tag:blogger.com,1999:blog-13397874513202229042024-03-08T03:37:08.651-06:00Dividend Value InvestorNicholashttp://www.blogger.com/profile/16914585372166059253noreply@blogger.comBlogger9125tag:blogger.com,1999:blog-1339787451320222904.post-39281532496886455532011-08-11T23:41:00.000-05:002011-08-11T23:41:33.084-05:00Eaton (ETN) - Valuation Analysis<div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Description</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="color: black; font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Arial;">Eaton Corporation (Eaton) is a diversified power management company. It is engaged in the manufacturing of electrical components and systems for power quality, distribution and control; hydraulics components, systems and services for industrial and mobile equipment; aerospace fuel, hydraulics and pneumatic systems for commercial and military use, and truck and automotive drivetrain and powertrain systems for performance, fuel economy and safety. On January 1, 2011, it closed the acquisition of the Tuthill Coupling Group, which is a division of the Tuthill Corporation. It has five segments: Electrical Americas and Electrical Rest of World; Hydraulics; Aerospace; Truck, and Automotive. On October 12, 2010, it acquired Chloride Phoenixtec Electronics. On October 1, 2010, it acquired CopperLogic, Inc. On August 25, 2010, it acquired Wright Line Holding, Inc. On July 15, 2010, it acquired EMC Engineers, Inc. In May 2011, it acquired Internormen Technology Group.</span><i style="mso-bidi-font-style: normal;"><span style="font-family: Calibri; font-size: 10pt;"></span></i></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><i style="mso-bidi-font-style: normal;"><span style="font-family: Calibri; font-size: 10pt;">Source: Reuters</span></i></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Valuation</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Key assumptions included:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Terminal growth rate: 5.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Risk-adjusted discount rate: 13.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Cost of sales: 70.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Selling, general, & administrative costs as % of sales: 18.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Research & development as % of sales: 3.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>CAPEX as % of sales: 4.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Depreciation as % of sales: 4.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Effective tax rate: 8.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales in receivables: 60</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales of inventory: 57</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Days payable outstanding: 53</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">At a 13% growth rate (bull case), I estimate the intrinsic value of ETN to be $40.59 per share.<span style="mso-spacerun: yes;"> </span>With a risk-adjusted margin of safety of 12.6%, the target purchase price is $35.47 per share.<span style="mso-spacerun: yes;"> </span>This is below the $40.65 per share MMM is currently trading at.<span style="mso-spacerun: yes;"> </span>At $40.65, ETN is trading at 0.2% premium to the intrinsic value indicating it is a value in this scenario.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">At a 6% growth rate (bear case), I estimate the intrinsic value of ETN to be $23.92 per share.<span style="mso-spacerun: yes;"> </span>With a risk-adjusted margin of safety of 19.3%, the target purchase price is $19.32 per share.<span style="mso-spacerun: yes;"> </span>This is below the $40.65 per share ETN is currently trading at.<span style="mso-spacerun: yes;"> </span>At $40.65, ETN is trading at 70.0% premium to the intrinsic value.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Dividends</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">ETN pays a quarterly dividend.<span style="mso-spacerun: yes;"> </span>From 2001 to 2010, ETN’s dividend has grown from $0.44 per share to $1.08 per share.<span style="mso-spacerun: yes;"> </span>Dividend growth appears to have slowed in recent years.<span style="mso-spacerun: yes;"> </span>The compound annual dividend growth rate is as follows: </span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Ten years: 10.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt; text-indent: 0.5in;"><span style="font-family: Calibri; font-size: 10pt;">Five years: 14.9%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Three years: 7.9%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">With the dividend appears to be growing slower earnings, the dividend appears to be sustainable.<span style="mso-spacerun: yes;"> </span>Based on net income, the dividend payout ratio has exceeded 50% once in the past five years.<span style="mso-spacerun: yes;"> </span>A dividend payout ratio of less than 50% is a positive allowing for sustainable growth and a cushion for short-term earnings volatility.<span style="mso-spacerun: yes;"> </span>Below is the dividend payout ratio for the past five years:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2006: 23.2%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2007: 25.3%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2008: 30.2%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2009: 87.2%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2010: 39.1%<br style="mso-special-character: line-break;" /><br style="mso-special-character: line-break;" /></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In the book, <i style="mso-bidi-font-style: normal;">The Ultimate Dividend Playbook</i>, Josh Peters discusses a model to calculate a stock’s prospective return.<span style="mso-spacerun: yes;"> </span>The model is called the Dividend Drill Return Model (DDRM).<span style="mso-spacerun: yes;"> </span>It is based on the premise that the dividend total return is equal to the yield plus dividend growth.<span style="mso-spacerun: yes;"> </span>Dividend growth is then broken into core growth (the rate of growth for total profits) plus share change (reduction of shares due to share repurchase).<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given a core growth rate of 13.0% and current dividend yield of 3.3%, ETN’s cost of growth is $2.87 per share.<span style="mso-spacerun: yes;"> </span>After reducing this amount and dividends of $2.20 per share, the funding deficit is $1.46 per share; this amount is forecasted to have a -3.6% impact on share price. <span style="mso-spacerun: yes;"> </span>As a result, the DDRM forecasts the projected total return for ETN to be 12.8%.<span style="mso-spacerun: yes;"> </span>Below is a breakdown of the total return:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 13.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Dividend yield: 3.3%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span><u>Funding surplus: -3.6%</u></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Total return: 12.8%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Summary</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In a bull case, based on a valuation $40.59, shares are trading at a 0.2% premium to their intrinsic value.<span style="mso-spacerun: yes;"> </span>In a bear case, base on a valuation of $23.92, shares are trading a 70.0% premium to their intrinsic value.<span style="mso-spacerun: yes;"> </span>ETN has a history of dividend increases and the dividend appears semi-sustainable as the payout ratio is less than 50%.<span style="mso-spacerun: yes;"> </span>Based on the DDRM, the projected total return for ETN is 12.8%. </span></div><br />
<span style="font-family: "Trebuchet MS", sans-serif; font-size: x-small;"><strong>Disclosure: I am not long ETN.</strong></span><br />
