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2012
Contents
1) EXECUTIVE SUMMARY ....................................................................................................... 4 COMPANY & INDUSTRY ANALYSIS ......................................................................................................................... 4 FINANCIAL ANALYSIS ......................................................................................................................................... 4 ACCOUNTING ANALYSIS ..................................................................................................................................... 4 VALUATION & RECOMMENDATION ....................................................................................................................... 4 2) ECONOMIC ENVIRONMENT ............................................................................................... 5 2.1) 3) IN CONTEXT: THE UK PROPERTY MARKET ................................................................................................. 5
INDUSTRY ANALYSIS .......................................................................................................... 6 3.1) 3.2) 3.3) 3.4) UK HOUSE BUILDING INDUSTRY PERFORMANCE ......................................................................................... 6 AFFORDABLE HOUSING: ROBUST FOR INDUSTRY VOLUMES............................................................................ 7 TRENDS IN THE NEW BUILD INDUSTRY ...................................................................................................... 8 HOUSE BUILDING INDUSTRY STRUCTURE AND ANALYSIS................................................................................ 9
4)
BUSINESS ANALYSIS ......................................................................................................... 11 4.1) 4.2) 4.3) STRATEGY ANALYSIS .......................................................................................................................... 11 COMPETITIVE POSITIONING ................................................................................................................. 12 SOCIAL HOUSING MIX ........................................................................................................................ 12
5) 6)
SWOT ANALYSIS .............................................................................................................. 13 ACCOUNTING ANALYSIS .................................................................................................. 14 6.1) 6.2) 6.3) 6.4) INTANGIBLE ASSETS ........................................................................................................................... 14 INVENTORIES ................................................................................................................................... 15 REVENUE RECOGNITION ...................................................................................................................... 15 FORWARD CURRENCY SWAPS .............................................................................................................. 16
7)
FINANCIAL ANALYSIS ....................................................................................................... 17 7.1) 7.2) 7.3) 7.4) GROWTH ........................................................................................................................................ 17 PROFITABILITY .................................................................................................................................. 19 WORKING CAPITAL MANAGEMENT ....................................................................................................... 21 COMMON SIZE ANALYSIS ..................................................................................................................... 22
8)
FORECASTING .................................................................................................................. 23 8.1) 8.2) 8.3) 8.4) MACROECONOMIC AND INDUSTRY FACTORS ............................................................................................ 23 INDUSTRY CRITERIA ........................................................................................................................... 25 FORECASTING ASSUMPTIONS: .............................................................................................................. 26 TERMINAL PERIOD ASSUMPTION: ......................................................................................................... 26
9)
VALUATION ..................................................................................................................... 28 9.1) 9.2) VALUATION MODEL CHOSEN ............................................................................................................... 28 SENSITIVITY ANALYSIS ......................................................................................................................... 29
10) 11)
INVESTMENT RECOMMENDATION .................................................................................. 31 APPENDICES: ................................................................................................................... 32 APPENDIX 1: STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER 2011( M) ............................................. 32 APPENDIX 2: CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 2011(M) 33
11.1) 11.2)
11.3) 11.4) 11.5) 11.6) 11.7) 11.8) 11.9) 11.10) 11.11) 11.12) 11.13) 11.14) 11.15) 11.16) 11.17) 11.18) 11.19) 12) 13)
APPENDIX 3: CONSOLIDATED CASH FLOW STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2011(M) ................ 34 APPENDIX 4: CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2011(M) .. 36 APPENDIX 5: REFORMULATE BALANCE SHEET (M) ................................................................................... 40 APPENDIX 6: REFORMULATED INCOME STATEMENT (M) ........................................................................... 41 APPENDIX 7: COMMON SIZE ANALYSIS OF INCOME STATEMENT VERTICAL..................................................... 43 APPENDIX 8: COMMON SIZE ANALYSIS OF INCOME STATEMENT HORIZONTAL ................................................ 45 APPENDIX 9: COMMON SIZE ANALYSIS OF BALANCE SHEET VERTICAL ........................................................... 47 APPENDIX 10: COMMON SIZE ANALYSIS OF BALANCE SHEET HORIZONTAL ................................................ 48 APPENDIX 11: RATIO ANALYSIS ........................................................................................................ 49 APPENDIX 12: FORECASTING ASSUMPTIONS ........................................................................................ 51 APPENDIX 13: PRO FORMA FINANCIAL STATEMENTS (IN MILLIONS) ......................................................... 53 APPENDIX 14: VALUATION ESSENTIALS: ............................................................................................. 55 APPENDIX 15: VALUATION ASSUMPTIONS: ......................................................................................... 56 APPENDIX 16: VALUATION CASH FLOW BASED MODELS ....................................................................... 57 APPENDIX 17: VALUATION RESIDUAL EARNINGS MODELS: ................................................................... 59 APPENDIX 18: VALUATION ABNORMAL EARNINGS MODELS: ................................................................ 61 APPENDIX 19: MULTIPLES VALUATION ............................................................................................... 62
Executive Summary
1) Executive Summary
Company & Industry Analysis
Whilst the new build market for private homes has contracted sharply, the affordable homes segment has demonstrated significant growth in recent years. The UKs ongoing shortage of housing, rising population and shrinking household size presents a positive long term picture for house builders, though exposure to the European debt crisis continues to dampen short term market prospects. Persimmon has seen a significant shift in its market share and dominant position since 2007. Following the financial crisis, the UKs third largest house builder has struggled to deliver output volumes similar to that of its peers. A healthy landbank and strong cost management strategies have positioned the company relatively well for an upward turn in the market.
Accounting Analysis
According to or research, we found that intangible assets, inventories, revenue recognition, and forward currency swaps are crucial in Persimmons financial statements. The policies of these accounts provide Persimmon a huge space of flexibility, especially in estimating NRV and testing impairments.
Financial Analysis
Persimmon demonstrates both good growth and profitability. Since 2007, Persimmon has weathered the financial crisis though relatively poorly, compared to its peers. In 2010 the sales showed a 10.5% growth, whilst the European sovereign debt crisis 2011 saw a 2.2% contraction in revenue. In comparison to one of its major peers, Taylor Wimpey, Persimmon has a higher return on equity (6.5%). When considering working capital management, Persimmon has more favourable inventory holding periods and account receivable periods. Persimmon has considerably reduced its financial liabilities in the past three years, which has cut financial costs and positioned itself well to secure cheap debt in the future.
Executive Summary
2) Economic Environment
2.1) In Context: the UK Property Market
The UK property market is inextricably linked to the health of the wider economy, the financial markets and consumer confidence1. Rising incomes increase demand, house prices and stimulate the construction industry. Whilst over the past decade, the housing industry has contributed significantly to the health of the UKs economy: accounting for roughly 3% the total GDP. This intricate connection between the economy and the housing market makes it highly volatile and difficult to predict. Following the 2007 financial crisis, the UK property market took a significant downturn. From 2007 to 2010, the number of property sales in England and Wales almost halved to 650,000 (Figure 1), with areas in the North, Midlands and Wales seeing the greatest reduction in volume. At the same time, the share of home occupiers renting their property increased substantially (from 31% in 2006 to currently 35% of all dwellings rented). As Figure 1 shows, real house prices in the UK roughly doubled from the turn of the millennium to the 2007 financial crisis. Since then prices have fallen by 20%, from a high of 210,000 to a current low of 168,000. UK interest rates have remained at record lows during this period (0.5%) which has helped limit the extent of the housing crash2. Prices of New Homes In the two years following the 2007 financial crisis, the average price of a new build home crashed by 20% to 187,000. The market has since recovered slightly, but prices are still 15% lower than 2007 levels and remain below average prices for the existing housing stock, for the first time in 20 years.
1,400,000 1,200,000 1,000,000 Total Sales 800,000 600,000 400,000 200,000 0
1998
1996
2000
2002
2004
2006
2008
This sharp decline in prices has had a significant effect on the UKs house builders ability to operate in profit in recent years..
House Price (000's) 250 200 70% 50% 30% 10% 1996 1999 2002 2005 2008 -10% 2011
150
100 50 0 1993
Industry Analysis
2010
3) Industry Analysis
3.1) UK House Building Industry Performance
The UK new build housing market took a significant downturn following the 2007 financial crisis. New housing completions have decreased 38% since 2006 to just 135,000 in 2010. As expected in such difficult conditions, this drop in volume was reflected by a reduction in house builders revenue: the combined turnover of the 20 largest house builders has fallen by 32% since 2009 4.
