Description
Equity value is the value of a company available to owners or shareholders. It is the enterprise value plus all cash and cash equivalents, short and long-term investments, and less all short-term debt, long-term debt and minority interests.
Executive MBA Program Management 2004
Valuation Professor Aswath Damodaran
Equity Valuation Project
Charles J. Montalbano
Due Date: March 26, 2004
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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Company Overview:
Granite Construction Incorporated has its corporate headquarters in Watsonville, CA and operates two divisions, the Heavy Construction Division and the Branch Division. They are one of the largest heavy civil construction contractors in the US. They have 19 branch offices throughout the United States, 7 in the Heavy Construction Division and 12 in the Branch Division. Granite serves both the private and public sector and derives all of its revenue from within the United States. The most recent information available was the 10-K for the year ending December 31, 2003. Granite generated $1.844 billion in 2003. The Heavy Construction Division generated 37.5% ($692M) and the Branch Division 62.5% ($1,153M) of the revenue this period. Granite generated $60.5 million in net income in 2003. The Heavy Construction Division mainly builds large public infrastructure projects of long duration throughout the nation (e.g. highways, bridges, tunnels, airports, mass transit, etc.). The Branch Division serves local markets in the West and builds smaller, shorter duration projects (e.g. paving, site development and utilities). The Branch Division also mines aggregates (e.g. sand, gravel, concrete and asphalt) and operates plants that process aggregates into construction materials for internal use and for sale. Construction materials were 12.76% of revenues for this period. Owning its own aggregate business gives Granite a competitive advantage by providing materials to their projects at lower prices and by ensuring material availability.
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1. Discounted Cash Flow Valuation Risk Free Rate, 10 year US Treasury Bond, as of February 27, 2003 = 4.03%1 Expected Growth rate of the S&P for the next 5 years = 7.9%2 Expected Long Term Growth Rate = 4.03% Implied risk premium = 3.372% 3 (this is a market neutral position) Market Cap as of March 19, 2003 = 41,533,435 shares x 23.83/share = $989,741,756 Tax Rate = 38% (this is a mature company; effective tax rate = marginal tax rate) Unlevered Beta There are very few public companies that have the same business model as Granite – US based revenue, heavy civil construction contractor and material supplier. Therefore, it is better to use the unlevered beta for the Building Material industry (.67) and the beta for the Cement and Aggregate industry (.59) as calculated in your spreadsheet for 2002 (note that Granite is listed in your spreadsheet under Building Materials). The Building Material beta was used for Construction revenue and the Cement and Aggregate beta for Materials revenue. The unlevered Beta used in this valuation was calculated as follows:
Revenues Business Construction Materials Estimated (billions) Decem ber 31, Value/Sales Unlevered Value 2003 Segment* Beta (billions) 1.69 0.235 0.6 1.17 0.67 0.59 Segment Weight Weight*b 1.014 79% 0.53 0.275 21% 0.13 Unlvered Beta = 0.65
*http://pages.stern.nyu.edu/~adamodar/New _Home_Page/data.html; Multiples, Price and Value to Shares Ratio and Marginsby Industry; US 2002
Cost of Debt: Interest Coverage = EBIT/Interest Expense = $74,571,000 / $8,577,000 = 8.7 Granite is a smaller company, Market Cap < $5b estimated Bond Rating4 = A+ Default Spread5 = 0.85
1 2
Wall Street Journal February 27, 2004 http://www.zacks.com/research/earnings/ 3 http://pages.stern.nyu.edu/~adamodar/New_Home_Page/spreadsh.htm; Valuation input spreadsheets; implprem.xls 4 Investment Valuation second edition; Aswath Damodaran; page 209; Table 8.1
