Kenya Lopez
In-Class Discounted Cash Flow
Costco Wholesale
Corp. (NASDAQ: COST)
FIN 4370
Costco is a retail worldwide company that operates on United
States, Puerto Rico, Canada, United Kingdom, Mexico, Japan, Australia, and
Spain. Its main business consists on selling a high-quality “a limited selection of nationally branded and select
private-label products in a wide range of merchandise categories” (costco.com) at low price through the operation of membership
warehouses. Its merchandise include
food, sundries, appliances, electronic, fresh food, apparel. Costco offer as
well optical dispensing center services, food courts, and has hearing-aide
centers. A major service is the operation of gas station, currently they
operate more than 5 Million gas stations around the world. They provide online
services, mainly in e-commerce, delivery and travel services.
Assumptions that need to be consider when building a
forecasting model for Costco.
A good approach to build a forecast
model it would be using a Discounted-cash-flow model. This
model is used to obtain an estimate of the current value of the company (Enterprise
value) based on the present value of its future cash flow using Weighted
Average Cost of capital (WACC) as a discount rate. Data is obtained from 2016 Costco’s
financial statements. Weights in the equation are based on market not book
value, and the calculated cost of debt is after tax.
Weighted Average Cost of capital (WACC): Is the rate a company is expected
to pay for financing its assets. To obtain this calculation we use the
following the formula:
Cost of Equity: To
obtain the cost of equity I am using Capital Asset Pricing Model (CAPM)
Formula: E(R) =Rf+B(Rm-Rf)
For Risk free (Rf) I am using the interest rate available for U.S. 10 Year Treasury
Bond since is more commonly known as the benchmark for many corporation when
calculating Cost of equity. Current yield as of October 17, 2017 is 2.341 (MarketWatch)
Current Chair of the
Board of Governors of the Federal Reserve System Janet L. Yellen had maintained
rates lower. Rated were increased this year only one time and another increase is
expected at the end of this year. However, Yellen period finishes on February
2018, and another Chair must be appointed by the president. In the article “World’s Central Bankers, Finance Officials
Keep Close Eye on Selection of Next Fed Chief,” Josh Zumbrun mention, that three other people
have been interviewed by the president Donald Trump: Jerome Powell current Fed
governor, Kevin Warsh another former Fed governor and Jonh Taylor, an economist
from Stanford University, and not everyone favors low rates policies. So, a lot
of uncertainty exist along with the low level of inflation. Therefore, I
estimate that interest rates would at least increase two more times in the
following years for 25 basis point each. Thus, for this model I would use:
2.341 +
.50=2.841 as risk free.
Beta: Is the current
volatility of the stock price. This number varies depending on the source we
are looking at and for how long the volatility is calculated.
The following are betas comes from two different sources:
Yahoo Finance: 1.03 Market Watch: 0.68
I would use the higher considering Costco’s risk higher than the market. |
Rf
|
Beta
|
Mr
|
Rf
|
|
|
2.841
|
1.03
|
11.05
|
2.841
|
|
|
Cost of Equity:
|
11.29627
|
|||
Cost of Debt: To obtain
the cost of debt I am dividing the total interest paid by the total short and long-term
debt outstanding from the balance sheet statement, then I would multiply by the
effective tax rate. (1-T). t= (income Tax/Pretax income)
|
Cost of Debt:
|
|
|
|
Total Interest Paid
|
0.133
|
B
|
|
Outstanding debt
|
1.11
|
B
|
|
Cost of debt before taxes
|
0.1198
|
|
|
Tax expenses:
|
1.24
|
B
|
|
Pretax Income
|
3.62
|
B
|
|
Effective Tax Rate: Income
Tax/Pretax Income
|
0.3425
|
|
|
Cost of debt after Tax: (Total cost of debt)*(1-Tax Rate)
|
0.0788
|
Market Value Weights and Calculation:
Because the weights in the equation are based on
market value not book value. I would use the following formula to obtain
accurate market values. The value of equity equals the current market cap
value. It is obtained by multiplying the current price of the stock times the
number of stocks outstanding.
|
Current Stock Price
|
157.83
|
|
|
Shares Outstanding
|
438.59
|
|
|
|
|
|
|
Market Cap:
|
69222.66
|
M
|
|
|
|
|
|
Total Debt:
|
1,100.000
|
M
|
|
Total Stockholders’ Equity:
|
69222.66
|
M
|
|
|
|
|
|
|
|
|
|
Weight Market Value of Debt: 1,100
M/ (1,100 M +69222.66M)
|
0.0156
|
|
|
Weight Market Value of equity:
(6922.66 M /(1,100 M 69222.66M)
|
0.9844
|
|
|
Weight of Debt
|
0.0156
|
|
Cost of Debt
|
0.0788
|
|
|
|
|
Weight of Equity:
|
0.9844
|
|
Cost of Equity
|
11.2963
|
|
|
|
|
WACC:
|
11.1208
|
Enterprise
Value and T-value:
To continue with the valuation, it
is necessary to do a forecast for the unleveraged free cash flow of the
company, and determine the terminal value. Bruner, Eades, Schill states,
“terminal value is estimated in the last year of the forecast period and capitalizes
the present value of all future cash flows beyond the forecast period.” (572) Therefore,
the t value needs to have especial attention because with this we assume cash
flows would growth in a perpetuity for its remaining life.
The Enterprise value (EV) would be the sum of all future cash flow
discounted at present value.
Other Assumptions :
·
As a growth rate for the forecast I
would use the average growth rate of gross income from 2013 to 2016, which is
4.1%. The following chart shows the calculation.
|
|
2013
|
2014
|
2015
|
2016
|
|
Revenue
|
13.21
|
14.18
|
15.13
|
15.82
|
|
Growth
|
0.6525
|
|
||
|
.6525/15.82 / 89.73
|
4.1%
|
Growth Rate
|
||
·
I am forecasting Unleveraged free
cash flow for five years. My starting point is the Unleveraged cash flow 2016.