250,000 200,000 Number 150,000 of Homes Built 100,000 50,000 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Social Private
-38% on 2006
Figure 3 Number of New Dwellings Built in UK The decline in industry output since 2007 was caused by the UKs falling demand for new homes . This was a result of tightening credit conditions and a lack of mortgage availability, as illustrated by Figure 4.
1,500 Mortgage 1,000 Loans (Thousands) 500 0 2000 2002 2004 Loans 2006 2008 2010 Average price () 300,000 250,000 200,000 Average Mortgage 150,000 Value 100,000 () 50,000 0
Figure 4: UK Mortgage Lending Volume and Average Price As seen above, the volume of mortgage loans approved halved following the economic crisis. Existing mortgage holders stopped moving house and the tightening of credit conditions reduced the number of first time buyers, who constitute approximately a third of the new build industrys customers. Over the past decade, they have been priced out of an increasingly expensive market, seeing their share of the mortgage market fall from 50% of all loans to 38% in 2011. As a result there has been a significant shortage of affordable housing throughout the UK in recent years.
Industry Analysis
Such governmental support has driven growth in the affordable market. Unofficial targets aim to deliver 170,000 new homes from 2011 2015. If met, this will maintain the current industry output for the next 5 years. Affordable housing remains a critical issue on the political agenda and will continue to form a revenue foundation for many of the UKs house builders.
Industry Analysis
20%
37%
20%
2001
2003 Terraced/Other
2005 Detached/Semi
2007 Flat
2009
2011
Geographic Variation House building in the North has significantly declined in recent years to a 20% share of new housing completions. The South & London now account for 50% of the new build market and 43% of the affordable homes market. These areas have received 870m of government investment for affordable housing since July 2011, more than double the 370 received in the North & Yorkshire areas. Environmental Expectations Government law stipulates any home built after 2016 must comply with the Carbon Neutral level 6 of the Code for Sustainable Homes (CSH). Prototype homes to this standard currently incur a 175,000 build premium, more than double the cost of a normal home (RuralZed6). Technically and financially unviable on a large scale, industry experts (Jon Ward, Chris Trott, Arup) expect its legal enforcement in 2016 is unlikely. For house builders however, sustainability continues to climb higher on the agenda and developing capabilities now remains key.
Industry Analysis
70%
10.9bn
of the total revenue generated by the top 20 largest house builders came from 5 firms (by decreasing market share): Taylor Wimpey, Barratt, Persimmon, Bellway and Berkley.
Figure 5: Division of the top 20 house builders revenue Threat from Potential Entrants To the established tier one firms, there is a minimal threat of new entrants to the marketplace. Extremely high capital costs form a significant barrier to entry (land bank acquisition, planning costs, design costs, high overheads and construction). Manpower, plant and equipment requirements also limit the scope for entry. Further barriers include limited operations without a strong track record (acquiring planning permission, health and safety issues etc.). Environmental Entrants As sustainability requirements for new homes increase (towards 2016), the threat from new entrants with strong environmental capabilities will rise. Entry barriers may be lowered for these firms: through government subsidies; tax breaks; or lighter planning regulations for new, sustainable homes. If established players are under-qualified to meet standards, they risk losing their market position. House Builder Rivalry Competitive rivalry between established, major house builders is high. Brand strength and reputation is a key driver of sales (after price). As affordable housing opportunities offer a lifeline from a sluggish private market, rivalry will increase. Securing government backed mortgages will be a key area of competition between the top three firms (Taylor Wimpey, Barratt and Persimmon). All three firms showed 5% deposit offers on the front page of their websites. For smaller firms, rivalry for government investment has increased (e.g. the 420m Get Britain Building fund was three times oversubscribed). Homeowner Bargaining Power Individual customers purchasing a single dwelling have little or no bargaining power (geographically varies) as there is currently a shortage of supply. Housing associations or multiple-property landlords have a stronger position with greater purchasing power. Government bodies tending contracts for high volume social developments hold the strongest position.
Industry Analysis
Bargaining Power of Construction Contractors Suppliers generally have very low bargaining power. Most home builders contract a variety of companies on an individual development basis. A diverse use of contractors maintains a highly competitive market with multiple firms bidding to provide services. Bargaining Power of Other Suppliers Expert environmental, legal and architectural consultants have higher bargaining power as delays in construction quickly eat away at margins: however they represent a small proportion of build cost. Subsidised Competition to the House Building Industry The conversion of vacant properties into new dwellings represents the largest substitute to the industry. Around 3% of the UKs housing stock (730,000 homes) stand vacant. Government programmes (100m Empty Homes and 50m Clusters of Empty Homes) are driving for more conversions to address the housing shortage. In the long term, growth of the prefabricated (factory built) housing sector represents a slight threat, but remains an immature market. Market Risk Exposure to risks, beyond the economic factors affecting the price and demand of the exisiting housing stock, include: Shortage of land supply: house builders face increasing compeition to secure land with residential planning permission at viable prices Regulatory risk: environmental, planning and health and safety legislation can cause significant delays in land development, incuring significant costs Capital access: as a capital intensive industry, exposure to capital markets remains high Reputational risk: a serious product failure, resulting in injury or significant environmental damage could be terminal for a house builder, should their brands reputation be damanged significantly
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Industry Analysis
4) Business Analysis
Persimmon Plc. is the currently third largest home builder in the UK by annual revenue and annual completions. Persimmon owns three distinct subsidiaries: Persimmon Homes, Charles Church and Westbury Partnerships. Across these brands it delivers a variety of private and social housing: from single bed affordable flats to large, premium family homes. It firmly established itself as a major player when floated on the London Stock Exchange in 1985 and has developed a dominant position through large acquisitions in 1996, 2001 and 2006.
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Business Analysis
8,000 10,000 12,000 14,000 16,000 18,000 Homes Sold Barratt Barratt '07 Bellway Berkeley
Figure 6: Revenue, Volume and Average House Prices of the 5 largest house builders (tier one) From 2007 2010 Persimmons market share fell from 7% to 4%, of a market that contracted by 46%. Figure 8 illustrates a 65% fall in Persimmons completions, far beyond its 4 major competitors, who have seen their sales volume decline by only 29% on average.
Barratt
23%
Taylor Wimpy
12
Barratt
Completions
Business Analysis
5) SWOT Analysis
Strengths
Healthy landbank (6.5yrs) Very low debt Good cost leadership through divisional structure Combined strength of Charles Church and Persimmon brands Strong beta (1.1) compared to rivals (>2)
Weaknesses
Dependent on contracting private market Geographically skewed, not capitalising on growing southern markets. Poor apparent application of sustainable build techniques Seeming lack of appetite for large affordable housing projects
Opportunities
Space4 subsidiary demonstrating strong, consistent growth in a rapidly expanding market Achieved largest FirstBuy allocation of any house builder Good strategic landbank position
Threats
General market contraction Falling house prices Reputational threats, numerous court cases and health & safety failures in recent years Lost significant market share in 3 years Performance in recession considerably worse than peers
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Business Analysis
6) Accounting analysis
Evaluating a companys accounting treatments is the first step in understanding its financial statements. In general, Persimmon prepares its financial statements in compliance with IFRS on a historical cost basis. We identified four key accounting policies in accordance with the nature of the house building industry and Persimmons operations, namely intangible assets; inventories; revenue recognition; and forward currency swaps. These policies were compared to one of Persimmons major competitors, Taylor Wimpey.
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Accounting Analysis
6.2) Inventories
Inventories, including land, work in progress, part exchange properties and show houses, as the biggest portion of total operating assets, are measured at the lower of cost and net realizable value (NRV). Land is recorded at discounted cost and work in progress contains the costs of direct materials, labours and other related charges. NRV is calculated by the estimation of selling prices less all estimated costs of completion and the estimated costs necessary to make the sale. If the costs are less than NRV, the difference will be recognised as expenses immediately. However, if there is a significant recovery of inventories value, Persimmon will reverse and write back previous impairment provisions. Persimmon has to allocate site-wide development costs between units built in the current year and in future years due to the scale of its development. It also has to estimate costs to complete on such development. In making these assessments, there is a degree of inherent uncertainty. This may allow accounting flexibility. Moreover, in estimating the NRV, the estimation of likely prices, house types and costs to completion the developments, provides accounting flexibility for Persimmon. Taylor Wimpey uses the similar methods to measure inventories. It is noteworthy that land options and fees are held in trade and other receivables before 2008. From 2009, the related costs are reclassified as inventories. In order to be consistent, in the reformulated balance sheets, the amount of land options in 2006-2008 has been reclassified from trade and other receivables to inventories.
