a well-diversified high net-worth individual

a well-diversified high net-worth individual who is interested in investing in shares with a fundamental value greater than the share price
Question 1. (Gino)
What are the competitive forces behind the industry’s structure?
How does competition affect the margins of the industry and the company?
How does the company’s profitability compare relatively to its peers (you should select between 3 and 5 industry peers)?
Wesfarmers
Tesco PLC (London)
Seven & I Holdings (Tokyo)
Sun Art Retail
What is the firm’s business strategy?
Please highlight potential investment risks the company could face in the future (please refer to Lectures 1 and 2); (Simon)
Question 2. (Anne)
Analyse how the market is pricing the firm using different relative (or market) valuation techniques. Please use the same group of industry peers identified in the previous section (please refer to Lectures 3 and 4);
Question 3. (林良鑫)
Estimate carefully the cost of debt, cost of equity and cost of capital for this company (please refer to Lectures 6 and 7);
Question 4. (ThucQuyen)
Estimate the free cash flows of the company (please refer to Lectures 8 to 10);
Question 5. (Simon)
Estimate the target price of the company, issue a buy/hold/sell recommendation to your client, and draw your conclusion. (please refer to Lectures 11 and 12).
b) Industry competitive forces, firm strategy, and investment risks
c) Financial (profitability) analysis
Executive Summary
We issue a Buy recommendation on Woolworths Limited (WOW).
Target price，reasons
Valuation:
Growth Drivers:
Main Risks:
Current price:$20.1
Business description
Woolworths Limited (WOW) is a major Australian company with extensive retail interest throughout Australia and New Zealand.
Industry Overview and Competitive Positioning
Industry’s structure
The Supermarkets and Grocery Stores industry is one of the most fiercely competitive industries in Australia. Traditionally, the Australian food retail market has been under duopoly structure with Woolworth and Coles (owned by Westfarmers) dominated majority of the market. And other smaller franchises and convenience stores occupied the rest of the food retail market. The companies always compete on their prices and the range of commodities in the industry competition. The food retail companies in Australia sold the products that are similar to each other particularly for main brands. In order to increasing the market share and sales turnover, the company made the profit margin to be very low at only about 5%. For a period of time, the companies also offered the different services for increased sales, e.g. reward program, score card, free toys, petrol discount, etc. Both companies possess other businesses outside food retailing as well, such as Big W.
How does competition affect the margins of the industry and the company
Strength
Woolworths, has large number of supermarkets and a huge market share, is one of the oldest and well-known retail brands in Australia. A lot of products and services are offered in Woolworths, in addition, there is a good combination of online store and physical store for the customers. The complete distribution network and logistics system are convenient, and the company build a strong relationship with suppliers.
Weaknesses
In spite of Woolworths is well-known retail brands in Australia, it has a low international influence. Compared to other companies in Australia and New Zealand, it lacks obvious competitive advantage.
Opportunities
One of significant opportunities is population growth, the demand from local and oversea rises. And company made some promotion to attract some customers from the competitors and increased the sale in online store.
Threats
Every food retail company has led to price war in order to win more customers. On the other way, more and more overseas competitors appear in the market, such as Aldi and Amazon, that caused the loss of customers.

Risk Matrix
Investment risks
Impact and probability of the following risks are presented in the Risk Matrix.
Regulatory Risks
Failure to Comply with Regulations (RR1) | High Likelihood & High Impact
The business operations of Woolworth Holdings limited expands across multiple industries, thus subject to extensive regulatory authorities which include, State Health Regulators for its organic food products, WorkCover Group for its self-insurance of work health and safety, RSA for its licences for the provision of alcohol, ASIC for its financial services in credit card and insurance services that are outsourced, the nature of outsourced services are outside the micro manageable internal control.
Despite mitigation of these risks through periodic auditing, internal and external, monitoring in governance to the extensive operations of 995 brick and mortar stores (as at 2018) in Australia is costly. Hence changes by regulatory authorities enforcing effective implementation of processes to a satisfactory standard increases regulatory risks. The trespass in compliance could result in the loss of a licence and thus the material risks representative of a large proportion of revenue.
Market Risks
Increasing competition and expanding rivals (MR1) |Moderate Likelihood & Moderate Impact
Currently Woolworths is facing the increasing competition of the expansion of Aldi and Coles in conjunction with the entry of international supermarket wholesaler Costco, local organic specialty stores including farmer’s market, in addition to increasing online competition of Amazon in the category of processed foods and threat of entry by competitive advantage of artificial intelligent technology and international wholesale retailer Amazon GO.
Despite Woolworth’s monopolistic economies of scales in reduced costs due to larger operations in Australia and inherent brand loyalty of its current operations, the probable likelihood of threats in increasing competition and new entrants that provide better quality or more efficient delivery of services and processes, inevitable result in a loss of market share over time.
