perpetuity in year ten dollars discounted
back to the present value of $2,583,860.88. These values added together will get
you to the value of the firm of $4,825,343.88. Next we subtracted out the book
value of the liabilities to arrive at the estimated market value of equity of
$3,567,949.88. That total dollar amount then needed to be divided by the shares
outstanding. Since it is impossible to predict shares outstanding in the future we
used an estimation of 138,000,000. Since the other numbers are in thousands,
we then converted shares outstanding to 138,000 to keep it consistent with the
113
rest of the model. When dividing the estimated market value of equity by the
selected shares outstanding gets you to the estimated share price. Our estimated
share price came out to $25.85 which was closer to our November 1, 2007 price
of $35.80 than the discounted dividends model.
The sensitivity analysis showed up once again that Hormel was
overvalued, but not to the same degree. It did show areas of fair value and
undervalue. Where the analysis showed Hormel to be undervalued was with a
growth rate of four and six percent. This could be possible if the weighted
average cost of capital was at the estimation of 8.2% or seven percent as well as
nine percent in one case. Some fair value points showed up periodically
throughout the sensitivity analysis, while the rest came up to be overvalued. As
stated before the explanatory power of this model is not very high, so therefore
it’s hard to really believe what the model shows.
We then ran this model with Hormel’s adjusted earnings for the
amortization of goodwill at twenty percent per year. What this did was decrease
the annual free cash flow by quite a bit, for example, Hormel’s annual free cash
flows went from $267,010 to $111,377 in 2007. Then these calculated annual
free cash flows were inserted into the model just the same as when we ran the
model with Hormel’s published earnings.
The sensitivity analysis on the following assumptions gave us an initial
estimated price per share of $.49, which is an extremely low number. Companies
that do not impair goodwill do not show the most accurate earnings possible,
thus making them look even more overvalued when this step is taken into
account in a firm valuation. The analysis showed us that the only way Hormel
could become undervalued with the adjusted earnings is with a low cost of
equity of seven percent and a high growth rate of six percent. The extremities in
this model show a price per share at a very unlikely state for Hormel, therefore
we do not see it feasible for Hormel to ever be in this situation.
114
Residual Income Model
Of all the models being used in this valuation of Hormel, the Residual
Income model is said to be the most accurate with explanatory power upwards
of eighty percent in some cases. This model uses the forecasted earnings and
even though these numbers are estimated, they are substantially more accurate
than having values in a perpetuity. This model is not highly sensitive to errors in
the cost of equity and free cash flows, and that’s why this model shows such a
high explanatory power in most cases. The following shows the results of the
residual income model.
$
$
$
$
$
Sensitivity Analysis
Actual
-0.2
-0.3
21.74 $
21.36
17.19 $
17.19
14.01 $
14.21
10.44 $
10.81
7.74 $
8.19
$
$
$
$
$
Sensitivity Analysis
Goodwill adjusted earnings
-0.2
-0.3
14.01 $
14.08
10.87 $
11.14
8.67 $
9.06
6.23 $
6.68
4.39 $
4.87
g
ke
Overvalued
Fairly valued
Undervalued
0.07
0.086
0.1
0.12
0.14
$
$
$
$
$
-0.1
22.56
17.19
13.59
9.72
6.92
g
ke
Overvalued
Fairly valued
Undervalued
0.07
0.086
0.1
0.12
0.14
$
$
$
$
$
-0.1
13.87
10.29
7.90
5.35
3.53
$
$
$
$
$
-0.4
21.15
17.19
14.34
11.04
8.47
$
$
$
$
$
-0.4
14.12
11.31
9.29
6.97
5.17
To start off the residual income we used our forecasted net income to find
the “approximated” actual earnings. The normal benchmark earnings were
computed by taking last years (2006) book value of equity divided by the cost of
equity. Just as a check figure we found the book value of equity by taking the
book value of equity at time t-1 plus net earnings in time t minus dividends paid
115
in time t to arrive at the book value of equity for 2007 of $2,188,778.97. Looking
back at the forecasted numbers for Hormel’s book value of equity this number
was consistent with our forecasted number proving that our balance sheet was
working properly. The difference between these two numbers brings you to the
actual residual income, which is the added or destroyed value to the company.
With all companies the residual income throughout time eventually converges
back to 0 which in our forecasted numbers, this would occur between 2016 and
2017. This happens because a firm cannot have an increase in residual income
for long without converging back to the market. This number multiplied by the
respective present value factor will bring you to the present value of the annual
residual income of $142,496.54. Just like the models used before we found the
sum of the annual residual income for ten years ($569,738.91) and added the
perpetuity value as well discounted back ten years to the present value ($54).
These two numbers added together plus the book value of equity in the current
year will get us to the estimated value. This estimated value is divided by the
shares outstanding to find the estimated share price of $17.19. This is
substantially smaller than the November 1st share price of $35.80. We were able
to find out that in order for Hormel to reach a price of around $35.80 they would
have to have sales growth of sixteen percent per year. Looking back at the past
five years of data for Hormel this does not seem like a very likely scenario with
the highest being from 2003 to 2004 of 13.8% while only a six percent increase
last year. Just for a check figure we checked the analyst’s estimates off of yahoo
finance for sales forecast and they predicted Hormel’s sales growth of 7.8% for
2007 and 5.7% in 2008. That said, we are ok with the number our model
conveyed to us because a lot of the difference can be explained by sales growth.
The sensitivity analysis on this model showed that Hormel was extremely
overvalued throughout the entire analysis. This may seem strange, but as
mentioned before this model is not sensitive to the change in the cost of equity
therefore the prices at different growth rates and costs of equity does not
change by a very large amount like you may see in some other models. After
116
examining the results of this model, we had to conclude that Hormel truly is
overvalued due to the fact that the residual income model has the highest
explanatory power out of all the models used.
In order to try and get a more accurate view of Hormel’s valuation we
implemented the residual income model with earnings that were adjusted to
impaired goodwill. A goodwill depreciation expense of twenty percent per year
was used to come up with our new adjusted earnings. These earnings were
placed in the model and the results showed that this causes Hormel to look even
more overvalued than the previous earnings, which would make sense since the
impairment of goodwill would decrease earnings.
Long-Run Residual Income Model
The long-run residual income model uses similar methods of the residual
income model in a perpetuity in order to calculate the value of a firm. The three
main variables are the return on equity, the cost of equity, and long run growth
on equity. Even though this is a perpetuity, it makes a more accurate assumption
due to the fact that it uses long term trends of the firm and brings theory to the
P/B ratio.
The cost of equity for Hormel was calculated with this model: P/B =
1+((ROE-Ke)/(Ke-g)) solving for Ke. This approach was used because of the low
number we received through our regression analysis. Within the residual income
model we calculated the long run return on equity by taking net earnings at time
t divided by the book value of equity at time t-1. This calculation gave us a
return on equity for 2007 of 16.5%. This number was calculated through 2016
and the long-run average of the return on equity for Hormel came out to be
11.44%.The last variable we needed to come up with in order to implement our
model was the long run percent change in the book value of equity to figure out
a growth rate. This was done by taking the book value of equity at time t divided
117
by the book value of equity at time t-1 and that amount subtracted by one to get
the calculation into a percentage of 21.4% for 2007. The same approach from
finding the return on equity was used to find the long-run average of the growth
rate of the book value of equity for Hormel, which came out to be 14.65%. With
all the variables calculated the following shows the results of this model in
action.
BV equity
Ke
ROE
BV equity g
$ 1,802,912.00
8.60%
11.44%
14.65% ROE
PPS
Shares out
PPS
$
$
956,586.37
138,000
6.93
ROE
Overvalued
Fairly valued
Undervalued
Ke
0.05
0.07
0.09
0.1144
0.13
Sensitivity Analysis
g
0.11
0.13 0.1465
0.17
$ 32.66 $ 23.75 $ 20.84 $ 18.66
$ 21.77 $ 17.82 $ 16.52 $ 15.55
$ 10.89 $ 11.88 $ 12.20 $ 12.44
$ 4.63 $ 6.93 $ 8.65
$ 3.56 $ 6.22
$
$
$
$
$
0.05
0.07
0.09
0.1144
0.13
Ke
0.07
0.086
0.1
$ 16.48 $ 20.84 $ 27.11
$ 13.06 $ 16.52 $ 21.49
$ 9.65 $ 12.20 $ 15.87
$ 5.48 $ 6.93 $ 9.02
$ 2.82 $ 3.56 $ 4.64
0.12
$ 47.57
$ 37.71
$ 27.85
$ 15.83
$ 8.13
0.14
$ 193.96
$ 153.76
$ 113.56
$ 64.52
$ 33.16
g
0.11
0.13 0.1465
0.07
$ 3.40 $ 5.48
0.086
$ 4.63 $ 6.93
0.1
$ 6.79 $ 9.02
0.12 $ 5.75 $ 20.38 $ 15.83
0.14 $ 1.92
$ 64.52
0.17
$ 7.26
$ 8.65
$ 10.38
$ 14.53
$ 24.21
0.19
$ 8.23
$ 9.50
$ 10.97
$ 14.11
$ 19.75
118
0.19
17.59
15.07
12.56
9.50
7.54
Sensitivity Analysis
Goodwill adjusted earnings
0.08
0.1 0.1159
0.14
$ 37.33 $ 24.43 $ 19.35
$ 19.69 $ 16.17 $ 14.78
$ 43.55
$ 6.95 $ 9.68
$ 87.10
$ 4.84
$ 130.65
g
ROE
ROE
Ke
0.06
0.0789
0.1
0.12
0.14
0.16
$ 17.65
$ 14.32
$ 10.59
$ 7.06
$ 3.53
Ke
0.07
0.086
0.1
0.12
0.14
0.06 $ 15.91 $ 24.43 $ 45.93
0.0789 $ 10.53 $ 16.17 $ 30.40
0.1 $ 4.53 $ 6.95 $ 13.06
0.12
$ 13.06 $ 2.22
0.14
$ 76.79 $ 13.06
0.07 $
0.086
0.1
0.12
0.14
g
0.08
0.1 0.1159
0.14
1.44 $ 9.19 $ 10.53 $ 11.40
$ 19.69 $ 16.17 $ 14.78
$ 30.40 $ 19.96
$ 39.91
BV equity
Ke
ROE
BV equity g
$ 1,802,912.00
8.60%
7.89%
11.59%
PPS
Shares out
PPS
$ 2,231,028.23
138,000
$
16.17
0.16
$ 11.77
$ 14.32
$ 17.66 Overvalued
$ 26.49 Fairly valued
$ 52.98 Undervalued
With our variables needed calculated, it was time to plug them into the
following equation to get an estimated value of the firm:
Value of Firm = BVE*[1+((ROE+Ke)/(Ke-g))]
When our above found variables were plugged into the equation we came
up with an estimated value of Hormel of $956,586.37. The next step is to divide
that number by the number of shares outstanding of course to create an
estimated share price of $6.93. The sensitivity analysis on this model was run in
a little different fashion than any of the previous one’s. For this model we ran
three different sensitivity analysis’ holding one of our variables constant in each
situation. First, the cost of equity was held constant; second, the growth of the
book value of equity and lastly, the long-run return on equity. This was done to
attempt to show what each variable does to the sensitivity of this model.
