Prospective Analysis And Application
Forecasting
Sales and other ratios of the company have been forecasted for a period of 5 years. The actual year upon which the estimators calculated is 2016. In this case the discounted growth rate has been calculated for the historic data from 2013-2017. Sales, income ratios and many others ratio has been forecasted in order to observe the health of the company in future periods. Refer to appendix table number for the calculations that has been carried out for forecasting the future periods. The sales will be increasing in 15% on average every year. The ATO is increasing at seven percent on average every year. The net operating profit after tax is at a rate of fifteen percent per year. In the historic data the PM of the company was wobbly but after the new reforms and the new product launched the company has been estimated to maintain constant growth rate of 16.33% (API, 2018b).
In the initial calculation of the financial ratios of the historic data was used for the calculation. During the forecast the average growth rates discounted to all historic period has been utilised as the estimate to calculate the future financial ratios of the company. The growth rate has been discounted on the basis of total years for the historical data four years. This factor is then added to previous year growth rate.
The present price of API in the Australian stock exchange is one dollar and sixty-five cents. The present research has used various valuation models to estimate the price of the share and check whether the stock is undervalued or overvalued. If the estimate of the stock is above the marketable price then the stock is undervalued, while when the estimate is lower than the actual price then the stock is termed as overvalued. Investors usually sell away the overvalued stocks while buys undervalued stock. Investors tend to do this because the stocks which are undervalued have the potential to grow in the future. With time the demand of such stocks increases, which increases the stock price. Soon the stock becomes overvalued and this lowers the price of the stock by increasing its supply. Thus it can be inferred that investors are sceptic towards overvalued stocks. Investors use different valuation models for valuing the stocks. Presently four valuation models have been used, the four valuation model are dividend discount model (DDM), residual income model (RIM), residual operating income model (ROIM) and free cash flow model (FCFM). The data mining was conducted from the last five annual reports of the company available on its website that is from 2016-17 to 2013-14 (API, 2018a).
Valuation
DDM is the basic valuation model that is used to value a firm’s stock. The theory behind this model is that the stock is worth of its entire future dividend payments, discounted to their present value. The formula can be written down as P = D? (1+g)/(r-g) (Mehta and Shah, 2018; Penman, 1998; Penman and Sougiannis, 1998.). Here P stands for the price of the stock, D? represents the initial dividend payment made by the firm, g is termed as the constant growth rate of the dividends and r is the desired rate of return. The basic assumption of this model is that dividends grow at a constant growth rate throughout its life.
In case for API the DDM is not the best suited model to derive the price of the stock. This is because the growth rate of the dividend (19%) is much higher than the desired growth rate of the stock (API, 2018b; API, 2017; API, 2016; API, 2015; API, 2014). As the investors want to cover up their expense of equity, that is why it has been assumed that the cost of equity is the desired rate of return. In this case the cost of equity for the investors is 8.55%. Observing the rates it can be inferred that r is lesser than g (r<g). Therefore, the denominator of the ratio becomes negative and an infinite value is obtained as the result of this ratio, which is not at all desirable (Ibrahim, Topowijono and Nurlaily, 2018). Moreover, in case for API the dividend growth rate is not constant throughout the time period, this is another reason that makes DDM unsuitable for the stock valuation of API.
It is another approach of valuating the stocks of a company. The term residual denotes the excess opportunity cost which is measured in relation to the book value of shareholders’ equity (Kaszas and Janda, 2018). This approach is similar to the model of economic value added. Thus residual income is the level by which the firm has outperformed the expectations of the investors. Thus the residual income is calculated by subtracting the shareholders’ funds from the gross profit of the firm (Bergeron, Gueyie and Sedzro, 2018). The present value of the residual income is calculated and this reveals the expected price of the stock (Saleh, 2017).
In this case also the cost of equity has been assumed as the expected rate of return for the investors. According to this method, the stock price of API happened to be ninety-three Australian cents. The present market value of the stock is one Australian dollar and sixty-five cents. Thus it can be evaluated that stock is overvalued in this period. Thus it better for the investor to sell this particular stock right now.
Sensitivity Analysis
It is another method of valuating the stocks of a firm, it also analyses the sensitivity of the core assumptions that has been used in other models (Hand, Coyne, Green and Zhang, 2017). It is calculated by deducting the weighted average cost of capital times the net operating assets of the earlier period from the net operating profit after tax.
It is another process of evaluating businesses or projects. The underlying assumption in this case is that, the value of the stock or the business is equal to the present value of the free cash flow generated by the company (Bian, et al, 2018). The free cash flow of the company can be calculated by using three different approaches.
