Valuation Of Ansell Ltd Using Discounted Cash Flow Technique

About Ansell Ltd

The purpose of the report is to conduct a valuation of the stock of Ansell Ltd which is an Australian firm listed in the Australian Stock exchange. The company operates in two different sectors; healthcare and industrial. The company is the leading supplier of gloves and another personal protective equipment which provides 60 percent of the revenue to the company. The company earns 70 percent of the profit from the healthcare segment and the remaining coming from the segment of industries. The company has a lot of patents held with them and a major chunk of the sales come from its branded range of products. The report utilizes the discounted cash flow technique to arrive at the intrinsic value of the stock using information from the most recent financial statement published by the firm. The report is designed to answer 8 questions which is related to the valuation process. The final portion of the report compares and analyzes the price to book ratio of our company with other companies belonging to the same sector operating in Australia.

Discounted Cash Flow Analysis is a valuation technique which uses the free cash flows of the company to predict the value of the stock of the company that is being analyzed (Fernandez 2019). The conversion of the expected future cash flows using an appropriate cost of capital is called discounting. Based on the present value of a company’s investment accounts, the discounted cash technique makes it easier to anticipate how much money it will produce in the future (DeFusco et al 2015). Outside investors and chief executives who want to start a new firm or make major changes to the existing one might use this. The primary notion of the method is that the value of a stock depends upon the estimated capability of the firm to generate cash flows. The higher the ability to generate cash flows, the higher the valuation of the company (De la and Myers 2021). The formula for estimating the intrinsic value of a stock using the DCF method is shared below:

Discounted Cash Flow={[CF0?] +[CF1?/(1+i1?)¹] +[CF2?/(1+i)²] +[CFn?/(1+i) ⁿ]}

The formula for C stands for cash flow for respective periods with C0 representing cash flows for the first period, C1 representing cash flows for second period and Cn representing cash flows for Nth period. I in the formula represents the discount rate which is used to discount the cash flows.

The discounted cash flow approach is appropriate for businesses that do not have any earnings to report on their balance sheets. The model may be used for a variety of things, including evaluating possible mergers and acquisitions candidates, determining the return potential of a stock, and selecting whether or not to invest in a firm. The model is appropriate for Ansell Group Ltd since the firm has been producing positive cash flows for the previous three years, thanks to a growth in earnings per share and revenue. Other approaches, such as the dividend discount model, can be used to analyze the company’s stock price, especially because it pays a monthly dividend. The model may not have been acceptable for the corporation since the dividend distribution policy may be changed in the future owing to economic and financial concerns.

Discounted Cash Flow Analysis

The discount rate which would be used to discount the future estimated free cash flows is known as the Weighted Average Cost of Capital (WACC) which represents the formation of the capital structure of the company (Budhathoki and Rai 2020). The WACC of the company comprises of the cost of equity and cost of debt of the company.

The company’s cost of equity was calculated using the Capital Asset Pricing Model, which incorporates market data such as market premium and the country’s risk-free rate. The CAPM model believes that an asset’s return is solely determined by systematic risk factors, which are represented by the stock’s sensitivity to the market, as measured by beta (Fernandez 2015). The risk-free rate was proxied by the yield on the 10-year Australian government bond, while the market premium was proxied by the 10-year market return on the S&P/ASX200 index. The stock’s beta was calculated using yahoo finance and was 0.42. The company’s cost of equity has been determined to be 4.58 percent.

The cost of debt of the company was calculated by estimating the interest cost by dividing the interest expense of the company with the long-term debt of the company. The interest cost of the company was equal to 1.76 percent. The effective tax rate was calculated using the tax expense of the company with the profit before taxes and it was equal to 21.94 percent. The cost of debt of the company was equal to 1.37 percent.

For calculating the WACC, the book value weights of the company’s equity and debt were used as the weights. In the capital structure, debt accounted for 24.18 percent of the total, while equity accounted for 75.82 percent. The firm’s WACC was 3.81 percent after factoring the facts mentioned above.