119
The sensitivity analysis showed us once again Hormel was overvalued.
When holding the cost of equity constant at 8.6% the only way Hormel could
even be fairly valued is with a return on equity of five percent and a growth rate
of eleven percent. Looking into it a little more this would seem to be possible
about ten years from now, but the accuracy of the forecasted numbers that far
out is just too highly unlikely to rely on what the model is telling us. Next holding
the growth rate constant at the long run average of 14.65%, we were able to
find Hormel to be undervalued with a fourteen percent cost of equity, but
seeming how that is double what our regression analysis gave us for a cost of
equity and quite a bit larger than the assumed cost of equity calculated for
Hormel, this turns out to be once again a doubtful situation. In the last model of
sensitivity analysis we held the return on equity constant at our long-run average
of 11.44%. This analysis showed Hormel to be overvalued across the board
unless we increased our cost of equity up to fourteen percent which we runs us
into the same situation that we did in the first model, and we would have a hard
time believing that the cost of equity could be that high.
Like the residual income model, we implemented the long-run residual
income model using the adjusted earnings for the impairment of goodwill. We
used the same cost of equity and had to recalculate the return on equity and the
growth of the book value of equity using the same methods that we did before
with the published earnings of the company. Our new long-run average of the
return on equity came out to be 7.89% and we considered our new percentage
change in the book value of equity of 11.59%. With these assumptions made,
the model kicked out a price per share of $16.17, which was still far from our
November 1st share price of $35.80, but a lot closer than the $6.93 price per
share that the published earnings gave us.
The sensitivity analysis on this model of adjusted earnings holding the
cost of equity constant at 8.6%, showed that Hormel would be undervalued with
a growth rate of eight percent and a return on equity between ten and fourteen
percent. Upon further review, our return on equity for Hormel using the adjusted
120
earnings for the forecasted ten years was never over ten percent; therefore we
feel it is safe to say that it’s not very possible for that to occur. On top of that,
the return on equity throughout the ten years turned out to decrease through
time. This would mean that even if the forecasted numbers aren’t close, and
Hormel is able to have a return on equity of over ten percent in 2007, it’s bound
to drop below that number within the next year or two; thus, concluding the
doubtfulness of this situation happening. The ten to fourteen percent return on
equity also requires a growth rate of only eight percent, and even though it’s
already been proved that it doesn’t matter what the growth rate is, the growth
rate within our ten year forecasting never dropped below nine percent. Next, we
held the growth rate constant at 11.59%, and the sensitivity analysis showed
Hormel to be overvalued. The only way to come up with an undervalued
prediction for Hormel in this situation is with either an extremely low or high
return on equity with a cost of equity around ten to twelve percent. These
numbers speak for themselves, because when dealing with these numbers, the
extremes are just not very believable numbers, judging by our assumptions of
Hormel as a company. Lastly, we held the return on equity constant at the longrun average of 7.89%. Once again we see that Hormel is overvalued, unless we
were to use an extremely high cost of equity of fourteen percent and a high
growth rate of sixteen percent. We keep running into the same situation of not
being able to believe these extreme situations happening, because we did an in
depth regression analysis to calculate a cost of equity of 7.31% as well as, a
back door method that gave us 8.6%. So, that right there just tells us that a
fourteen percent cost of equity for Hormel is not a trustworthy assumption.
Overall, both the adjusted and published earnings implemented into this
model shows that Hormel is an overvalued company within all of our sensitivity
analysis.
121
Abnormal Earnings Growth Model
The abnormal earnings growth model (AEG) is another model that has a
higher explanatory power than the discounted dividends model and the
discounted free cash flows model. It’s considered to be pretty accurate and
would make sense considering it is directly linked with the residual income
model. The main difference between the two models is the year that we discount
our abnormal earnings and residual income back to. In the residual income
model everything is discounted to 2006 dollars and in the abnormal earnings
growth model they are discounted to 2007 dollars. This model also brings theory
to the P/E ratio. The following shows the results and the sensitivity analysis of
the abnormal earnings growth model.
ke
ke
0.07
0.086
0.1
0.12
0.14
0.07
0.086
0.1
0.12
0.14
$
$
$
$
$
$
$
$
$
-0.1
23.15
13.78
8.83
4.54
2.06
-0.1
10.75
5.50
2.80
0.53
$
$
$
$
$
$
$
$
$
Sensitivity Analysis
g
-0.2
-0.3
24.09 $
24.53
14.97 $
15.55
10.00 $
10.59
5.56 $
6.09
2.90 $
3.36
Sensitivity Analysis
Adjusted for goodwill
g
-0.2
-0.3
11.70 $
12.14
6.51 $
6.99
3.73 $
4.19
1.31 $
1.71
$
0.26
$
$
$
$
$
-0.4
24.78
15.89
10.94 Overvalued
6.42 Fairly valued
3.65 Undervalued
$
$
$
$
$
-0.4
12.39
7.27
4.47 Overvalued
1.96 Fairly valued
0.47 Undervalued
122
The first number needed in the AEG model is the cumulative-dividend
earnings for 2008. This is found by taking our dividends payable for 2007 and
multiplying that number by Hormel’s cost of equity of 8.6%. That number is then
added to net earnings for 2008 to come up with our cumulative-dividend
earnings for 2008 of $310,779.74. This number was calculated for every year up
to 2016. Next, we found our normal or “benchmark” earnings for 2008 by taking
2007’s net income and multiplying it by one plus our cost of equity. The normal
earnings for 2008 came out to be $323,136.01 and this number was computed
through 2016 as well. The cumulative-dividend earnings minus the projected
normal earnings derives us to our abnormal earnings growth of $(12,356.27) for
2008. This is where the linkage between the residual income model and the
abnormal earnings growth model, as mentioned before, comes into play. It is
crucial to have this step to verify that your models are working properly. The
change in the residual income from year to year must equal the abnormal
earnings growth on the abnormal earnings growth model. For example, the
change in residual income from 2007 to 2008 is equal to $(12,356.27) and in
return the abnormal earnings growth for 2008 must equal that number. The
following chart will show the evidence of this situation occurring in our models of
Hormel.
AEG and Residual Income Check Figure
2008
2009
2010
2011
2012
2013
2014
2015
2016
AEG
(12,356.27)
(13,164.24)
(13,995.54)
(14,851.81)
(15,734.77)
(16,646.32)
(17,588.44)
(18,563.29)
(19,573.14)
Change
(12,356.27)
(13,164.24)
(13,995.54)
(14,851.81)
(15,734.77)
(16,646.32)
(17,588.44)
(18,563.29)
(19,573.14)
in RI
The next step in our model is to find the present value of our abnormal
earnings growth by multiplying each year’s abnormal growth earnings by its
respective present value factor to get these numbers to 2007 dollars. We then
took the core earnings for 2007 which is just equal to Hormel’s 2007 earnings of
$297,546.97. The next number calculated was the total present value of the
123
abnormal earnings growth by taking the sum of the present values of the
abnormal earnings growth from 2008 to 2016 to come up with the total of
$(93,489.04). In this model to find our continuing perpetuity we used a little
different strategy than in all the previous models. The average of all the
abnormal earnings growths was taken into consideration in our perpetuity. This
average came out to be $(85,109.81) for 2008 to 2016. This number was then
inserted into the following formula:
AEG Perpetuity = avg AEG/(Ke-g)
The AEG perpetuity discounted back to 2007 dollars gave us a present
value of the terminal value of $(40,505.24). The total present value of AEG was
found by adding the total present value of AEG plus to the present value of the
perpetuity to arrive at $(133,994.28). The next number needed in our model is
the total average earnings at time t+1. We calculated it by taking our previous
value of $(133,994.28) and adding that to our core earnings for Hormel to create
a total average earnings of $163,552.69. This value was then divided by our
capitalization rate or the cost of equity for Hormel to arrive at an intrinsic value
of $1,901,775.47. To find the estimated price per share we simply divided our
intrinsic value by our shares outstanding and came up with a price per share of
$13.78.
Again, going back to the previously mentioned linkage between the AEG
model and the residual income model, since they are so similar we should see a
similar estimated price per share as well. Our residual income model gave us an
estimated share price of $17.19, which is pretty close to the $13.78 that the AEG
model conveyed to us. As the perpetuity continues to infinity, we should see the
gap between these two numbers shrink.
