Module 9: Valuation of equity

1. Module 9: Valuation of equity By jenniferkellner (Discount, Variety Stores Industry)

2. Target (in brief) • Similar to Walmart, but target a customer willing to spend more • Focus on the “shopping experience” • Refer to their customers as “guests” • Sales pretty evenly distributed; mainly in household essentials • Currently expanding (to continue within forecast horizon) • CityTargets • > SuperTargets (grocery) • Stores in Canada, U.S. • Recent data breach (December 2013) • Loss of trust • But updated security, focus on becoming leaders • Yields uncertainty in Target’s future

3. Visuals 10-K

4. Discount, Variety stores industry Target Dollar General Wal-Mart Costco *Costco is least comparable

5. Objective • To find • the equity value of Target directly, • discover related issues, • evaluate analysts’ forecasts, • show the impact of several assumptions through a sensitivity analysis, • and discuss timing adjustments.

6. steps • Estimate the value of an equity share in Target • Compare Enterprise vs. Equity Valuation • Which is superior? Discuss related issues • Estimate equity value using analysts’ forecasts • Dividend discount model • RI model • Sensitivity analysis • Adjustments • Date adjustment • Mid-year adjustment

7. Step 1:Estimate equity value Recall: • Enterprise value less NFL from 2013 • Divide by the number of Common Shares Outstanding • Above current stock price; $59.70 as of 3/20/14 • Signaling it could be undervalued • Target recently released its 10-K; recent data

8. Step 2: Enterprise v. Equity valuation • So far, we’ve valued equity indirectly • Assumed a constant cost of enterprise capital (rent) • Risk of Target’s operating activities will be constant (assumed) • To value equity directly, we also need to make assumptions • That equity risk going forward will be constant • Not a reasonable assumption; assumes leverage will be constant • Infeasible to forecast leverage going forward and rEqeach period Rearranging…

9. Step 3: Using analysts’ forecasts to estimate equity value • Two forecast sets: Valueline and 4-Traders • Make the previous assumption that leverage is constant • Nevertheless, we can gather an indication of value • Results fell in a wide range (varied significantly) Valueline 4-Traders $66.33 $71.96 $122.29 $166.31

10. Valueline: estimate • Information, given and implied (calculated): • Growth rate implied by 2016-2018 forecast; 13.08% and 7.72% • Used to develop EPS, dividends, and BV per share for 2014-2018

11. Estimate using Div Discount model • Using information just gathered, • Discount dividends each year back to today • Add to continuing value (Target price of $80) • $66.83 per share is higher than at 2/20/14, $59.70

12. Estimate using REI model • Discount REI each year back to today • Add to beginning book value, $27.40 in 2013 • Add continuing value (assumed growth rate of 3% in perpetuity; appears reasonable) • Much higher value

13. Step 4: Sensitivity Analysis(evaluating uncertainty) • How does a change in WACC impact Target’s enterprise value? • How does a change in growth rate impact the value? • Every value indicates Target is currently undervalued; Buy • Concerns • The expectation was a mix of buy/sell values • ALL indicate buy, over optimism in valuation? • Or pessimism in the market? (Data breach, etc.) • Target’s future is especially uncertain

14. Step 5:adjustments • Information availability • Use information after balance sheet date, necessitates adjustment • “Roll” the estimated value forward using rEnt • Target’s year end is 2/1/14 • Multiply by (1+rEnt)87/365 • Timing • Thus far, we’ve assumed pay-offs occurred at year-end • Assuming they occur evenly, adjustment is necessary • Multiply above value by (1+[rEnt/2])

15. 2 Adjustments

16. Questions?