The share price of APN can be estimated by discounting the future cash flows with the WACC to obtain the present value. The estimation of revenues, operating expenses, depreciation and future cash flows involves calculation of the expected growth rate. We have determined the growth rate by using the double moving average method (refer Appendix A – for the relevant tables) on historical values from 1999 to 2009 to forecast future values from 2010 to 2014. Similarly, the unlevered cash flows are calculated using double moving average method which can be seen in appendix A.
The snapshot of historical values is as follows: Based on the above forecasts, the unlevered cash flows for APN are forecasted as follows: The above table illustrates the growth of UCF over the years 2010-14. An average of these values gives us the growth rate of 2. 21%. Using this approximated growth rate and the WACC as the discount rate, we have calculated the present value of the future cash flows. For this purpose we have discounted the cash flows to 2014 and taken the cash flow as perpetuity from 2014 onwards.
The unlevered cash flow discounted by WACC provides the present value for both debt and equity, then we need to subtract the debt figures from the present value to get the present value of the equity of the firm and divide this figure by the number of shares on issue will give us the share price. The closing share price for APN as at 24th January 2011 was $1. 79; this is significantly lower than the share price determined using the WACC method which was $3. 23. This indicates that the share price is undervalued.
Based on this information alone, we should increase our holding in APN. However to derive an accurate recommendation we had to consider several other factors which are discussed below. It can be seen from the sensitivity analysis of the growth rate and the WACC that changes in these two factors impact the share price valuation. If any of the underlying inputs in determining the growth rate or the WACC were to increase or decrease, then this would alter the share price valuation.
For example, had 2010 year end results been available, this may have altered the inputs in the WACC formula. For example, an increase in WACC of 50% would result in a decrease in the present value of future cash flows. From the sensitivity analysis, it can be seen that 50% increase in WACC will result in a share price of $1. 50 which is in fact lower than the current trading price of $ 1. 79, thus altering our initial argument to increase our holding. A comparison of APN to its peers shows that it is more diversified.
In addition, APN’s beta is lower than WAN and FXJ which makes it a less risky company, this may be due to the diversification. AEO has a lower beta than the other companies which makes it the least risky company however it is not as diversified. Lastly in considering whether or not to increase an investment, the economic environment should be considered. The recent flooding in Australia has caused significant damage to property and the damage bill has escalated to $15B.
The effect has detracted on the economic growth however growth will rebound once re-building commences. In our view, APN is a defensive stock which indicates that it should not be impacted as much as aggressive stocks by bad economic conditions. In addition, given that we expect the economy to rebound in the next quarter as re-building commences and government subsidies and talk of potential government fiscal policy, (eg raising medicare levy), the economy should be on the rise. In this environment, defensive stocks would not be a wise choice.