GIS was successful in delivering value to its shareholders from 2004 to 2008. Their performance was above the market in 2005, 2007 and 2008. CAG recorded a lower TSR in all years under consideration except for 2004. GIS recorded unprecedented value of TSR in 2007 attributed to strong productivity and effective pricing strategy.
GIS reported negative TSR in 2009 and a very low value in 2004. In 2004, although GIS earnings grew, it was not reflected in their stock price leading to the reduced TSR. In 2005, GIS was able to deliver value despite facing challenges such as increasing commodity cost. The company increased dividends to shareholder by 13% to $1.24 (GIS Online 2009).
In 2006, the company performed well and grew their net sales by 4% to give $11.6billion. Despite the increasing commodity costs and inflation, they delivered return to their shareholder and increased dividends by 8% to $1.34. In 2007, the company experienced unprecedented success across all operating segments. Operating profits grew 8% to $2.1billion and dividend payout increased by 7% to $1.44 leading to value delivery to shareholders (GIS Online 2009).
Despite significant increase in commodity cost in 2008, the company was able to capitalize on preceding year’s success and further increase operating profit by 6% to over $2.4billion. GIS’s sales and profit growth, coupled with a dividend yield of between 2 and 3 percent of stock price, resulted in returns to shareholder above the S&P 500 index. GIS recorded negative TSR in 2009 due to the fall in stock price caused by the current economic and financial recession which started in 2008. However, they still seem to perform better than competition ConAgra and the S&P 500 index.
Table 1 shows comparative figures for GIS, CAG’s and the S&P 500 Index (See appendix 2 for TSR formula).
Figure (b): 5-year TSR - GIS, CAG’s and S&P 500
Source: Own Illustration
The trend variations correspond to the environment in the food industry, with dips in periods of increased ingredients and packaging costs. The most recent figures 2008 and 2009 show a decline in TSR in line with the current financial and economic environment, GIS outperformed the S&P 500. Their performance was driven by their effective cost control mechanisms, effective marketing and pricing strategy.
Although TSR provides a holistic measurement of value created and a useful instrument for comparison, it cannot be used at business level unit and by privately held companies. It also functions on the assumption that efficient markets reflect and react to information about companies through the market share price (12manage 2009).
- CHANGES IN EQUITY VALUE IN THE LAST 12 MONTHS
The EMH postulates that new information made available to the market is reflected in the changes in market value of shares. From the period between 30 May 2008 and 30 April 2009, GIS’s equity value has decreased by 19.79% from 6320c to 5069c. CAG’s reduced by 24.94% and the S&P 500 reduced by 37.67%.
The recession brought about by the shakedown in the US mortgage market which began in 2008 led to the huge loss of points in the S&P 500 in the last 12 months. The large drop of equity value was the resultant outcome. Figure (c) shows GIS’s share price movements and Figure 4 shows comparative data.
Figure (c) – GIS Monthly Share Price for Last 12 months
Source: Own Illustration (Data from GIS 2009)
In spite of the current economic recession’s effect on the S&P 500, some analysts comment that GIS is not getting enough credit for its strong balance sheet, high sales and expansion into high growth market. According to Barron’s Neil A. Martin (2009) GIS share price may increase to the low 60’s.
Figure (d) – GIS, CAG’s and S&P 500
Source: Own Illustration (Data from GIS, CAG, Yahoo Finance 2009)
GIS share price trends corresponds with that of CAG and S&P 500. February 2009 recorded the highest monthly variance in the last 12 months with a steady decline in price from $59.15 on January 30 to $52.48 on February 27 although there was no significant daily price change throughout February. 1 October recorded the highest price of $70.16 while 20 March 2009 recorded the lowest price of $47.22 in the 12 month period under consideration. The 5 most significant daily changes were identified and shown in Table 2.
Table 2 – GIS Significant Daily Changes
GIS lost value of about 7.72% on 09 October, 2008. This was during the sharp decline that took place in the NYSE which FT.com 2009 attributed to mutual funds redemptions sudden sell offs.