124
The sensitivity analysis was then run on our abnormal earnings growth
model and once again showed that Hormel is overvalued. It did not matter if we
increased or decreased the cost of equity, while decreasing the growth rate on
the perpetuity, the model showed red or overvalued throughout.
The model was then put into place using our adjusted earnings for
Hormel. Like before, we ran all the previous calculations to come up with an
estimated share price of $5.50. This number is obviously substantially lower than
the November 1st share price of $35.80. The only explanation is due to the fact
that companies do not impair goodwill properly in order to have higher net
earnings. When the amortization is done it lowers the net earnings by quite a bit
and shows a more accurate opinion of the company, which is obviously not done
by the public or else no one would be buying Hormel’s stock at its current price.
Going back to the linkage between the two models, the residual income model
with the adjusted earnings gave us a share price of $10.29, which we feel is
close enough, considering the gap will shrink in the perpetuity, to be confident
that our models are correct.
The sensitivity analysis on the new numbers was consistent with the
published earnings model of AEG, and conveyed the message of Hormel being
overvalued once again.
125
Conclusion
The implementation of all the previous models showed the same results
regarding the valuation of Hormel. They all proved to us that Hormel is
overvalued. The discounted dividends model did not really show us a whole lot
due to such a low explanatory power and the discounted free cash flows model
gave us an estimated price per share of $25.85 that was closest to the
November 1st price of $35.80. If someone were to go by this model we feel they
would be making a mistake in their valuation of Hormel. The residual income and
the abnormal earnings growth models are the most trustworthy models in our
valuation and they showed that Hormel was overvalued by about $22-$25 and
when we adjusted their earnings, these models showed Hormel to be overvalued
by roughly $30. That said we think it is safe to say that Hormel as of November
1, 2007 is an overvalued firm.
126
Credit Analysis
In order to predict distress and turn around within a company there are
several models to choose from. For our credit analysis of Hormel Foods
Corporation we decided to implement the Altman Z-Score Model, which attempts
to compute bankruptcy score. This score is computed by the weights of five
variables that are shown in the proceeding formula. The higher the number the
Z-Score Model predicts the lower the probability of bankruptcy within the next
year or two. This model has proven to be accurate by successfully predicting
over 70 percent of firm bankruptcies. When putting this model into action we
looked for the Z-Score to be above 2.75. Any number below 2.75 would indicate
that a firm has an increased possibility of going bankrupt in the near future.
⎡ Retained Earnings ⎤
⎡ Working Capital ⎤
+
Z − score = 1.2 ⎢
1.4
⎢⎣ Total Assets ⎥⎦
⎣ Total Assets ⎥⎦
⎡ Earnings Before Interest and Taxes ⎤
+ 3.3⎢
⎥⎦
Total Assets
⎣
⎡ Market Value of Equity ⎤
+ 0.6 ⎢
⎣ Book Value of Liabilities ⎥⎦
⎤
⎡ Sales
+ 1.0⎢
⎥
⎣ Total Assets ⎦
127
Hormel’s Z-Score
Z-Score
2002
2003
2004
2005
2006
4.93
5.07
5.66
5.57
5.90
The Altman Z-Score Model gave us a current Z-Score of 5.90 which implies that
Hormel is not in any danger of going bankrupt any time soon, due to the fact that its
credit rating is almost double the benchmark score of 2.75. As you can see in the table
above, Hormel has never in the past five year history had a high probability of
bankruptcy according to the Z-Score Model used. Therefore it is safe to conclude that
Hormel as a whole does not have an issue with paying back their debt.
128
Appendix
Hormel Foods
Liquidity Ratios
Current Ratio
Acid Test
Inventory Turnover
Receivables Turnover
Working Capital Turnover
Operating Efficiency
Gross Profit Margin
Operating Expense Ratio
Operating Profit Margin
Net Profit Margin
Asset Turnover
Rate of Return on Assets
Return on Equity
Capital Structure Ratios
Debt to Equity Ratio
Times Interest Earned
Debt Service Margin
Z-Score
2002 2003 2004 2005 2006
2002 2003 2004 2005 2006
2.35
1.43
8.29
14.20
7.08
2.11
0.81
6.65
12.78
8.27
25%
17%
8%
5%
1.76
9%
17%
0.99
10.13
8.05
4.93
Smithfield Foods
Liquidity Ratios
1.86 2.22 1.83 1.95 2.04 Current Ratio
0.88 1.21 0.81 0.88
Quick Asset Ratio
7.90 8.59 7.72 7.64
Inventory Turnover
14.41 17.53 17.99 16.80
Receivables Turnover
11.00 8.46 11.23 10.32
Working Capital Turnover
24%
17%
7%
4%
1.76
8%
15%
0.91
9.74
3.00
5.07
24%
16%
8%
5%
1.89
10%
17%
0.81
14.01
20.91
5.66
24%
16%
8%
5%
1.90
10%
16%
0.78
15.35
14.05
5.57
24%
16%
8%
5%
1.88
10%
16%
0.70
17.58
20.72
5.90
2.02
0.57
6.48
17.84
8.57
2.09
0.59
6.20
18.42
8.69
2.31
0.68
5.89
17.00
7.78
1.95
0.60
6.51
17.52
9.68
Operating Efficiency
Gross Profit Margin
Operating Expense Ratio
Operating Profit Margin
Net Profit Margin
Asset Turnover
Return On Assets
Return on Equity
15% 10% 10% 11% 10%
8% 8% 6% 6% 6%
6% 2% 3% 4% 2%
3% 0% 2% 3% 2%
1.85 1.77 2.03 2.12 1.91
6% 1% 5% 6% 3%
19% 2% 17% 18% 9%
Capital Structure Ratios
Debt to Equity Ratio
Times Interest Earned Ratio
Debt Service Margin
Z-Score
1.83
4.44
3.39
3.78
2.23
1.42
0.51
2.67
1.97
2.14
4.04
3.23
129
2.02
3.42
1.09
3.37
2.04
1.81
7.86
3.01
Tyson Foods
Liquidity Ratios
Current Ratio
Acid Test
Inventory Turnover
Receivables Turnover
Working Capital Turnover
Operating Efficiency
Gross Profit Margin
Operating Expense Ratio
Operating Profit Margin
Net Profit Margin
Asset Turnover
Rate of Return on Assets
Return on Equity
2002 2003 2004 2005 2006
1.50 1.36 1.54 1.62 1.47
0.55 0.53 0.56 0.58 0.43
11.43 11.44 11.90 11.78 11.97
21.22 19.18 21.32 21.43 21.61
22.23 27.40 21.34 19.59 19.06
ConAgra Foods Inc.
Liquidity Ratios
Current Ratio
Acid Test
Inventory Turnover
Receivables Turnover
Working Capital Turnover
8% 7% 7% 7% 4%
4% 3% 3% 4% 4%
4% 3% 4% 3% 0%
2% 1% 2% 1% -1%
2.23 2.35 2.52 2.48 2.36
4% 3% 4% 4% -2%
11% 9% 10% 9% -4%
Operating Efficiency
Gross Profit Margin
Operating Expense Ratio
Operating Profit Margin
Net Profit Margin
Asset Turnover
Rate of Return on Assets
Return on Equity
Capital Structure Ratios
Debt to Equity Ratio
1.83 1.65 1.44 1.25 1.50
Times Interest Earned
2.91 2.83 3.30 3.14 (0.29)
Debt Service Margin
(0.74) 1.04 2.41 4.13 0.40
Z-Score
3.32 3.50 3.90 3.95 3.30
2002 2003 2004 2005 2006
1.49 1.59 1.61 1.68 1.92
0.33 0.42 0.57 0.71 0.76
4.60 4.14 7.86 9.33 8.43
17.50 17.36 16.55 19.64 19.90
10.53 7.33 5.09 5.33 6.29
16%
9%
3%
4%
1.43
5%
18%
20%
12%
7%
5%
1.10
5%
17%
26%
16%
7%
7%
0.99
5%
17%
25%
15%
9%
6%
0.87
5%
13%
25%
17%
8%
5%
0.96
4%
11%
Capital Structure Ratios
Debt to Equity Ratio
2.57
Times Interest Earned
3.11
Debt Service Margin
84.69
Z-Score
2.66
2.26
4.41
2.25
2.44
1.97
2.96
2.62
2.32
1.67
3.14
2.16
2.56
1.57
3.47
0.92
2.64
130
Altman's Z-Score
Hormel
Sales
OI
Mkt Cap
CA
TA
CL
TL
RE
part 1
part 2
part 3
part 4
part 5
total
Shares out
price
Tyson
Sales
OI
Mkt Cap
CA
TA
CL
TL
RE
part 1
part 2
part 3
part 4
part 5
total
Shares out
2002
3,910,314
318,250
3,093,493.40
962,170
2,220,196
410,111
1,104,941
1,140,103
2002
0.298
0.719
0.473
1.680
1.761
4.931
2003
4,200,328
310,410
3,715,761.01
823,974
2,393,121
441,990
1,140,386
1,265,684
2003
0.192
0.740
0.428
1.955
1.755
5.070
2004
4,779,875
380,377
4,220,360.21
1,029,403
2,533,968