In this case the free cash flow of API has been calculated through the earnings before interest and tax (EBIT) approach (Kadioglu, Kilic and Yilmaz, 2017). In this case the stock has been undervalued from its estimate. According to the model the price of the stock should be two dollar and ten cents. The problem in this approach was that the company did not disclose their depreciation rate on their assets (Olsson and Levin, 2015). This can be the prime reason for such high stock value.
Thus all the four models are showing the value of the stock in between one dollar to two dollar. Thus the investors in turmoil position, where they cannot decide whether to keep the stock or sell it. Thus the nature of the investors will lead them to focus on the on the value derived from these models. The investors who are of risk-averse will focus on the value derived from RIM and will try to sell their stocks at this present moment, as they can some capital gain by selling the stocks in this present period. The investors those are optimistic or risk lovers will focus on the value derived from FCFE model. They will wait for the stocks to rise above the expected value in the future and then the investors will sell their stocks for achieving higher capital gain.
ROIM has been used for evaluate the sensitive test on the three valuation models used for valuing the stocks of API. Valuing models have appropriated the discount rate that has been taken as the average growth rate of ratios (Hakim and Sugianto, 2018). Investors would like to cover the cost they have paid to own the equity that is expense of equity, which leads to the assumption that the cost of equity is the desired rate of return. In residual model it is assumed that the income is calculated by subtracting the shareholders’ funds from the gross profit of the firm gives the residual expectation of the shareholders that has either fulfilled or missed. The underlying assumption in the case for free cash flow model is that, the value of the stock or the business is equal to the present value of the free cash flow generated by the company. Free cash flow considers all the liquid assets that is available to any company, thus it can treated as the indicator of the stock value of a firm. The free cash flow has been discounted in order to calculate the present value of the cash flow. All these assumptions of different models has been tested by sensitivity analysis.
Management Consulting Advice
API is in the health care industry, and healthcare industry is one of the fastest growing industries in the world, which is something around seventy-six percent (Martin, Josephson, Vadakkepatt and Johnson, 2018). Thus the company has also very high potential to grow in the future. The company has pretty firm financial pillars. The ROE of the company after receiving the jolt in 2015, it has steadily increased and is maintaining its levels in the present state too. The ATO of the company has kept a constant increase throughout the time period. The PM of the company is also increasing with time. The company is also increasing their storage houses and also their distribution process but this is not getting reflected in their profit margin because the expense for maintaining these extra services is taking a heavy toll on the company (Gereffi, 2017). Thus the company is efficient in turning their operations into profits at the end of every year.
So, it is advisable to increase the efficiency in maintaining their inventories and other distribution systems. Moreover the company should focus on developing their products that is the company needs to invest in their research and development department. Otherwise the company can also increase its product base to medical consumables like syringes or surgical cotton etc. Developing new products will create a roar in the market which will help the stock prices to rise, this way the company increase their return on equity to another level.
Moreover, the company only utilizes debt funds or ordinary shares to raise capital. The company is not venturing into other capital mobilizing techniques that incur low cost. The company enter into option trading. The company should issue other forms of equities like convertible share, preference shares (Pilon and Hadjielias, 2017). This type of shares is more volatile and requires less cost on the parts of the investor. This is another way to increase their earrings.
In order to increase their efficiency performance tests should be conducted and amendments should be conducted wherever is possible. The growth in the liquidity ratio is delivering positive vibes to the investors; this is the reason for the increase in number of shareholders of the company every year. But the efficiency in the operation management is not increasing, which is evident from the increase in warehouse maintenance cost due to increase in inventories. Thus the company should follow just in delivery system. This system is less wasteful, and lowers the inventory concentration in the warehouses. This will lower the cost and increase the efficiency of the company. This increase in efficiency will eventually get reflected in the profit margin of the company and also in the dividend.
Overall Report Quality
Reference list
API, 2014. Annual Report. [online] Available at <https://www.api.net.au/wp-content/uploads/2015/10/2014-Annual-report.pdf> [Accessed 8 October 2018]
API, 2015. Annual Report. [online] Available at <https://www.api.net.au/wp-content/uploads/2015/12/5-Final-ASX-API-Annual-Report-2015-4-Dec-2015.pdf> [Accessed 8 October 2018]
API, 2016. Annual Report. [online] Available at <https://www.api.net.au/wp-content/uploads/2016/12/FINAL-API-Annual-Report-2016-web-ready.pdf> [Accessed 8 October 2018]
API, 2017. Annual Report. [online] Available at <https://www.api.net.au/wp-content/uploads/2017/12/3-API-Annual-Report-2017.pdf> [Accessed 8 October 2018]
API, 2018a. Annual Reports – API. [online] Available at <https://www.api.net.au/investor/annual-reports/ > [Accessed 8 October 2018]
API, 2018b. [online] Available at <https://www.api.net.au/wp-content/uploads/2015/10/2013-Annual-report.pdf> [Accessed 8 October 2018]
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