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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Cost of Debt (COD)= risk free rate + default spread = 0.85 + 4.03 = 4.88% Market Value of Debt As of December 31, 2003 Granite had the following lease noncancellable lease commitments:
Commitment Ending December 31, 2004 2004 2005 2006 2007 Through 2046 As of December 31,2003 Long term Debt Short Term Debt Lease Commitments
(thousands)
$ $ $ $ $ $
5,784 4,580 4,007 2,858 1,702 255
$ $ $ $ $ $ $
PV 1,348 4,367 3,643 2,477 1,407 3,444 16,685
$ 126,708 $ 8,182 $ 16,685
Interest Expense Cost of Debt Balance Sheet Debt Weighted Avg Maturity Market Value of Book Debt **Market Value of Total Debt =
$ $ $ $
8,577.00 4.88% 134,890 7 years 146,481 163,166
** Total debt = PV of lease commitments+Market Value of book Debt
Levered Beta
BL = Bu x (1+ (1-t) x D/E)
Bu = 0.65 Tax Rate (t) 38% Market Cap = $ 989,741,756 Total Market Debt = $ 163,166,000 BL = 0.72
5
http://www.bondsonline.com/asp/corp/spreadbank.html; March 21, 2003 Default Spread for Industrials
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Cost of Equity and Cost of Capital
Cost of Equity (COE) = Rf + BL *(RP) Market Equity $ 989,741,756 Cost of Debt Market Debt $ 163,166,000 Risk Free Rate BL = 0.72 Risk Premium Tax Rate (t) COE = 6.46%
4.88% 4.03% 3.37% 38.00%
Cost of Capital = COE x (E/(D+E)) + [(COD *(1-t)) x (D/(D+E))] COC = 5.97%
Normalize Cap Ex and ROC:
Cp Ex Acquis. Deprec. Adj Cap Ex EBIT EBIT(1-t) Net Cp Ex as % EBIT(1-t) Revenues % Change Non-Cash Current Asets Non-Cash Current liabilities Non-Cash WC As % of Revevues Book D + E + *L EBIT + *Leases EBIT(1-T) ROC
1998 52462 0 38124 14338 69258 42940 33.39% 1226100
1999 82035 0 42363 39672 84262 52242 75.94% 1328744 8.37% 294244 252679 41565 3.13% 410595 84847 52605 12.81%
2000 52454 0 44624 7830 85575 53057 14.76% 1348325 1.47% 310897 230447 80450 5.97% 454982 86168 53424 11.74%
2001 65265 11400 50017 26648 64334 39887 66.81%
2002 57415 36034 58668 34781 78117 48433 71.81%
2003 Normalized 62805 372436 0 47434 65693 299489 -2888 120381 74571 46234 239853 -6.25% 1844491 4.52% 457863 340522 117341 6.36% 667989 75383 46737 7.00% 50.19% 9060396
1547994 1764742 14.81% 14.00% 393683 330389 63294 4.09% 572009 65015 40309 7.05% 398963 318859 80104 4.54% 627181 78893 48914 7.80%
249384 217573 31811 2.59% 392306 69797 43274 11.03%
414565 4.58%
9.57%
*leases are a percent of revenue based on 2003
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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Actual FCFF for 2003:
FCFF (thousands)
EBIT Adj for Leases Adj EBIT Tax Rate EBIT(1-t) -(Cap EX + Acqu. - Depr) - Change in WC FCFF Reinvetment Rate $ $ $ $ $ $ $ 74,571 814 75,385 38% 46,739 2,888 (37,237) 12,390 73.49%
Expected Growth in EBIT
GEBIT = (Net Cap Ex. + Change in WC) / EBIT(1-t) x ROC = Reinvestment Rate x ROC December 31 2003 (thousands) Tax Rate 38% Book Value Debt (December 31, 2003) + Adj for Leases $ 151,575.00 Book Value Equity (December 31,
2003)
$ $ $
516,414.00 3,652.50 23,458.15 58.00% 9.57% 5.55%
Normalize Change in WC Normalize Net Cap. Ex. Normalized Reinvestment Rate *ROC Expected Growth Rate
*Normalized ROC
Valuation Granite Construction is a mature company competing in a mature industry that is dependent on public spending. The construction industry, as a whole, grows with the economy and can be highly cyclical. Construction makes up approximately 4% to 5% of GDP. The ROC used in
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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perpetuity was 11%. This is less than the Industry average but slightly higher than the ROC during the high growth period. This was chosen because it is in line with Granite’s historical ROC. The industry averages for the COC, which were taken from your web site for the industries in which Granite competes, are as follows: COC Construction (Building Materials) Cement and Aggregates 6.82% 6.31% Weight .78 .22 Total COC COC 5.34% 1.39% 6.73%
This COC was used to estimate the terminal value and to estimate the reinvestment rate during the stable growth period. The length of the high growth period was estimated to be 5 years.