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Accounting Analysis
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Accounting Analysis
7) Financial Analysis
Persimmons performance and trends are evaluated in this report on the basis of ratio analysis and common size analysis. The performance of Persimmon will be compared to its largest competitor by revenue, Taylor Wimpey.
7.1) Growth
Due to the 2007 financial crisis Persimmons income significantly decreased in 2008. However following that period, the industry showed signs of recovery due to an increase in demand of housing. Annual growth rate 2007 2008 2009 -19.1% -13.1% 4.4% -20.4% -115.7% -109.3% 2010 10.5% -4.3% 7.4% 63.9% 63.0% 98.6% 2011 -2.2% 0.3% 5.5% 16.6% -23.4% -9.9%
Sales -4.0% -41.8% Net operating assets 13.9% -29.8% Shareholders' equity 15.5% -33.7% Core operating income after tax 2.0% -84.0% Operating income (after tax) 13.4% -227.7% Comprehensive income 14.9% -252.7% Figure 9: Annual growth rate of Persimmon from 2007 to 2011
From 2008 to 2010, Persimmon showed an increasing trend in sales growth, which reached 10.5% in 2010. However, in 2011 sales growth decreased by 2.2% due to the sovereign debt crisis and slowing European economies. Compared to Taylor Wimpey, Persimmon weathered the financial crisis worse but in the past three years has shown an improved sales growth rate.
150.00% 100.00% 50.00% 0.00% -50.00% -100.00% -150.00% -200.00% -250.00% -300.00% core operating income operating income comprehensive income
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Financial Analysis
Persimmon
2007 2008 2009 2010 2011 Taylor Wimpey
-0.2
-0.4 -0.6
Figure 11 ROE Persimmon VS Taylor Wimpey9 From Figure 11 ROE Persimmon VS Taylor Wimpeywe see the growth rate of core operating income has increased steadily in the recent years. In 2011 whilst sales decreased by 2.2%; the core operating income had a improved considerably by 16.6%. It is further shown that cost of sales decreased from 1374.7 million in 2010 million to 1312 million in 2011. This trend, can thus be explained due to a powerful cost controls enacted by Persimmons cost management strategy. Furthermore, operating income and comprehensive income increased significantly by 63% and 98.6% respectively in 2010. This is due to large write-downs in 2009 and 2010, when Persimmon claimed 70.4 million and 80.2 million respectively, which resulted in a high unusual operating income after the huge reduction in inventory impairments in 2008. Based on accounting analysis, the reverted amount in inventory write-back lead to increase in assets, as the company adjusted this figure which is based on strength of the economy. However, in 2011 the operating income after tax decreased by 23.4% which lead to a decrease in comprehensive income of 9.9%. There are two explanations for these reductions. Firstly, the speed of house price recovery slowed in 2011, due to the European sovereign debt crisis, which lead to a fall in sales. Secondly, together with the slightly price reduction, there is a decrease in operating income due to the value of inventory write-back in 2011 (13.30 million), which was significantly lower compared to 2009 and 2010. This reduction in inventory write-back could be a result of temporary aggressive accounting policy in 2009 and 2010; hence, in 2011, the company had to reduce this write-back amount to cope with the aggressive accounting in previous years. The growth rate of net operating asset shows an increasing trend since 2008 and finally becomes positive in 2011.The shareholder's equity has consistently increased since 2009.This rise has occurred as since 2008, Persimmon has been clearing its debt. The decreasing net financial obligations are the main reason of increasing the shareholder's equity.
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Financial Analysis
7.2) Profitability
This report focuses on the return on equity (ROE) to demonstrate the profitability of Persimmon. The report uses both traditional and alternative approaches (DuPont decomposition). In order to reconcile with the forecasting section, we derive an alternative approach based on the year beginning formula. Company time-trends Analysis After 2008, the return on equity has remained positive for last three years. In 2011 the return on equity was 6.5%, which is slightly lower than 7.8% in 2010. In order to explain this decrease, this section will base on DuPont decomposition approach. From the alternative approach, it is clearly seen that there are two main drivers that can influence this performance: return on operating assets (RNOA) and financial leverage gain. Firstly, in 2011 the return on net operating asset (RNOA) decreased to 6.9%, compared to 8.7% in 2010. Reliant on the decomposition of operating profit margin (PM), it reveals that this ratio decreased from 10.4% in 2010 to 8.1% in 2011. However, at the same time, net operating assets turnover (ATO) remained almost constant. Therefore, the main driver, which lead to the reduction in return of net operating assets (RNOA) in 2011, is the operating profit margin (PM). It further explains that together with the decrease in sales, the falling operating income also lessens operating profit margins. The core operating income margin has increased from 6.2% to 7.4%; however, the operating income margin decreased significantly from 10.4% to 8.1%. As discussed in the growth analysis, the decrease of operating income is mainly due to reduced inventory write-back in 2011. The decomposition of Persimmons fin ancial leverage gain reveals that the net borrowing cost has been increasing in the past three years because Persimmon has been reducing its debt. In addition, the companys financial spread has not only decreased as a result of a considerable increase in net borrowing cost (from 14.5% to 21.8%), but also because of the falling return on net operating assets (RNOA) from 8.7% to 6.9%. Furthermore, the financial leverage gain keeps relatively low because the increasing return on net operating assets (RNOA) cannot offset the reduction in net borrowing cost.
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Financial Analysis
Traditional DuPont decomposition of ROE Comprehensive income margin x Asset turnover = Return on assets (ROA) x Financial leverage = Return on equity Figure 12 Traditional DuPont decomposition of ROE Alternative DuPont decomposition of ROE Operating margin x Net operating assets turnover = Return on net operating assets (RNOA) - Net borrowing costs (NBC) = Spread Financial leverage (FLEV) Financial leverage gain (Spread x FLEV) ROE = RNOA + FLEV x Spread
7.0% 10.4% 0.66 0.84 4.6% 8.7% 6.0% 14.5% -1.4% -5.8% 0.39 0.15 -0.5% -0.9% 4.1% 7.8%
Figure 13.Alternative DuPont decomposition of ROE Cross-sectional Comparison with Competitors Compared to the ROE of Taylor Wimpey the performance of Persimmon demonstrates more stability whilst Taylor Wimpey fluctuates more. Overall, from 2007 to 2011 Persimmon is doing out performing Taylor Wimpey, except in 2010. In 2011 the performance of Persimmon and Taylor Wimpey are relatively close to each other.
30.00% 20.00% 10.00% 0.00% -10.00% -20.00% -30.00% -40.00% -50.00% -60.00% -70.00% -80.00% 2007 2008 2009 2010 2011 Persimmon Taylor Wimpey
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Financial Analysis
Persimmons inventory hold days have been decreasing from 2008 to 2010, whilst have slightly increased in 2011.The principle driver of change is the continuous decrease in inventory from 2008 to 2011.The inventory holding days of Persimmon and Taylor Wimpey both rose dramatically due to the financial crisis. In 2009 and 2010, it seems that Persimmon showed an improved performance and by 2010 Persimmon had claimed a lower inventory holding days.
800.00 600.00 Inventory Holding 400.00 Days 200.00 0.00 2006 2007 2008 2009 2010
Figure 16 The inventory holding days Persimmon VS Taylor Wimpey The account receivable days dropped considerably in 2009 and continued this trend over the following two years. Compared to Taylor Wimpey the account receivable days of Persimmon remained lower than the past 5 years. This implies Persimmon collects its revenue more efficiently than its competitor.