The DCF valuation is based upon the amount of free cash flows generated by the company in the future based on an appropriate growth rate as estimated in the question above. The Free Cash Flow formula is shared below:

Net Income + Non-cash Charges + (Interest Expense x (1–t) – Fixed Capital Investment (Net CAPEX) – Working Capital Investment = Free cash flow to the company (FCF).

As we can see the free cash flow is influenced by an increase/decrease in factors like fixed capital investment, working capital investment and tax expense. The following table explains the increase/decrease in those factors influencing the free cash flow of the firm:

Changes in net working capital, which declined by 168 percent in 2021, had a significant impact on the firm’s free cash flow, resulting in a decrease in FCF. The second most important effect was an increase in tax expenditure of 65.40 percent, which reduced earnings before interest and tax. The company’s capital expenditures were boosted by 27.62 percent, substantially reducing the firm’s free cash flows.

The free cash flow prediction would be for five years, with the firm projected to continue indefinitely after the fifth year. The PRAT model was utilized as the way of calculating growth for projecting future free cash flows. The PRAT model incorporates the profit margin of the company, retention rate, asset turnover and financial leverage of the company to estimate the growth rate. The corporation was expected to be growing in stages, finally settling at a long-term growth rate of 1%, which was identical to the country’s estimated GDP growth rate. The forecasted FCF for the company is shared below in the table:

The intrinsic value of the stock was equal to AUD 30.36. The indicated intrinsic value was greater than the company’s observed market price, which was AUD 26.15 per share.

For many reasons, such as growth rate estimates, irrational behaviour of investors purchasing or selling the company’s shares, and different sorts of behavioural biases that investors suffer from, the estimated intrinsic value may differ from the observed market value (Damodaran 2015). To increase the accuracy of the estimate, the company’s growth rate might be calculated as the average of numerous analysts’ projections. The following section presents the sensitivity analysis of the stock price based on different growth rate and WACC assumptions:

The stock can reach a maximum value of AUD 85.94 in a situation where the firm’s WACC is 3% and the growth rate is 2%. In the scenario of a 7% cost of capital and 0% growth, the stock’s lowest probable price is AUD 11.47.

The following table represents the firms operating in the same segment as our company with the P/B ratios of respective companies:

Based on the price to book ratios of the comparable companies and the intrinsic value suggested by the DCF method, it can be said the stock of the company is comparatively undervalued. The highest P/B ratio amongst the firms was of Pro Medicus whereas the lowest P/B ratio was of Healius ltd. Ansell Group Ltd has the second lowest price to book ratio amongst the peers which makes it a suitable investment to make.

Conclusion

The purpose of the report was to perform a DCF analysis of the stock of Ansell Group ltd an Australian company listed on the ASX. The DCF valuation approach employed several assumptions and market data to come up with an intrinsic value of AUD 30.36, which was higher than the stock’s current market price. In comparison to its rivals, the company’s P/B ratio was likewise one of the lowest. The stock had the second lowest P/B ratio among ten companies in the same industry that were listed on the ASX. The report’s conclusion includes a sensitivity analysis of the stock, which shows that in the best-case scenario, the price might rise to AUD 85, while the worst-case scenario could see the stock fall to AUD 11.

References

Budhathoki, P.B. and Rai, C.K., 2020. The Impact of the Debt Ratio, Total Assets, and Earning Growth Rate on WACC: Evidence from Nepalese Commercial Banks. Asian Journal of Economics, Business and Accounting, 15(2), pp.16-23.

Damodaran, A., 2015. Valuation: Lecture Note Packet 1 Intrinsic Valuation. Master Class.

De La O, R. and Myers, S., 2021. Subjective cash flow and discount rate expectations. The Journal of Finance, 76(3), pp.1339-1387.

DeFusco, R.A., McLeavey, D.W., Pinto, J.E., Runkle, D.E. and Anson, M.J., 2015. Quantitative investment analysis. John Wiley & Sons.

Fernandez, P., 2015. CAPM: an absurd model. Business Valuation Review, 34(1), pp.4-23.

Fernandez, P., 2019. Three residual income valuation methods and discounted cash flow valuation.

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