7.1.3 E i e e i ed a e f e
To estimate equity investors required rate of return, the capital asset pricing model (CAPM) is generally used. The formula for equity owners required rate of return is according to CAPM:
∗
Where re is equity owners required rate of return, rf is the risk-free rate as described above, (rm -rf) is the equity risk premium. e is the systematic risk on equity (levered beta). Thus, beta measures the relative risk of a stock compared to the general market. The general stock market (market portfolio) has a beta of 1, and interpretations of beta is therefore that a beta below 1 means the investment has a lower risk then the market, while a beta above 1 indicates that the investment is more risky than the market. (Petersen et al., 2017)
7.1.4 Beta
The conventional approach for estimating the beta of an investment is a regression of returns e e e aga e a a e de (Damodaran, p. 183, 2012) The regression shows the co-variation between the returns on the market and the individual stock. Thus, estimations of beta are based on historical stock returns. Regressions are conducted on Norwegian and peers, against the respective main stock index in each country where the company is listed. All data for historical returns on the indices and companies were collected from Yahoo Finance (2019). The data for Norwegian and OSEBX are retrieved from Oslo Børs (2019a; 2019b) and manually sorted to match the dates in Yahoo s dataset. OSEBX is the main index in Norway and Norwegian are included in it. The index is heavily weighted within the oil industry and might therefore not be the best proxy of a market index which should include all assets (Damodaran, 2012).
Regressions are conducted on both 5-year monthly data, and 2-year weekly data. The beta retrieved from the regressions varies from 1.28 (2-year weekly) to 1.47 (5-year monthly).
Norwegian has grown and changed their risk profile significantly during the last 5 years. Since beta is a measure of risk in a company, the 5-year monthly data were not viewed as a good proxy. This is supported by the standard deviation of that regression, which is 0.70. I.e. the true value of the beta for Norwegian could range from 0.77 to 2.18 with 67% confidence. Beta
regressions of Norwegian s returns are also run against the following indices: S&P500, FTSE100 and EURO100 on 2-year weekly data. The results are 1.04, 1.47 and 0.99. The lowest standard deviation is found against the S&P500 index, where the standard deviation was 0.44.
R-squared showed a value of 0.05. According to Damodaran (2012), the economic rationale behind r-squared is that it provides an estimate of the proportion of the risk of a firm that can be attributed to market risk (Damodaran, 2012, p.184). One minus r-squared is then the firm-specific risk.
The beta results differ, and according to Damodaran (2012) most financial service companies e.g. Bloomberg, adjust their beta towards 1 which relies on empirical studies that implies that the beta for most companies will tend to move towards the market beta. According to Damodaran s home page (2020), the levered beta within the airline industry in Europe is 1.01.
Therefore, it is sensible to choose an average out of the 2-year regression beta (against OSEBX) with the average of the European industry, as retrie ed from Damodaran s home page. The formula for adjusting the beta is the one that Bloomberg uses:
𝐴 1.28 ∗2
3 1.01 ∗1 3
The adjusted beta calculated above is 1.19. This is the same beta as retrieved from taking the arithmetic mean of all regression s beta on Norwegian against the market indices.
7.1.5 Deb h de e i ed a e f e
According to Petersen et al. (2017), the required rate on return on net interest-bearing liabilities (NIBL) after tax is calculated as:
∗ 1
Where rd is the required rate of return on NIBL. rf is the risk-free interest rate chosen above. t is the corporate tax rate and rs is the credit spread, also called the risk-premium on NIBL.
The credit spread can be determined by investigating the firms default risk. According to Damodaran (2012) the defa lt risk is a combination of t o ariables, the first is the compan s capacity to generate cash flow from operations, the second is its committed financial obligations, e.g. interest and principal payments. Damodaran also states that the volatility of
the operating cash flows influences the default risk. As mentioned under the financial analysis, Norwegian have a negative interest coverage ratio. According to a report from S&P Global Market Intelligence (2019), Norwegian s financial ratios categorized as a triple C rated company, suggesting a credit spread according to Damodaran (2020b) of 8.20%. Norwegian also issued a convertible bond in late 2019 which had a fixed interest of 6.375% per annum.