Valuation (thousands)
Year 0 EBIT $ 75,143 EBIT(1-t) - Reinvest. FCFF Terminal value = PV 1 $ $ $ $ $ 79,314 49,175 (28,521) 20,653 $ $ $ $ 2 83,716 51,904 (30,104) 21,800 $ $ $ $ 3 88,363 54,785 (31,775) 23,010 4 $ 93,268 $ $ 57,826 $ $ (33,539) $ $ 24,287 $ $ $ $ $ $ 19,259 $ 19,183 $ 5 98,445 61,036 (35,401) 25,635 Terminal 102,412 63,495 (23,262) 40,233 1,490,111 1,115,075
19,490 $
19,413 $ 19,336 $
Value of Operating Assets = + Cash & Marketable Securities - Debt -Minor interest = Equity Value per Share (41,533,436 shares)
$ 1,211,755 $ 160,788 $ (163,166) $ (25,006) $ 1,184,372
$
28.52
Stable Growth Period 38% 4.03% 36.64% 6.73% 11.00%
Tax Rate Growth Rate Reinvestment Rate COC ROC Minority Interest P/BV of Industry Value of Minority Holding
High Growth Period 38.00% 5.55% 58.00% 5.97% 9.57% $10,872 2.30 $25,005.60
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As of March 19, 2004 Granite was trading at $23.83 per share. It appears that it is undervalued by approximately 16.4% as compared to the above valuation, which resulted in a price per share of $28.52. 4. Value Enhancement Strategy Three factors were considered in devising a strategy to enhance value. They are as follows: a. Cost Of Capital: The COC for Granite as of this valuation was 5.97%, which is less than the average COC for the sectors that Granite participates in – Building Materials 6.82% and Cement and Aggregate 6.31%. This is a positive sign and therefore this is not a target for immediate value enhancement. b. Increase Cash Flows: Granite can increase value by increasing cash flow. This can be done in several ways but the most applicable to Granite is to increase operating margin. This may be achieved by divesting branches that are earning less than the cost of capital. Although obvious, increasing operational efficiency is a place to start. Granite’s average operating margin over the last 3 years was 4.2%. If Granite can increase its operating margin by 0.5% then it can increase the above valuation, while holding all else constant, to $33.00 per share that is an increase of 15.7%. This is an area to increase value. c. Growth Rate: Granite’s expected 5-year growth rate, 5.33%, as calculated in the valuation is well below that expected by Zacks Investment Service; 9.8% for Granite and 12.7% for the Industry sector. In order for Granite to meet these growth rates, holding the investment rate constant, Granite will have to increase its ROC to 16.9% and 21.9% respectively. This is well above Granite’s average ROC between 1998 and 2003 of 9.57%. It should be noted that the average ROC for the Building Materials Industry is 18.62% and the average ROC for the Cement and Aggregate Industry is 14.48% (this information was obtained from your website). If Granite can meet the expected growth rate of 9.8% it can increase valuation to $34.67 per share and if it meets the 12.7% growth rate it can increase valuation to $39.44 per share. This is an increase of 21.6% and a 38.3% respectively, as compared to the share price calculated in the above valuation. Growth is clearly a viable avenue to add value. Granite can increase its
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growth rate by increasing its operating efficiency, by investing in higher margin projects or by making acquisitions that generate a higher ROC than the current ROC. Granite can also consider expanding into areas of the country that are less competitive or by venturing outside of the US. 3. Value Relative to Comparables: Zacks investment Services 6, Yahoo Finance7 and Morningstar.com8 were used to obtain the information, which is listed in the table below, to value Granite in comparison to other firms in its sector. The Industry sector is Building- Heavy Construction. There are approximately 33 companies in this sector. All 33 firms were investigated and only the necessary information for 10 of the firms was available.
Company Emcor Group Inc. Insituform Tech Dycom Ind. Jacobs Eng. Group Chicago B & I Layne Christensen Fluor Corp. Perini Corp URS Granite Construction Average
P/E 3/12/04 27.7 18.50 32.50 18.20 18.70 46.10 17.2 12.10 16.90 21.40 22.93
P/B 3/12/04 1.1 1.50 2.50 2.70 3.00 2.00 2.9 2.70 1.30 2.00 2.17
Est. 5 Year Growth 15.5% 15.0% 14.3% 15.0% 14.3% 14.00% 13.0% 9.0% 10.0% 9.8% 12.99%
Beta 0.54 1.39 1.65 0.35 0.60 0.39 0.38 0.24 1.30 0.25 0.71
5 Year Avg.ROE 15.00% 16.40% 12.40% 16.10% 16.80% 4.40% 18.10% 17.50% 16.40% 13.50% 14.66%
The average P/E and the average P/B for these firms are 22.93 and 2.17 respectively. Compared to the average P/E Granite is approximately 6.7% undervalued and compared to the average P/B granite is approximately 7.8% undervalued.
6 7
8
http://www.zacks.com/research/earnings/ http://finance.yahoo.com/q/ks?s=WGII
Http://library.morningstar.com/Stock/Profitability10.asp?Country=USA&Symbol=URS&stocktab=keyratio
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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Regression The information from your website, compfirm.xls, was used to obtain the information for the regression. P/E was used as the Response and Regression Betas and the 5-year expected Growth Rate as the predictors. The companies chosen are from the Building Materials, Cement and Aggregate and Industrial Services industries. All three of these sectors were used because the comparable firms are from one of these sectors. The payout ratio was not used as a predictor because most comparable companies paid no dividends. The total number of firms used was 50. Below are the results of the Regression. Regression analysis: P/E versus Growth and Beta P/E = 15.6 + 61.1 Growth - 4.73 Beta Predictor Constant Growth Beta S = 5.990 Coef SE Coef T 15.614 2.977 61.07 19.12 -4.728 2.156 P 5.25 3.19 -2.19 0.000 0.002 0.033
R-Sq = 25.0% R-Sq (adj) = 21.8%
*Company Emcor Group Inc. Insituform Tech Dycom Ind. Jacobs Eng. Group Chicago B & I Layne Christensen Fluor Corp. Perini Corp URS Granite Construction
P/E Est. 5 Year 3/12/04 Growth Beta 27.7 15.5% 0.54 18.50 15.0% 1.39 32.50 14.3% 1.65 18.20 15.0% 0.35 18.70 14.3% 0.60 46.10 14.00% 0.39 17.2 13.0% 0.38 12.10 9.0% 0.24 16.90 10.0% 1.30 21.40 9.8% 0.25
Predicted P/E 22.5 18.19 16.53 23.11 21.50 22.31 21.75 19.96 15.56 20.41
(+) Over (-)Under 18.7% 1.7% 49.1% -27.0% -15.0% 51.6% -26.4% -65.0% 7.9% 4.6%
A regression was also run for the P/B verse Beta and ROE. The information was obtained in the same way as the regression above and the sample contained 76 firms.