Economics Risks
Unfavourable Interest Rate Movements (ER1) | High Likelihood & Low Impact
The current economic horizon of increasing interest rates by the US Federal reserve has prompted incremental increasing interest rates in Australia. The increased interest rates have prompted higher loan repayments and thus decreased customer sentiment in light of the going concern of mortgages thus decrease of consumer spending.
Legal Risks
Risk of litigations (LR1) | Low Likelihood & High Impact
Despite Woolworths tight processes and procedures, regulations, agreements and the periodic auditing of the compliance of these to mitigate adverse risks. The robustness of these processes and procedures that are not agreeable to all stakeholders in all situations and may lead to litigation.
An example of this includes that of the current ongoing EBA bargaining class action where the negotiations that may result in a contingent settlement value of $100 million or the potential of $1 billion if court hearing occurs, exclusive of legal costs. This contingent liability is a legal risk, that may be unavoidable that can potentially occur on any level of trespass in governance.
Operational Risks
Risk of Adverse Supplier Union Demands (OR1) | Moderate Likelihood & Moderate Impact
Woolworths provide its customers with a one stop shop experience operation which heavily rely on contracts and liaises with numerous suppliers, the increasing interest of unions such as the National Farmers’ Federation or Dairy Australia for better bargaining power and demands often relate to price and adversely affect Cost of Goods sold, which prompts potential decreased profits.
Theft in Self Service Checkouts (OR2) | Moderate Likelihood & Low impact
The introduction of self-service checkouts to decrease administrative costs and protect profits has also adversely increased the risk of customers scanning cheaper items for more expensive items increasing shrinkage of inventory with less staff to keep customers accountable.
Figure 1. Risk Matrix
Question 2 Relative Valuation (Note: All values compute with US dollar)
EV/EBITDA Multiple
The beneficial of employing EV/EBITDA – It is focused on earnings before interest, tax, depreciation and amortization, which applies cash return on investment to determine the real value of a business. – It could be compared with varying leverage level companies in the same industry.
The actual EBITDA margin of Woolworths Group Ltd (Wow) is 11.9, which above the midpoint and median of peer firms by approximately 2. There are two different outcomes based on regression model of estimated coefficients, leading to 11.24 and 15.28 respectively of different drivers’ computations. Due to the larger standard error was calculated by using ROC only, the application of ROC, Net CapEx/EBITDA, DA/EBITDA and tax rate is more accurate in this circumstance. Thus with the 11.29 actual EV/EBITDA, the result was undervalued comparing to predict margin of 15.28 (Table 1).
The average and median are both multiples that were calculated by operating peer firms to conclude our suggestions of Wow stock. As the result, a value per share of Wow is $20.94US and $21.86US respectively by using average and median multiple to calculate, a ~4% or ~9% premium contrast to the current share price of $20.1US (Table 2 & 3).
P/BV Multiple
To evaluate Wow stock with more confident, P/BV is another valuation that provides comparatively steady approach could simply compared with actual price.
Again, the current P/BV of Wow is 3.5, exceeding the mean and median P/BV of comparable firms og roughly 1, with the strong gains. 3.56 and 3.50 are the predict results after running two disparate regression models(ROE only / ROE, Payout Ratio, Beta, and LTG Forecasts), which have same level figures to the real P/BV of Wow could not conclude whether its undervalued or overvalued (Table 4).
The average and median valuation cause $23.14US and $24,36US respectively for Wow, indicating ~15% and ~21% premium compared to the current share price (Table 5 & 6).
P/E Ratio
Since EV/EBITDA and P/BV valuations both have large premiums, and the P/E ratio is not a perfect tool to analysis per share value, in this case instead of analysing multiples we change a different angle to assess Wow which is
by looking through the different periods of P/E. Wow would move to downward trend in the future as the tough environment of retail business. Contrast with comparable firms, all the P/E ratios of Wow are at the level of median point, which is still sound.
Conclusion:
Due to the calculation of predict number over the actual EV/EBITDA, and premiums are consistently over the current share value, we recommend BUY suggestion that indicate the highly expectations of Wow in the future.
Financial Analysis
Question 5.
References:
Raza, S 2013, ‘EV/ EBITDA versus P/B: Pros and Cons of
Both Valuation Metrics’, vw, viewed 10 October 2018,
<https://www.valuewalk.com/2013/01/ev-ebitda-versus-pb-pros-and-cons-of-both-valuation-metrics/>
Price-To-Book Ratio – P/B Ratio, ‘Investopedia’, viewed 23 October 2018, < https://www.investopedia.com/terms/p/price-to-bookratio.asp>
https://www.nff.org.au/commodities-dairy.html