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Forecasting the free cash flows

Page 59 of 131

9 Tican stand-alone valuation

The third part of this thesis is the valuation of the stand-alone companies as well as the busi-ness case. This section analyses the stand-alone value of Tican, which is based on the perspec-tive of the cooperaperspec-tive members of Danish Crown. In other words, this section will discount the free cash flows of Tican with the WACC of Danish Crown, as this is the best measure of the required return that Danish Crown would require, if they should merge with Tican. As the WACC in Danish Crown of 6.40% is lower than the WACC of Tican estimated below of 9.38%, this will generally result in a more positive valuation than Tican would have obtained without the financial support of Danish Crown.

9.1 Forecasting the free cash flows

Page 60 of 131 The price growth rate has been reduced by 20% based on the results of Porters Five Forces indicating a tight price competition in the industry. Secondly, pork is a commodity product associated with a high price elasticity of demand (Andreyeva, Long, & Brownell, 2010).

Thirdly, the data extractions on price growth include all fresh meat products and all processed foods respectively, which for fresh meats implies that poultry is included in the estimates. As shown in section 6.1.1, poultry consumption has been growing relatively to other types of meat (OECD, 2015; Statista forecasts, 2016). Finally, the price effect has been adjusted by exchange rate forecasts due to the high exposure to foreign markets and thus currency effects (Bloomberg Terminal, 2016; Tican, 2014a).

The result is volume and price growths which are then weighted by country, subjective ad-justments, industry and exchange rate risks. The volume data (Euromonitor forecasts, 2016), price data (Euromonitor forecasts, 2016) and exchange rate risks data (Bloomberg Terminal, 2016) is included in appendix 35.

Table 9-1: Tican volume and price growth weighted by industry, geography. Own creation based on (Bloomberg Terminal, 2016; Euromonitor forecasts, 2016).

Revenue growth in % 2014 2015 2016 2017 2018 2019 2020 Weighted average volume growth 0.70 0.00 0.30 0.66 0.80 0.87 1.10 Weighted average price growth 1.47 0.95 1.95 2.56 2.75 2.86 3.00 Revenue growth forecast 2.13 0.95 2.25 3.24 3.57 3.76 4.13

The revenue growth forecasted is significantly lower than the average historical revenue growth of 6.59% in the period of 2010-14 (Tican, 2014a). The revenue growth is largely driv-en by the gdriv-eneral price growth in the markets that Tican operate within, where the volume growth, subject to adjustments based on the strategical and financial analysis is relatively low.

The revenue growth is, by construction, driven primarily by the forecasted market prospects in the industry, however is subject to a series of subjective adjustments which are outlined below. Due to Tican primarily selling commodity products, the authors find it unreasonable to argue for adjustments in Tican’s ability to increase pricing on their products and thus the fol-lowing adjustments in percentage points refer only to growth rate prospects on its respective markets.

Russia has been removed due to the aforementioned embargo. Russia accounted for 4.4% of Tican’s revenue in 2014 for which the removal caused a downwards shock to the revenue of 2015. The authors found it reasonable to shift some of the lost production towards other mar-kets in the European area with Tican’s sales team working hard to shift sales (Tican, 2014a);

however the overall effect is negative.

Page 61 of 131 Volume growth in Poland has been reduced in both processed and fresh meat markets due to the annual reports of Tican stating a current capacity constraint where Tican is unable to han-dle more activity (Tican, 2014a). In response to the capacity constraint, the assets of Tican are adjusted since new investments are expected to be a precondition for further growth in the market. The new capacity investments in Poland are expected complete after 2016, until which the authors allocate a negative effect of -5% and -4% in 2015 and 2016, respectively.

The United Kingdom has been granted an additional 1% volume growth on processed prod-ucts. Tican has a strong position in the market and have distribution agreements with retailers such as Lidl, Aldi and from 2015, Netto (Tican, 2014a). Furthermore, Danish Bacon is widely regarded a premium product in the UK, which will help Tican increase their market share (Mørch, 2016). The fresh meat market has been slightly reduced in terms of volume growth as Tican has been unable to match the prices in the market due to increased demand for discount.

Japan and China has positively adjusted 1% each in terms of processed food. Tican has histor-ically been generating most of their revenue from China through sales of pig ears, tails and feet but has been pushing for new markets in the Asia-pacific region. Moreover, the manage-ment of Tican has emphasized increased focus on the Asian markets in the following years (Tican, 2014a) supported by the projected growth in consumption (OECD, 2015). Tican’s products are generally considered to be of very high quality and with high standards of food safety, giving Tican a competitive edge over local producers (Kristensen, 2011).

9.1.2 Operational costs

As found in the financial analysis, the operational costs has been historically high in 2013/14 due to the Russian embargo and increased activity in the affiliates of Tican. The embargo hit Tican hard and forced the company to shut down their affiliate, Fjerritslev, which processed pork for Russia in particular (Nordjyske.dk, 2014). Increased storage costs and costs associat-ed with shutting down the affiliate have decreasassociat-ed the profit margin of Tican in recent years.