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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Regression Analysis: P/B versus Beta, ROE P/B = 0.889 - 0.477 Beta + 12.8 ROE Predictor Coef SE Coef Constant 0.8885 0.1473 Beta -0.4770 0.1297 ROE 12.791 1.146 S = 0.4942 T P 6.03 -3.68 11.16 0.000 0.000 0.000
R-Sq = 63.8% R-Sq (adj) = 62.8%
Company Emcor Group Inc. Insituform Tech Dycom Ind. Jacobs Eng. Group Chicago B & I Layne Christensen Fluor Corp. Perini Corp URS Granite Construction
P/B 3/12/04 1.1 1.50 2.50 2.70 3.00 2.00 2.9 2.70 1.30 2.00
Beta 0.54 1.39 1.65 0.35 0.60 0.39 0.38 0.24 1.30 0.25
5 Year Avg.ROE 15.00% 16.40% 12.40% 16.10% 16.80% 4.40% 18.10% 17.50% 16.40% 13.50%
Predicted P/B 2.56 2.34 1.70 2.79 2.76 1.28 3.03 3.02 2.38 2.51
(+) Over (-) Under -132.86% -55.68% 32.03% -3.44% 7.89% 36.19% -4.64% -12.02% -82.93% -25.39%
Based on the P/E regression it appears that Granite Construction is overvalued by approximately 4.6%. However, one should consider the low r-squared value when using this regression in making a determination regarding valuation. Also, the standard error, 5.99, is relatively high. In considering the standard error Granite is approximately in the middle of the range, which indicates that it may be fully valued based on this regression. Based on the P/B regression Granite appears to be approximately 25.39% undervalued. The standard error of this regression is 0.492 and the r-squared is 62.8%, which is relatively high. Granite’s P/B is just below the bottom of the range. Since the r-squared of this regression is much higher (2.88x) than that of the P/E regression it is fair to say that ROE and Beta are better predictors of P/B than Growth and Beta are predictors of P/E in this case. Therefore the P/B ratio should be used in this case. Therefore, Granite appears to be undervalued.
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4. Value Relative to the Market The intercept regressions from your website for P/E and P/B are as follows: P/E = 9.475 + .814 x Growth + 0.06 x Payout Ratio + 6.283 x Beta P/B = .14 x ROE + .599 x Beta + 0.08 x Growth + .002 x Payout Ratio 5-year Growth Rate from Zacks = 9.8% Beta calculated for the Discounted Cash flow Valuation = 0.72 3-year Average Payout Ratio from Bloomberg Financial Analysis = 26.5% 10-Year Avg. ROE from Bloomberg Financial Analysis = 13.5% The P/E and P/B based on the Regression of the market is 23.57 and 3.16 respectively. As of March 12, 2004 Granite’s P/E = 21.4 and P/B = 2. This indicates that Granite Construction is approximately undervalued by between 9.2% and 36.7% compared to the market. 5. Final Value Estimate and Recommendation BUY… BUY…. BUY…. Granite Construction appears to be undervalued based on all of the valuation techniques used. It is undervalued compared to the average P/B and P/E of the 10 comparable firms chosen by between 6.7% and 7.8%. The regression of the Industry, which was expanded to include Building Materials, Cement and Aggregates and Industrial Services, indicated that Granite was 25.39% undervalued based on P/B. However, this result was based on a regression Beta of 0.25, which appears to be low compared to the Beta calculated for the Discounted Cash Flow valuation (DCF). By substituting the Beta calculated in the DCF Valuation, which was 0.72, the under-valuation reduces from 25.39% to 14.2%. This is in line with the DCF valuation, which indicated a 16.4% under-valuation. Granite appears to be between 9.2% and 36.7% undervalued compared to the Market; depending on which multiple you use. Based on the results of the above analysis the DCF valuation and the P/B valuation based on a regression of its Industry, appears to be the most reliable. These two valuations are in line with each other and indicate an overvaluation of between 14.2% and 16.4%. Also, the DCF valuation appears to be conservative considering the expected growth rate of Granite and the expected growth rate of the Industry in which it competes. It is foreseeable that Granite can exceed the 5.55% growth rate calculated in the DCF valuation.
doc_835371546.pdf
Equity value is the value of a company available to owners or shareholders. It is the enterprise value plus all cash and cash equivalents, short and long-term investments, and less all short-term debt, long-term debt and minority interests.