Nicholashttp://www.blogger.com/profile/16914585372166059253noreply@blogger.com0tag:blogger.com,1999:blog-1339787451320222904.post-40585874037337503082011-08-11T23:16:00.001-05:002011-08-11T23:16:57.202-05:003M (MMM) - Valuation Analysis<div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Description</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="color: black; font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Arial;">3M Company (3M) is a diversified technology company with a presence in industrial and transportation; health care; display and graphics; consumer and office; safety, security and protection services, and electro and communications. 3M manages its operations in six operating business segments: industrial and transportation; health care; display and graphics; consumer and office; safety, security and protection services, and electro and communications. 3M products are sold through numerous distribution channels, including directly to users and through numerous wholesalers, retailers, jobbers, distributors and dealers in a variety of trades in many countries. In February 2011, 3M (industrial and transportation business) announced that it completed its acquisition of the tape-related assets of Alpha Beta Enterprise Co. Ltd. In February 2011, it acquired Hybrivet Systems Inc. In April 2011, it acquired Original Wraps Inc. In July 2011, it acquired Advanced Chemistry & Technology Inc.</span><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;"></span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><i style="mso-bidi-font-style: normal;"><span style="font-family: Calibri; font-size: 10pt;">Source: Reuters</span></i></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Valuation</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Key assumptions included:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Terminal growth rate: 3.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Risk-adjusted discount rate: 10.8%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Cost of sales: 52.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Selling, general, & administrative costs as % of sales: 21.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Research & development as % of sales: 5.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>CAPEX as % of sales: 4.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Depreciation as % of sales: 4.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Effective tax rate: 30.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales in receivables: 50</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales of inventory: 82</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Days payable outstanding: 44</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">At a 12% growth rate (bull case), I estimate the intrinsic value of MMM to be $95.00 per share.<span style="mso-spacerun: yes;"> </span>With a risk-adjusted margin of safety of 11.1%, the target purchase price is $84.46 per share.<span style="mso-spacerun: yes;"> </span>This is above the $81.22 per share MMM is currently trading at.<span style="mso-spacerun: yes;"> </span>At $81.22, MMM is trading at 14.5% below the intrinsic value indicating it is a value in this scenario.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">At a 6% growth rate (bear case), I estimate the intrinsic value of MMM to be $79.56 per share.<span style="mso-spacerun: yes;"> </span>With a risk-adjusted margin of safety of 15.4%, the target purchase price is $67.30 per share.<span style="mso-spacerun: yes;"> </span>This is below the $81.22 per share MMM is currently trading at.<span style="mso-spacerun: yes;"> </span>At $81.22, MMM is trading at 2.1% premium to the intrinsic value.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Dividends</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">MMM pays a quarterly dividend.<span style="mso-spacerun: yes;"> </span>From 2001 to 2010, MMM’s dividend has grown from $1.20 per share to $2.10 per share.<span style="mso-spacerun: yes;"> </span>The dividend appears to grow slower than earnings and management appears to have an aggressive stock repurchase program.<span style="mso-spacerun: yes;"> </span>The compound annual dividend growth rate is as follows: </span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Ten years: 6.8%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt; text-indent: 0.5in;"><span style="font-family: Calibri; font-size: 10pt;">Five years: 5.7%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Three years: 3.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">With the dividend appears to be growing slower earnings, the dividend appears to be sustainable.<span style="mso-spacerun: yes;"> </span>Based on net income, the dividend payout ratio has exceeded 50% in the past five years.<span style="mso-spacerun: yes;"> </span>A dividend payout ratio of less than 50% is a positive allowing for sustainable growth and a cushion for short-term earnings volatility.<span style="mso-spacerun: yes;"> </span>Below is the dividend payout ratio for the past five years:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2006: 35.7%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2007: 33.7%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2008: 40.4%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2009: 44.8%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2010: 36.7%<br style="mso-special-character: line-break;" /><br style="mso-special-character: line-break;" /></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In the book, <i style="mso-bidi-font-style: normal;">The Ultimate Dividend Playbook</i>, Josh Peters discusses a model to calculate a stock’s prospective return.<span style="mso-spacerun: yes;"> </span>The model is called the Dividend Drill Return Model (DDRM).<span style="mso-spacerun: yes;"> </span>It is based on the premise that the dividend total return is equal to the yield plus dividend growth.<span style="mso-spacerun: yes;"> </span>Dividend growth is then broken into core growth (the rate of growth for total profits) plus share change (reduction of shares due to share repurchase).<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given a core growth rate of 12.0% and current dividend yield of 2.7%, MMM’s cost of growth is $2.69 per share.<span style="mso-spacerun: yes;"> </span>After reducing this amount and dividends of $2.20 per share, the funding surplus is $0.83; this amount is forecasted to have a 1.0% impact on share price. <span style="mso-spacerun: yes;"> </span>As a result, the DDRM forecasts the projected total return for MMM to be 15.7%.<span style="mso-spacerun: yes;"> </span>Below is a breakdown of the total return:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 12.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Dividend yield: 2.7%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span><u>Funding surplus: 1.0%</u></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Total return: 15.7%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Summary</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In a bull case, based on a valuation $95.00, shares are trading at a 14.5% discount to their intrinsic value.<span style="mso-spacerun: yes;"> </span>In a bear case, base on a valuation of $79.56, shares are trading a 2.1% premium to their intrinsic value.<span style="mso-spacerun: yes;"> </span>MMM has a history of dividend increases and the dividend appears semi-sustainable as the payout ratio is less than 50%.<span style="mso-spacerun: yes;"> </span>Based on the DDRM, the projected total return for MMM is 15.7%. </span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><strong>Disclosure: I am long MMM.</strong></span></div>Nicholashttp://www.blogger.com/profile/16914585372166059253noreply@blogger.com0tag:blogger.com,1999:blog-1339787451320222904.post-58158376000808336152011-08-11T22:47:00.001-05:002011-08-11T22:51:32.619-05:00McDonald's (MCD) - Valuation Analysis<div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Description</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="color: black; font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Arial;">McDonald’s Corporation franchises and operates McDonald’s restaurants in the global restaurant industry. These restaurants serve a varied, limited, value-priced menu in more than 100 countries around the world. All restaurants are operated either by it or by franchisees, including conventional franchisees under franchise arrangements, and foreign affiliated markets and developmental licensees under license agreements. The Company and its franchisees purchase food, packaging, equipment and other goods from various independent suppliers. It offers a range of products. Independently owned and operated distribution centers, approved by it, distribute products and supplies to McDonald’s restaurants. s menu includes hamburgers and cheeseburgers, Big Mac, Quarter Pounder with Cheese, Filet-O-Fish, several chicken sandwiches, Chicken McNuggets, Chicken Selects, Snack Wraps, french fries, salads, shakes, McFlurry desserts, sundaes, soft serve cones, pies and cookies.