40.00 30.00 Account Receivable 20.00 Days 10.00 0.00 2006 2007 2008 2009 2010
21
Financial Analysis
Core operating income after tax 15.4% 4.2% Operating income after tax 16.5% -36.1% Comprehensive income 14.8% -38.8% Figure 18 Common size analysis of expense and income
The cost of sales is a large proportion of the sales, which is indicative of the house building industry as it requires a large capital investment. It is clear that Persimmon has been reducing the cost of sales following the crisis. Moreover, the operating expense is also stable and fluctuates at around 5% after 2008.This may also imply the success of the cost control strategy enforced by Persimmon in the past three years. The core net finance expense has decreased since 2008. Persimmon is reducing its debt following the 2007 financial crisis. 2006 2007 2008 2009 2010 2011
Net operating assets 132.70% 130.88% 138.66% 115.44% 102.84% 97.78% Net financing assets/(liabilities) -32.70% -30.88% -38.66% -15.44% -2.84% 2.22% Ordinary shareholder equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Figure 19 Percentage of Ordinary shareholder equity In the Figure 19, we see that the percentage of net financing liabilities had decreased form 2008 to 2010. In 2011 Persimmon got net financing assets, instead of net financial obligations. As mentioned above, this is because Persimmon has paid almost all of its financial obligations. Furthermore, the ordinary shareholder equity from 2006 to 2010, following net operating assets, Persimmon will pay off their net financial obligation. Hence, the amount of ordinary shareholder equity received was lower than net operating assets. However, in 2011, shareholder equity also received benefits from net financial assets arising from Persimmons activities. Therefore, the value that equity received in 2011 was related to all the increasing in assets of the company. As a result, this trend could present a strong outlook for Persimmons investors in 2011.
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Financial Analysis
8) Forecasting
8.1) Macroeconomic and Industry Factors
Macroeconomic Criteria The house building industry is a major segment of the construction industry. This industry is cyclical: customers generally have the option to delay a purchase during periods of uncertainty. Duet to this cyclical nature, it is necessary to analyse macroeconomic factors based on long-term GDP, interest rate, population growth and unemployment rate. There is a correlation among these economic variables that influences the housing market. GDP It is predicted that the average GPD growth of UK will grow slowly to around 0.5% in 2012 and increase significantly in the later years to around 2.3% in 2016 10.
Figure 20: HM Treasury figures for GDP growth rates In addition, although the main growth remains much stronger in China, India and other large emerging countries, the sluggish recovery of Europe economy, except Germany, and the slowdown of America will likely push up commodities prices in 2012. This in turn will increase costs in the house-building industry11. Moreover, as the result of the economic slowdown, it will squeeze the real income of UKs household, which in turn influences the demand for housing. Interest rates The Bank of Englands Monetary Policy Committee has kept interest rates at a record low (0.5%) for 27 months in a row. It is commonly expected that interest rates will have rise by the end of 2012, as
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Forecasting
inflation continues to remain above the Banks 2% target (CPI stood at 3.6% in February 201 2)12. Hence, it is expected that mortgage rates will increase during 2012. Population Growth With a steadily rising population (government projections estimate 0.7% per year, hitting 70m by 2025) overall demand for properties to either rent or buy is on the rise13.
Unemployment rate: Another factor that can influence the housing market is unemployment rate. The unemployment rate increased from around 5% before 2008 to 8%14. And, it is predicted that it will increase significantly to around 1.52 million in 2011 to 1.8 million in 2012. The figure bellowed shows that unemployment in the UK has increased by more than 15% since February 201115.
20% Unemployment 10% Rate (%) 0% Mar-11 -10% May-11 Jul-11 Sep-11 Nov-11 Jan-12
24
Forecasting
25
Forecasting
Figure 24 Sales Growth Forecasts Moreover, because of mean reverse characteristics, after the growing period, the sales growth of Persimmon will reverse to a mean average growth rate at 3% in 2017 and after
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Forecasting
We also assume that proportion of other operating income to sales in 2012 and years after is 6% because its proportion is quite stable every year. Margins As the our common size analysis, the proportions of cost of sales to sales range from 76% and 91% so as we assume that this figure is about 82% for 2012 to later year. Moreover, we expect that the ratio of operating expenses to sales account the same proportion as 2011. These above proportions we assumed is based on the cost control strategy of Persimmon plc. Borrowing Costs and Interest Rates We assume that the net borrowing cost in 2012 decrease to 6% because company strategy from 2012 is un-geared the borrowing. Hence, we expect that from 2012, the net borrowing cost decrease. However, this rate will be higher than 0% because company may still have financial expense and it still need to pay long-term debt or long-term debt maturity dates have not come yet. Therefore, from 2013, we assume that net borrowing cost is about 3% Together with that argument, we also expect the financial leverage will be at -0.02 in 2012 and it will be constant at -0.01 from 2013 because Persimmon plc wants to release all the debt and keep it nearly 0% debt; however, in some special case in future, maybe the group still need to raise money from debt activities. Hence, we assume that financial leverage is just around -0.01 Unusual items and Investment Income Furthermore, exceptional items are material amount and it is not expected to recur. However, intangible assets impairment is quite stable every year. Hence, for our forecasts, although intangible asset impairment is exceptional items, we still assume the proportion of this item over sales is constant overtime from 2012. Other unusual operating income and unusual financing income is zero from 2012. We also assume that joint ventures entities, which Persimmon plc invests in, grow at the same rate with average sale growth rate of house building industry, 3%. Tax Rate and Turnover Ratios Effective tax rate of Persimmon plc in 2012 is assumed that it will equal the rate in 2011 and we expect that it will be constant overtime at 26%. Lastly, with the turnover ratios, because we do not have efficiency information about those criteria, we assume these ratios will stay the same as its performance in 2011.
27
Forecasting
9) Valuation
9.1) Valuation Model Chosen
When evaluating Persimmons share price, we use both direct and indirect approaches of residual earnings model. Due to three major reasons, we believe that this valuation model is more suitable for the company than other methods. First, in terms of using accounting information, stock prices calculated by using residual earnings model reflect companies past and future performance. Residual earnings model, PB and PE ratios, are all based on accounting information from balance sheets and income statements. The former integrates concepts of book value and earnings to assess companies equity value, and these two ideas illustrate companies past operation results and abilities to earn future profits, respect ively. However, PB and PE ratios only focus on single aspect which means that they cannot demonstrate companies performance completely. Therefore, we believe that residual earnings model is more appropriate for evaluating Persimmons share price than PB and PE ratios. Secondly, the residual income also allows the re-express the discount model in term of the price to book ratio19. Hence, based on residual earnings model, we an know the drivers of price to book ratio. In addition, residual earnings model is derived from return on equity (ROE), cost of equity and book value of equity. Therefore, it concentrates on the profitability and growth in investment, which are the main criteria that investors want to focus when they evaluate the share prices. Moreover, residual earnings model defines value based on wealth generation but not wealth distribution. This means that the model focuses on earnings but not dividends. Persimmon is a house building company which is mainly influenced by economic situation so that its dividend payment policies may be different year by year. Thus, residual earnings model is suit for Persimmon while the dividends payment situations will not affect the valuation of share price. Furthermore, residual earnings model uses the properties of accrual system of accounting which regard expenditures with future economic benefits as assets, and assesses companies value by these assets. In Persimmons case, trade and other trade receivables had a considerable change from 2006 to 2011. If we use residual earnings model to evaluate its share price, the bias will decrease. There is a small difference in the valuation between indirect and direct approaches. The former valuation is more accurate because it uses WACC. Followed Modigliani and Miller proposition II, WACC for the firm is uninfluenced by the amount of debt or equity in the financing of the
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operational assets. Hence, discounting by WACC will be more precise than using cost of equity. Thus, the share price comes from indirect approach will be regarded as the final result.
Terminal growth rate 2.00% Share price as of valuation date indirect method 6.22 Figure 25 Terminal Growth Rate and Indirect Method
2.50% 6.56
2.70% 6.72
2.82% 6.82
3.00% 6.97
From the result of sensitivity analysis: If we rely on indirect method, for steady state, the sales growth should be 2.82% for terminal period to have the same price at the current. Therefore, it is quite conservative compared to our forecasting.
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Multiples Valuation Multiples valuation is calculated based on the comparative set of top largest house-building companies in UK. The criteria to choose these companies are they have the similar operating activities and financial activities, and similar business risk. The following table shows the share prices of Persimmon at 15th March 2012 based on the comparable companies: Mean P/B ratio Median P/B ratio Mean trailing P/E ratio Median trailing P/E ratio Mean forward P/E ratio Median forward P/E ratio 6.19 5.7 6.67 5.47 6.88 7.26
The estimated price using mean P/B ratio and median trailing P/E ratio is much lower than actual price of Persimmon, while using median forward P/E ratio is higher than actual price. This can be explained by the differences in fundamental of Persimmon relative to peer group. In addition; and assuming that trailing earnings per share, forward earnings per share and long-term growth and are representative of a growth that adds value to the company. Hence, due to the difference in accounting methods, leverage and dividend payout are ignored when we analyse the fundamental drivers of PE and PB. The PE is higher than a normal PE, which means that growth can be expected to increase in the future. For long-term expectations, there is a negative indication, which suggests the market thinks long term abnormal earnings growth will decrease. Hence, there is mismatch between fundamental analysis and market analysis in term of PE. However PB is higher than normal PB, which means that in the future the residual earnings will increase or the ROE will increase higher than cost of equity capital, to have positive residual earnings. Therefore, in the long-term, Persimmon still appears to be a sound investment.