464,366
1,134,720
1,414,703
2004
0.268
0.782
0.495
2.232
1.886
5.662
2005
5,413,997
425,939
4,521,253.35
1,065,238
2,846,560
583,172
1,247,830
1,612,315
2005
0.203
0.793
0.494
2.174
1.902
5.566
2006
5,745,481
450,709
5,213,801.46
1,141,671
3,060,306
585,014
1,257,394
1,821,202
2006
0.218
0.833
0.486
2.488
1.877
5.903
138,411.34
22.35
138,596.08
26.81
137,875.21
30.61
137,843.09
32.80
137,639.95
37.88
2002
23,367
887
4,291.47
3,144
10,372
2,093
6,710
2,097
2002
0.122
0.283
0.282
0.384
2.253
3.323
2003
24,549
837
5,213.97
3,371
10,486
2,475
6,532
2,380
2003
0.103
0.318
0.263
0.479
2.341
3.504
2004
26,441
917
5,927.40
3,532
10,464
2,293
6,172
2,728
2004
0.142
0.365
0.289
0.576
2.527
3.899
2005
26,014
745
6,678.50
3,485
10,504
2,157
5,833
3,032
2005
0.152
0.404
0.234
0.687
2.477
3.953
2006
25,559
(77)
5,875.60
4,187
11,121
2,846
6,681
2,781
2006
0.145
0.350
-0.023
0.528
2.298
3.298
369.00
369.00
370.00
370.00
370.00
131
Altman's Z-Score
Smithfield
Sales
OI
Mkt Cap
CA
TA
CL
TL
RE
part 1
part 2
part 3
part 4
part 5
total
Shares out
price
ConAgra
Sales
OI
Mkt Cap
CA
TA
CL
TL
RE
part 1
part 2
part 3
part 4
part 5
total
Shares out
2002
6,605
304
2,326.99
1520
3,873
722
1,105
836
2002
0.247
0.302
0.259
1.264
1.705
3.777
2003
7,135
17
2,145.42
1651
4,211
818
2,907
862
2003
0.237
0.287
0.013
0.443
1.694
2.674
2004
9,178
254
2,952.01
2024
4,786
967
3,174
1,089
2004
0.265
0.319
0.175
0.558
1.918
3.234
2005
11,245
454
3,366.39
2,547
5,774
1,102
3,849
1,385
2005
0.300
0.336
0.259
0.525
1.948
3.368
2006
11,404
279
2,990.39
2,475
6,177
1,314
4,131
1,558
2006
0.226
0.353
0.149
0.434
1.846
3.008
110.28
21.10
109.46
19.60
110.98
26.60
111.25
30.26
111.17
26.90
2002
22,336
762
13,917.18
6,434
15,571
4,313
11,263
1,822
2002
0.163
0.164
0.161
0.741
1.434
2.665
565.51
2003
16,534
812
13,727.52
6,060
15,071
3,803
10,450
2,081
2003
0.180
0.193
0.178
0.788
1.097
2.436
565.62
2004
10,926
539
15,911.48
5,149
14,222
3,005
9,428
2,349
2004
0.181
0.231
0.125
1.013
0.768
2.318
565.84
2005
11,384
559
14,799.38
4,775
13,043
2,640
8,183
2,438
2005
0.196
0.262
0.141
1.085
0.873
2.557
565.94
2006
11,482
589
12,796.44
4,790
11,970
2,965
7,320
2,455
2006
0.183
0.287
0.162
1.049
0.959
2.641
566.21
132
3-month Regression
SUMMARY OUTPUT
72 month
Regression Statistics
Multiple R
0.317842478
R Square
0.101023841
Adjusted R Square
0.088362205
Standard Error
0.042832391
Observations
73
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
71
72
SS
MS
F
Significance F
0.014637897 0.014637897 7.978735183
0.006139744
0.130257574 0.001834614
0.144895471
Coefficients Standard Error
t Stat
P-value
0.006761611
0.005043642 1.340620694 0.184317462
0.412340014
0.145978352 2.824665499 0.006139744
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.003295126 0.016818347 -0.003295126 0.016818347
0.121267451 0.703412576 0.121267451 0.703412576
SUMMARY OUTPUT
60 month
Regression Statistics
Multiple R
0.21907772
R Square
0.047995048
Adjusted R Square
0.03185937
Standard Error
0.043908671
Observations
61
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
59
60
SS
MS
F
Significance F
0.005734688 0.005734688 2.974467515
0.089823651
0.113750313 0.001927971
0.119485001
Coefficients Standard Error
t Stat
P-value
0.007834619
0.005884115 1.33148632 0.188150736
0.351015381
0.203526766 1.724664464 0.089823651
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.003939468 0.019608705 -0.003939468 0.019608705
-0.056240734 0.758271496 -0.056240734 0.758271496
SUMMARY OUTPUT
48 month
Regression Statistics
Multiple R
0.172331203
R Square
0.029698044
Adjusted R Square
0.009053321
Standard Error
0.039498653
Observations
49
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
47
48
SS
MS
F
Significance F
0.002244313 0.002244313 1.438529564
0.23638915
0.073326748 0.001560144
0.075571061
Coefficients Standard Error
t Stat
P-value
0.009667592
0.005883701 1.643114085 0.107033701
0.306713469
0.255725156 1.199387162 0.23638915
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.002168887 0.021504071 -0.002168887 0.021504071
133 0.821166117
-0.207739179 0.821166117 -0.207739179
SUMMARY OUTPUT
36 month
Regression Statistics
Multiple R
0.184862123
R Square
0.034174004
Adjusted R Square
0.006578976
Standard Error
0.034154235
Observations
37
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
35
36
SS
MS
F
Significance F
0.001444622 0.001444622 1.238411641 0.273362429
0.040827911 0.001166512
0.042272533
Coefficients Standard Error
t Stat
P-value
0.00868889 0.005821758 1.492485603 0.144531907
0.296008624 0.265994007 1.11283945 0.273362429
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.003129907 0.020507686 -0.003129907 0.020507686
-0.243987914 0.836005162 -0.243987914 0.836005162
SUMMARY OUTPUT
24 month
Regression Statistics
Multiple R
0.246798887
R Square
0.060909691
Adjusted R Square
0.020079677
Standard Error
0.031278782
Observations
25
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
23
24
SS
MS
F
Significance F
0.001459508 0.001459508 1.491787181
0.234311668
0.022502331 0.000978362
0.023961839
Coefficients Standard Error
t Stat
P-value
0.003867364
0.006488497 0.596033856
0.5569735
0.374450394
0.306577908
1.2213874 0.234311668
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.009555114 0.017289841 -0.009555114 0.017289841
-0.259754325 1.008655112 -0.259754325 1.008655112
134
1-Year Regression
SUMMARY OUTPUT
72 month
Regression Statistics
Multiple R
0.317961428
R Square
0.10109947
Adjusted R Square
0.088438899
Standard Error
0.042830589
Observations
73
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
71
72
SS
MS
0.014648855 0.014648855
0.130246616 0.001834459
0.144895471
F
Significance F
7.98538002
0.006119556
Coefficients Standard Error
t Stat
P-value
0.00685596
0.005039852 1.360349356 0.178022794
0.412176328
0.145859678 2.825841471 0.006119556
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.00319322 0.016905139 -0.00319322 0.016905139
0.121340394 0.703012263 0.121340394 0.703012263
SUMMARY OUTPUT
60 month
Regression Statistics
Multiple R
0.21904078
R Square
0.047978863
Adjusted R Square
0.031842912
Standard Error
0.043909044
Observations
61
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
59
60
SS
MS
0.005732755 0.005732755
0.113752247 0.001928004
0.119485001
F
Significance F
2.97341395
0.089879158
Coefficients Standard Error
t Stat
P-value
0.007910339
0.005871437 1.347257741 0.183048849
0.350629186
0.203338856 1.724358997 0.089879158
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.003838379 0.019659058 -0.003838379 0.019659058
-0.056250922 0.757509295 -0.056250922 0.757509295
SUMMARY OUTPUT
48 month
Regression Statistics
Multiple R
0.17223052
R Square
0.029663352
Adjusted R Square
0.009017892
Standard Error
0.039499359
Observations
49
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
47
48
SS
MS
F
Significance F
0.002241691 0.002241691 1.436797789
0.236667259
0.07332937 0.001560199
0.075571061
Coefficients Standard Error
t Stat
P-value
0.009738874
0.005867503 1.659798596 0.103613734
0.30626973
0.255509028 1.198665003 0.236667259
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
135
-0.00206502 0.021542768 -0.00206502 0.021542768
-0.207748125 0.820287585 -0.207748125 0.820287585
SUMMARY OUTPUT
36 month
Regression Statistics
Multiple R
0.183477161
R Square
0.033663869
Adjusted R Square
0.006054265
Standard Error
0.034163253
Observations
37
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
35
36
SS
MS
F
Significance F