</span><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;"></span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><i style="mso-bidi-font-style: normal;"><span style="font-family: Calibri; font-size: 10pt;">Source: Reuters</span></i></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Valuation</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Key assumptions included:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Terminal growth rate: 3.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Risk-adjusted discount rate: 9.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Cost of sales: 60.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Selling, general, & administrative costs as % of sales: 10.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>CAPEX as % of sales: 9.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Depreciation as % of sales: 5.3%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Effective tax rate: 28.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales in receivables: 17</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales of inventory: 3</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Days payable outstanding: 24</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">At a 10% growth rate (bull case), I estimate the intrinsic value of MCD to be $75.66 per share.<span style="mso-spacerun: yes;"> </span>With a risk-adjusted margin of safety of 11.2%, the target purchase price is $67.15 per share.<span style="mso-spacerun: yes;"> </span>This is below the $86.28 per share MCD is currently trading at.<span style="mso-spacerun: yes;"> </span>At $86.28, MCD is trading at 14.0% above the intrinsic value indicating it is may be overvalued.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">At a 5% growth rate (bear case), I estimate the intrinsic value of MCD to be $59.99 per share.<span style="mso-spacerun: yes;"> </span>With a risk-adjusted margin of safety of 14.4%, the target purchase price is $51.33 per share.<span style="mso-spacerun: yes;"> </span>This is below the $86.28 per share MCD is currently trading at.<span style="mso-spacerun: yes;"> </span>At $86.28, MCD is trading at 43.8% above the intrinsic value indicating it may be overvalued in this scenario.<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Dividends</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">MCD has paid a quarterly dividend since 2008.<span style="mso-spacerun: yes;"> </span>Before that, MCD paid an annual dividend.<span style="mso-spacerun: yes;"> </span>From 2001 to 2010, MCD’s total annual dividend has grown from $0.23 per share to $2.26.<span style="mso-spacerun: yes;"> </span>The dividend appears to be grow faster than forecasted growth.<span style="mso-spacerun: yes;"> </span>The compound annual dividend growth rate is as follows: </span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Ten years: 29.9%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt; text-indent: 0.5in;"><span style="font-family: Calibri; font-size: 10pt;">Five years: 35.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Three years: 14.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Although the dividend is growing faster than net earnings, the dividend appears to be sustainable.<span style="mso-spacerun: yes;"> </span>Based on net income, the dividend payout ratio has exceeded 50% once in the past five years.<span style="mso-spacerun: yes;"> </span>A dividend payout ratio of less than 50% is a positive allowing for sustainable growth and a cushion for short-term earnings volatility.<span style="mso-spacerun: yes;"> </span>From 2006 to 2010, the dividend payout ratio based on net income has grown from 34.3% to 48.7%.<span style="mso-spacerun: yes;"> </span>Below is the dividend payout ratio for the past five years:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2006: 34.3%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2007: 73.7%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2008: 42.3%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2009: 49.1%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2010: 48.7%<br style="mso-special-character: line-break;" /></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In the book, <i style="mso-bidi-font-style: normal;">The Ultimate Dividend Playbook</i>, Josh Peters discusses a model to calculate a stock’s prospective return.<span style="mso-spacerun: yes;"> </span>The model is called the Dividend Drill Return Model (DDRM).<span style="mso-spacerun: yes;"> </span>It is based on the premise that the dividend total return is equal to the yield plus dividend growth.<span style="mso-spacerun: yes;"> </span>Dividend growth is then broken into core growth (the rate of growth for total profits) plus share change (reduction of shares due to share repurchase).<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given a core growth rate of 10.0% and current dividend yield of 2.8%, MCD’s cost of growth is $1.37 per share.<span style="mso-spacerun: yes;"> </span>After reducing this amount and dividends of $2.44 per share from earnings per share, the funding surplus is $0.83; this amount is forecasted to have a 1.0% impact on share price. <span style="mso-spacerun: yes;"> </span>As a result, the DDRM forecasts the projected total return for MCD to be 13.8%.<span style="mso-spacerun: yes;"> </span>Below is a breakdown of the total return:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 10.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Dividend yield: 2.8%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span><u>Funding surplus: 1.0%</u></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Total return: 13.8%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Summary</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In a bull case, based on a valuation $75.66, shares are trading at a 14.0% premium to their intrinsic value.<span style="mso-spacerun: yes;"> </span>In a bear case, base on a valuation of $59.99, shares are trading a 43.8% premium to their intrinsic value.<span style="mso-spacerun: yes;"> </span>MCD has a history of dividend increases, whether annual or quarterly.<span style="mso-spacerun: yes;"> </span>The dividend appears sustainable as the payout ratio is less than 50%.<span style="mso-spacerun: yes;"> </span>Based on the DDRM, the projected total return for MCD is 13.8%. </span><br />
<br />
<strong><span style="font-family: Calibri; font-size: x-small;">Disclosure: I am not long MCD.</span></strong></div>Nicholashttp://www.blogger.com/profile/16914585372166059253noreply@blogger.com0tag:blogger.com,1999:blog-1339787451320222904.post-30674545005799094452011-08-11T22:02:00.000-05:002011-08-11T22:34:35.548-05:00Waste Management (WM) - Valuation Analysis<div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Description</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="color: black; font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Arial;">Waste Management, Inc. is a holding company and all operations are conducted by its subsidiaries. The Company is a provider of waste management services in North America. Its subsidiaries provide collection, transfer, recycling and disposal services. The Company is also a developer, operator and owner of waste-to-energy and landfill gas-to-energy facilities in the United States. The Company manages and evaluates its operations through five groups. The Company’s four geographic operating groups, consisting of its Eastern, Midwest, Southern and Western Groups, provide collection, transfer, disposal and recycling services. Its fifth Group is the Wheelabrator Group, which provides waste-to-energy services, and manages waste-to-energy facilities and independent power production plants (IPPs). In January 2010, the Company acquired City Wide Recycling LLC.</span><span style="color: black; font-family: Calibri; font-size: 10pt;"></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><i style="mso-bidi-font-style: normal;"><span style="font-family: Calibri; font-size: 10pt;">Source: Reuters</span></i></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Valuation</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Key assumptions included:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Terminal growth rate: 3.