When we start with forecasting individual line items, we have to prepare the structure of the forecast. It means the order in which the variables are forecasted and how they relate to each other. The forecast should start with an integrated income statement and balance sheet.
70 http://www.investopedia.com/terms/c/cagr.asp
Sales estimates 2010 2011 2012 2013 CAGR total growth
CZ mil sticks -0.39% 1.04% 1.27% 0.64% 0.65% 2.59%
SK mil sticks 0.96% 1.06% 1.26% 0.36% 0.92% 3.68%
CZ CZK mil 4.38% 6.23% 5.99% 5.87% 6.11% 24.43%
SK EUR mil 2.14% 2.58% 3.20% 2.72% 2.77% 11.07%
EU EUR bio 2.15% 1.94% 1.91% 2.26% 2.31% 11.56%
The most common approach to forecasting of the income statement and balance sheet for non - financial companies is a demand-driven forecast, which starts with sales. Most of the other variables are driven off the sales forecast.
I will use a top-down forecast, where the revenues are estimated by sizing the total market, determining market share, and forecasting prices. The bottom-up approach, where the company's forecasts are used, is impossible, as it is Company's policy not to publish any forecasts.
I consider the tobacco industry as a mature one, where the aggregate market grows slowly and is closely tied to long-term trends (e.g. changing consumer preferences). Therefore, I rely on professional forecasts of the aggregate market (by Euromonitor International and Datamonitor) and I will mainly focus on Company's market share.
When forecasting revenues for next years, I made few assumptions:
● market share for the Czech and Slovak market will remain more or less stable, I assume that Company is able to capture the current market share, Company will follow the strategy of close monitoring of customers' tastes, Company will still continue like market leader
● Company (due to the opening of new producing facilities) will produce more cigarettes and therefore increase its export to the EU countries
● the revenues growth until 2013 is computed from data by Euromonitor International and Datamonitor, like an weighted arithmetic mean, where there are different weights for all three geographical segments
● since 2014, I projected expected rise in excise tax (following the example that already happened to Philip Morris in 2008), which is likely to increase the illicit trade and make the customers to start buying cigarettes in the neighbouring countries with lower excise tax, nevertheless, by 2018, the excise tax rate set by the EU, will apply to those countries as well
● the total growth will be mainly derived by rises in price, while the total shipment in the Czech and Slovak market will probably decline due to the strict regulations and
consumers life style which is becoming to be healthier
● however cigarettes will not have a substitute and many people will still be so-called
“core smokers” (consumers, who are impervious to price, bans, health warnings and anything else)71, so even though that number of smokers is slowly decreasing, it will never get close to zero
● Company will go on with innovation and development of new products in order to attract new or retain old customers
When the revenues forecasts are known for the upcoming years, we can move on to forecasting of individual lines. First step is to find out what economically drives each line. We can suppose that most of the lines in the income statement are derived from revenues. To check this hypothesis, I will apply correlation analysis.
Source: own computations
I consider the driver as relevant only if the correlation coefficient is at least 0.8. The correlation analysis confirmed that the revenues are key forecast driver – COGS, administrative expenses and other income is derived by revenues. However, a bit surprising fact was that distribution expenses are derived by COGS more than by revenues. Other operating expenses are mainly driven by distribution expenses and other operating income is dependant on the other operating expenses. Tax on operating profit is dependant on EBIT more than on the revenues.
I will use ROIC tree to check consistency of the forecast. With the historical levels calculated, there are few points which help to gain insight into the future level of each valuation variable.
We have to judge whether the industry and company capabilities are expected to maintain
71 Global Tobacco, Euromonitor International, p. 30
Driver
COGS 0.92 revenues
Distribution expenses 0.88 COGS Administrative expenses 1 revenues Other operating expenses 0.94 distribution exp.
Other income 0.8 revenues
Other operating income 1 other operating exp.
Tax on operating earnings 0.87 EBIT Correlation
coefficient
historical patterns in the future. And what factors can cause significant shift in the historical level of the company's value drivers.
The effective tax rate, will be predicted as well. The problem of the effective tax rate is that to calculate and predict it correctly, one needs internal information. Especially, because the Company is active in three different business segment. The tax will be predicted mainly on the basis of possible development of a Czech corporate tax rate.
COGS moved over the covered period from 49% to 54%. The current trend shows that it could stay somewhere around 55% over the years. This level will be used in the forecasts.
The distribution expenses decreased over the years from almost 35% to less than 20% of COGS. But as Company will produce bigger shipment for export, the assumption is that the level of distribution expenses will rise slightly to around 20%, which will be used in the forecast.
The administrative expenses stayed around 8% over all the years. So that level will be used in the forecasting.
Other operating expenses converges to around 20% of distribution expenses. Other operating income closely correlates with other operating expense. Its level is around 92%. These levels will be used.