The authors conclude the effect of the Russian embargo to be transitory and that Tican are able to re-stablish their operational costs equal to their historical average of 2010 to 2014. The table below represents the value-drivers applied in the sales-driven forecast. Note however that distribution costs are not scaled towards a historical level as Tican is increasing exports, with much growth taking place outside Denmark. Furthermore, due to geopolitical changes such as the Russian embargo and strategic choices to focus on foreign markets far away such as Japan and China the distribution costs will have a changed pattern.

Other operating income as % of revenue represents revenue income/loss from equity invest-ments in associated affiliates. Variations in this value driver would imply that the affiliate

Page 62 of 131 owned by Tican would be more (or less) profitable in the upcoming year which would require a separate analysis to determine. The adjustment is deemed out of scope for this thesis, rather the author’s base the value driver on last year’s activity as % of revenue (Petersen & Plen-borg, 2012:184). The value drivers are shown in Table 9-2 below.

Table 9-2: Operational value-drivers as % of revenue, own creation.

Value-drivers as % of revenue Historical 2015 2016 2017 2018 2019 2020

Revenue growth 6.6 0.9 2.2 3.2 3.6 3.8 4.1

Production cost -87.2 -88.0 -87.8 -87.7 -87.5 -87.4 -87.2

Distribution cost -6.0 -6.4 -6.4 -6.4 -6.4 -6.4 -6.4

Administration cost -2.5 -2.6 -2.6 -2.6 -2.5 -2.5 -2.5

Other operating cost 1.5 0.4 0.4 0.4 0.4 0.4 0.4

EBITDA 5.1 3.4 3.6 3.8 3.9 4.1 4.3

9.1.3 Other operational value-drivers

Other value-drivers include the efficient tax rate, depreciations as % of intangible and tangible assets and the net borrowing cost used to forecast net financial expenses as % of net-interest-bearing debt (Petersen & Plenborg, 2012, p. 176).

Table 9-3: Other operational value drivers, own creation

Value-drivers as % Historical 2015 2016 2017 2018 2019 2020 NBC after tax, interest rate -5.1 -5.1 -5.1 -5.1 -5.1 -5.1 -5.1 Efficient tax as % of NOPAT 11.2 11.2 11.2 11.2 11.2 11.2 11.2 Depreciation as % of

intangible and tangible assets -8.6 -8.6 -8.6 -8.6 -8.6 -8.6 -8.6

The remaining operating value-drivers are based on their historical average and are expected grow with the activity of the company. Note that the tax has been extraordinarily high for Ti-can in recent years due to the Russian embargo driving up the inventories, and thus taxable assets subject to cooperative tax since tax is assets based rather than revenue based. The au-thors found it unlikely that Tican would increase their relative interest payments or deprecia-tions relative to the activity and thus forecast these based on a historical level.

Page 63 of 131 9.1.4 Forecasting of balance sheet items

The sales-driven approach links balance sheet items and the underlying activity in revenue, rather than forecasting each line item separately (Petersen & Plenborg, 2012, p. 177).

Table 9-4: Balance sheet value drivers, own creation

Value drivers as % Historical 2015 2016 2017 2018 2019 2020 Intangible and tangible as % of

revenue 17.1 18.1 17.7 17.4 17.1 17.1 17.1

NWC as % of revenue 6.8 4.8 4.8 4.8 4.8 4.8 4.8

NIBD as % of invested capital 45.0 45.0 45.0 45.0 45.0 45.0 45.0

Intangible and tangible assets as % of revenue has been increased to accommodate the in-creased investments in capacities needed to grow, especially in Poland and UK which has been facing capacity constraints. The tangible assets are increased by 50 mDKK correspond-ing to 0.9% of revenue and are based on historical investments in property, plant and equip-ment related to capacity improveequip-ments in Tican (Tican, 2014a; Tican, 2014c). The ~ 1% of revenue, in addition to the 17.1% in average historical assets as % of revenue, grants a new ratio of 18.1% in 2014/15. The effect declines as the revenue increase following the capacity adjustments and reach a historical average of 17.1% by 2018.

New working capital as % of revenue is adjusted based on the “Net Working Capital Project”

launched in 2013, which aimed to reduce the NWC by 100 mDKK (Tican, 2014a). The pro-ject has been successful and achieved its target in June 2014 and is assumed to remain at this level. The decrease in 100m mDKK NWC corresponds to 2% revenue, which reduces the average NWC from 6.8% to 4.8% in 2015 onwards.

The NIBD as % of Invested Capital has not been adjusted further, as the model directly ad-justs the debt level as a % of total net operating assets. Further changes would imply that Ti-can intends to adjust their capital structure which is considered unlikely given the stable his-torical average of 45% NIBD to Invested capital ratio.