Excerpt
Table of Contents
Company Overview
Market conditions
Competition & Growth Rates
SWOT
Correcting accounting earnings
Weighted average cost of capital
Risk free rate (rf)
Capital-Structure
Beta
Unlevered Beta
Levered Beta
Market Risk Premium
Country Risk Premium
Cost of Equity
Cost of Debt (rd)
Interest Coverage Ratio
Default Spread
WACC
Free cash flow to the firm (FCFF)
Forecasting free cash flow
Growth Rate
Reinvestment Rate
Return on Capital (ROC)
Fundamental Growth Rate
Discounted cash flow
Relative Valuation
P/E:
EV/EBITDA:
Conclusion
Bibliography
Company Overview
SalMar ASA is a Norwegian fish farm company, listed on the Oslo Stock Exchange. With 100 marine production licenses for Atlantic salmon in Norway, the company is today one of the world's largest producers of farmed salmon. In addition to their operations in Norway, the company operates in both Iceland and Scotland. Their operations in Iceland are represented with a 59% ownership in Arnarlax, the country's largest salmon farming firm. Similarly, the company controls 50% of Norskott Havbruk AS, which is the sole owner of UK's second-largest salmon producer (SalMar ASA, 2019).
Today, SalMar's four main business areas are smolt production, fish farming, processing and sales & distribution (Salmar ASA, 2019). On the production and farming side, SalMar aim to produce their fish at the lowest cost by having the best operational efficiency. On the processing and sales side, they strive to achieve the best possible price for their salmon and ensure optimal yield (SalMar ASA, 2020). These two strategic objectives allow the company to pursue a cost leadership strategy.
Market conditions
Norway is the world leading supplier of Atlantic salmon. The country supplies approximately twice as much Chile, which is the second largest supplier. From 2018 to 2019, Norwegian export increased by 7% due to the stable price of salmon. Europe, as the most important export destination accounted for 74% of the export in 2019. Poland, Denmark, and Sweden were the most significant single markets along the 56 countries SalMar exports to. In addition, Asia is another important market for SalMar. The imports in the region grew by 29% between 2018 and 2019 (SalMar ASA, 2019).
According to MOWI (2020), the production of Atlantic Salmon has increased with more than 1000% since 1990. Today, about 69% of the world's salmon harvest is farmed. The industry is characterized by huge barriers of entry, mainly because of the lack of coastlines suitable for salmon farming. One of the reasons for this is that the optimal sea-temperature for salmon farming is between 8 and 14 degree Celsius (MOWI, 2020).
Figure 1: Coastlines suitable for salmon farming
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Source: Authors' own compilation based on data from (MOWI, 2020)
Competition & Growth Rates
The total Revenue of the industry is around 125.83B NOK. In 2019, SalMar had a revenue of 12.2B NOK, which equals approximately 10% of the market share. Only MOWI (40.84B NOK), Austevoll Seafood ASA (23.3B NOK) and Leroy Seafood Group (20.4B NOK) had larger revenue streams (Bloomberg, 2020). Looking at the market capitalization and the already mentioned export structure (the EU is the most important export area), it can be seen that the competitiveness in the aquaculture sector is concentrated in Europe, production is concentrated here and about 25% of the total exports are outside the EU. The expected growth of revenues for the next 2 years for the business, in which Salmar is operating, are 15.64% for Food Processing and 12.92% for Farming/Agriculture. For the expected growth in EPS for the next 5 years it is 11.54% for Food Processing and 13.96% for EPS (Damodaran, Historical Growth Rates, 2020).
SWOT
A strategic analysis is presented in a SWOT-analysisbelow. The analysis identifies external and internal factors affecting SalMar's competitive position, as well as their current and future potential.
Figure 2: SWOT-analysis of SalMar ASA
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Figure 2: Authors' own creation
Correcting accounting earnings
In order to enable a credible forecasting of future cash flows, it is essential to develop a throughout understanding of SalMar's historical financial performance. The historical financial statements do not separate “operations” and “investments in operations” from “financing activities”, so it is necessary to adjust the financial statements to make it better suited for valuation purposes (Peterson & Plenborg, 2012). SalMar continues to pursue its stated aim of cost leadership, which reflects their small investments in R&D. These expensesare therefore not considered to be of significant importance. Consequently, the R&D expenses are not capitalized in the adjusted financial statements.
For the case of SalMar, themost crucial adjustment is related to operating leases. Apart from 2019, operating leases is treated as operating expenses, but according to Damodaran (2012), these expenses should in reality represent financing expenses. Consequently, operating leases are capitalized and thus adjusted in the balance sheet. The value of the operating leases is included as debt in the balance sheet.
Next, the company's assets increase with the corresponding amount. Please see the table 1&2 for the reported and adjusted balance sheets.