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10)
Investment recommendation
On the basis of this reports forecasting model, we conclude Persimmons current market price is significantly undervalued to our valuation; and hence this report makes a buy or hold recommendation. In addition, based on various analysis methods, Persimmons shares seem a sound investment in terms of PB. Furthermore, from multiples valuation methods, we conclude that Persimmon shares are a favourable stock, which suggests the market is eager to buy shares in the company.
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11)
Appendices:
Note 1
FL OL FL OL
(70.60) (130.90) (147.60) (117.00) (48.40) (0.10) (706.40) (749.00) (551.90) (464.50) (463.30) (482.40) (6.70) (10.00) (9.50) (106.70) (150.40) (74.20) (82.70) (71.30) (78.70) (890.40) (1040.30) (773.70) (673.70) (583.00) (561.20) (1722.60) (1810.90) (1598.70) (1172.40) (980.60) (734.30) 2031.30 2345.10 1555.20 1623.20 1744.00 1839.30 29.90 233.40 (5.10) (4.30) 281.40 1496.00 2031.30 30.30 233.60 0.70 281.40 1779.40 2325.40 30.30 233.60 0.10 281.40 1009.80 1555.20 30.30 233.60 (0.40) 281.40 1078.30 1623.20 30.30 233.60 281.40 1198.70 1744.00 30.30 233.60 281.40 1294.00 1839.30
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Appendicles
11.2) Appendix 2: Consolidated statement of comprehensive income for the year ended 31 December 2011(m)
2006 Continuing operations Revenue Cost of sales Gross profit Other operating income Operating expenses Share of results of jointly controlled entities Profit from operations Finance income Finance costs Profit before tax Tax Profit after tax (all attribute to equity holders of the parent) Other comprehensive income/(expense) Net gain/(loss) on cash flow hedges Actuarial gains/(losses) on defined benefit pension scheme Tax Other comprehensive income/(expense) for year, net of tax Total recognised income/ (expense) for the year Earnings per share Basic Diluted Non-GAAP measures-Underlying earnings per share Basic Diluted 3141.90 (2404.20) 737.70 29.60 (130.70) 0.70 637.30 0.50 (71.10) 566.70 (170.30) 396.40 (7.00) (4.70) 3.50 (8.20) 388.20 133.8p 133.1p 118.4p 118.0p 2007 3014.90 (2278.80) 736.10 40.10 (122.30) 1.00 654.90 1.90 (74.10) 582.70 (169.20) 413.50 11.90 36.10 (15.60) 32.40 445.90 137.7p 136.8p 138.3p 137.6p 2008 1755.10 (2178.00) (422.90) 21.40 (313.90) 0.80 (714.60) 10.40 (75.80) (780.00) 155.00 (625.00) (0.80) (43.80) (11.30) (55.90) (680.90) (208.3p) (208.3p) 35.3p 35.2p 2009 1420.60 (1222.20) 198.40 8.80 (78.70) (0.50) 128.00 4.80 (55.00) 77.80 (3.70) 74.10 (0.80) (29.00) 19.30 (10.50) 63.60 24.7p 24.5p 2.1p 2.1p 2010 1569.50 (1294.50) 275.00 10.90 (81.80) 0.20 204.30 13.40 (63.80) 153.90 (38.60) 115.30 0.60 2.50 7.90 11.00 126.30 38.3p 38.1p 24.8p 24.6p 2011 1535.00 (1298.70) 236.30 8.90 4 (83.30) 5 Note
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11.3) Appendix 3: Consolidated Cash Flow Statement for the year ended 31 December 2011(m)
2006 Cash flow from operating activites: Profit/(Loss) for the year Tax charge recognised in profit or loss Finance income Finance costs Depreciation charge Amortisation of intangible assets Impairment of intangible assets Share of results of jointly controlled entities Profit on disposal of property, plant and equipment Loss on disposal of assets held for sale Share-based payment charge Exceptional items Other non-cash items Movements in working capital: Decrease/(increase) in inventories Decrease/(increase) in trade and other receivables Increase/(decrease) in trade and other payables Increase in available for sale financial assets 186.0 32.0 (67.8) (426.7) (7.2) 25.6 185.5 (5.8) (173.6) 501.5 24.9 (164.5) (41.8) 194.8 5.5 25.9 (47.2) 83.0 7.9 (42.6) (48.8) 396.4 170.3 (0.5) 71.1 9.6 0.3 (0.7) (0.7) 5.3 (8.3) 642.8 413.5 169.2 (1.9) 74.1 9.8 0.2 2.4 (1.0) (1.0) 6.0 671.3 (625.0) (155.0) (4.1) 75.8 8.7 0.3 1.8 (0.8) (0.7) 4.4 892.7 (3.1) 195.0 74.1 3.7 (4.8) 55.0 6.3 0.3 4.0 0.5 (0.6) 3.6 (74.8) 3.5 70.8 115.3 38.6 (6.0) 39.2 4.5 0.3 4.6 0.5 (1.3) 0.1 3.4 (63.0) 1.5 137.7 109.0 38.2 (7.5) 12.4 3.8 0.3 4.4 (0.4) 4.2 (3.5) 2.5 163.4 2007 2008 2009 2010 2011
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Cash generated from operations Interest paid Payments on cancellation of swaps Make-whole fees on early redemption of senior loan notes Interest received Receipts on cancellation of swaps Tax received/(paid) Net cash inflow from operating activities 793.0 (57.6) 0.5 (146.8) 589.1 263.0 (66.2) 1.9 (126.3) 72.4 (67.6) 4.1 106.2 243.8 201.1 390.9 (45.9) 7.8 0.3 353.1 316.7 (30.1) (1.6) (13.4) 1.4 7.4 (54.9) 225.5 162.9 (10.9) (15.3) 0.2 7.1 (22.1) 121.9
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11.4) Appendix 4: Consolidated Statement of Changes in Equity for the year ended 31 December 2011(m)
Other reserves Ordinary shares Balance at December 31, 2005 Exercise of share options/share awards Scrip dividends Share option charge and taxation thereon Valuation of currency swaps and taxation thereon Movement in pension deficit and taxation thereon Dividends approved and paid Retained profits for the year Balance at December 31, 2006 Own share reserve transfer Exercise of share options/share awards Scrip dividends Own shares purchased 0.1 0.3 0.5 (0.3) 29.9 233.4 (5.1) 5.1 (3.3) (96.7) 396.4 1,496.0 (5.1) 6.5 39.5 (4.3) 281.4 29.5 0.1 0.3 Share Premiu m account 229.2 4.5 (0.3) Own shares (4.1) (1.0) Retained earnings 1,155.4 (1.4) 37.1 8.5 (4.9) Other reserves 281.4
Hedging 0.6
Total 1,692.0 2.2 37.1 8.5 (4.9) (3.3) (96.7) 396.4 2,031.3 7.1 39.5 (25.5)
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(25.5) Share option charge and taxation thereon Valuation of currency swaps and taxation thereon Movement in pension deficit and taxation thereon Dividends approved and paid Other reserve movement Retained profits for the year Balance at December 31, 2007 Exercise of share options/share awards Own shares purchased Share option charge and taxation thereon Valuation of currency swaps and taxation thereon Movement in pension deficit and taxation thereon Dividends approved and paid Other reserve movement Retained losses for the year Balance at December 31, 2008 30.3 233.6 (55.4) (113.1) (0.6) (625.0) 1,009.8 0.1 281.4 30.3 233.6 24.1 (153.6) 0.6 413.5 1,799.4 3.2 (2.4) 3.7 (0.6) 0.7 281.4 (3.3) 3.4 8.3 3.4 8.3 24.1 (153.6) (2.7) 413.5 2,345.4 3.2 (2.4) 3.7 (0.6) (55.4) (113.1) (0.6) (625.0) 1,555.2
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Exercise of share options/share awards Own shares purchased Share based payments Other reserve movement Other comprehensive expense Retained losses for the year Balance at December 31, 2009 Dividends on equity shares Exercise of share options/share awards Share based payments Satisfaction of share options from own share held Other comprehensive expense Retained losses for the year Balance at December 31, 2010 Dividends on equity shares Exercise of share options/share awards Share based payments 30.3 233.6 30.3 233.6 -
0.2 (0.2) 3.6 0.8 (10.0) 74.1 1,078.3 (9.0) 0.3 3.6 (0.4) 10.6 115.3 1,198.7 (25.6) (1.1) 281.4 0.4 (0.4) 281.4 (0.5)
0.2 (0.2) 3.6 0.8 (10.5) 74.1 1,623.2 (9.0) 0.3 3.6 (0.4) 11.0 115.3 1,744.0 (25.6) (1.1) 4.7
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4.7 Satisfaction of share options from own share held Other comprehensive expense Retained losses for the year Balance at December 31, 2011 30.3 233.6 3.5 4.8 109.0 1,294.0 281.4 3.5 4.8 109.0 1,839.3
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250.80 Note 2 28.70 3.00 Note 3 164.00 Note 4 55.50 25.20 2003.40 Note 5 2.00 2532.60 576.40 19.60 59.50 78.70 734.20 1798.40