Executive MBA Program Management 2004
Valuation Professor Aswath Damodaran
Equity Valuation Project
Charles J. Montalbano
Due Date: March 26, 2004
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
1
Company Overview:
Granite Construction Incorporated has its corporate headquarters in Watsonville, CA and operates two divisions, the Heavy Construction Division and the Branch Division. They are one of the largest heavy civil construction contractors in the US. They have 19 branch offices throughout the United States, 7 in the Heavy Construction Division and 12 in the Branch Division. Granite serves both the private and public sector and derives all of its revenue from within the United States. The most recent information available was the 10-K for the year ending December 31, 2003. Granite generated $1.844 billion in 2003. The Heavy Construction Division generated 37.5% ($692M) and the Branch Division 62.5% ($1,153M) of the revenue this period. Granite generated $60.5 million in net income in 2003. The Heavy Construction Division mainly builds large public infrastructure projects of long duration throughout the nation (e.g. highways, bridges, tunnels, airports, mass transit, etc.). The Branch Division serves local markets in the West and builds smaller, shorter duration projects (e.g. paving, site development and utilities). The Branch Division also mines aggregates (e.g. sand, gravel, concrete and asphalt) and operates plants that process aggregates into construction materials for internal use and for sale. Construction materials were 12.76% of revenues for this period. Owning its own aggregate business gives Granite a competitive advantage by providing materials to their projects at lower prices and by ensuring material availability.
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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1. Discounted Cash Flow Valuation Risk Free Rate, 10 year US Treasury Bond, as of February 27, 2003 = 4.03%1 Expected Growth rate of the S&P for the next 5 years = 7.9%2 Expected Long Term Growth Rate = 4.03% Implied risk premium = 3.372% 3 (this is a market neutral position) Market Cap as of March 19, 2003 = 41,533,435 shares x 23.83/share = $989,741,756 Tax Rate = 38% (this is a mature company; effective tax rate = marginal tax rate) Unlevered Beta There are very few public companies that have the same business model as Granite – US based revenue, heavy civil construction contractor and material supplier. Therefore, it is better to use the unlevered beta for the Building Material industry (.67) and the beta for the Cement and Aggregate industry (.59) as calculated in your spreadsheet for 2002 (note that Granite is listed in your spreadsheet under Building Materials). The Building Material beta was used for Construction revenue and the Cement and Aggregate beta for Materials revenue. The unlevered Beta used in this valuation was calculated as follows:
Revenues Business Construction Materials Estimated (billions) Decem ber 31, Value/Sales Unlevered Value 2003 Segment* Beta (billions) 1.69 0.235 0.6 1.17 0.67 0.59 Segment Weight Weight*b 1.014 79% 0.53 0.275 21% 0.13 Unlvered Beta = 0.65
*http://pages.stern.nyu.edu/~adamodar/New _Home_Page/data.html; Multiples, Price and Value to Shares Ratio and Marginsby Industry; US 2002
Cost of Debt: Interest Coverage = EBIT/Interest Expense = $74,571,000 / $8,577,000 = 8.7 Granite is a smaller company, Market Cap < $5b estimated Bond Rating4 = A+ Default Spread5 = 0.85
1 2
Wall Street Journal February 27, 2004 http://www.zacks.com/research/earnings/ 3 http://pages.stern.nyu.edu/~adamodar/New_Home_Page/spreadsh.htm; Valuation input spreadsheets; implprem.xls 4 Investment Valuation second edition; Aswath Damodaran; page 209; Table 8.1
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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Cost of Debt (COD)= risk free rate + default spread = 0.85 + 4.03 = 4.88% Market Value of Debt As of December 31, 2003 Granite had the following lease noncancellable lease commitments:
