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Debt Structure and Capital Gearing Ratio

The debts of the Company as at 30th July, 2016 consist of a revolving cash advance syndicated facility of $600 million. 

As at 30th July, 2016 and 25th July, 2015 the company owed the following amounts of short-term and long-term debts:-

Nature of debt

2016

2015

$'000

$'000

Total Debt (Long term)

 147,273

 441,179

Less: Cash Equivalents (deducted to know net debt)

  (45,207)

  (53,323)

Net Debt

 102,066

 387,856

Consistent with others in the industry, the company structures capital on the basis of various balance sheet ratios including the gearing ratio. This ratio is calculated as net debt divided by total capital. Net debt is calculated as total borrowings less cash and cash equivalents. Total capital is equity plus net debt. Thus, the debt structure is consistent with the industry as the company regularly takes steps to ensure that the capital gearing ratio is kept lower and consistent with its peers in the industry.

MYER group continues to put in best efforts in managing its capital structure efficiently and to make it consistent with the industry. This is done through monitoring the Capital gearing ratio of the company and continuously comparing it with the peers in the industry.

To stand in the market and to compete with the competitors in the market, the gearing ratio of the company has decreased during 2016 primarily driven by a decrease in net debt and an increase in equity.

Cost of debt refers to the interest rate paid by a company on its debt obligations. It is calculated as follows:- 

Cost of Equity refers to the return that a company pays for the risk undertaken by its shareholders in investing their capital.

Evaluation of Revenue, EPS, dividends and Growth Expectations 

(a) Revenue

Total sales of the company rose by 2.9 percent to approx. $3,289.6 million due to steps taken for rollout of wanted brands and improved customer service as well as continuous growth in the company’s business. 

(b) EPS = Earnings after tax / No. of shares outstanding 

Since the earnings of the company have increased in 2016 as compared to previous year, there has been growth in EPS from $5.05 per share to $7.67 per share. 

(c) On account of the progress made through implementation of New Myer, the company declared a total dividend of 5 cents per share.

Comparables Approach (P/E):-

Under this method of stock valuation, the stock market price is divided      by EPS of the company.

Formula = Stock price per share / Earning per share (EPS)

The Valuation of stock of MYER as per P/E ratio is:-

Evaluation of Revenue, EPS, and Dividends

The P/E ratio of the company has reduced to 17.46% but as compared to the industry the ratio is good and can be better with continued growth of the company.

Constant Dividend Growth Rate Model:-

This model considers dividend growth as a measure of stock valuation and to decide whether or not a particular investment should be bought.

Formula = (dividend of current year x (1+growth in dividend))/(required return-dividend growth)

The Valuation of stock of MYER as per this model is as follows:-

  Particulars

2016

2015

2014

2013

2012

Dividend per share (in cents)

              5.00

              7.00

14.5

18

19

Dividend Growth rate

           (28.57)

           (51.72)

    (19.44)

      (5.26)

     (15.56)

Since the growth rate of dividends of the company is negative, therefore it is not possible to do stock valuation.

To do stock valuation under dividend growth model, there should be continuous growth in dividends payouts during the last five years.

Thus factors affecting stock valuation as explained above are:-

  1. EPS
  2. DPS
  3. Dividend growth rate
  4. Market Price

With respect to MYER, P/E ratio is more suitable and effective method of stock valuation as dividend growth rate is negative and it is not possible to make stock valuation through dividend growth model.

In addition to factors mentioned above, the characteristics of stock, its compatibility and closeness with its intrinsic value and discounted value of the future earnings of the company should be kept in mind while doing stock valuation. 

It is the weighted average cost of equity, preference, debt and any other capital and the weights used for averaging are the quantum of capital supplied by respective capital.

Formula:- 

WACC = Ce x E/F + Cd x (1-Tc) x D/F 

Where,

Ce = Cost of Equity

Cd= Cost of Debt

Tc= Corporate Tax Rate

E = Market Value of Company’s Equity

D = Market Value of Company’s Debt

F = Total Market Value of Company

The Australian Tax rate is 30% on companies.

The tax rate as specified above is used in calculation of weighted cost of debt.

After debt cost of debt (1-Tc) is used as company claims tax deductions on the interest paid by it on debt and thus net cost of debt is interest paid less tax deductions claimed.