The option to convert the bond to shares lowers the interest rate charged on the bond, thus, the newly issued bond supports the credit spread of approximately 8.20% which will be applied in this thesis.
7.1.6 Capital structure
When computing the weighted average cost of capital, the capital structure must be based on market values (Petersen et. al., 2017). This can be problematic when computing the market value of debt since few firms have all their debt outstanding as bonds. Most of Norwegians debt are lease commitments and aircraft financing given by export credit agencies in the United States and EU (Norwegian, 2018). Damodaran (2020c) recommends treating the entire debt as a one coupon bond, with the coupon set equal to the interest expenses on all the debt and maturity set equal to the face-value weighted average maturity of the debt. Following, the coupon bond is valued at the current cost of debt for the company. As stated under chapter 5, Norwegian leases their aircraft between 3 and 12 years. The outstanding bonds matures within a couple of years, and owned aircraft are divided into two parts and depreciated over their useful life (maintenance parts and aircraft frame). Useful life is approximated to be 8 years. Using the NIBL of NOK 52,353 million for 2019, the interest expense of NOK 3,075 million, the cost of debt of 7.56 percent and 8 years as maturity yields a market value of debt of NOK 47,197 million.
The share price of Norwegian traded at NOK 37.75 at December 30th, 2019 (Oslo Børs, 2019a).
Total shares outstanding at the end of 2019 were 163,558,377 (Norwegian, 2020a). Multiplying the share price with outstanding shares gives us the market capitalization or market value of equity of the company. Norwegians market value of equity at the end of the year were NOK 6,174 million. Thus, the equity weight is 12% and the weight of the debt is 88%.
7.1.7 Weighted average cost of capital (WACC)
The combination of equity owners required rate of return and lenders required rate of return make up the weighted average cost of capital for the company. The formula for WACC is:
𝐴𝐶𝐶 𝐵
𝐵 𝐸 ∗ ∗ 1 𝐸
𝐵 𝐸 ∗
Where NIBL is the market value of net interest-bearing liabilities, while equity is the market value of equity. rd is the required rate of return on NIBL as computed above, and re is equity owners required rate of return. t is the corporate tax rate. (Petersen, et. al., 2017)
The equity owners required rate of return using the CAPM model yields re = 1.49% + 1.19 * 5% = 7.44%. The required return for debt owners is calculated as; rd = (1.49% + 8.20%) * (1-22%) = 7.56%. Using the formula above for WACC, and the weights estimated under capital structure above yields a WACC of 7.54%.
7.2 Final Value estimate
The value of one share in Norwegian is estimated using the discounted cash flow approach.
The free cash flows to the firm is discounted with the weighted average cost of capital of 7.54 percent. The growth rate in the continuing period is set equal to 2 percent. Sum of the present value in the forecasted horizon and the terminal value make up the enterprise value of the company. The market value of net interest-bearing liabilities is deducted from the enterprise value to retrieve at the estimated market value of equity. The share price retrieved from the discounted cash flow model is NOK 37.45 per share. This is very similar to the actual market price, on the 30th of December 2019 which was NOK 37.75.
Table 14: Final Value Estimate
Discounted cash flow model 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030E Free cash flow to the firm (FCFF) (571) 412 1,234 2,917 384 5,835 3,587 3,892 4,328 4,810 4,284
WACC 7.54% 7.54% 7.54% 7.54% 7.54% 7.54% 7.54% 7.54% 7.54% 7.54% 7.54%
Discount factor 0.930 0.865 0.804 0.748 0.695 0.647 0.601 0.559 0.520 0.483 0.483
Present value, FCFF (531) 356 992 2,181 267 3,772 2,157 2,176 2,250 2,325 2,071
WACC 7.54%
Growth in terminal value 2%
PV of FCFF, forecast horizon 15,945 PV of FCFF, continuing period 37,377 Estimated Enterprise value 53,322 Net interest-bearing liabilities (47,197) Estimated market value of equity 6,125
# of shares 164
Price per share 37.45