Commitment Ending December 31, 2004 2004 2005 2006 2007 Through 2046 As of December 31,2003 Long term Debt Short Term Debt Lease Commitments
(thousands)
$ $ $ $ $ $
5,784 4,580 4,007 2,858 1,702 255
$ $ $ $ $ $ $
PV 1,348 4,367 3,643 2,477 1,407 3,444 16,685
$ 126,708 $ 8,182 $ 16,685
Interest Expense Cost of Debt Balance Sheet Debt Weighted Avg Maturity Market Value of Book Debt **Market Value of Total Debt =
$ $ $ $
8,577.00 4.88% 134,890 7 years 146,481 163,166
** Total debt = PV of lease commitments+Market Value of book Debt
Levered Beta
BL = Bu x (1+ (1-t) x D/E)
Bu = 0.65 Tax Rate (t) 38% Market Cap = $ 989,741,756 Total Market Debt = $ 163,166,000 BL = 0.72
5
http://www.bondsonline.com/asp/corp/spreadbank.html; March 21, 2003 Default Spread for Industrials
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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Cost of Equity and Cost of Capital
Cost of Equity (COE) = Rf + BL *(RP) Market Equity $ 989,741,756 Cost of Debt Market Debt $ 163,166,000 Risk Free Rate BL = 0.72 Risk Premium Tax Rate (t) COE = 6.46%
4.88% 4.03% 3.37% 38.00%
Cost of Capital = COE x (E/(D+E)) + [(COD *(1-t)) x (D/(D+E))] COC = 5.97%
Normalize Cap Ex and ROC:
Cp Ex Acquis. Deprec. Adj Cap Ex EBIT EBIT(1-t) Net Cp Ex as % EBIT(1-t) Revenues % Change Non-Cash Current Asets Non-Cash Current liabilities Non-Cash WC As % of Revevues Book D + E + *L EBIT + *Leases EBIT(1-T) ROC
1998 52462 0 38124 14338 69258 42940 33.39% 1226100
1999 82035 0 42363 39672 84262 52242 75.94% 1328744 8.37% 294244 252679 41565 3.13% 410595 84847 52605 12.81%
2000 52454 0 44624 7830 85575 53057 14.76% 1348325 1.47% 310897 230447 80450 5.97% 454982 86168 53424 11.74%
2001 65265 11400 50017 26648 64334 39887 66.81%
2002 57415 36034 58668 34781 78117 48433 71.81%
2003 Normalized 62805 372436 0 47434 65693 299489 -2888 120381 74571 46234 239853 -6.25% 1844491 4.52% 457863 340522 117341 6.36% 667989 75383 46737 7.00% 50.19% 9060396
1547994 1764742 14.81% 14.00% 393683 330389 63294 4.09% 572009 65015 40309 7.05% 398963 318859 80104 4.54% 627181 78893 48914 7.80%
249384 217573 31811 2.59% 392306 69797 43274 11.03%
414565 4.58%
9.57%
*leases are a percent of revenue based on 2003
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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Actual FCFF for 2003:
FCFF (thousands)
EBIT Adj for Leases Adj EBIT Tax Rate EBIT(1-t) -(Cap EX + Acqu. - Depr) - Change in WC FCFF Reinvetment Rate $ $ $ $ $ $ $ 74,571 814 75,385 38% 46,739 2,888 (37,237) 12,390 73.49%
Expected Growth in EBIT
GEBIT = (Net Cap Ex. + Change in WC) / EBIT(1-t) x ROC = Reinvestment Rate x ROC December 31 2003 (thousands) Tax Rate 38% Book Value Debt (December 31, 2003) + Adj for Leases $ 151,575.00 Book Value Equity (December 31,
2003)
$ $ $
516,414.00 3,652.50 23,458.15 58.00% 9.57% 5.55%
Normalize Change in WC Normalize Net Cap. Ex. Normalized Reinvestment Rate *ROC Expected Growth Rate
*Normalized ROC
Valuation Granite Construction is a mature company competing in a mature industry that is dependent on public spending. The construction industry, as a whole, grows with the economy and can be highly cyclical. Construction makes up approximately 4% to 5% of GDP. The ROC used in
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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perpetuity was 11%. This is less than the Industry average but slightly higher than the ROC during the high growth period. This was chosen because it is in line with Granite’s historical ROC. The industry averages for the COC, which were taken from your web site for the industries in which Granite competes, are as follows: COC Construction (Building Materials) Cement and Aggregates 6.82% 6.31% Weight .78 .22 Total COC COC 5.34% 1.39% 6.73%
This COC was used to estimate the terminal value and to estimate the reinvestment rate during the stable growth period. The length of the high growth period was estimated to be 5 years.