0.001423057 0.001423057 1.219281122 0.277035571
0.040849476 0.001167128
0.042272533
Coefficients Standard Error
t Stat
P-value
0.008752213
0.00581138 1.506047284 0.141027862
0.293529313 0.265827283 1.104210633 0.277035571
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.003045515 0.020549942 -0.003045515 0.020549942
-0.246128759 0.833187384 -0.246128759 0.833187384
SUMMARY OUTPUT
24 month
Regression Statistics
Multiple R
0.245965525
R Square
0.06049904
Adjusted R Square
0.019651172
Standard Error
0.03128562
Observations
25
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
23
24
SS
MS
F
Significance F
0.001449668 0.001449668 1.481081947
0.235946012
0.022512171 0.00097879
0.023961839
Coefficients Standard Error
t Stat
P-value
0.003906525
0.006482973 0.602582408 0.552681983
0.372788005
0.306317907 1.216997102 0.235946012
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.009504526 0.017317576 -0.009504526 0.017317576
-0.26087886 1.00645487 -0.26087886
1.00645487
136
2-Year Regression
SUMMARY OUTPUT
72 month
Regression Statistics
Multiple R
0.317803725
R Square
0.100999208
Adjusted R Square
0.088337225
Standard Error
0.042832978
Observations
73
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
SS
MS
F
Significance F
0.014634328 0.014634328 7.976571094
0.006146334
0.130261143 0.001834664
0.144895471
1
71
72
Coefficients Standard Error
t Stat
P-value
0.006952602
0.005036742 1.380376851 0.171801295
0.411486314
0.145695881 2.824282403 0.006146334
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.003090376 0.016995579 -0.003090376 0.016995579
0.120976982 0.701995647 0.120976982 0.701995647
SUMMARY OUTPUT
60 month
Regression Statistics
Multiple R
0.218590773
R Square
0.047781926
Adjusted R Square
0.031642636
Standard Error
0.043913586
Observations
61
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
59
60
SS
MS
F
Significance F
0.005709223 0.005709223 2.960596634
0.090557509
0.113775778 0.001928403
0.119485001
Coefficients Standard Error
t Stat
P-value
0.007971688
0.005862848 1.359695363 0.179100106
0.349932796
0.203373811 1.720638438 0.090557509
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.003759845 0.01970322 -0.003759845
0.01970322
-0.057017256 0.756882848 -0.057017256 0.756882848
SUMMARY OUTPUT
48 month
Regression Statistics
Multiple R
0.170983811
R Square
0.029235464
Adjusted R Square
0.008580899
Standard Error
0.039508067
Observations
49
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
47
48
SS
MS
F
Significance F
0.002209355 0.002209355 1.415448075
0.240129502
0.073361706 0.001560887
0.075571061
Coefficients Standard Error
t Stat
P-value
0.009790926
0.0058601 1.670777851 0.101412506
0.304012987
0.255531924 1.18972605 0.240129502
Lower 95% Upper 95% Lower 95.0% Upper 95.0%
-0.001998075 0.02158 -0.001998075 0.021579927
-0.210050929 0.818077 -0.210050929 0.818076903
137
SUMMARY OUTPUT
36 month
Regression Statistics
Multiple R
0.182124184
R Square
0.033169218
Adjusted R Square
0.005545482
Standard Error
0.034171996
Observations
37
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
35
36
SS
MS
F
Significance F
0.001402147 0.001402147 1.200750605
0.280654797
0.040870386 0.001167725
0.042272533
Coefficients Standard Error
t Stat
P-value
0.008770862
0.005811348 1.50926475 0.140206615
0.291083829
0.265638899 1.095787664 0.280654797
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.003026801 0.020568525 -0.003026801 0.020568525
-0.248191803 0.83035946 -0.248191803
0.83035946
SUMMARY OUTPUT
24 month
Regression Statistics
Multiple R
0.24553404
R Square
0.060286965
Adjusted R Square
0.019429876
Standard Error
0.031289151
Observations
25
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
23
24
SS
MS
F
Significance F
0.001444587 0.001444587 1.475557049
0.236795166
0.022517252 0.000979011
0.023961839
Coefficients Standard Error
t Stat
P-value
0.003877761
0.006490731 0.597430457 0.556056803
0.371607358
0.305918895 1.214725092 0.236795166
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.00954934 0.017304861 -0.00954934 0.017304861
-0.261234089 1.004448805 -0.261234089 1.004448805
138
5-Year Regression
SUMMARY OUTPUT
72 month
Regression Statistics
Multiple R
0.317138765
R Square
0.100576996
Adjusted R Square
0.087909066
Standard Error
0.042843035
Observations
73
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
71
72
SS
MS
F
Significance F
0.014573151 0.014573151 7.939497524
0.00626038
0.13032232 0.001835526
0.144895471
Coefficients Standard Error
t Stat
P-value
0.007180195
0.005030852 1.427232452 0.157896243
0.410339281
0.14562857 2.817711398 0.00626038
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.002851039 0.017211429 -0.002851039 0.017211429
0.119964164 0.700714398 0.119964164 0.700714398
SUMMARY OUTPUT
60 month
Regression Statistics
Multiple R
0.217379949
R Square
0.047254042
Adjusted R Square
0.031105806
Standard Error
0.043925756
Observations
61
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
59
60
SS
MS
F
Significance F
0.005646149 0.005646149 2.926266402
0.092402662
0.113838852 0.001929472
0.119485001
Coefficients Standard Error
t Stat
P-value
0.008140979
0.005839688 1.394077751 0.168522383
0.348648096
0.203812289 1.710633334 0.092402662
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.003544209 0.019826167 -0.003544209 0.019826167
-0.05917935 0.756475541 -0.05917935 0.756475541
SUMMARY OUTPUT
48 month
Regression Statistics
Multiple R
0.167337972
R Square
0.028001997
Adjusted R Square
0.007321188
Standard Error
0.039533159
Observations
49
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
47
48
SS
MS
F
Significance F
0.002116141 0.002116141 1.354008802
0.25045193
0.07345492 0.001562871
0.075571061
Coefficients Standard Error
t Stat
P-value
0.009920991
0.005843472 1.697790566 0.096160022
0.298014442
0.256110018 1.163618839 0.25045193
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.001834558 0.021676541 -0.001834558 0.021676541
-0.217212449 0.813241333 -0.217212449 0.813241333
139
SUMMARY OUTPUT
36 month
Regression Statistics
Multiple R
0.179781202
R Square
0.032321281
Adjusted R Square
0.004673317
Standard Error
0.034186978
Observations
37
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
35
36
SS
MS
F
Significance F
0.001366302 0.001366302 1.169029349
0.286994604
0.04090623 0.001168749
0.042272533
Coefficients Standard Error
t Stat
P-value
0.008815167
0.005808409 1.517656184 0.138082784
0.287389989
0.265802418 1.081216606 0.286994604
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.002976529 0.020606864 -0.002976529 0.020606864
-0.252217605 0.826997582 -0.252217605 0.826997582
SUMMARY OUTPUT
24 month
Regression Statistics
Multiple R
0.245346954
R Square
0.060195128
Adjusted R Square
0.019334046
Standard Error
0.03129068
Observations
25
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
23
24
SS
MS
F
Significance F
0.001442386 0.001442386 1.473165313
0.237163974
0.022519453 0.000979107
0.023961839
Coefficients Standard Error
t Stat
P-value
0.003872251
0.006492605 0.596409539 0.556726833
0.37115773
0.305796681 1.213740216 0.237163974
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.009558725 0.017303228 -0.009558725 0.017303228
-0.261430898 1.003746358 -0.261430898 1.003746358
140
7-Year Regression
SUMMARY OUTPUT
72 month
Regression Statistics
Multiple R
0.316871394
R Square
0.10040748
Adjusted R Square
0.087737163
Standard Error
0.042847072
Observations
73
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
71
72
SS
MS
F
Significance F
