Reading 14: Industry and Company Analysis

18thNov 2022 FridayPage No. 121Date / /Reading 14 : Indus UP AndCompany AnotysisApproaches for Developing InputsTop - DownBegins with expectations about a macroeconomicvariable Ex expected growth rate of nominal GDPBottom-Forecaste rely on company - specific information(e.g product introduction)HybridCombaineboth top-down & botton- up elements in analysisForecasting RevenueCompanyIn agrowth relative to GDP growth approach salesCouldmodeled as I GDP growth + X > or toincrease be at the growth rate of GDP times (1 tx%)Ex: Expected GDP growth is 5% & Company sev will15%growfaster Page No.122Date= ForecastedCompany growth rate=5 + 15%= 5.75 %A Market growth and market Share approach begins4ui&Est industry Sale (market growth)2Est Company revenue as a % of industry sales/markprigolousEconomics of ScalesIf Sales the avg cost of production decreasesasindusincrease,wesaythattheindustryexhibitsEconomies of ScaleA Company with economies of scale will have high1,operating margins as productionvolume increaseSalvolumes Correlated. and margins will tend to be positivelyEconomics of Scale in an industry are evidencedOur : Industry X do you think it exipit eco of scalelarger companies having higherbyMarginsCompany with eco of scale will have lower COGS & SGAoperating margins as production volumesincreasesAns Two Cos lay & smuh Calculate MarginLarge higher than socalle CosMarginLurger margin > Small margia = eco of Scule inLarger margin = Small margin = No Page No. 123Date//Forecasting the Income StatementCOGS can be forecaste based on forecasted Sales.Gross margins need to be evaluated in relationto marginsImpact of hedging activities should be consideredSG&A comprises elements that are relatively fixed(office (selling exp) & and distribution those that exp) are relatively variableLOGS : Forecasted as a % of SaleSGA : Forecasted as a % of salesFinancing Cost : Forecaste using debt lul and int rateDep : Forecasted using dep schedule & historical depIncome tax : Forecasted using effective rate (takexpPBT)Interest ExpenseThe primary determinants of int exp are level ofgross debt & Int rateeNet debt is gross debt - Cash & equivalents and ST securitiesNet int exp is gross exp - Int income on cash 4ST debt securities Page No. 125DateIncome TaxFThe Statutory Rate is the % tax charged in theCountrywherethefirmisdemiciled.us&The Effective tax Rate is income tax exp as a %pretax income on the I/SofThe Cash tax rate is cash taxes paid as a % ofpre tax come.Orangesinbet"deferredtaxitemsaccountfortheincometaxexp& Cash taxes duediffIf a multinational company has relatively more (less)rapid earnings tax growth rate in a high tax country + itseffective will increase (decrease)An tax analysts should pay special attentiontoes-of an effective rates tax for rate companies that is that less consistently than thereportstatutory rate ( or Consistently less than that ofComparable peer Coparat (o.s)Effective < statutoryRed fleg PageNo. 125Date / /Satutory taxEffective TaxCash taxrateRate% tax charged inIncome Tax ExpCash tax paidthe domiciled Countrypretar incomepretax IncomeFore castingthe B/SManyBIS itemsflowsfromI/Sforecaste.Forecasted Inventory=Forecasted COGSCOGSInventory TurnoverInventoryForecasted AIR =Days Salesoutstanding(Forecast 365 sales)AR T/oSales365ARNet PPE = Beg Balance + Copex-accdepCapex Canbebased on a relationship with sales orbased on company - specific infoCopex can be separated intocapex for maintenance 4Capex for growth. Page No. 126Date / /Capital Structer : Forecasted using leverage ratios Howeverhistorical Company practice management financial Stratand Capital needs in the future should b alsobe consideredU8Maintenance Capital exp : Exp necessary to sustainCurrent bizGrowth Capital Exp : Exp necessary to expand the bizMaintenance Capital exp forecaste should normally beAnalyst should use sensitity anlysis or analysis tohigher than dep because of inflationest the effect of changes in assumptions onCompany valuationROIC and Competitive AdvantageROIC = No PATEBIT - Actual takesInvested Capitaloperating assets - Operating liabilROCE = Operatin g profitDebt t EquityFirms with higher ROIC (relative to their peers) are likelyand los of their products.exploiting sale some Competivitive advantage in the production Page No. 127Date//When Comparing