Later in the month of October, stock prices rose in the wake of news of recovery of the financial market. This was reflected in the S&P 500 index which increased by 11.58% and 10.79% on October 13 and 28 respectively. GIS stock also appreciated in line with the market trend during this period by significant stock price increases of 9.43% and 6.07% respectively.
GIS was among the companies who had a second-tier credit rating in the commercial paper markets, where companies raise funding for typically anywhere between overnight and 90 days and this reflected in their stock price drop in December 9. On December 17, GIS stock jumped by 0.2% to $61.35 after announcement of better than expected second quarter profits (FT.com 2009)
In March, GIS share price dipped by about 11.24% to $47.63 after company announced that corporate earnings came in below estimates as high costs took their toll (FT Online, 2009)
Today, amid the current US economic crisis, GIS Foods is still relatively stable. Part of the reason for this is the better outlook painted for packaged food manufacturers since consumer habit seems to be changing to in-home eating.
- VALUATION OF EQUITY
- Net Asset Value
The net asset value (NAV) of equity is the value of owner’s stake in a firm and calculated by deducting total liabilities from total assets (Pike & Neale, 2009). Its reliance on historic cost, assumption on reliability of published account and ignoring earning power of the assets are some of the bane of NAV (Barber 2009) although using value stated in accounts has appeal for those impressed by objectivity of published accounting data (Pike & Neale, 2009). However the original intent of published accounts was providing a measure of true earnings and reliable estimate of a company’s asset and equity. Damodaran (2006)
GIS’s current NAV is computed using its 22 February, 2009 balance sheet. The NAV is 1671 cents. This is about 33% of the market value of 5069 cents as at 30 April, 2009. Table 3 shows NAV for the last 5 years.
Table 3: Net Asset Value Computation
Source: Own Illustration
NAV views a company’s worth as the sum of its net asset value. Major limitation of this method is its use of values stated in a company’s financials which are historical and fail to reflect true market value of those assets. NAV also does not take the cash earnings of the company into consideration. In view of this, current value methods are preferred. However Atrill (2005) identified a flaw of current value as they fail to take the company value as a going concern into account.
NAV is useful because of its simplicity and ease of obtaining data in the valuation of a company. It provides a minimum value comparable with the market value to make investment decisions and measure risk associated with investing in a company (Atrill, 2005).
4.2. Price Multiples
Various price multiples are used in the valuation of a company. For the purpose of this work I will be using the price to earnings ratio (PER). PER measures the markets confidence in a company (Pike & Neale, 2009). Damodaran (2006) also mentioned that one of the most intuitive ways of valuing an asset is a multiple of the earnings it generates and PER does this effectively.
In valuing GIS’s equity, values obtained are compared with CAG (a comparable firm). Comparable firms are those with similar growth potential, risks and cash flow (Damodaran, 2006). Principle underlying the use of comparable company as described by Hume (2000) is the law of one price which states that comparable assets ought to have the same price.
Table 4: Price Earnings Ratio
The 2009 PER was calculated using EPS* for Q3 2009. A value of 2684 cents was obtained when the PER of CAG was used. This is about 53% of GIS market value ($50.69). This variance was less in previous years compared as shown in table 4 particularly in 2005 where the variance was less than 1%.
- Discounted Cash Flow (DCF)
DCF valuates a company based on the future cash flow adjusted for the time value of money. The method is now gaining popularity thanks to the criticisms and limitations of the use of accounting methods in equity valuation. DCF functions majorly on two elements: future cash flow and cost of equity. There are two models of DCF – Free cash flow to equity (FCFE) and free cash flow to firm.
The DCF model used here is the Free Cash flow to firm (FCFF) model. In estimating future cash flows, the 2009 account which provides the most recent financial data is used to ensure a more reliable estimate of future figures. Table 5 provides details of the 2009 base year figures.