Tax on operating income follows EBIT, and will be set on the level of 21%, mainly in accordance with the Czech corporate tax rate.
When we are done with forecasting of the analytical income statement, we can go to the forecasting of the invested capital.
I will start the same way like with the income statement, I will apply correlation analysis in order to find what economically drives the selected lines. I will not forecast the whole analytical balance sheet in details, but I will forecast operating working capital (OWC) and long-term assets.
Source: own computations
Level of OWC changes significantly every year. But when we explore its level more deeply, we will find out that it correlates really closely with the sum of all expenses. Its level will be set as 60% of the sum of all expenses.
Net PP&E correlates with the revenues. Its level has been similar for few years, a bit above 22%. However, Company invested considerable funds into new production facilities. From this year, when the new production facilities will start to work, so the net PP&E is supposed to rise. Therefore the level of PP&E will be set at 26% of the revenues.
Concerning intangible assets we do not have any information from the Annual Reports.
Therefore, the level for the forecasted period will be the same like in 2009. Deferred tax assets has had the same level for two preceding years and in addition, it counts for a really tiny part of the invested capital. So I will leave the level the same like in 2009, too. PP&E classified as held-for-sale has been for the majority of years 0. So it will be in the anticipated period. More detailed forecasts can be found in the Appendices 3 and 4.
All the forecasts were prepared without anticipation of inflation. The reason is that the inflation was not taken in account in the historical analysis, meaning that all the historical analysis and forecasts are in nominal, not in real currency units. And moreover, inflation is not a big deal in the Czech Republic. E.g. inflation in 2009 reached only 1%. And in the previous years the inflation usually was around 2%.72
The forecast for next ten years plus for CV is in the following graph:
72 http://www.czso.cz/csu/redakce.nsf/i/mira_inflace
Driver Operating working capital 0.99 sum of all expenses Property, plant and equipment 0.94 revenues
Intangible assets
-Deferred tax assets
-PP&E classified as held-for-sale -Correlation
coefficient
Source: own estimates
Table 22: Forecast for 2010 – 2019 + CV
CV 2019e 2018e 2017e 2016e 2015e Revenues 12,611 12,486 12,362 12,301 12,425 12,678 COGS (6,936) (6,867) (6,799) (6,765) (6,834) (6,973) Distribution expenses (1,387) (1,373) (1,360) (1,353) (1,367) (1,395) Administrative expenses (1,009) (999) (989) (984) (994) (1,014) Other operating expenses (277) (275) (272) (271) (273) (279) Sum of all expenses (9,609) (9,514) (9,420) (9,373) (9,468) (9,661)
Other income 60 60 60 60 60 60
Other operating income 255 253 250 249 251 257
Sum of all incomes 315 313 310 309 311 317
EBIT 3,317 3,284 3,252 3,237 3,269 3,334
Tax on operating earnings 696 690 683 680 686 700
NOPAT 2,620 2,595 2,569 2,557 2,582 2,634
Effective tax rate 21.00% 21.00% 21.00% 21.00% 21.00% 21.00%
2014e 2013e 2012e 2011e 2010e 2009 Revenues 13,207 13,975 13,339 12,714 12,115 11,690 COGS (7,264) (7,686) (7,337) (6,992) (6,663) (6,398) Distribution expenses (1,453) (1,537) (1,467) (1,398) (1,333) (1,236) Administrative expenses (1,057) (1,118) (1,067) (1,017) (969) (923) Other operating expenses (291) (307) (293) (280) (267) (251) Sum of all expenses (10,064) (10,649) (10,164) (9,688) (9,231) (8,808)
Other income 60 60 60 60 60 60
Other operating income 267 283 270 257 245 264
Sum of all incomes 327 343 330 317 305 324
EBIT 3,471 3,669 3,505 3,343 3,189 3,206
Tax on operating earnings 729 770 736 702 670 681
NOPAT 2,742 2,899 2,769 2,641 2,519 2,525
Effective tax rate 21.00% 21.00% 21.00% 21.00% 21.00% 21.24%
CV 2019e 2018e 2017e 2016e 2015e
Operating working capital 5766 5709 5652 5624 5681 5797
Property, plant and equipment 3279 3246 3214 3198 3230 3296
Intangible assets 111 111 111 111 111 111
Deferred tax assets 5 5 5 5 5 5
PP&E classified as held-for-sale 0 0 0 0 0 0
Invested capital 9160 9071 8982 8938 9027 9209
2014e 2013e 2012e 2011e 2010e 2009
Operating working capital 6038 6390 6099 5813 5539 382
Property, plant and equipment 3434 3634 3468 3306 3150 2561
Intangible assets 111 111 111 111 111 111
Deferred tax assets 5 5 5 5 5 5
PP&E classified as held-for-sale 0 0 0 0 0 0
Invested capital 9588 10139 9683 9234 8805 3059