2.10 2.10
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Note 6 Note 7
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schemes Deferred tax recognised in other comprehensive income Total unusual operating income/(expense) Operating income after tax Net financing expense Finance income Finance expense Net interest expense before tax Tax benefit of debt Core net financing expense after tax Unusual financing income/(expense) (net of tax) Gain on cancellation of interest rate swaps Increasing in interest expense on bank overdrafts and loans Loss on cancellation of interest rate swaps Unusual financing income/(expense) Tax benefit of debt Total unusual financing income/(expense) (net of tax) Total net financing expense Comprehensive income Tax rate Statutory tax rate Effective tax rate
6.30 0.00 0.00 6.30 (1.80) 4.50 (46.76) (680.90) 29% 27.3%
7.40 (23.00) (1.60) (17.20) 4.82 (12.38) (36.29) 126.30 28% 25.1%
Note 11
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Actual gains/(losses) on defined benefit pension schemes Deferred tax recognised in other comprehensive income Total unusual operating income/(expense) Operating income after tax Net financing expense Finance income Finance expense Net interest expense before tax Tax benefit of debt Core net financing expense after tax Unusual financing income/(expense) (net of tax) Gain on cancellation of interest rate swaps Increasing in interest expense on bank overdrafts and loans Loss on cancellation of interest rate swaps Unusual financing income/(expense) Tax benefit of debt Total unusual financing income/(expense) (net of tax) Total net financing expense Comprehensive income
-1.57% 12.36%
-1.68% 14.79%
-2.54% 4.48%
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-12.08% -2.00% Note 12 -490.91% -57.79% -458.18% -51.05% -504.94% -60.68% -8.57% -53.19% -165.96%
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schemes Deferred tax recognised in other comprehensive income Total unusual operating income/(expense) Operating income after tax Net financing expense Finance income Finance expense Net interest expense before tax Tax benefit of debt Core net financing expense after tax Unusual financing income/(expense) (net of tax) Gain on cancellation of interest rate swaps Increasing in interest expense on bank overdrafts and loans Loss on cancellation of interest rate swaps Unusal financing income/(expense) Tax benefit of debt Total unusual financing income/(expense) (net of tax) Total net financing expense Comprehensive income
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
-322.86% 3733.53% -144.91% 820.00% 106.61% 101.56% 96.48% 103.73% 100.00% 100.00% 100.00% 100.00%
551.43% -213.26% 22.79% 960.00% 77.36% 71.10% 66.36% 73.14% 73.14% 16.38%
225.71% -344.74% 37.15% 1200.00% 55.13% 47.03% 43.89% 48.37% 117.46% -273.02% -268.23% -274.93% 73.43% 32.53%
-85.71% -59.76% 28.47% 1500.00% 17.44% 6.94% 6.13% 7.29% 112.70% Note 12 -155.56% Note 12 -144.64% Note 12 -159.91% 21.86% 29.31%
102.27% 114.86%
94.62% -175.40%
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11.10)
Net operating assets Operating assets Intangible assets Property, plant and equipment Investment accounted for using the equity method Available for sale financial assets Trade and other trade receivables Deferred tax assets Inventories Assets held for sale Total operating assets Operating liabilities Trade and other payables Deferred tax liabilities Retirement benefit obligation Current tax liabilities Total operating liabilities Financial assets Forward currency swaps Cash and cash equivalent Total financing assets Financing obligations Loans and borrowings Forward currency swaps Total financing obligation As percentage of OSE Net operating assets Net financing assets/(liabilities) Ordinary shareholder equity
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11.11)
Annual growth rate Sales Net operating assets Shareholders' equity Core operating income after tax Operating income (after tax) Comprehensive income Dividend payout Return on equity Sustainable growth rate Performance Return on equity (ROE) Return on assets (ROA) - traditional Return on net operating assets (RNOA) alternative Core return on net operating assets (Core RNOA) Core net borrowing costs Traditional DuPont decomposition of ROE Comprehensive income margin x Asset turnover = Return on assets (ROA) x Financial leverage = Return on equity
Comprehensive income/Sales Sales/Beginning total assets Comprehensive income/Beginning total assets Beginning total assets/ Beginning SE Comprehensive income/Beginning OSE
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Alternative DuPont decomposition of ROE Operating margin x Net operating assets turnover = Return on net operating assets (RNOA) - Net borrowing costs (NBC) = Spread Financial leverage (FLEV) Financial leverage gain (Spread x FLEV) ROE = RNOA + FLEV x Spread Margins Core operating income margin Operating income margin Comprehensive income margin Turnover ratios Asset turnover Net operating assets turnover PPE turnover OTHER RATIOS Liquidity ratios Current ratio Acid ratio Working capital management ratios Inventory holding days Trade receivables collection period Trade payables days Operating cycle
OI/Sales Sales/Beginning NOA OI/Beginning NOA NFE/Beginning NFO RNOA - NBC Beginning NFO/Beginning SE RNOA +FLEV x Spread
Core OI/Sales OI/Sales Comprehensive income/Sales Sales/Beginning total assets Sales/Beginning NOA Sales/Beginning PPE
Current Assets/ Current Liabilities (Current Assets - Inventories)/ Current Liabilities (Inventories/Cost of sales)*365 Trade receivable *365/Credit sales Trade Payables *365/ Credit Purchases
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11.12)
Forecasts of key income statement ratios 2019E and 2007A 2008A 2009A 2010A 2011A 2012E 2013E 2014E 2015E 2016E 2017E 2018E after 2020E -4.0% -41.8% -19.1% 10.5% -2.2% -2.0% 3.0% 5.0% 4.0% 3.5% 3.0% 3.0% 3.0% 3.0% 1.3% 76.5% 3.7% 80.2% 29.2% 7.6% 1.2% 0.1% 75.6% 4.0% 79.6% 62.7% 6.5% 0.6% 11.6% 84.9% 5.1% 90.0% -3.6% 6.0% 0.7% 0.3% 91.3% 5.3% 96.6% 24.5% 14.5% 0.6% 0.3% 0.6% 0.3% 0.6% 0.3% 0.6% 0.3% 0.6% 0.3% 0.6% 0.3% 0.6% 0.3% 0.6% 0.3% 0.6% 0.3% 82.0% 4.5% 86.5% 26.0% 3.0%
Sales growth Other income ratios: Operating income Intangible asset impairment Expense ratios: Cost of sales Operating expenses Total Effective tax rate on operating income Net financial expense/Beginning NFO
87.6% 82.0% 82.0% 82.0% 82.0% 82.0% 82.0% 82.0% 4.9% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 92.5% 86.5% 86.5% 86.5% 86.5% 86.5% 86.5% 86.5% 26.0% 26.0% 26.0% 26.0% 26.0% 26.0% 26.0% 26.0% 21.8% 6.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
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Forecasts of turnover (inverse) 2007A 2008A 2009A 2010A 2011A 2012E 2013E 2014E 2015E 2016E 2017E 2018E 0.016 0.027 0.032 0.020 0.019 0.019 0.019 0.019 0.019 0.019 0.019 0.019 1.299 1.930 1.793 1.394 1.351 1.351 1.351 1.351 1.351 1.351 1.351 1.351 0.24 0.24 0.25 0.29 0.30 0.30 0.30 0.30 0.30 0.30 0.30 0.30 0.27 0.48 0.48 0.35 0.38 0.38 0.38 0.38 0.38 0.38 0.38 0.38 0.01 0.03 0.04 0.25 0.02 0.03 0.09 0.24 0.02 0.07 0.05 0.28 0.02 0.07 0.05 0.13 0.01 0.06 0.05 0.03 0.01 0.06 0.05 -0.02 0.01 0.06 0.05 -0.01 0.01 0.06 0.05 -0.01 0.01 0.06 0.05 -0.01 0.01 0.06 0.05 -0.01 0.01 0.06 0.05 -0.01 0.01 0.06 0.05 -0.01 2019E and after 2020E 0.019 0.019 1.351 1.351 0.30 0.30 0.38 0.38 0.01 0.06 0.05 -0.01 0.01 0.06 0.05 -0.01