Table 5: Base Year Figures
Revenue
GIS’s revenue has been growing since 2005. This growth peaked in 2008 with a 9.7% spike in revenue growth. However, based on estimated figures for 2009 end of year (using 9 month financial report) this growth dipped to 1.1% and its attributable to the current financial and economic climate leading to reduction in consumer products. CAG’s revenue growth seems to be erratic with declines in 2005, 2006 and 2008. The major loss of revenue was in 2005, about 20%. See table 6.
Table 6: GIS Foods and CAG’s Co. Revenue
Source: Thomson Financial
GIS’s main growth strategies include cost-saving efforts and price. They also increased our spending on advertising and other consumer marketing programs, which help generate consumer awareness and purchase their brands. Increased foray into international operations and partnership with retailers were some of the other strategies employed.
Although the prognosis for food manufacturing companies is stable, this especially applies to manufacturers of packaged foods such as GIS because of consumer’s propensity for “in-home” eating (Fitch 2008). Also GIS current drive towards international expansion in fast growth markets coupled with a historic review of their performance is my justification for a conservative estimated growth rate of 1% and 3% in 2010 and 2012 respectively. Sustainable growth rate will not exceed 3%.
Operating Margin
Operating margin for GIS currently stands at 14.2%. GIS performed better than forecasted in 2007 and 2008. However their performance in 2009 was below planned due to the crunch of the financial climate. However, with the bright outlook for commodity manufacturers, and GISs’ capability at cost management, I have estimated that GIS performance will improve to the average of 17% which they have kept for over 5 years.
Terminal Value
The terminal value is used as an effective close point in cash flow estimations especially when publicly traded companies which do not have a fixed life span or life expectancy is being valuated and estimations cannot be made to infinity. The assumption is that cash flows will continue in perpetuity after the terminal period at a constant rate which is sustainable (Damodaran, 2000). The formula for estimating the terminal value is given below:
Terminal value = FCFF2019 / (Ke2019 - g2019)
At the sustainable growth rate of 3%, the TV is estimated at $35, 592mn. See Appendix 2.
Future Cash Flow Estimation
Table 7: Cash Flow Estimation
Discounting Rate
Organisations usually combine debt and equity financing. The combined costs of debt (Kd) and cost of equity (Ke) and their Weightage in the finance structure of a company is appropriately shown in the weighted average cost of capital (WACC).
GIS’s debt proportion is calculated as shown below:
Cost of debt is computed as shown below:
Cost of equity can be estimated using the Gordon Growth Model (GGM) and the Capital Asset Pricing Model (CAPM).
CAPM considers the risk free rate (Rf), the company’s beta (β) and the market premium. Generally government securities are considered and acceptable to be free of risk. The Rf of the 3-month government bond rate is sufficient in carrying out valuations (Barber 2009). The Rf used is therefore 0.18%.
Although the market Premium is not directly observable from market data due to uncertainty in future payouts, credit suise research institute published a yearbook in 2009 in which the market premium for USA was given as 5% (Credit Suise 2009). This value is used in the calculation.
Beta is the measure of the risk of an asset compared to the market. The reliability of the value of Beta obtained depends on the source and Beta changes over time. According to Reuter (2009), GIS has a beta of 0.28.
Therefore GIS’s Ke under CAPM is:
Using the estimated Ke from both the Gordon growth model and the capital asset pricing model, the WACC is computed as shown below:
GIS has a lower WACC using the Ke obtained from CAPM compared to the Ke obtained from the GCM. The Gordon’s growth model gave a cost of equity higher that the cost of debt while the CAPM gave a cost of equity lower than the cost of debt. Since the tax shields in a company usually make the cost of equity higher than the cost of debt, the WAAC of 10.07% derived using the Ke obtained by the GGM will be used.
Table 8 – Present Value of GIS FCFF
Table 9 – DCF Value of GIS’s Equity
GIS’s equity value under the DCF model is 6058 cents.