0.014548589 0.014548589 7.924622472
0.00630676
0.130346882 0.001835872
0.144895471
Coefficients Standard Error
t Stat
P-value
0.007279573
0.005028622 1.447627899 0.152122507
0.409943982
0.145624761 2.815070598 0.00630676
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.002747214 0.01730636 -0.002747214 0.01730636
0.11957646 0.700311505
0.11957646 0.700311505
SUMMARY OUTPUT
60 month
Regression Statistics
Multiple R
0.21688556
R Square
0.047039346
Adjusted R Square
0.030887471
Standard Error
0.043930705
Observations
61
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
59
60
SS
MS
F
Significance F
0.005620496 0.005620496 2.912314813
0.093164456
0.113864505 0.001929907
0.119485001
Coefficients Standard Error
t Stat
P-value
0.00821865
0.005829198 1.409910825 0.163816004
0.348192568
0.204032963 1.70655056 0.093164456
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.003445549 0.019882848 -0.003445549 0.019882848
-0.060076445 0.756461581 -0.060076445 0.756461581
SUMMARY OUTPUT
48 month
Regression Statistics
Multiple R
0.165886282
R Square
0.027518258
Adjusted R Square
0.006827158
Standard Error
0.039542995
Observations
49
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
47
48
SS
MS
F
Significance F
0.002079584 0.002079584 1.329956227
0.254644312
0.073491477 0.001563648
0.075571061
Coefficients Standard Error
t Stat
P-value
0.009978974
0.005835499 1.710046381 0.09385213
0.295634899
0.256352187 1.153237281 0.254644312
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.001760536 0.021718484 -0.001760536 0.021718484
-0.220079172 0.811348971 -0.220079172
1410.811348971
SUMMARY OUTPUT
36 month
Regression Statistics
Multiple R
0.178620631
R Square
0.03190533
Adjusted R Square
0.004245482
Standard Error
0.034194324
Observations
37
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
35
36
SS
MS
F
Significance F
0.001348719 0.001348719 1.153488988
0.290168929
0.040923814 0.001169252
0.042272533
Coefficients Standard Error
t Stat
P-value
0.008843814
0.005805353 1.523389574 0.136646619
0.285660832
0.265976931 1.074006047 0.290168929
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.002941679 0.020629307 -0.002941679 0.020629307
-0.254301041 0.825622705 -0.254301041 0.825622705
SUMMARY OUTPUT
24 month
Regression Statistics
Multiple R
0.245298963
R Square
0.060171581
Adjusted R Square
0.019309476
Standard Error
0.031291072
Observations
25
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
23
24
SS
MS
F
Significance F
0.001441822 0.001441822 1.472552157
0.237258641
0.022520017 0.000979131
0.023961839
Coefficients Standard Error
t Stat
P-value
0.00388123
0.006490809 0.597957843 0.555710843
0.371145102
0.305849934 1.213487601 0.237258641
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.009546032 0.017308492 -0.009546032 0.017308492
-0.261553687 1.003843891 -0.261553687 1.003843891
142
10-Year Regression
SUMMARY OUTPUT
72 month
Regression Statistics
Multiple R
0.31659189
R Square
0.100230425
Adjusted R Square
0.087557614
Standard Error
0.042851288
Observations
73
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
71
72
SS
MS
F
Significance F
0.014522935 0.014522935 7.909091765
0.006355567
0.130372536 0.001836233
0.144895471
Coefficients Standard Error
t Stat
P-value
0.007365182
0.005026981 1.465130224 0.147299827
0.409637687
0.145658757 2.812310752 0.006355567
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.002658333 0.017388697 -0.002658333 0.017388697
0.11920238 0.700072995
0.11920238 0.700072995
SUMMARY OUTPUT
60 month
Regression Statistics
Multiple R
0.21642015
R Square
0.046837681
Adjusted R Square
0.030682388
Standard Error
0.043935353
Observations
61
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
59
60
SS
MS
F
Significance F
0.0055964
0.0055964 2.899215732
0.093886091
0.113888601 0.001930315
0.119485001
Coefficients Standard Error
t Stat
P-value
0.008293225
0.005819313 1.425121034 0.159391063
0.347718073
0.204214699 1.702708352 0.093886091
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.003351193 0.019937642 -0.003351193 0.019937642
-0.060914592 0.756350739 -0.060914592 0.756350739
SUMMARY OUTPUT
48 month
Regression Statistics
Multiple R
0.16461482
R Square
0.027098039
Adjusted R Square
0.006397997
Standard Error
0.039551537
Observations
49
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
47
48
SS
MS
F
Significance F
0.002047828 0.002047828 1.309081362
0.258354796
0.073523233 0.001564324
0.075571061
Coefficients Standard Error
t Stat
P-value
0.0100374
0.005826916 1.722592287 0.091537292
0.293568968
0.256582378 1.144150935 0.258354796
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.001684842 0.021759643 -0.001684842 0.021759643
-0.222608189 0.809746125 -0.222608189 0.809746125
143
SUMMARY OUTPUT
36 month
Regression Statistics
Multiple R
0.17782032
R Square
0.031620066
Adjusted R Square
0.003952068
Standard Error
0.034199362
Observations
37
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
35
36
SS
MS
0.00133666 0.00133666
0.040935873 0.001169596
0.042272533
F
Significance F
1.14283896
0.292371005
Coefficients Standard Error
t Stat
P-value
0.008875097
0.005800573 1.530038133 0.134996297
0.284529885
0.266155454 1.069036463 0.292371005
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.002900691 0.020650886 -0.002900691 0.020650886
-0.255794408 0.824854178 -0.255794408 0.824854178
SUMMARY OUTPUT
24 month
Regression Statistics
Multiple R
0.245118477
R Square
0.060083068
Adjusted R Square
0.019217114
Standard Error
0.031292545
Observations
25
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
23
24
SS
MS
F
Significance F
0.001439701 0.001439701 1.470247547
0.237614888
0.022522138 0.000979223
0.023961839
Coefficients Standard Error
t Stat
P-value
0.003900655
0.006487217 0.601283236 0.553532003
0.3709897
0.305961387 1.212537648 0.237614888
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
-0.009519176 0.017320485 -0.009519176 0.017320485
-0.261939647 1.003919048 -0.261939647 1.003919048
144
Method of Comparables
(in millions)
Current selling price Nov. 1, 2007
PPS
EPS Forecast
EPS
DPS
BPS
35.80
15.45
28.11
23.29
2.23
1.06
1.98
1.38
2.08
0.76
1.68
1.54
0.60
0.16
N/A
0.72
13.10
13.29
21.66
9.43
P/E
forward
16.05
14.62
14.17
16.91
15.23
P/B
D/P
PEG
Hormel
Tyson
Smithfield
ConAgra
Industry Avg
P/E
trailing
17.21
20.33
16.73
15.12
17.39
2.73
1.16
1.30
2.47
1.64
0.02
0.01
N/A
0.03
0.02
2.46
2.99
2.05
2.00
2.35
Price Comparables
P/E
P/B
D/P
PEG
P/EBITDA
P/FCF (per share)
EV/EBITDA
Trailing
36.18
21.53
29.08
34.22
13.37
14.43
30.09
Forward
33.97
Hormel
Tyson
Smithfield
ConAgra
EV
5,935.73
7,990.00
7,330.00
15,360.00
FCF
156.05
431.13
N/A
19.73
FCF
(per share)
1.13
1.21
N/A
0.04
P/FCF
EBITDA
P/EBITDA
EV/EBITDA
(in millions)
(per share)
577.28
0.06
31.68
10.28
1,140.00
0.01
12.77
7.01
653.70
0.04
N/A
11.21
1,800.00
0.01
N/A
8.53
1,197.90
0.02
12.77
8.92
145
Discounted Dividends Model
WACC
EPS
DPS
BPS
PV Factor
PV Dividends year by year
Total PV of annual Dividends
Continuing (terminal) value Perpetuity
PV of Terminal Value Perpetuity
Estimated Price per Share (end of 2007)
Observed Share Price
Initial Cost of Equity
Perpetuity Growth Rate
$
$
$
0
1
2006 2007
2.08 $ 2.16 $
0.60 $ 0.64 $
13.10
0.9208
$ 0.59 $
$
5.18
$
$
5.10
10.28
0.082
2
2008
2.31 $
0.68 $
Kd
3
2009
2.47 $
0.72 $
4
2010
2.64 $
0.76 $
0.064
5
6
2011
2012
2.83 $ 3.02 $
0.80 $ 0.84 $
Keq
7
2013
3.24 $
0.88 $
8
2014
3.46 $
0.92 $
0.086
9
10
2015
2016
3.70 $ 3.96
0.96 $ 1.00
0.8479
0.7807
0.7189
0.6620
0.6096