Beginning PPE/Sales Beginning Inventories/Sales Beginning other OA/Sales Beginning trade payabes/Sales Beginning deferred tax liabilities/ Sales Beginning retirement benefit obligation/Sales Beginning current tax liability/Sales Financial leverage (Beginning NFO/Beginning NOA)
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11.13)
Pro forma financial statements 2007A Income statement Sales Other operating income Cost of sales Operating expenses Core operating income before tax Taxes Core operating income after tax Other operating income (expense) Operating income Net financial expense after tax Comprehensive income Balance sheet Property, plant and equipment Inventories Other operating assets Trade payables Current tax liabilities Deferred tax liabilities Retirement benefit obligations Net operating assets (NOA) Net financial obligations (NFO) Ordinary shareholders' equity Operating income Change in NOA Free cash flow to investors 3014.9 29.6 (2278.8) (119.9) 656.3 (191.58) 465.72 30.72 496.44 (50.54) 445.90 47.8 3386.6 719.8 841.4 150.4 32.0 60.7 3069.7 (724.3) 2345.4 496.4 374.2 122.2 2008A 2009A 2010A 2011A 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2020E 1971.0
1755.1 1420.6 1569.5 1535.0 1504.3 1549.4 1626.9 1692.0 1751.2 1803.7 40.1 21.4 8.8 10.9 8.7 9.3 9.8 10.2 10.5 10.8 (1489.8) (1297.0) (1374.7) (1312.0) (1233.5) (1270.5) (1334.1) (1387.4) (1436.0) (1479.1) (89.2) (74.7) (77.2) (78.9) (67.69) (69.72) (73.21) (76.14) (78.80) (81.17) 197.5 57.7 128.5 153.0 211.80 218.47 229.39 238.57 246.92 254.33 (123.82) 2.07 (31.54) (39.74) (55.01) (56.74) (59.58) (61.96) (64.13) (66.05) 74.48 59.27 97.16 113.26 156.79 161.73 169.82 176.61 182.79 188.27 (708.62) 40.48 65.43 11.34 (4.51) (4.65) (4.88) (5.08) (5.25) (5.41) (634.14) 99.74 162.59 124.60 152.28 157.08 164.93 171.53 177.54 182.86 (46.76) (36.14) (36.29) (10.80) 2.45 0.52 0.54 0.57 0.59 0.61 (680.90) 63.60 126.30 113.80 154.73 157.60 165.47 172.10 178.13 183.47 45.1 2546.5 444.7 683.9 74.2 26.5 95.3 2156.4 (601.2) 1555.2 (634.1) (913.3) 279.2 32.0 2187.8 417.0 541.7 82.7 24.1 114.4 1873.9 (250.7) 1623.2 99.7 (282.5) 382.2 29.1 2073.2 468.0 585.3 71.3 21.8 98.3 1793.6 (49.6) 1744.0 162.6 (80.3) 242.9 28.7 2003.4 500.5 576.4 78.7 19.6 59.5 1798.4 40.9 1839.3 124.6 4.8 119.8 28.5 2031.7 448.6 573.6 69.9 21.4 96.3 1747.6 17.5 1765.1 152.28 (50.8) 203.0 29.4 2092.7 462.0 590.8 72.0 22.0 99.2 1800.1 18.0 1818.1 157.08 52.4 104.7 30.8 2197.3 485.1 620.3 75.6 23.1 104.2 1890.1 18.9 1909.0 164.93 90.0 74.9 32.1 2285.2 504.5 645.2 78.6 24.0 108.4 1965.7 19.7 1985.3 171.53 75.6 95.9 33.2 2365.2 522.2 667.7 81.3 24.9 112.1 2034.5 20.3 2054.8 177.54 68.8 108.7 34.2 2436.2 537.8 687.8 83.8 25.6 115.5 2095.5 21.0 2116.5 182.86 61.0 121.8
1857.8 1913.6 11.1 11.5 (1523.4) (1569.1) (83.60) (86.11) 261.96 269.81 (68.03) (70.08) 193.92 199.74 (5.57) (5.74) 188.35 194.00 0.63 0.65 188.98 194.65 35.2 2509.2 554.0 708.4 86.3 26.4 119.0 2158.4 21.6 2180.0 188.35 62.9 125.5 36.3 2584.5 570.6 729.7 88.9 27.2 122.5 2223.1 22.2 2245.4 194.00 64.8 129.2
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Comprehensive income Change in equity Free cash flow to equity Operating profit margin (Operating income/Sales) Net operating asset turnover (Sales/NOAt-1) RNOA (Operating PM x NOA turnover) ROE Growth in operating income Growth in comprehensive income Growth in net operating assets Growth in Ordinary shareholders' equity
(680.9) (790.2) 109.3 -36% 0.57 (0.21) -29% 227.7% 252.7% -29.8% -33.7%
126.3 120.8 5.5 10% 0.84 0.09 8% 63.0% 98.6% -4.3% 7.4%
154.73 (74.2) 228.91 10% 0.84 0.08 8% 22.2% 36.0% -2.8% -4.0%
157.60 53.0 104.65 10% 0.89 0.09 9% 3.2% 1.9% 3.0% 3.0%
165.47 90.9 74.57 10% 0.90 0.09 9% 5.0% 5.0% 5.0% 5.0%
172.10 76.4 95.74 10% 0.90 0.09 9% 4.0% 4.0% 4.0% 4.0%
178.13 69.5 108.64 10% 0.89 0.09 9% 3.5% 3.5% 3.5% 3.5%
183.47 61.6 121.83 10% 0.89 0.09 9% 3.0% 3.0% 3.0% 3.0%
188.98 63.5 125.48 10% 0.89 0.09 9% 3.0% 3.0% 3.0% 3.0%
194.65 65.4 129.25 10% 0.89 0.09 9% 3.0% 3.0% 3.0% 3.0%
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11.14)
Net income component Operating income (OI) Net financial expense (NFE) Earnings
Value of operations = Value of common equity = Value of operations = Discount rates Cost of capital for equity Cost of capital for debt Cost of operations
Net operating assets + Book value of common equity + Value of common equity + Denoted as re rd rf
For Persimmon plc. on 15 March 2012 Riskfree rate (T-bill rate) Beta Market risk premium (rm-risk-free) re rd Persimmon's closing price on 5 Mach, 2011 Ordinary shares outstanding (in 000) Market value of equity Market value of financial assets Market value of the firm WACC (based on market value of equity) Estimated value of equity - direct method Fair value of financial assets Estimated value of the firm WACC (based on estimated value of equity from direct methods)
Note 14
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11.15)
Assumptions Growth in terminal period Cost of operations (WACC) Cost of equity Number of shares Equivalent number of shares at valuation date Financial year end Valuation date
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Comprehensive income Change in equity Free cash flow to equity (Comprehensive income - Change in equity) Discount rate: (1 + Cost of equity) t PV of free cash flow to equity Terminal value (Free cash flows to equity/(Cost of equity - Growth)) PV of FCFE in forecasting period PV of terminal value Value of equity before time adjustment Value of equity as of valuation date Share price as of valuation date Target price
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2011A Indirect valuation Operating income Change in NOA Free cash flow to investors (operating income Change in NOA) Discount rate: (1+WACC)t PV of free cash flows Terminal value (FCF/(WACC - Growth)) PV of FCF in forecasting period PV of terminal value Value of firm from discount future value Plus: Value of financing assets Value of equity before time adjustment Value of equity as of valuation date Share price as of valuation date Target price 626 1,407 2,033 41 2,074 2,109 6.97 7.42
2453
Note 14
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Direct valuation
Comprehensive income (CI) Ordinary shareholders' equity (OSE) Residual comprehensive income (CI - Cost of Equity x OSEt-1) Discount rate: (1 + Cost of equity) t PV of residual comprehensive income Terminal value (Residual comprehensive income/(Cost of equity - Growth)) Book value of equity PV of residual income in forecasting period PV of terminal value Value of equity before time adjustment Value of equity as of valuation date Share price as of valuation date Target price
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2011A Indirect valuation Operating income (OI) Net operating assets (NOA) Residual operating income (OI - WACC x NOAtp1) Discount rate: (1+WACC)t PV of residual operating income Terminal value (Residual operatingf income/(WACC-Growth)) Net operating assets PV of ReOI in forecasting period PV of terminal value Value of firm Plus: Value of financial asset Value of equity before time adjustment Value of equity as of valuation date Share price as of valuation date Target price 1,798 66 169 2,033 41 2,074 2,109 6.97 7.42 1,798
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Note 14
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Direct valuation