Table 1 & 2: Reported and adjusted balance sheets
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Sources: Authors own compilation based on data from SalMar‘s annual reports (2015-2019)
After the operating leases are reclassified as debt, the operating income has been adjusted in two steps. First, the lease expenses are added back to the operating income, as it is treated as a financing expense. Finally, as the capitalization of operating leases creates an asset in the balance sheet, the depreciation of the asset is subtracted out to in order to calculate the adjusted operational EBIT. The depreciation is assigned in a straight-line over the expected lifespan of the asset. As the vast majority of SalMar's operating leases has a lifespan between 5-15 years, we argue that a 10-year straight-line depreciation is a fair assumption. Please see table 3 & 4 for the reported and adjusted income statement.
Table 3: Simplified Reported income statement
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Source: Authors own compilation based on data from SalMar annual reports (2015-2020)
Table 4: Simplified Adjusted income statement
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Source: Authors own compilation based on data from SalMar annual reports (2015-2020)
Weighted average cost of capital
At the beginning of the valuation of our selected company, we have to calculate weighted average cost of capital (WACC). The general formula for WACC can be derived as (Peterson & Plenborg, 2012): Eq: 1
D z x E
WACC = -^rdx(l-T)+-xre
In 2019, the corporate tax rate in Norway were 22%, and is used throughout our valuation.
Risk free rate (rf)
The first step is to determine the risk-free rate that will be used throughout our valuation. In the case of our company SalMar ASA, the currency of our valuation is Norwegian Krone (NOK), and therefore the risk-free rate is equal to the yield on a Norwegian 10-year government Bond.
On April 24, 2020, our valuation date, the 10-year government yield bond was at 0.769%. (Bonds, 2020).
Capital-Structure
We calculated the average of the market value (MV) of equity from the past five years by multiplying the outstanding shares with the stock price at the end of each FY.
The average past five years market value of equity equals 34832,95 NOK million.
In order to calculate the market value of debt, we used the following formula:
Eq: 2
MV debt = 119.67 * f' (1+2-17%)8'A + 6787'44= 6,984.22 NOK million
\ 2.17% I (1+2.17%)8-5
Where: 119.67 equals the average five-year interest expenses, 1.399% equals the cost of debt, 8.5 equals the average maturity of debt, 6787.44 equals average five year of total liabilities.
That leads to D/E = 20.1%; D/V = 16.7%; E/V = 83.3%
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Table 5: Capital structure
Capital structure
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Beta
To estimate the volatility in relation to the overall market, we used two Beta-approaches and weighted them up. The first approach was to calculate the Bottom-up-Beta for our company and the second one to search in Bloomberg for the adjusted two-year Beta.
Unlevered Beta
SalMar ASA operates business in 2 divisions, firstly in Sales & Processing and secondly in Agriculture & Farming. Therefore, the weighted unlevered beta must first be calculated from the two sectors. As reference we took the average Unlevered Beta of the Agriculture & Farming and Sales & Processing Industry. The two industries were first weighted according to revenue and multiplied by the average unlevered beta of the industries (Damodaran, 2020). The result of the unlevered beta is 0.6281. The adjusted 2-year unlevered beta is 0.58, so we decided to go with our unlevered beta further. (Infrontanalytics, 2020)
Table 6: Unlevered Bottom-up-Beta
Bottom up Beta
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Levered Beta
The (weighted) unlevered beta was then converted into a levered beta using the market values of SalMar's capital structure, and using the Norwegian 22% tax rate. The formula used to calculate the levered Bottom-up-Beta is:
Eq: 3
Bottom-Up-Beta: 0.6281 * (1+(1-22%)*(20.1%) = 0.7264
To get a good comparison for the calculated levered beta, we used the Bloomberg database to get a beta from another financial source. The published two-year beta was 0.741, which is very close to our calculated bottom-up beta. Based on this, we decided to continue with our calculated levered beta.
Market Risk Premium
Determining an appropriate market risk premium (MRP) is probably one of the most discussed issues in finance. For the case of this valuation, the Norwegian Market Risk Premium was taken as reference, which stood at 6.01% in April 2020 (Damodaran, NYU, 2020).
Country Risk Premium
In order to calculate the Country Risk Premium (CRP), we have weighted the turnover per country or continent as a percentage (with regard to the geographical distribution of sales volume) and multiplied it by the CRP of the country or the average CRP of the continent. For reference, we have taken the CRP by country or the average CRP by continent from the Damodaran April 2020. The calculated CRP equals 1.78% (Damodaran, Historical Growth Rates, 2020).
Table 7: Geographical distribution of sales and country/continent risk premium
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Cost of Equity
After calculating the risk-free rate, the levered beta, the MRP and the CRP, we now have all the parameters necessary to calculate the Cost of Equity (re). The cost of equity is calculated using the CAPM formula, adjusted for country risk premium:
Eq: 4
re = Tf + Ee x MRP + CRP
Table 8: Cost of equity
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Table 1: Cost of Equity
Cost of Debt (rd)
Due to the fact that we could not find traded debt nor a credit rating, we used the synthetic approach to calculate the cost of debt.
Eq 5:
Cost of Debt = Default Spread + Risk free rate
Interest Coverage Ratio
In order to find the default spread, we calculated the Interest Coverage Ratio:
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