0.5613
0.5168
0.4759 0.4382
0.58 $ 0.56 $ 0.55 $ 0.53 $ 0.51 $ 0.49 $ 0.48 $ 0.46 $ 0.44
$ 11.63
$35.80
0.086
0
ke
Overvalued
Fairly valued
Undervalued
0.07
0.08
0.086
0.11
0.13
0.15
Sensitivity Analysis
g
0
0.02
0.04
0.06
$ 12.87 $ 15.77 $ 22.55 $ 56.44
$ 11.12 $ 13.05 $ 16.91 $ 28.49
$ 10.28 $ 11.82 $ 14.71 $ 22.04
$ 7.83 $ 8.54 $ 9.66 $ 11.67
$ 6.50 $ 6.91 $ 7.51 $ 8.44
$ 5.54 $ 5.79 $ 6.14 $ 6.64
0.08
$ 78.22
$ 16.37
$ 10.13
$ 7.42
0.1
$ 39.85
$ 14.06
$ 8.83
146
Free Cash Flow Model
Net Income
Dividends
Book value of equity
CFFO
CFFI
CFtA
Annual Free Cash Flow
PV Factor
PV of Free cash flows
Total PV of annual free cash flows
Continuing (terminal) value perpetuity
PV of terminal value perpetuity
Value of the Firm
Book Value of debt and preferred stock
Estimated Market Value of Equity
Number of shares
Estimated price per share
WACC
0.082
Kd
0.064
Keq
0.086
0
1
2
3
4
5
6
7
8
9
10
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
$
286,139 $ 297,546.97 $ 318,375.26 $ 340,661.53 $ 364,507.83 $ 390,023.38 $ 417,325.02 $ 446,537.77 $ 477,795.41 $ 511,241.09 $ 547,027.97
$
(75,840.00) $ (88,320.00) $ (93,840.00) $ (99,360.00) $ (104,880.00) $ (110,400.00) $ (115,920.00) $ (121,440.00) $ (126,960.00) $ (132,480.00) $ (138,000.00)
$ 1,802,912.00
$386,811
$413,888
$442,860
$473,860
$507,030
$542,523
$580,499
$621,134
$664,613
$711,136
($119,801)
($142,691)
($152,679)
($163,366)
($174,802)
($187,038)
($200,131)
($214,140)
($229,130)
($245,169)
$267,010
$271,197
$290,181
$310,494
$332,228
$355,484
$380,368
$406,994
$435,484
$465,967
$267,010
0.9242
$246,774
$271,197
0.8542
$231,649
$290,181
0.7894
$229,080
$310,494
0.7296
$226,539
$332,228
0.6743
$224,027
$355,484
0.6232
$221,542
$380,368
0.5760
$219,085
$406,994
0.5323
$216,656
$435,484
0.4920
$214,253
$465,967
0.4547
$211,877
$2,241,483
$ 2,583,860.88
$ 4,825,343.88
$
1,257,394
$ 3,567,949.88
138,000
$
25.85
WACCbt
WACC
observed share price
initial WACC
Perpetuity growth rate (g)
$35.80
0.082
0
Overvalued
Fairly valued
Undervalued
0.07
0.082
0.09
0.1
0.11
$
$
$
$
$
0
32.67
25.85
22.35
18.79
15.89
$
$
$
$
$
Sensitivity Analysis
Actual
g
0.02
0.04
42.47 $
65.36
31.89 $
43.69
26.88 $
35.03
22.04 $
27.46
18.30 $
22.07
$ 5,682,529.97
$
$
$
$
$
0.06
179.79
76.92
54.05
38.31
28.87
Goodwill adjusted earnings
WACC
Net Income
Dividends
Book value of equity
CFFO
CFFI
CFtA
Annual Free Cash Flow
PV Factor
PV of Free cash flows
Total PV of annual free cash flows
Continuing (terminal) value perpetuity
PV of terminal value perpetuity
Value of the Firm
Book Value of debt and preferred stock
Estimated Market Value of Equity
Number of shares
Estimated price per share
0.082
Kd
0.064
Keq
0.086
0
1
2
3
4
5
6
7
8
9
10
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
$
175,998 $
177,829 $
190,277 $
203,597 $
217,849 $
233,098 $
249,415 $
266,874 $
285,555 $
305,544 $
326,932
$
(75,840.00) $ (88,320.00) $ (93,840.00) $ (99,360.00) $ (104,880.00) $ (110,400.00) $ (115,920.00) $ (121,440.00) $ (126,960.00) $ (132,480.00) $ (138,000.00)
$ 1,802,912.00
$231,178
$247,361
$264,676
$283,203
$303,027
$324,239
$346,936
$371,221
$397,207
$425,011
($119,801)
($142,691)
($152,679)
($163,366)
($174,802)
($187,038)
($200,131)
($214,140)
($229,130)
($245,169)
$111,377
$104,670
$111,997
$119,837
$128,225
$137,201
$146,805
$157,081
$168,077
$179,843
$111,377
0.9242
$102,936
$111,997
0.7894
$88,415
$119,837
0.7296
$87,434
$128,225
0.6743
$86,464
$137,201
0.6232
$85,505
$146,805
0.5760
$84,557
$157,081
0.5323
$83,619
$168,077
0.4920
$82,692
$179,843
0.4547
$81,775
$872,804
$
997,254.54
$ 1,870,058.84
$
1,802,912
$
67,146.84
138,000
$
0.49
WACCbt
WACC
observed share price
initial WACC
Perpetuity growth rate (g)
$104,670
0.8542
$89,406
$35.80
0.082
0
Overvalued
Fairly valued
Undervalued
0.07 $
0.082 $
0.09
0.1
0.11
0
1.73 $
0.49 $
$
$
Sensitivity Analysis
Adjusted for Goodwill
g
0.02
0.04
5.12 $
13.02
2.82 $
7.37
1.72 $
5.11
0.66 $
3.12
$
1.71
$ 2,193,201.99
$
$
$
$
$
0.06
52.53
20.20
13.01
8.06
5.09
147
Residual Income Model
Change in RI
Net Income
Total Dividends
total BV Equity
cost of equity
Book value of equity change
Actual earnings
"Normal" (Benchmark) Earnings
Residual Income (Actual)
PV Factor
PV of Annual residual income
ROE
BV Equity
Total PV of annual residual income
Continuing (Terminal) value perpetuity
PV of terminal value perpetuity
Estimated Value
shares outstanding
Estimated Share Price
WACC
0.082
(12,356.27)
0
1
2
2006
2007
2008
$ 286,139.00 $ 297,546.97 $ 318,375.26
$ (75,840.00) $ (88,320.00) $ (93,840.00)
$ 1,802,912.00 $ 2,188,778.97 $ 2,600,994.23
0.086
21.40%
18.83%
$
$
$
$
$
$ 1,802,912.00
$ 569,738.91
297,546.97
155,050.43
142,496.54
0.9208
131,212.28
16.50%
gr
$
$
$
54
$ 2,372,704.42
138,000
$
17.19
observed share price
initial cost of equity
Perpetuity growth rate (g)
$
$
$
318,375.26
188,234.99
130,140.27
0.8479
110,344.84
14.55%
(0.12)
$
(13,164.24)
3
2009
$ 340,661.53
$ (99,360.00)
$ 3,041,015.75
Kd
$
(13,995.54)
4
2010
$ 364,507.83
$ (104,880.00)
$ 3,510,403.59
(14,851.81)
5
2011
$ 390,023.38
$ (110,400.00)
$ 4,010,826.97
0.064
(15,734.77)
6
2012
$ 417,325.02
$ (115,920.00)
$ 4,544,071.99
(16,646.32)
7
2013
$ 446,537.77
$ (121,440.00)
$ 5,112,049.75
Keq
$ (17,588.44)
8
2014
$ 477,795.41
$ (126,960.00)
$ 5,716,805.17
(18,563.29)
9
2015
$ 511,241.09
$ (132,480.00)
$ 6,360,526.26
0.086
(19,573.14)
10
2016
$ 547,027.97
$ (138,000.00)
$ 7,045,554.23
15.44%
14.26%
13.30%
12.50%
11.83%
11.26%
10.77%
16.92%
$
$
$
$
$
340,661.53
223,685.50
116,976.02
0.7807
91,328.72
13.10%
(0.10)
$
$
$
$
$
364,507.83
261,527.35
102,980.48
0.7189
74,034.75
11.99%
(0.08)
$
$
$
$
$
$
g
0.07
0.086
0.1
0.12
0.14
ke
Overvalued
Fairly valued
Undervalued
$35.80
0.086
-0.1
$
$
$
$
$
-0.1
22.56
17.19
13.59
9.72
6.92
$
$
$
$
$
390,023.38
301,894.71
88,128.67
0.6620
58,340.23
11.11%
(0.07)
$
$
$
$
$
$
417,325.02
344,931.12
72,393.90
0.6096
44,128.89
10.40%
(0.06)
Sensitivity Analysis
Actual
-0.2
-0.3
21.74 $
21.36
17.19 $
17.19
14.01 $
14.21
10.44 $
10.81
7.74 $
8.19
$
$
$
$
$
$
446,537.77
390,790.19
55,747.58
0.5613
31,290.84
9.83%
(0.06)
$
$
$
$
$
477,795.41
439,636.28
38,159.13
0.5168
19,722.41
9.35%
(0.05)
$
$
$
$
$
$
511,241.09
491,645.24
19,595.85
0.4759
9,326.00
8.94%
(0.04)
$
$
$
$
$
$
$
$
$
$
$
$
547,027.97
547,005.26
22.71
0.4382
9.95
8.60%
(0.04)
122.10
-0.4
21.15
17.19
14.34
11.04
8.47
Goodwill adjusted earnings
WACC
Change in RI
Net Income
Total Dividends
total BV Equity
cost of equity
Book value of equity change
Actual earnings
"Normal" (Benchmark) Earnings
Residual Income (Actual)
PV Factor
PV of Annual residual income
ROE
BV Equity (per share)
Total PV of annual residual income
Continuing (Terminal) value perpetuity
PV of terminal value perpetuity
Estimated Value
shares outstanding
Estimated Share Price
observed share price
initial cost of equity
Perpetuity growth rate (g)
0.082
(10,440.79)
0
1
2
2006
2007
2008
$ 175,997.80 $ 177,829.29 $ 190,277.34
$ (75,840.00) $ (88,320.00) $ (93,840.00)
$ 1,802,912.00 $ 2,069,061.29 $ 2,353,178.63
0.086
14.76%
13.73%
$
$
$
$
$
$ 1,802,912.00 gr
$ (155,124.95)
$
(227,953)
$ 1,419,833.81
138,000
$
10.29
$35.80
0.086
-0.1
177,829.29
155,050.43
22,778.86
0.9208
20,975.01
9.86%
$
$
$
$
$
190,277.34
177,939.27
12,338.07
0.8479
10,461.35
9.20%
(0.07)
$
(11,114.68)
3
2009
$ 203,596.75
$ (99,360.00)
$ 2,656,135.38
Kd
$
(11,802.51)
4
2010
$ 217,848.53
$ (104,880.00)
$ 2,978,863.91
(12,505.26)
5
2011
$ 233,097.92
$ (110,400.00)
$ 3,322,361.83
0.064
(13,223.97)
6