There is difference between the cost of equity and debt as debt refers to the borrowed funds and have to be repaid at a later date with interest payable at regular intervals at a fixed rate called interest rate. This interest rate is the cost of debt. Equity is the funds invested by the shareholders. Though equity is not to be repaid, but there is a return of investment that the shareholders expect based on performance of the company. This is known as cost of equity. Thus cost of equity and debt will always be different.

Stock Valuation and Factors Affecting It

The current liabilities are not included in cost of capital calculation. The cost of capital calculates the opportunity cost of different sources of capital employed in the company. Opportunity cost is what a company gives up by investing some scarce resources in one project or initiative instead of another. Capital involves all monies invested in the business and includes all debt and equity. Although current liabilities are not included in cost of capital calculation because it is not a capital, but it is considered when cash flows of an internal project are calculated.

The WACC enables a company to know minimum cost which it has to pay for using equity and debt capital. MYER’s WACC of 6.12% indicates the minimum rate of return that MYER has to earn to create value for the risk undertaken by its investors.

It is very effective in estimating the cost and evaluating projects with same risk and thus planning investments.

Current projects undertaken by using WACC in decision making

New Myer has been built up after calculation and evaluation with the help of WACC. It has been estimated that the New Myer will lead to sales growth of more than 3% in the next three years and return on funds employed to 15% from 9.1% by opening a number of new stores and better service and investment models.

The capital structure of Myer consists of both debt and equity as follows:-

 Particulars

2016

2015

$'000

$'000

Equity

 1,107,765.00

          863,016.00

Debt

    147,273.00

          441,179.00

 Total

 1,255,038.00

        1,304,195.00

The capital structure of Myer is consistent with the industry and debt equity ratio is quite low as compared to the industry.

An optimal capital structure is the perfect ratio of debt and equity for a company that maximizes its return and minimizes its cost of capital. 2:1 is considered as an ideal debt-equity ratio and Myer has a lower ratio which is considered positive.

The growth of economy of a country and economic balances and imbalances have a great impact on the stock prices of any company.

When the growth of market is low, the company opts for more of debt and less equity. And if the market is expected to grow, equity is preferred to debt.

Short-term loans from banks and other financial institutions and long-term loans by through stocks and debentures are availed as debt. The value of money affected by economy’s economic conditions, has a great impact when funds are raised by issue of securities. 

Retail industry in Australia has increased by approx. 3% during 2016 which is consistent with the growth observed during previous year. Total sales of MYER grew by 2.9% and is expected to rise by 3% till 2020. Myer Holdings Limited’s ROE of approx. 6% over the past year, compared to its industry’s 17.4%, indicates that investors would have been better off choosing the broader industry in terms of returns generated on their committed capital.

For a company to create value for its shareholders in the industry, it must generate an ROE higher than the cost of equity. Myer Holding Limited plans to grow by 0.6% till 2018. (Myer Holdings Ltd 2016).

Myer Holdings Ltd. is financial stable and healthy. This is evident by its relative increase in its ROA, ROE, profit margin as well as its increase in interest during 2016. Although decrease in P/E ratio and dividend yield may be observed in the current year, the company may be considered financially healthy on account of increase in new profits during 2016. Its debt equity ratio is also less and has good financial liquidity and solvency ratios. Therefore, Myer Holdings Ltd. Has the capability to increase its market share and grow in the industry.Yes I agree with the views of the analysts and this is clearly evident from the financial data of the company.

Initiatives are continuously taken by Myer Holdings in the form of New Myer with new marketing strategy and improved customer service to maintain its position and to increase its market share. Thus the confidence Myer has in itself and continuous development of new strategies and policies makes it different and unique from other players in the market.  

References

Investopedia, n.d., Cost of Debt, Viewed on 08/10/2017, <https://www.investopedia.com/terms/c/costofdebt.asp#ixzz4uhhle1iX>

Investopedia, n.d., Cost of Equity, Viewed on 08/10/2017, <https://www.investopedia.com/terms/c/costofequity.asp>

Dividend Monk, n.d., Stock Valuation: An Overview, <https://www.dividendmonk.com/stock-valuation-methods/>

Investopedia, n.d., Investment Valuation Ratios: Price/Earnings Ratio, <https://www.investopedia.com/university/ratios/investment-valuation/ratio4.asp#ixzz4ukFvqCae>

MYER, 2016, Annual Report, <https://investor.myer.com.au/FormBuilder/_Resource/_module/dGngnzELxUikQxL5gb1cgA/file/Myer_Annual_Report_2016.pdf>

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