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Risk-adjusted discount rate: 9.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Cost of sales: 72.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Selling, general, & administrative costs as % of sales: 11.7%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>CAPEX as % of sales: 10.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Depreciation as % of sales: 9.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Effective tax rate: 28.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales in receivables: 48</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales of inventory: 5</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Days payable outstanding: 28</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">At a 10% growth rate (bull case), I estimate the intrinsic value of WM to be $36.94 per share.<span style="mso-spacerun: yes;"> </span>With a risk-adjusted margin of safety of 9.9%, the target purchase price is $33.27 per share.<span style="mso-spacerun: yes;"> </span>This is above the $30.73 per share WM is currently trading at.<span style="mso-spacerun: yes;"> </span>At $30.73, WM is trading at 16.8% below the intrinsic value indicating it is a value in this scenario.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">At a 5% growth rate (bear case), I estimate the intrinsic value of WM to be $29.97 per share.<span style="mso-spacerun: yes;"> </span>With a risk-adjusted margin of safety of 13.7%, the target purchase price is $25.87 per share.<span style="mso-spacerun: yes;"> </span>This is below the $30.73 per share WM is currently trading at.<span style="mso-spacerun: yes;"> </span>At $30.73, WM is trading at 2.5% above the intrinsic value indicating it may be overvalued in this scenario.<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Dividends</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Waste Management has paid a quarterly dividend since 2005.<span style="mso-spacerun: yes;"> </span>From 2005 to 2010, WM’s dividend has grown from $0.80 per share to $1.26.<span style="mso-spacerun: yes;"> </span>The dividend appears to be grow in line with forecasted earnings.<span style="mso-spacerun: yes;"> </span>The compound annual dividend growth rate is as follows: </span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Five years: 12.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Three years: 9.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Although the dividend appears to be growing in line with earnings, the dividend appears to be sustainable.<span style="mso-spacerun: yes;"> </span>Based on net income, the dividend payout ratio has exceeded 50%.<span style="mso-spacerun: yes;"> </span>A dividend payout ratio of less than 50% is a positive allowing for sustainable growth and a cushion for short-term earnings volatility.<span style="mso-spacerun: yes;"> </span>From 2006 to 2010, the dividend payout ratio based on net income has grown from 41.4% to 63.4%.<span style="mso-spacerun: yes;"> </span>Below is the dividend payout ratio for the past five years:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2006: 41.4%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2007: 42.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2008: 48.9%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2009: 57.2%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2010: 63.4%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In the book, <i style="mso-bidi-font-style: normal;">The Ultimate Dividend Playbook</i>, Josh Peters discusses a model to calculate a stock’s prospective return.<span style="mso-spacerun: yes;"> </span>The model is called the Dividend Drill Return Model (DDRM).<span style="mso-spacerun: yes;"> </span>It is based on the premise that the dividend total return is equal to the yield plus dividend growth.<span style="mso-spacerun: yes;"> </span>Dividend growth is then broken into core growth (the rate of growth for total profits) plus share change (reduction of shares due to share repurchase).<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given a core growth rate of 10.0% and current dividend yield of 4.4%, WM’s cost of growth is $1.37 per share.<span style="mso-spacerun: yes;"> </span>After reducing this amount and dividends of $1.36 per share, the funding gap is $0.75; this amount is forecasted to have a -2.4% impact on share price.<span style="mso-spacerun: yes;"> </span>As a result, the DDRM forecasts the projected total return for WM to be 12.0%.<span style="mso-spacerun: yes;"> </span>Below is a breakdown of the total return:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 10.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Dividend yield: 4.4%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span><u>Funding surplus: -2.4%</u></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Total return: 12.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Summary</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In a bull case, based on a valuation $36.94, shares are trading at a 16.8% discount to their intrinsic value.<span style="mso-spacerun: yes;"> </span>In a bear case, base on a valuation of $29.97, shares are trading a 2.5% premium to their intrinsic value. <span style="mso-spacerun: yes;"> </span>WM has a short history of dividend increases and the dividend appears semi-sustainable as the payout ratio is more than 50%.<span style="mso-spacerun: yes;"> </span>Based on the DDRM, the projected total return for WM is 12.0%.</span><br />
<br />
<strong><span style="font-family: Calibri; font-size: x-small;">Disclosure: I am long WM.</span></strong></div>Nicholashttp://www.blogger.com/profile/16914585372166059253noreply@blogger.com0tag:blogger.com,1999:blog-1339787451320222904.post-50324226999029299982011-08-01T23:31:00.000-05:002011-08-01T23:31:13.765-05:00Investment Guidelines - Version 1<div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Objective</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">The first objective is to invest in companies that will generate a higher dividend yield than the current ten-year Treasury yield, with a second objective for capital appreciation so the annual return for the portfolio outperforms the total return of the S&P 500.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Investments will be primarily made in U.S.-based companies that are considered either large-cap or mid-cap.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Strategy</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">The primary strategy is to acquire shares of companies that are considered undervalued using a discounted cash flow (DCF) model.<span style="mso-spacerun: yes;"> </span>Companies must pay a sustainable dividend and the company must demonstrate a history of increasing dividends.<span style="mso-spacerun: yes;"> </span>Fundamental analysis for the company will be performed and the firm must demonstrate a durable competitive advantage.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Initial positions will be established by:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt 0.25in; mso-list: l1 level1 lfo1; tab-stops: list .25in; text-indent: -0.25in;"><span style="font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri;"><span style="mso-list: Ignore;">1.<span style="font: 7pt "Times New Roman";"> </span></span></span><span style="font-family: Calibri; font-size: 10pt;">Company must demonstrate a durable competitive advantage. </span></div><div class="MsoNormal" style="margin: 0in 0in 0pt 0.25in; mso-list: l1 level1 lfo1; tab-stops: list .25in; text-indent: -0.25in;"><span style="font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri;"><span style="mso-list: Ignore;">2.<span style="font: 7pt "Times New Roman";"> </span></span></span><span style="font-family: Calibri; font-size: 10pt;">If a company demonstrates a durable competitive advantage, shares must currently be trading below the intrinsic value with a risk-adjusted margin of safety.<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Ideally, positions will be held indefinitely to avoid transaction costs (i.e. taxes).