2012
$ 249,414.78
$ (115,920.00)
$ 3,687,696.61
(13,959.76)
7
2013
$ 266,873.81
$ (121,440.00)
$ 4,076,010.42
Keq
$ (14,713.82)
8
2014
$ 285,554.98
$ (126,960.00)
$ 4,488,525.40
(15,487.44)
9
2015
$ 305,543.83
$ (132,480.00)
$ 4,926,549.23
0.086
(16,281.98)
10
2016
$ 326,931.90
$ (138,000.00)
$ 5,391,481.13
12.15%
11.53%
11.00%
10.53%
10.12%
9.76%
9.44%
12.87%
$
$
$
$
$
203,596.75
202,373.36
1,223.39
0.7807
955.16
8.65%
(0.06)
$
$
$
$
$
217,848.53
228,427.64
(10,579.12)
0.7189
(7,605.54)
8.20%
(0.05)
$
$
$
$
$
233,097.92
256,182.30
(23,084.37)
0.6620
(15,281.60)
7.83%
(0.05)
$
$
$
$
$
Sensitivity Analysis
Goodwill adjusted earnings
-0.2
-0.3
14.01 $
14.08
10.87 $
11.14
8.67 $
9.06
6.23 $
6.68
4.39 $
4.87
$
g
ke
Overvalued
Fairly valued
Undervalued
0.07
0.086
0.1
0.12
0.14
$
$
$
$
$
-0.1
13.87
10.29
7.90
5.35
3.53
$
$
$
$
$
$
249,414.78
285,723.12
(36,308.34)
0.6096
(22,132.35)
7.51%
(0.04)
$
$
$
$
$
$
266,873.81
317,141.91
(50,268.10)
0.5613
(28,215.23)
7.24%
(0.04)
$
$
$
$
$
285,554.98
350,536.90
(64,981.92)
0.5168
(33,585.66)
7.01%
(0.03)
$
$
$
$
$
$
305,543.83
386,013.18
(80,469.36)
0.4759
(38,296.77)
6.81%
(0.03)
$
$
$
$
$
$
326,931.90
423,683.23
(96,751.34)
0.4382
(42,399.30)
6.64%
(0.03)
$ (520,168.48)
$
$
$
$
$
-0.4
14.12
11.31
9.29
6.97
5.17
148
Long Run Residual Income Model
BV equity $ 1,802,912.00
Ke
8.60%
ROE
11.44%
BV equity g
14.65% ROE
PPS
$ 956,586.37
Shares out
138,000
PPS
$
6.93
0.11
0.05 $ 32.66
0.07 $ 21.77
0.09 $ 10.89
0.1144
0.13
0.12
$ 47.57
$ 37.71
$ 27.85
$ 15.83
$ 8.13
0.14
$ 193.96
$ 153.76
$ 113.56
$ 64.52
$ 33.16
0.13
0.07
$ 3.40
0.086
$ 4.63
0.1
$ 6.79
0.12 $ 5.75 $ 20.38
0.14 $ 1.92
g
0.1465
$ 5.48
$ 6.93
$ 9.02
$ 15.83
$ 64.52
0.17
$ 7.26
$ 8.65
$ 10.38
$ 14.53
$ 24.21
0.19
8.23
9.50
10.97
14.11
19.75
0.11
Ke
$
$
$
$
$
0.19
17.59
15.07
12.56
9.50
7.54
Ke
0.1
$ 27.11
$ 21.49
$ 15.87
$ 9.02
$ 4.64
0.07
$ 16.48
$ 13.06
$ 9.65
$ 5.48
$ 2.82
Sensitivity Analysis
Goodwill adjusted earnings
0.08
0.1 0.1159
0.14
$ 37.33 $ 24.43 $ 19.35
$ 19.69 $ 16.17 $ 14.78
$ 43.55
$ 6.95 $ 9.68
$ 87.10
$ 4.84
$ 130.65
g
0.086
$ 20.84
$ 16.52
$ 12.20
$ 6.93
$ 3.56
0.05
0.07
ROE 0.09
0.1144
0.13
Overvalued
Fairly valued
Undervalued
Sensitivity Analysis
g
0.13 0.1465
0.17
$ 23.75 $ 20.84 $ 18.66
$ 17.82 $ 16.52 $ 15.55
$ 11.88 $ 12.20 $ 12.44
$ 4.63 $ 6.93 $ 8.65
$ 3.56 $ 6.22
$
$
$
$
$
0.06
0.0789
ROE
0.1
0.12
0.14
0.16
$ 17.65
$ 14.32
$ 10.59
$ 7.06
$ 3.53
Ke
0.07 0.086
0.1
0.12
0.14
0.06 $ 15.91 $ 24.43 $ 45.93
0.0789 $ 10.53 $ 16.17 $ 30.40
ROE
0.1 $ 4.53 $ 6.95 $ 13.06
0.12
$ 13.06 $ 2.22
0.14
$ 76.79 $ 13.06
Ke
g
0.08
0.1 0.1159
0.14
0.07 $ 1.44 $ 9.19 $ 10.53 $ 11.40
0.086
$ 19.69 $ 16.17 $ 14.78
0.1
$ 30.40 $ 19.96
0.12
$ 39.91
0.14
BV equity $ 1,802,912.00
Ke
8.60%
ROE
7.89%
BV equity g
11.59%
PPS
$ 2,231,028.23
Shares out
138,000
PPS
$
16.17
0.16
$ 11.77
$ 14.32
$ 17.66 Overvalued
$ 26.49 Fairly valued
$ 52.98 Undervalued
149
Abnormal Earnings Growth (AEG) Model
Net Income
Total Dividends
DPS invested at .08 (drip)
Cum-dividend Earnings
Normal earnings
Abnormal Earnings Growth (AEG)
PV Factor
PV of AEG
Residual Income Check figure
WACC
$
$
2006
286,139.00 $
(75,840.00) $
Core earnings
Total PV of AEG
Continuing (Terminal) value
PV of terminal value
Total PV of AEG
Total average EPS Perp (t+1)
Capitalization Rate (perpetuity)
Intrinsic Value
shares outstanding
Intrinsic Value per share
$
$
0.082
0
1
2007
2008
297,546.97 $ 318,375.26
(88,320.00) $ (93,840.00)
$ (7,595.52)
$ 310,779.74
$ 323,136.01
$ (12,356.27)
0.9208
$ (11,377.78)
$ (12,356.27)
Kd
2
2009
$ 340,661.53
$ (99,360.00)
$ (8,070.24)
$ 332,591.29
$ 345,755.53
$ (13,164.24)
0.8479
$ (11,161.85)
$ (13,164.24)
3
2010
$ 364,507.83
$ (104,880.00)
$ (8,544.96)
$ 355,962.87
$ 369,958.42
$ (13,995.54)
0.7807
$ (10,926.98)
$ (13,995.54)
4
2011
$ 390,023.38
$ (110,400.00)
$ (9,019.68)
$ 381,003.70
$ 395,855.51
$ (14,851.81)
0.7189
$ (10,677.26)
$ (14,851.81)
0.064
5
2012
$ 417,325.02
$ (115,920.00)
$ (9,494.40)
$ 407,830.62
$ 423,565.39
$ (15,734.77)
0.6620
$ (10,416.25)
$ (15,734.77)
Keq
6
2013
$ 446,537.77
$ (121,440.00)
$ (9,969.12)
$ 436,568.65
$ 453,214.97
$ (16,646.32)
0.6096
$ (10,147.04)
$ (16,646.32)
7
2014
$ 477,795.41
$ (126,960.00)
$ (10,443.84)
$ 467,351.57
$ 484,940.02
$ (17,588.44)
0.5613
$ (9,872.31)
$ (17,588.44)
8
2015
$ 511,241.09
$ (132,480.00)
$ (10,918.56)
$ 500,322.53
$ 518,885.82
$ (18,563.29)
0.5168
$ (9,594.37)
$ (18,563.29)
0.086
9
2016
$ 547,027.97
$ (138,000.00)
$ (11,393.28)
$ 535,634.69
$ 555,207.83
$ (19,573.14)
0.4759
$ (9,315.20)
$ (19,573.14)
297,546.97
(93,489.04)
$ (85,109.81)
$ (40,505.24)
$ (133,994.28)
$ 163,552.69
0.086
$ 1,901,775.47
138,000
$
13.78
Nov. 1 observed price
Ke
g
$
Actual price per share
$
35.80
0.086
-0.1
ke
35.80
0.07
0.086
0.1
0.12
0.14
$
$
$
$
$
-0.1
23.15
13.78
8.83
4.54
2.06
$
$
$
$
$
Sensitivity Analysis
g
-0.2
-0.3
24.09 $
24.53
14.97 $
15.55
10.00 $
10.59
5.56 $
6.09
2.90 $
3.36
$
$
$
$
$
-0.4
24.78
15.89
10.94 Overvalued
6.42 Fairly valued
3.65 Undervalued
Goodwill adjusted earnings
WACC
Net Income
Total Dividends
DPS invested at .08 (drip)
Cum-dividend Earnings
Normal earnings
Abnormal Earnings Growth (AEG)
PV Factor
PV of AEG
Residual Income Check figure
$
$
2006
175,997.80 $
(75,840.00) $
Core earnings
Total PV of AEG
Continuing (Terminal) value
PV of terminal value
Total PV of AEG
Total average EPS Perp (t+1)
Capitalization Rate (perpetuity)
Intrinsic Value
shares outstanding
Intrinsic Value per share
$
$
0.082
0
1
2007
2008
177,829.29 $ 190,277.34
(88,320.00) $ (93,840.00)
$ (7,595.52)
$ 182,681.82
$ 193,122.61
$ (10,440.79)
0.9208
$ (9,613.99)
$ (10,440.79)
177,829.29
(78,518.91)
$ (33,982.38)
$ (112,501.28)
$
65,328.01
0.086
$ 759,627.98
138,000
$
5.50
Nov. 1 observed price
Ke
g
$
35.80
0.086
-0.1
Actual price per share
$
35.80
ke
Kd
2
2009
$ 203,596.75
$ (99,360.00)
$ (8,070.24)
$ 195,526.51
$ 206,641.19
$ (11,114.68)
0.8479
$ (9,424.04)
$ (11,114.68)
3
2010
$ 217,848.53
$ (104,880.00)
$ (8,544.96)
$ 209,303.57
$ 221,106.07
$ (11,802.51)
0.7807
$ (9,214.78)
$ (11,802.51)
4
2011
$ 233,097.92
$ (110,400.00)
$ (9,019.68)
$ 224,078.24
$ 236,583.50
$ (12,505.26)
0.7189
$ (8,990.28)
$ (12,505.26)
Sensitivity Analysis
A djusted for goodwill
g
-0.1
0.07 $
10.75 $
0.086 $
5.50 $
0.1 $
2.80 $
0.12 $
0.53 $
0.14
0.064
5
2012
$ 249,414.78
$ (115,920.00)
$ (9,494.40)
$ 239,920.38
$ 253,144.34
$ (13,223.97)
0.6620
$ (8,754.12)
$ (13,223.97)
Keq
6
2013
$ 266,873.81
$ (121,440.00)
$ (9,969.12)
$ 256,904.69
$ 270,864.45
$ (13,959.76)
0.6096
$ (8,509.40)
$ (13,959.76)
7
2014
$ 285,554.98
$ (126,960.00)
$ (10,443.84)
$ 275,111.14
$ 289,824.96
$ (14,713.82)
0.5613
$ (8,258.80)
$ (14,713.82)
8
2015
$ 305,543.83
$ (132,480.00)
$ (10,918.56)
$ 294,625.27
$ 310,112.71
$ (15,487.44)
0.5168
$ (8,004.63)
$ (15,487.44)
0.086
9
2016
$ 326,931.90
$ (138,000.00)
$ (11,393.28)
$ 315,538.62
$ 331,820.60
$ (16,281.98)
0.4759
$ (7,748.88)
$ (16,281.98)
$ (71,403.94)
-0.2
11.70
6.51
3.73
1.31
$
$
$
$
$
-0.3
12.14
6.99
4.19
1.71
0.26
$
$
$
$
$
-0.4
12.39
7.27
4.47 Overvalued
1.96 Fairly valued
0.47 Undervalued
150
References
1. www.hormel.com
2. www.conagrafoods.com
3. www.smithfieldfoods.com
4. www.tyson.com
5. www.edgarscan.pwcglobal.com
6. www.finance.yahoo.com
7. www.moneycentral.msn.com
8. www.hoovers.com
9. www.brs-inc.com/porter.asp
10.
Business Analysis and Valuation, Using Financial Statements, Palepu
& Healy
11.
Hormel 10-k
12.
Tyson 10-k
13.
Smithfield 10-k
14.
ConAgra 10-k
15.
www.investopedia.com
151