firms with diff Capital structures &ROIC is preferred over ROE NI/Equitytax RuteReturnon capital employed is similar to ROICbut uses pre - tax earnings in numerator.ROEC is suitables for company Comparison of Companieswith diff tax rate.High Roll is a sign of competitive advantageEffect of Competitive factors on prices & CostsRevenue growth + profitability + WC investment capital expare all based on an est of company futureCompetitivestrengthPoter's Five Force AnalysisIRivarly amoung existiny Competitors:low intensity of rivarlyMore pricing power2Threate of entry:low threat of new entranteMore pricing power3Threat of substitution :Few substitutes More pricing powerpricing power is low when Industry concentration is low , whenfixed costs and exit barriers are high when industry growthis slow or -ve , and when products are not diff erentiatedto a significant degree. Specially in a circumstance where a small no - of customersPage No. 178are responsibility for a large proportion of 0 firmDate//Sale and also when switching costs are low4Power of Buyers :Low bargaining power of buyerMore price power5Power of Suppliers :ULow bargaining power of supplierMore price power8Input Cost Price Inflation& derivativeFirms with commoditity 1: type inputs Cun d hedge theirexposure Can incorporate price fluction slawelyVertically cost integrated firms are less affected by inputAnalyst must judge if a company Can pass onprice inflationthe price increase to customersThe effects of increasing a products price depend on theproducts elasticity of demand and the actions of rivalsPriceVolumedependsEach item of cost should be forecasted by making anassement about impact of potential inflation / deflation Page No. 129Date / /Technological Developments Supply curve shifts to therightSome advantage advances in tech decreaseCost.ofproduction, which will increase profit marginsTechnological advancement may result in improvedsubstitutes (cannibalization)Cannibalizationfactoris the% of the market for theexistingproductthat will be taken by the newSubstitute.Whentechdevelopmentresultsin substitute products thedemand Curveshifttotheleft*Forecaste HorizonTeMay bebased on expectingholdingperiodMustincludemid-cycleforcyclicalfirmsWhentherearerecentmaterialevents, such as acq,mergersorrestructuringstheforecasthorizonshouldbe,longenough that the perceivedbenefitsofsucheventscan be realized (or not)May be dictated by employerLong - Term Growth RateFor terminal value est, a long-term growth rateassumption is necessaryAnalysts shouldlook for Inflection points Page No.BoDate/Inflection points occurs due to changes in :- Overall economic environment- Biz cycle stage- Govt regulationsu- Technology&Sale -basedprofiomacompanymodelIEst Rev5Est Income tax expItems related2Est COGS6Model the B/S3Est SGA7Capex for replacementCon strut4proEst Financing lostformsOF statementusing pro formaIls&B/SAfter forecasting financial statement t analysts est a termindH is est using relative valuation approach or DCF approachMultiple used should be consitent with the long - ourgrowth rate and req return.Determine wheter terminal free CF needs to be normallDetermining how future long -run growth rate willfrom historial growth ratediferAnalyst should also take inflection points such economicsenvironment , biz cycle stage regulations&Consideration .technologyinto Page No. 13)Date / /*Analysts choices in developing projections beyond theshort - termforecasthorizon.Investment Strategy:For must professionally managed equityaccounts forecaste horizon is simply the avg holdingperiod for a stock leg forecast horizon of fdio with25% turnoverwill be4 yr)esout)Cyclicality of the Industry :Forecaste horizon should be longenough to allow the biz to reach an expectedmid - cycle Wl of sales & profitability.heCompany specific factor :In Case of recent M&A orrestructing activities, forecast horizon should be long beenough to reflectexpected benefits that canizedrealizedEmployer's preferences :Forecaste horizon is specified by theanalysts employer Page No. 132Date//Key to the ExamMethodsfor forecastingindividualfinancingstatementEconomiesof scalePorter'z fiveforces analysisCannibalizationfactorCannibalizationfactorInflection pointsForecasted dep rates are usually are based on historical infowhereas forecasted Copex is usually based on forecasted databetropys