Valuation (thousands)
Year 0 EBIT $ 75,143 EBIT(1-t) - Reinvest. FCFF Terminal value = PV 1 $ $ $ $ $ 79,314 49,175 (28,521) 20,653 $ $ $ $ 2 83,716 51,904 (30,104) 21,800 $ $ $ $ 3 88,363 54,785 (31,775) 23,010 4 $ 93,268 $ $ 57,826 $ $ (33,539) $ $ 24,287 $ $ $ $ $ $ 19,259 $ 19,183 $ 5 98,445 61,036 (35,401) 25,635 Terminal 102,412 63,495 (23,262) 40,233 1,490,111 1,115,075
19,490 $
19,413 $ 19,336 $
Value of Operating Assets = + Cash & Marketable Securities - Debt -Minor interest = Equity Value per Share (41,533,436 shares)
$ 1,211,755 $ 160,788 $ (163,166) $ (25,006) $ 1,184,372
$
28.52
Stable Growth Period 38% 4.03% 36.64% 6.73% 11.00%
Tax Rate Growth Rate Reinvestment Rate COC ROC Minority Interest P/BV of Industry Value of Minority Holding
High Growth Period 38.00% 5.55% 58.00% 5.97% 9.57% $10,872 2.30 $25,005.60
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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As of March 19, 2004 Granite was trading at $23.83 per share. It appears that it is undervalued by approximately 16.4% as compared to the above valuation, which resulted in a price per share of $28.52. 4. Value Enhancement Strategy Three factors were considered in devising a strategy to enhance value. They are as follows: a. Cost Of Capital: The COC for Granite as of this valuation was 5.97%, which is less than the average COC for the sectors that Granite participates in – Building Materials 6.82% and Cement and Aggregate 6.31%. This is a positive sign and therefore this is not a target for immediate value enhancement. b. Increase Cash Flows: Granite can increase value by increasing cash flow. This can be done in several ways but the most applicable to Granite is to increase operating margin. This may be achieved by divesting branches that are earning less than the cost of capital. Although obvious, increasing operational efficiency is a place to start. Granite’s average operating margin over the last 3 years was 4.2%. If Granite can increase its operating margin by 0.5% then it can increase the above valuation, while holding all else constant, to $33.00 per share that is an increase of 15.7%. This is an area to increase value. c. Growth Rate: Granite’s expected 5-year growth rate, 5.33%, as calculated in the valuation is well below that expected by Zacks Investment Service; 9.8% for Granite and 12.7% for the Industry sector. In order for Granite to meet these growth rates, holding the investment rate constant, Granite will have to increase its ROC to 16.9% and 21.9% respectively. This is well above Granite’s average ROC between 1998 and 2003 of 9.57%. It should be noted that the average ROC for the Building Materials Industry is 18.62% and the average ROC for the Cement and Aggregate Industry is 14.48% (this information was obtained from your website). If Granite can meet the expected growth rate of 9.8% it can increase valuation to $34.67 per share and if it meets the 12.7% growth rate it can increase valuation to $39.44 per share. This is an increase of 21.6% and a 38.3% respectively, as compared to the share price calculated in the above valuation. Growth is clearly a viable avenue to add value. Granite can increase its
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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growth rate by increasing its operating efficiency, by investing in higher margin projects or by making acquisitions that generate a higher ROC than the current ROC. Granite can also consider expanding into areas of the country that are less competitive or by venturing outside of the US. 3. Value Relative to Comparables: Zacks investment Services 6, Yahoo Finance7 and Morningstar.com8 were used to obtain the information, which is listed in the table below, to value Granite in comparison to other firms in its sector. The Industry sector is Building- Heavy Construction. There are approximately 33 companies in this sector. All 33 firms were investigated and only the necessary information for 10 of the firms was available.
Company Emcor Group Inc. Insituform Tech Dycom Ind. Jacobs Eng. Group Chicago B & I Layne Christensen Fluor Corp. Perini Corp URS Granite Construction Average
P/E 3/12/04 27.7 18.50 32.50 18.20 18.70 46.10 17.2 12.10 16.90 21.40 22.93
P/B 3/12/04 1.1 1.50 2.50 2.70 3.00 2.00 2.9 2.70 1.30 2.00 2.17
Est. 5 Year Growth 15.5% 15.0% 14.3% 15.0% 14.3% 14.00% 13.0% 9.0% 10.0% 9.8% 12.99%
Beta 0.54 1.39 1.65 0.35 0.60 0.39 0.38 0.24 1.30 0.25 0.71
5 Year Avg.ROE 15.00% 16.40% 12.40% 16.10% 16.80% 4.40% 18.10% 17.50% 16.40% 13.50% 14.66%
The average P/E and the average P/B for these firms are 22.93 and 2.17 respectively. Compared to the average P/E Granite is approximately 6.7% undervalued and compared to the average P/B granite is approximately 7.8% undervalued.
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http://www.zacks.com/research/earnings/ http://finance.yahoo.com/q/ks?s=WGII
Http://library.morningstar.com/Stock/Profitability10.asp?Country=USA&Symbol=URS&stocktab=keyratio
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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Regression The information from your website, compfirm.xls, was used to obtain the information for the regression. P/E was used as the Response and Regression Betas and the 5-year expected Growth Rate as the predictors. The companies chosen are from the Building Materials, Cement and Aggregate and Industrial Services industries. All three of these sectors were used because the comparable firms are from one of these sectors. The payout ratio was not used as a predictor because most comparable companies paid no dividends. The total number of firms used was 50. Below are the results of the Regression. Regression analysis: P/E versus Growth and Beta P/E = 15.6 + 61.1 Growth - 4.73 Beta Predictor Constant Growth Beta S = 5.990 Coef SE Coef T 15.614 2.977 61.07 19.12 -4.728 2.156 P 5.25 3.19 -2.19 0.000 0.002 0.033
R-Sq = 25.0% R-Sq (adj) = 21.8%
*Company Emcor Group Inc. Insituform Tech Dycom Ind. Jacobs Eng. Group Chicago B & I Layne Christensen Fluor Corp. Perini Corp URS Granite Construction
P/E Est. 5 Year 3/12/04 Growth Beta 27.7 15.5% 0.54 18.50 15.0% 1.39 32.50 14.3% 1.65 18.20 15.0% 0.35 18.70 14.3% 0.60 46.10 14.00% 0.39 17.2 13.0% 0.38 12.10 9.0% 0.24 16.90 10.0% 1.30 21.40 9.8% 0.25
Predicted P/E 22.5 18.19 16.53 23.11 21.50 22.31 21.75 19.96 15.56 20.41
(+) Over (-)Under 18.7% 1.7% 49.1% -27.0% -15.0% 51.6% -26.4% -65.0% 7.9% 4.6%
A regression was also run for the P/B verse Beta and ROE. The information was obtained in the same way as the regression above and the sample contained 76 firms.