Sensitivity Analysis
The macroeconomic environment and uncertainties in the assumptions made (see appendix 1) determine quality of a valuation exercise rather than the precision of the values obtained it is important to deal with this since they can not be eliminated (Damodaran 2000). Sensitivity analysis does just that! According to Breierova & Choudhari, (1996), a sensitivity analysis is used to measure the responsiveness of a model to deviations in the values of the parameters used. The DCF valuation obtained is tested based on this theory using the changes in variable listed below.
The table below shows a snapshot of GIS’s equity value estimated using the DCF based on the above changes. See Appendix 5 for details. The sensitivity of the DCF equity value to cash flow assumptions and discount rate changes is reflected in changes ranging from 15% to -37% from the original valuation.
Table 10: Sensitivity Analysis Summary
- Reconciliation of Differences in Valuation
The table below summarizes the equity value obtained for GIS Foods using the various models discussed above.
Table 11: Summary of Equity Value
GIS values estimated range from 1671c (NAV) to 6058c (DCF). DCF records the value closest to the market value with a difference of about 20%. As observed, different methods of valuation yields different results for the value of GIS. The PER which is effective at comparing like with like shows that GIS is either undervalued or that investors expect the price/value to increase. The NAV which is limited because of its use solely of historical data is not the most representative value. However it shows that GIS stock is overvalued. The results generated using the DCF show that the stock is currently undervalued and this is understandable bearing in mind that the DCF takes the future earnings of the firm into consideration. According to Pike and Neale (2009), the use of multiples to detect under- or overvalued companies implies that the market is inefficient.
The appropriate method of valuating a company is determined by the purpose for the valuation. Fernandez (2007) stated that different valuation methods are useful in different circumstances, and advised that a combination of methods be used to obtain a more reliable valuation. Atrill (2005) also share his views on the combination of more than one valuation method. A most noteworthy saying is one made by Hume (2000) that valuation of a company is both a science and an art, which requires sound thinking, financial and commercial knowledge. Valuation exercises should does not be taken as cast in stone, but the efficiency of a valuation can only by appreciated with hindsight.
This report valuated General mills using various valuation methods, identified the strengths and weaknesses of each method. The report also analysed GIS value delivery over a 5 year period and attempted to explain the reason for GIS stock price fluctuations over the last 12 months. A consensus that seems to reverberate is that there is no “one” correct method at valuation and the best that can be obtained is the market value in an efficient market where the market reflects / values a firm as information is made available.
- APPENDICES
Appendix 1: Assumptions in calculating DCF
Experts such as Damodaran (2000) and Barber (2009) advised the use of the latest financials published in valuation of a company. The task required that valuation be at the 1st of May 2009 and the following assumptions were made.
1. Financial year ended 30th April 2009 was assumed to be the base
2. Operating margins was calculated as an average of base year 14.2% and previous 5 year average 17.43%
3. Rate of revenue growth was based on:
- Base year growth of 1 % reflecting the current economic climate.
- Average of 5 years taken as 5.43%
- Historical trend of revenue growth peaking at 9% and sustained at 3%
- GIS core capability to control cost and effective pricing strategy.
4. Depreciation was estimated based on the average of past 5 years as 3.35% of revenue
5. Working capital expenditure was estimated based on average of past 5 years as 4% of revenue.
Appendix 2: Formulae and Equations
1. Total Shareholders Return: Rjt = Djt + ( Pjt – Pjt-1 ) * 100
Pjt-1
Rjt - Total shareholders return
Djt – Company J’s dividend in year t
Pjt – Company J’s share price at the end of year t
Pjt-1 – Company J’s share price at the end of year t
2. Cost of Equity (CAPM): Ke = Rf + β * (Rm – Rf)
Ke – Cost of Equity
Rf – Risk Free Rate
β - Beta
Rm – Market Return
Rm – Rf – Market Premium
3. Cost of Equity (GGM): Ke = D1
MV (ex div) + g
D1 – Next year’s Dividend
g – Dividend Growth Rate
MV – Market Value of Equity
4. Weighted Average Cost of Capital: WACC = (Debt Proportion * Kd) + (Equity Proportion * Ke)
5. Terminal Value: TV = FCFF2019 / Ke – g
FCFF2019 computed = $2,516mn
Ke (CAPM) = 10.07%
g = 3% (The sustainable revenue growth rate)
Terminal Value = $35,592mn
APPENDIX 3: GIS 2009 Preliminary Results
GIS FOODS INC. AND SUBSIDIARIES: BALANCE SHEET AS AT 22 FEBRUARY 2009
Appendix 4: Dividend Growth Estimation
GIS dividend has been on an unabated increase since 2005 at an average increase of 7%. The value stated for 2009 is an estimation based on 3rd quarter financials published and GIS goal of paying a minimum of 43 cents per share per quarter. Estimated dividend growth rate is given as 7% taking the current market situation into consideration.