<span style="mso-spacerun: yes;"> </span>Once shares of the company reach their intrinsic value, analysis will be performed to see if any fundamental factor has changed to force a sale of the position and to see if the intrinsic value of the company is higher than originally calculated.<span style="mso-spacerun: yes;"> </span>If the fundamentals remain intact, the position will continually be held.<span style="mso-spacerun: yes;"> </span>If the fundamentals do not remain intact, the position will be sold.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Allocation</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">The portfolio will be primarily held in equities and cash.<span style="mso-spacerun: yes;"> </span>Portfolio can be invested in up to 90% equities at any given time.<span style="mso-spacerun: yes;"> </span>Cash may not exceed 90% at any given time. </span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Positions will not be allowed to exceed 10% of the total portfolio value at the time of purchase. </span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Company selection</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="color: #333333; font-family: Calibri; font-size: 10pt; mso-font-kerning: 0pt;">Fundamental analysis will be completed before any position is added to the portfolio.<span style="mso-spacerun: yes;"> </span>This includes:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt 0.25in; mso-list: l0 level1 lfo2; tab-stops: list .25in; text-indent: -0.25in;"><span style="color: #333333; font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-font-kerning: 0pt;"><span style="mso-list: Ignore;">1.<span style="font: 7pt "Times New Roman";"> </span></span></span><span style="color: #333333; font-family: Calibri; font-size: 10pt; mso-font-kerning: 0pt;">Analysis to determine does the company demonstrate a durable competitive advantage as indicated by the income statement, balance sheet, and cash flow statement</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt 0.25in; mso-list: l0 level1 lfo2; tab-stops: list .25in; text-indent: -0.25in;"><span style="color: #333333; font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-font-kerning: 0pt;"><span style="mso-list: Ignore;">2.<span style="font: 7pt "Times New Roman";"> </span></span></span><span style="color: #333333; font-family: Calibri; font-size: 10pt; mso-font-kerning: 0pt;">The purchase price must be less than the current trading price and include a risk-adjusted margin of safety.<span style="mso-spacerun: yes;"> </span>The risk adjusted margin of safety will be calculated as follows:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="color: #333333; font-family: Calibri; font-size: 10pt; mso-font-kerning: 0pt;">Margin of safety<span style="mso-tab-count: 2;"> </span>30%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="color: #333333; font-family: Calibri; font-size: 10pt; mso-font-kerning: 0pt;">x business risk<span style="mso-tab-count: 2;"> </span>1.00<span style="mso-spacerun: yes;"> </span>(constraints 0.8<x<1.2)</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><u><span style="color: #333333; font-family: Calibri; font-size: 10pt; mso-font-kerning: 0pt;">x financial risk</span></u><span style="color: #333333; font-family: Calibri; font-size: 10pt; mso-font-kerning: 0pt;"><span style="mso-tab-count: 2;"> </span>1.00<span style="mso-spacerun: yes;"> </span>(constraints 0.8<x<1.2)</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="color: #333333; font-family: Calibri; font-size: 10pt; mso-font-kerning: 0pt;">Risk-adjusted margin of safety</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt 1in;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="color: #333333; font-family: Calibri; font-size: 10pt; mso-font-kerning: 0pt;">3. Any investment must have a yield higher than the current yield of the ten-year Treasury</span><span style="color: #333333; font-family: Verdana; font-size: 10pt; mso-font-kerning: 0pt;"></span></div>Nicholashttp://www.blogger.com/profile/16914585372166059253noreply@blogger.com0tag:blogger.com,1999:blog-1339787451320222904.post-5722643006831900942011-08-01T22:41:00.000-05:002011-08-01T22:43:58.619-05:00Praxair Inc. (PX) - Valuation Analysis<b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Description</span></b> <br />
<div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="color: black; font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Arial;">Praxair, Inc. (Praxair) is an industrial gas supplier. Praxair’s primary products for its industrial gases business are atmospheric gases (oxygen, nitrogen, argon, rare gases) and process gases (carbon dioxide, helium, hydrogen, electronic gases, specialty gases, acetylene). It also designs, engineers, and builds equipment that produces industrial gases for internal use and external sale. Its surface technologies segment, operated through Praxair Surface Technologies, Inc. Praxair serves approximately 25 industries, such as healthcare and petroleum refining; computer-chip manufacturing and beverage carbonation; fiber-optics and steel making; and aerospace, chemicals and water treatment. During the year ended December 31, 2010, 94% of revenue was generated in four geographic segments (North America, Europe, South America and Asia). As of December 31, 2010, it had acquired a 49% interest in Refrigeration and Oxygen Company Limited (ROC).</span><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;"></span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><i style="mso-bidi-font-style: normal;"><span style="font-family: Calibri; font-size: 10pt;">Source: Reuters</span></i></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Valuation</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">I estimated the intrinsic value of PX to be $77.05.<span style="mso-spacerun: yes;"> </span>Key assumptions included:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 12.4%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Terminal growth rate: 5.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Risk-adjusted discount rate: 10.2%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Cost of sales: 66.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Selling, general, & administrative costs as % of sales: 12.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Research & development as % of sales: 1.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>CAPEX as % of sales: 14.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Depreciation as % of sales: 9.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Effective tax rate: 28.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales in receivables: 60</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales of inventory: 22</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Days payable outstanding: 45</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given the current market price of $102.51, PX is overvalued by 33.0% to its intrinsic value.<span style="mso-spacerun: yes;"> </span>The risk-adjusted margin of safety was calculated to be 10.5%.<span style="mso-spacerun: yes;"> </span>Since the actual margin of safety (-33.0%) is less than the risk-adjusted margin of safety (10.5%), this indicates PX is overvalued and should be purchased at a lower price per share.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Dividends</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">The dividend appears to be growing faster than earnings growth, but has slowed in recent years.<span style="mso-spacerun: yes;"> </span>From 2000 to the 2010, the dividend has grown from $0.31 per share to $1.80 per share.<span style="mso-spacerun: yes;"> </span>The compound annual growth rates for the past ten-, five-, and three-years are:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Ten years: 21.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Five years: 25.7%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Three years: 14.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Although growing faster than earnings, the dividend appears to be sustainable.<span style="mso-spacerun: yes;"> </span>Based on either net income or free cash flow, the dividend payout ratio has not exceeded 50%.<span style="mso-spacerun: yes;"> </span>A dividend payout ratio of less than 50% allows for sustainable growth and a cushion for short-term earnings volatility.