Comprehensive income Change in equity Dividends(or Free cash flow to equity) Earnings on reinvested dividends (Cost of equity x FCFEt-1) Cum-dividend earnings (CI + Earnings on reinvested dividends) Normal earnings ((1+Cost of equity) x CIt-1 ) Abnormal earnings growth (Cumdividend earnings - Normal earnings) Discount rate: (1 + Cost of equity)t Present value of AEG at t=1 Terminal value (AEG/(Cost of equity Growth)) Comprehensive income at t=1 PV of AEG in forecasting period at t=1 PV of terminal value at t=1 Total earnings to be capitalised Capitalisation rate (1/Cost of equity) Value of equity before time adjustment Value of equity as of valuation date Share price as of valuation date Target price
2011A
2012E
2013E
2014E
2015E
2016E
2017E
2018E
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Indirect valuation Operating income Change in net operating assets Free cash flows Operating income on reinvested free cash flows (WACC x FCFt-1) Cum-free cash flow operating income (OI + Operating income on reinvested free cash flows) Normal operating income ((1+WACC) x OIt-1 ) Abnormal opearting income growth (Cum-free cash flow earnings - Normal earnings) Discount rate: (1 + WACC)t Present value of AOIG at t=1 Terminal value (AOIG/(WACC - Growth)) Operating income at t=1 PV of AOIG in forecasting period at t=1 PV of terminal value at t=1 Total operating income to be capitalised Capitalisation rate (1/WACC) Value of firm Plus: Value of financial assets Value of equity before time adjustment Value of equity as of valuation date Share price as of valuation date Target price 152 10 5 168 12.09 2,033 41 2,074 2,109 6.97 7.42 152 (51) 203 157 52 105 17 174 165 9 1.0827 8 165 90 75 9 174 170 4 1.1722 3 172 76 96 6 178 179 (1) 1.2691 (1) 178 69 109 8 185 186 (0) 1.3740 (0) 183 61 122 9 192 192 (0) 1.4877 (0) 188 63 125 10 198 198 0 1.6107 0 9 194 65 129 10 204 204 0
Note 14
11.19)
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Source: bloomberg.com Date: 15 March 2012 PE Trailing twelve moths 18.84 29.31 4.07 14.47 15.14 29.15 Forward PE 15.01 15.98 3.24 14.30 22.46 19.79 EPS trailing twelve months 0.3617 0.018 0.3617 0.953 0.552 0.1751 Forward EPS LTMD 0.454 -23.61 0.033 0.454 0.964 0.372 0.258 -46.26 -6.89 -21.20 -26.12 Cost of ROE equity 6.08% 8.16% 3.06% 0.25% 13.26% 4.76% 3.23% 15.7% 14.2% 6.25% 7.93% 8.24% Norm Nor al mal trailin fwd g PE PE 13.25 12.25 7.36 6.36 8.05 7.05 17.01 16.01 13.62 12.62 13.13 12.13
PERSIMMON PLC Taylor Wimpley plc Barrat Developments plc Berkeley Group Holding plc Bellway plc Bovis Home Group
LTMD = Median analysts' long term growth estimate. A composite estimate of the anticipated annual growth rate in EPS over a five year period. Valuation of Persimmon plc Largest housebuilding companies as the benchmark Mean P/B ratio 1.02 Estimated share price 6.19 Median P/B ratio 0.94 Estimated share price 5.70 Mean trailing P/E ratio 18.43 Estimated share price 6.67 Median trailing P/E ratio 15.14 Estimated share price 5.47 Mean forward P/E ratio 15.16 Estimated share price 6.88 Median forward P/E ratio 15.98 Estimated share price 7.26
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Note:
1. In our report, we based our analysis on annual financial reports rather than restate figures. From 2009, there were changes in the accounting policies of Persimmon plc. However, in order to analyse the financial performance of company on an annual basis, we relied on actual performance at the end of each financial year. 2. Intangible assets consist mainly from goodwill with a small proportion of brand and know-how. Hence, intangible assets are considered to be operating assets 3. Investment was accounted for using the equity method and was considered an operating asset, because this is the long-term equity investment in associated and jointly-controlled companies. 4. Available for sale financial assets comprises loans provided as part of sales transactions. Hence, this item is classified as operating assets because it relates to sales activities of Persimmon. 5. Based on argument of note 1, inventories in 2006 and 2007 are different from the restate figures of 2006 and 2007 in annual report of fiscal year in 2009. 6. Other operating incomes are related to the sale of land holdings, freehold reversions, rent receivable and other incidental sundry income. It could be considered as unusual operating income. However, this amount is recurred every year. Moreover, other incidental sundry income is just a small part of item. Hence, we consider other operating income as the core operating from sales of company. 7. Operating expenses item has included intangible assets. However, intangible assets item is exceptional item; hence, we split the amount of intangible assets in operating income and put in to unusual income part. 8. According to note 9, financial report of 2007, we have restructuring cost of 2006.
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9. Intangible asset impairment is the amount that has been split from operating expense plus the exceptional items in annual reports. 10. In 2011 final results, we do not have enough information about unusual financial expense. However, based on 2010 annual report, the amount of increasing in interest expense on bank overdraft and loans item accounted a large proportion. Moreover, based on Persimmon strategy, in 2011, company has paid out a huge amount of debt. Hence, we assume and consider financial expense of Persimmon in 2011 entirely focusing on increasing in interest expense on bank overdraft and loans item 11. This effective tax rate, we take from annual report every year. However, in 2011, final result of Persimmon has not been revealed this rate. Hence, we do not add this information in for the year 2011. 12. For common size horizontal analysis, there are some items arising after the based year 2006. Hence, we take the first year happening as the base year instead of 2006. 13. 10 years UK Government Bonds (maturity on 15 March 2022, coupon payment rate 4%source: Financial Times) 14. Value of equity is related to all activities that generate assets for firm: Value of equity = value of firm + Net financial assets Hence, when we calculate value of share based on indirect method, the value of net financial assets have been deducted to the value of equity for WACC calculation
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References
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(2011), Laying the Foundations: A Housing Strategy for England Executive Summary Page 8
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Hilary Osbourne, (2012), House Prices in 2012, The Nationwide Building Society (2011) House Price Data The Construction Index (2011), Top 20 House Builders Communities and Local Government (2011), Regulated RuralZed (2011), The Zero Carbon House is Ready Cornwall Council v Persimmon Ltd (2011), Taunton Persimmon Homes (2011), Annual Report 2011 dated 2012 March 1th HM Treasury, Forecast for the UK economy: a comparison of
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independent forecast Available from: http://www.hmtreasury.gov.uk/d/201202forcomp.pdf PricewaterhouseCoopers, UK Economic Outlook: July 2011
Available from: http://www.rics.org/site/download_feed.aspx?fileID= 8638&fileExtension=PDF Bhojraj S. & Lee C.M.C, 2001, Who is My Peer? A
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Available from: http://www.pwc.com/im/en/assets/document/UK_Eco nomic_Outlook_July_2011.pdf Bank of England, (2012) CPI Data February 2012 BBC, UK population to increase to 70 million by 2027
Valuation-Based Approach to the Selection of Comparable Firms, Journal of Accounting Research, Vol. 40, No. 2, USA
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