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Regression Analysis: P/B versus Beta, ROE P/B = 0.889 - 0.477 Beta + 12.8 ROE Predictor Coef SE Coef Constant 0.8885 0.1473 Beta -0.4770 0.1297 ROE 12.791 1.146 S = 0.4942 T P 6.03 -3.68 11.16 0.000 0.000 0.000
R-Sq = 63.8% R-Sq (adj) = 62.8%
Company Emcor Group Inc. Insituform Tech Dycom Ind. Jacobs Eng. Group Chicago B & I Layne Christensen Fluor Corp. Perini Corp URS Granite Construction
P/B 3/12/04 1.1 1.50 2.50 2.70 3.00 2.00 2.9 2.70 1.30 2.00
Beta 0.54 1.39 1.65 0.35 0.60 0.39 0.38 0.24 1.30 0.25
5 Year Avg.ROE 15.00% 16.40% 12.40% 16.10% 16.80% 4.40% 18.10% 17.50% 16.40% 13.50%
Predicted P/B 2.56 2.34 1.70 2.79 2.76 1.28 3.03 3.02 2.38 2.51
(+) Over (-) Under -132.86% -55.68% 32.03% -3.44% 7.89% 36.19% -4.64% -12.02% -82.93% -25.39%
Based on the P/E regression it appears that Granite Construction is overvalued by approximately 4.6%. However, one should consider the low r-squared value when using this regression in making a determination regarding valuation. Also, the standard error, 5.99, is relatively high. In considering the standard error Granite is approximately in the middle of the range, which indicates that it may be fully valued based on this regression. Based on the P/B regression Granite appears to be approximately 25.39% undervalued. The standard error of this regression is 0.492 and the r-squared is 62.8%, which is relatively high. Granite’s P/B is just below the bottom of the range. Since the r-squared of this regression is much higher (2.88x) than that of the P/E regression it is fair to say that ROE and Beta are better predictors of P/B than Growth and Beta are predictors of P/E in this case. Therefore the P/B ratio should be used in this case. Therefore, Granite appears to be undervalued.
C. J. Montalbano EMBA Management 04 Valuation Equity Valuation Project March 26, 2004
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4. Value Relative to the Market The intercept regressions from your website for P/E and P/B are as follows: P/E = 9.475 + .814 x Growth + 0.06 x Payout Ratio + 6.283 x Beta P/B = .14 x ROE + .599 x Beta + 0.08 x Growth + .002 x Payout Ratio 5-year Growth Rate from Zacks = 9.8% Beta calculated for the Discounted Cash flow Valuation = 0.72 3-year Average Payout Ratio from Bloomberg Financial Analysis = 26.5% 10-Year Avg. ROE from Bloomberg Financial Analysis = 13.5% The P/E and P/B based on the Regression of the market is 23.57 and 3.16 respectively. As of March 12, 2004 Granite’s P/E = 21.4 and P/B = 2. This indicates that Granite Construction is approximately undervalued by between 9.2% and 36.7% compared to the market. 5. Final Value Estimate and Recommendation BUY… BUY…. BUY…. Granite Construction appears to be undervalued based on all of the valuation techniques used. It is undervalued compared to the average P/B and P/E of the 10 comparable firms chosen by between 6.7% and 7.8%. The regression of the Industry, which was expanded to include Building Materials, Cement and Aggregates and Industrial Services, indicated that Granite was 25.39% undervalued based on P/B. However, this result was based on a regression Beta of 0.25, which appears to be low compared to the Beta calculated for the Discounted Cash Flow valuation (DCF). By substituting the Beta calculated in the DCF Valuation, which was 0.72, the under-valuation reduces from 25.39% to 14.2%. This is in line with the DCF valuation, which indicated a 16.4% under-valuation. Granite appears to be between 9.2% and 36.7% undervalued compared to the Market; depending on which multiple you use. Based on the results of the above analysis the DCF valuation and the P/B valuation based on a regression of its Industry, appears to be the most reliable. These two valuations are in line with each other and indicate an overvaluation of between 14.2% and 16.4%. Also, the DCF valuation appears to be conservative considering the expected growth rate of Granite and the expected growth rate of the Industry in which it competes. It is foreseeable that Granite can exceed the 5.55% growth rate calculated in the DCF valuation.
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