<span style="mso-spacerun: yes;"> </span>From 2006 to 2010, the dividend payout ratio based on net income has increased from 32.7% to 46.1%.<span style="mso-spacerun: yes;"> </span>Below is the dividend payout ratio for the past five years:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2006: 32.7%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2007: 32.4%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2008: 38.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2009: 39.2%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2010: 46.1%</span><span style="font-family: Calibri; font-size: 10pt;"><br style="mso-special-character: line-break;" /></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In the book, <i style="mso-bidi-font-style: normal;">The Ultimate Dividend Playbook</i>, Josh Peters discusses a model to calculate a stock’s prospective return.<span style="mso-spacerun: yes;"> </span>The model is called the Dividend Drill Return Model (DDRM).<span style="mso-spacerun: yes;"> </span>It is based on the premise that the dividend total return is equal to the yield plus dividend growth.<span style="mso-spacerun: yes;"> </span>Dividend growth is then broken into core growth (the rate of growth for total profits) plus share change (reduction of shares due to share repurchase).<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given a core growth rate of 12.4% and current dividend yield of 2.0%, PX’s cost of growth is $2.48 per share.<span style="mso-spacerun: yes;"> </span>After reducing this amount and dividends of $2.00 per share, the funding gap is $0.59.<span style="mso-spacerun: yes;"> </span>PX will need to borrow an additional $0.59 for any additional cash deployment items like share repurchase.<span style="mso-spacerun: yes;"> </span>Ths amount is forecasted to have a (0.6%) impact on share price.<span style="mso-spacerun: yes;"> </span>As a result, the DDRM forecasts the projected total return for UTX to be 13.8%.<span style="mso-spacerun: yes;"> </span>Below is a breakdown of the total return:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 12.4%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Dividend yield: 2.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span><u>Funding surplus: -0.6%</u></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Total return: 13.8%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Summary</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Based on a valuation $77.05, shares are trading at a 33.0% premium to the intrinsic value.<span style="mso-spacerun: yes;"> </span>PX has a history of dividend increases that grow faster than earnings and the dividend appears sustainable as the payout ratio is less than 50%.<span style="mso-spacerun: yes;"> </span>Based on the DDRM, the projected total return for PX is 13.8%.<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="line-height: 15pt; margin: 0in 0in 0pt; vertical-align: baseline;"><b><span style="font-family: Calibri; font-size: 8pt; mso-bidi-font-family: Arial; mso-font-kerning: 0pt;">Disclosure: </span></b><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri; font-size: 8pt; mso-bidi-font-family: Arial; mso-font-kerning: 0pt;">I have no positions in Praxair (PX), and no plans to initiate any positions within the next 72 hours.</span></b></div>Nicholashttp://www.blogger.com/profile/16914585372166059253noreply@blogger.com0tag:blogger.com,1999:blog-1339787451320222904.post-12298007645544336212011-07-27T19:43:00.000-05:002011-07-27T19:43:23.202-05:00Union Pacific (UNP) - Valuation Analysis<div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Description</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><span style="font-family: Calibri; font-size: 10pt;">Union Pacific Corporation, incorporated in 1969, is engaged in the transportation business. The Company’s principal operating company, Union Pacific Railroad Company, links 23 states in the western two-thirds of the United States of America. Union Pacific Railroad Company serves many United States population centers and provides them with mode of freight transportation. Union Pacific Railroad Company’s business mix includes Agricultural Products, Automotive, Chemicals, Energy, Industrial Products and Intermodal. The Company has 31,953 route miles, linking Pacific Coast and Gulf Coast ports with the Midwest and the eastern United States gateways and providing several corridors to key Mexican gateways. It serves the western two-thirds of the United States and maintains coordinated schedules with other rail carriers to move freight to and from the Atlantic Coast, the Pacific Coast, the Southeast, the Southwest, Canada and Mexico. </span><br />
<i style="mso-bidi-font-style: normal;"><span style="font-family: Calibri; font-size: 10pt;">Source: Reuters</span></i><span style="font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Arial;"></span><br />
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</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Valuation</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">I estimated the intrinsic value of UNP to be $99.37.<span style="mso-spacerun: yes;"> </span>Key assumptions included:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 17.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Terminal growth rate: 5.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Risk-adjusted discount rate: 11.1%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Operating ratio: 70%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>CAPEX as % of sales: 15.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Depreciation as % of sales: 9.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Effective tax rate: 36.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Working capital as % of sales: -7.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given the current market price of $102.20, UNP is overvalued by 2.9% to its intrinsic value.<span style="mso-spacerun: yes;"> </span>The risk-adjusted margin of safety was calculated to be 8.3%.<span style="mso-spacerun: yes;"> </span>Since the stock is trading above the estimated intrinsic value, it would be prudent to wait until shares of UNP fell.<span style="mso-spacerun: yes;"> </span>Based on the $99.37 intrinsic value and 8.3% risk-adjusted margin of safety, it might be prudent to consider shares at $91.14 or below.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Dividends</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">The dividend appears to be growing faster than earnings growth and has increased in recent years.<span style="mso-spacerun: yes;"> </span>From 2000 to the 2010, the dividend has grown from $0.40 per share to $1.31 per share.<span style="mso-spacerun: yes;"> </span>The compound annual growth rates for the past ten-, five-, and three-years are:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Ten years: 14.1%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Five years: 21.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Three years: 20.7%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Although growing faster than earnings, the dividend appears to be sustainable.<span style="mso-spacerun: yes;"> </span>Based on either net income, dividend payout ratio has not exceeded 50%.<span style="mso-spacerun: yes;"> </span>A dividend payout ratio of less than 50% is a positive allowing for sustainable growth and a cushion for short-term earnings volatility.<span style="mso-spacerun: yes;"> </span>Below is the dividend payout ratio for the past five years:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2006: 20.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2007: 19.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2008: 20.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2009: 28.8%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2010: 21.7%<br style="mso-special-character: line-break;" /><br style="mso-special-character: line-break;" /></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In the book, <i style="mso-bidi-font-style: normal;">The Ultimate Dividend Playbook</i>, Josh Peters discusses a model to calculate a stock’s prospective return.<span style="mso-spacerun: yes;"> </span>The model is called the Dividend Drill Return Model (DDRM).