Appendix 5: Sensitivity Analysis – Details of Present Value of FCFF
S1 – Based on the assumption of revenue growing at 1% (other variables remain as estimated).
S2 – Using Ke = 12.07%, arrived at using the GGM as shown above (All other variables for FCFF are as estimated).
REFERENCES
Atrill, P. (2005). Valuing Company Shares. Available at (Accessed on 23/02/2009)
Barber, P. (2009). Corporate Finance. MBA Module Manual, 2008/2009, University of Bradford, School of Management.
Barron’s Neil A. Martin. SeekingAlpha Online. Available at
(Accessed 29/06/2009)
Bradbury, M. E. and Ferguson, J. (2000).The Accuracy of Price-Earnings and Discounted Cash Flow Methods of IPO Equity Valuation. Journal of International Financial Management & Accounting, Vol. 11, no. 2.
Credit Suise yearbook online. Available at
(Accessed 29/06/2009)
Damodaran, A. (2000). The Dark Side of Valuation: Firms with no Earnings, no History and no Comparables. Can Amazon.com be valued? Available at
(Accessed 15/02/2009)
Damodaran, A. (2006). Valuation Approaches and Metrics: A survey of the Theory and Evidence. Available at (Accessed 03/03/2009)
Federal reserve Online. Available at
(Accessed 29/06/2009)
Fernandez, P. (2007). Company valuation methods. The most common errors in valuations. IESE Business School – University of Navara.
Fitch 2009 US Packaged Foods Outlook: Sector Stability despite Weak Economy. Available at
(Accessed 12/03/2009)
FT Online 2009. Available at
(Accessed 30/06/2009)
Hume, S. (2000). What's it Worth? A Guide to Valuation Techniques. Available at (Accessed on 25/02/2009)
Mayes, K. (2000). Shareholder Value. ACCA Online. Available at
(Accessed 20/02/2009)
Michael C. Jensen, 2000. Harvard Business School. Value maximisation and the corporate objective.
NYSE Euronext: History. Available at
(Accessed 06/02/2009)
Pike, R. and Neale, B. (2009). Corporate Finance and Investment, 6th Edition. FT Prentice Hall. Harlow.
Reuters online. Available at
(Accessed 29/06/2009)
Sparling, D. and C. G. Turvey (2003), ‘Further Thoughts on the Relationship Between Economic Value Added and Stock Market Performance’, Agribusiness, 19(2), pp. 255-267
TFAL 2009 Online. Available at
(Accessed 29/06/2009)
Thomson: Thomson One Banker Analytics (2009). Data from GIS Foods Inc. & CAG’s Company. (Accessed via Bradford School of Management Resources 29/06/2009)
12manage 2009 Online. Available at
(Accessed 29/06/2009)
2004 Annual Report. GIS INC Online. Available at
(Accessed 29/06/2009)
2005 Annual Report. GIS INC Online. Available at
(Accessed 29/06/2009)
2006 Annual Report. GIS INC Online. Available at
(Accessed 29/06/2009)
2007 Annual Report. GIS INC Online. Available at
(Accessed 29/06/2009)
2008 Annual Report. GIS INC Online. Available at
(Accessed 29/06/2009)
2009 Preliminary Report. GIS INC Online. Available at
(Accessed 29/06/2009)