Which is equal to 8.78 billion. Data
was obtained from financial statements from Marketwatch.com.
Unlevered Free Cash Flow = EBITDA - CAPEX - Working Capital
- Taxes
o
EBITDA (earnings before interest,
taxes, depreciation, and amortization)
o
CAPEX (capital expenditures)
o
Working Capital (which includes
inventory, accounts receivable and accounts payable)
|
Unlevered
Free Cash Flow
|
||||
|
2014
|
2015
|
2016
|
||
|
EBIDTA
|
4.25
|
4.75
|
4.93
|
|
|
-
|
Income Tax
|
1.11
|
1.2
|
1.24
|
|
-
|
Capital Expenditures
|
|
|
|
|
Current
Assets
|
17.59
|
17.3
|
15.22
|
|
|
Cash
& Shor Term Investments
|
7.32
|
6.42
|
4.73
|
|
|
Current
Liabilities
|
14.41
|
16.54
|
15.58
|
|
|
-
|
Working Capital
|
-4.14
|
-5.66
|
-5.09
|
|
|
|
|
||
|
=
|
Unleveraged Cash Flow
|
7.28
|
9.21
|
8.78
|
I am using as terminal value the current
long-term treasury note (30 years) 2.8455 plus 50 bases points to reflect
future rate increases. I consider that using a long-term risk-free rate would
be a close rate for an expected long-term growth of the economy and inflation.
Thus, a good proxy for the steady revenue growth of the company as well.
Therefore T-value for this model is
3.3455% (Marketwatch.com)
Per share value and Analysis :
The Enterprise value is the amount we would pay for a
company if we were to buy it today. In this model the enterprise value is the
sum of the future cash flow. I am adding the cash and equivalence and
subtracting debt, to get the shareholder equity value.
Costco Fair
Value based on its sum of the forecasted
unleveraged cash flow, Costco’s Enterprise value is $121 billion, plus cash
equivalents $4.73B less debt $15.58 B, the shareholder equity value would be
$110.00B. The estimate per-share value $250B: this is calculated by dividing
the $110B equity shareholder value by the current stocks outstanding. Comparing
Costco’s current stock price, with the Discounted Cash Flow Model, Costco’s Stock
it is undervalue by $92.1 meaning that the stock is being sold by at a price
below its intrinsic value. Therefore, the undervalue price give investors
security to keep investing in this company to obtain future returns. (See
calculations next page.)
Costco has been proven a successful corporation
that has been showing increasing revenues through the years. One of the most
important situations is that the company is operating in eight countries. This
show that the company has extremely room for improvement by expanding to other
countries. Also, Costco is well known for its quality products, one well
recognized in-store brand is Kirkland. The products under this brand are not
only sold by Costco, but as well for other retail stores, even amazon.
According to the business insider, in the article The No. 1 seller of
Costco-brand products online isn’t Costco, “Amazon
is responsible for 70% of Kirkland's online sales Jet.com is in third place
with a 5.5% share of Kirkland's online sales, while Costco is only responsible
for 23%, according to the study by analytics firm 1010data.” This means, that even when its in-house
product is being sold for other retailers it implies revenues for Costco. Therefore,
I see Costco continue being a successful company in the following 3 to 5 years.
As
competitive challenges, as every other retail company, Costco needs to maintain
competitive with online- retail service and competitive prices not only
in-store but as well within a range that can compete with other online- retail,
as amazon, and jet.
| Costco Enterprise Value Discounted Cash Flow |
|||||||||||
| (FYE December 31, $ in billions) | Historical | Forecast | Terminal | ||||||||
| Year | |||||||||||
| 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | |||||
| Unleverage Cash Flow | $ 8.78 | $ 9.14 | $ 9.51 | $ 9.90 | $ 10.31 | $ 10.73 | |||||
| Terminal Value 1 @ | 3.346% | $ 143 | |||||||||
| Discount Years | 1.0 | 2.0 | 3.0 | 4.0 | 5.0 | 5.0 | |||||
| Risk-Adjusted Discount Value @ | 11.12% | 0.900 | 0.810 | 0.729 | 0.656 | 0.590 | 0.590 | ||||
| Present Value of Cash Flows | $ 8.2 | $ 7.7 | $ 7.2 | $ 6.8 | $ 6.3 | $ 84.2 | |||||
| Business Enterprise Value | $ 120 | B | |||
| Plus: Cash en Equivalents | 4.73 | B | |||
| Less: Debt | 15.580 | B | |||
| Shareholder Equity Value | $ 110 | B | |||
| Estimated Per Share Value | $ 249.90 | ||||
| Actual Stock Price as of October 18,2017 | $ 158 | ||||
| Shares Outstanding | 438.59 | M | |||
| Price is Undervalued by: | 92.1 | ||||
Works Cited
Bruner,
Eades, Schill states. “Methods of
Valuation for Merges and Acquisitions.” Case Studies
in Finance. 6th Ed. 572. Boston: McGraw-Hill,
2010. Print.
Zumbrun, Josh. “World’s Central Bankers, Finance Officials
Keep Close Eye on Selection of
Next Fed Chief.” Wall Street Journal. October 15, 2017.
Retrieved from
Peterson, Hayley. “The No. 1 seller of Costco-brand products online isn’t Costco.” Business
Insider. Web. October 18, 2017. http://www.businessinsider.com/amazon-is-the-top-seller-of-costco-items-online-2016-9
Comments
Post a Comment