<span style="mso-spacerun: yes;"> </span>It is based on the premise that the dividend total return is equal to the yield plus dividend growth.<span style="mso-spacerun: yes;"> </span>Dividend growth is then broken into core growth (the rate of growth for total profits) plus share change (reduction of shares due to share repurchase).<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given a core growth rate of 17.0% and current dividend yield of 1.9%, UNP’s cost of growth is $6.06 per share.<span style="mso-spacerun: yes;"> </span>After reducing this amount and dividends of $1.90 per share, the funding gap is $2.38.<span style="mso-spacerun: yes;"> </span>UNP may need to borrow the $2.38 per share to reduce outstanding shares or increase expansion; this amount is forecasted to have a -2.3% impact on share price.<span style="mso-spacerun: yes;"> </span>As a result, the DDRM forecasts the projected total return for UTX to be 16.5%.<span style="mso-spacerun: yes;"> </span>Below is a breakdown of the total return:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 17.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Dividend yield: 1.9%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span><u>Funding surplus: -2.3%</u></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Total return: 16.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Summary</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Based on a valuation $99.37, shares are trading at a 2.9% premium to the intrinsic value.<span style="mso-spacerun: yes;"> </span>UNP has aggressively increased dividends and the dividend appears sustainable as the payout ratio is less than 50%.<span style="mso-spacerun: yes;"> </span>Based on the DDRM, the projected total return for UNP is 16.5%.<span style="mso-spacerun: yes;"> </span>Shares of UNP look attractive at lower prices than where UNP is currently trading at.</span></div>Nicholashttp://www.blogger.com/profile/16914585372166059253noreply@blogger.com0tag:blogger.com,1999:blog-1339787451320222904.post-69340696223936043082011-07-27T00:38:00.001-05:002011-07-27T00:39:46.954-05:00Sysco (SYY) - Valuation Analysis<b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Description</span></b> <br />
<div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Arial;">Sysco Corporation (Sysco), along with its subsidiaries and divisions, is a North American distributor of food and related products primarily to the foodservice or food-away-from-home industry. The Company provides products and related services to approximately 400,000 customers, including restaurants, healthcare and educational facilities, lodging establishments and other foodservice customers. Sysco provides food and related products to the foodservice or food-away-from-home industry. The Company has aggregated its operating companies into a number of segments, of which only Broadline and SYGMA are the main segments. Broadline operating companies distribute a line of food products and a variety of non-food products to their customers. SYGMA operating companies distribute a line of food products and a variety of non-food products to chain restaurant customer locations.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><span style="font-family: Calibri; font-size: 10pt; mso-bidi-font-family: Arial;">The products the Company distributes include a line of frozen foods, such as meats, fully prepared entrees, fruits, vegetables and desserts; full line of canned and dry foods; fresh meats; dairy products; beverage products; imported specialties, and fresh produce. Sysco also supplies a variety of non-food items, including paper products, such as disposable napkins, plates and cups; tableware, such as china and silverware; cookware, such as pots, pans and utensils; restaurant and kitchen equipment and supplies, and cleaning supplies. No single customer accounted for 10% or more of Sysco’s total sales during fiscal 2010.</span><br />
<div class="MsoNormal" style="margin: 0in 0in 0pt;"><i style="mso-bidi-font-style: normal;"><span style="font-family: Calibri; font-size: 10pt;">Source: Reuters</span></i></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Valuation</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">I estimated the intrinsic value of SYY to be $33.62.<span style="mso-spacerun: yes;"> </span>Key assumptions included:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 7.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Terminal growth rate: 3.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Risk-adjusted discount rate: 11.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Cost of sales: 81.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Selling, general, & administrative costs as % of sales: 14.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Research & development as % of sales: 0.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>CAPEX as % of sales: 1.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Depreciation as % of sales: 1.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Effective tax rate: 38.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales in receivables: 26</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales of inventory: 22</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Days payable outstanding: 24</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given the current market price of $31.29, SYY is undervalued by 6.9% to its intrinsic value, which is a positive.<span style="mso-spacerun: yes;"> </span>The risk-adjusted margin of safety was calculated to be 15.5%.<span style="mso-spacerun: yes;"> </span>Since the actual margin of safety (6.9%) is less than the risk-adjusted margin of safety (6.9%), SYY may not be appropriate to buy at this time.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Dividends</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">The dividend appears to be growing faster than earnings growth, but has slowed in recent years.<span style="mso-spacerun: yes;"> </span>From 2000 to the 2010, the dividend has grown from $0.24 per share to $1.00 per share.<span style="mso-spacerun: yes;"> </span>The compound annual growth rates for the past ten-, five-, and three-years are:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Ten years: 17.2%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Five years: 13.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Three years: 9.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Although growing faster than earnings, the dividend appears to be sustainable.<span style="mso-spacerun: yes;"> </span>Based on net income, the dividend payout ratio exceed 50% once.<span style="mso-spacerun: yes;"> </span>Based on free cash flow, the dividend payout ratio has fluctuated more ranging from 47.2% to 199.4%.<span style="mso-spacerun: yes;"> </span>A dividend payout ratio of less than 50% is a positive allowing for sustainable growth and a cushion for short-term earnings volatility.<span style="mso-spacerun: yes;"> </span>Below is the dividend payout ratio for the past five years:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2006: 46.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2007: 44.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2008: 45.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2009: 51.9%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2010: 49.1%<br style="mso-special-character: line-break;" /></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In the book, <i style="mso-bidi-font-style: normal;">The Ultimate Dividend Playbook</i>, Josh Peters discusses a model to calculate a stock’s prospective return.<span style="mso-spacerun: yes;"> </span>The model is called the Dividend Drill Return Model (DDRM).<span style="mso-spacerun: yes;"> </span>It is based on the premise that the dividend total return is equal to the yield plus dividend growth.<span style="mso-spacerun: yes;"> </span>Dividend growth is then broken into core growth (the rate of growth for total profits) plus share change (reduction of shares due to share repurchase).<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given a core growth rate of 7.5% and current dividend yield of 3.3%, SYY’s cost of growth is $0.48 per share.<span style="mso-spacerun: yes;"> </span>After reducing this amount and dividends of $1.04 per share, the funding surplus is $0.47.<span style="mso-spacerun: yes;"> </span>SYY can use this $0.47 per share to reduce outstanding shares; this amount is forecasted to have a 1.5% impact on share price.<span style="mso-spacerun: yes;"> </span>As a result, the DDRM forecasts the projected total return for UTX to be 12.3%.<span style="mso-spacerun: yes;"> </span>Below is a breakdown of the total return:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 7.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Dividend yield: 3.3%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span><u>Funding surplus: 1.5%</u></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Total return: 12.3%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Summary</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Based on a valuation $33.62, shares are trading at a 6.9% discount to the intrinsic value.<span style="mso-spacerun: yes;"> </span>Given a risk-adjusted margin of safety of 15.5%, SYY could be considered a buy at $28.40.<span style="mso-spacerun: yes;"> </span>SYY has a history of dividend increases and the dividend appears sustainable as the payout ratio is around 50%.<span style="mso-spacerun: yes;"> </span>Based on the DDRM, the projected total return for SYY is 12.3%. </span></div>Nicholashttp://www.blogger.com/profile/16914585372166059253noreply@blogger.com0tag:blogger.com,1999:blog-1339787451320222904.post-67331145068867919372011-07-26T23:43:00.000-05:002011-07-26T23:43:35.966-05:00United Technologies (UTX) - Valuation Analysis<div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Description</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="color: black; font-family: Calibri; font-size: 10pt;">UTX is a provider of technology products and services to the building systems and aerospace industries worldwide. The Company’s operating units include businesses with operations throughout the world. Otis, Carrier and UTC Fire and Security serve customers in the commercial and residential property industries worldwide. Carrier also serves commercial, industrial, transport refrigeration and food service equipment customers. Pratt and Whitney, Hamilton Sundstrand and Sikorsky serve commercial and government customers in both the original equipment and aftermarket parts and services markets of the aerospace industry. </span><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;"></span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><i style="mso-bidi-font-style: normal;"><span style="font-family: Calibri; font-size: 10pt;">Source: Reuters</span></i></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Valuation</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">I estimated the intrinsic value of UTX to be $104.25.<span style="mso-spacerun: yes;"> </span>Key assumptions included:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 10.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Terminal growth rate: 3.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Risk-adjusted discount rate: 12.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Cost of sales: 73.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Selling, general, & administrative costs as % of sales: 11.2%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Research & development as % of sales: 3.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>CAPEX as % of sales: 2.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Depreciation as % of sales: 2.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Effective tax rate: 28.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales in receivables: 60</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Day sales of inventory: 75</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Days payable outstanding: 45</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given the current market price of $86.18 UTX is undervalued by 17.3% to its intrinsic value.<span style="mso-spacerun: yes;"> </span>The risk-adjusted margin of safety was calculated to be 14.2%.<span style="mso-spacerun: yes;"> </span>Since the actual margin of safety (17.7%) is greater than the risk-adjusted margin of safety (14.2%), this stock should be considered a buy.</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Dividends</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">The dividend appears to be growing faster than earnings growth, but has slowed in recent years.<span style="mso-spacerun: yes;"> </span>From 2000 to the 2010, the dividend has grown from $0.41 per share to $1.70 per share.<span style="mso-spacerun: yes;"> </span>The compound annual growth rates for the past ten-, five-, and three-years are:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Ten years: 17.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Five years: 17.9%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Three years: 13.3%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Although growing faster than earnings, the dividend appears to be sustainable.<span style="mso-spacerun: yes;"> </span>Based on either net income or free cash flow, the dividend payout ratio has not exceeded 50%.<span style="mso-spacerun: yes;"> </span>A dividend payout ratio of less than 50% is a positive allowing for sustainable growth and a cushion for short-term earnings volatility.<span style="mso-spacerun: yes;"> </span>From 2006 to 2010, the dividend payout ratio based on net income has grown from 25.5% to 33.9%.<span style="mso-spacerun: yes;"> </span>Below is the dividend payout ratio for the past five years:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2006: 25.5%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2007: 25.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2008: 25.8%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2009: 35.4%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>2010: 33.9%<br style="mso-special-character: line-break;" /><br style="mso-special-character: line-break;" /></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">In the book, <i style="mso-bidi-font-style: normal;">The Ultimate Dividend Playbook</i>, Josh Peters discusses a model to calculate a stock’s prospective return.<span style="mso-spacerun: yes;"> </span>The model is called the Dividend Drill Return Model (DDRM).<span style="mso-spacerun: yes;"> </span>It is based on the premise that the dividend total return is equal to the yield plus dividend growth.<span style="mso-spacerun: yes;"> </span>Dividend growth is then broken into core growth (the rate of growth for total profits) plus share change (reduction of shares due to share repurchase).<span style="mso-spacerun: yes;"> </span></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Given a core growth rate of 10.0% and current dividend yield of 2.2%, UTX’s cost of growth is $2.49 per share.<span style="mso-spacerun: yes;"> </span>After reducing this amount and dividends of $1.92 per share, the funding surplus is $0.40.<span style="mso-spacerun: yes;"> </span>UTX can use this $0.40 per share to reduce outstanding shares; this amount is forecasted to have a 0.5% impact on share price.<span style="mso-spacerun: yes;"> </span>As a result, the DDRM forecasts the projected total return for UTX to be 12.6%.<span style="mso-spacerun: yes;"> </span>Below is a breakdown of the total return:</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Core growth rate: 10.0%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Dividend yield: 2.2%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span><u>Funding surplus: 0.5%</u></span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;"><span style="mso-tab-count: 1;"> </span>Total return: 12.6%</span></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><b style="mso-bidi-font-weight: normal;"><span style="font-family: Calibri;">Summary</span></b></div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><br />
</div><div class="MsoNormal" style="margin: 0in 0in 0pt;"><span style="font-family: Calibri; font-size: 10pt;">Based on a valuation $104.25, shares are trading at a 17.3% discount to the intrinsic value.<span style="mso-spacerun: yes;"> </span>UTX has a history of stable dividend increases and the dividend appears sustainable as the payout ratio is less than 50%.<span style="mso-spacerun: yes;"> </span>Based on the DDRM, the projected total return for UTX is 12.6%. </span></div>Nicholashttp://www.blogger.com/profile/16914585372166059253noreply@blogger.com0