Hasbro Valuation Project
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Hasbro Valuation Project Analysis Group Diana Duran [email protected] Marianne Francis [email protected] Ben Gergen [email protected] Stephen Milkowski [email protected] Table of Contents Executive Summary 3 Business and Industry Analysis 8 Company Overview 8 Industry Overview 10 Five Forces Model 11 Rivalry among Existing Firms 12 Threat of New Entrants 17 Threat of Substitute Products 19 Bargaining Power of Buyers 21 Bargaining Power of Suppliers 22 Analysis of Key Success Factors 24 Differentiation 24 Firm Competitive Advantage Analysis 28 Historical Competitive Analysis 28 Accounting Analysis 33 Key Accounting Policies 33 Accounting Flexibility 38 Actual Accounting Strategy 41 Qualitative Analysis of Disclosure 43 Quantitative Analysis of Disclosure 44 Potential Red Flags 51 Undo Accounting Distortions 52 1 Ratio Analysis, Forecast Financials, and Cost of Capital Estimation 61 Liquidity Analysis 61 Profitability Analysis 69 Capital Structure Analysis 77 Internal Growth Rate and Sustainable Growth Rate Analysis 81 Financial Statement Forecasting 83 Income Statement 83 Balance Sheet 87 Statement of Cash Flows 91 Cost of Capital Estimation 94 Valuation Analysis 99 Method of Comparables 99 Intrinsic Valuations 106 Analyst’s Recommendation 117 Appendix 118 2 Executive Summary Investment Recommendation: Overvalued, Sell April 1, 2004 PUT Z-SCORES IN HAS- NASDAQ 4/1/08 $29.27 Altman's Z-Score 2003 2004 2005 2006 2007 52 Week Range $21.57-$35.99 2.19 2.84 3.03 3.115 3.356 Revenue (billion)$ 3.92 Valuation Estimates Market Capitalization (billion)$ 5.14 Actual Price 4/1/08 $29.27 Shares Outstanding (million) 142.31 Percentage Institutonal Ownership 11% Financial Based Valuations Initial Revised Trailing P/E$ 28.69 $ 29.16 Forward P/E$ 28.90 $ 28.94 Book Value Per Share$ 9.58 P/B$ 19.97 $ 22.32 ROE 21.65% D/P$ 18.66 $ 18.66 ROA 10.75% PEG$ 22.58 $ 22.90 P/EBITDA$ 37.10 $ 37.10 Cost of Capital P/FCF$ 45.17 $ 45.67 Estimated R-squared Beta Ke EV/EBITDA$ 36.06 $ 35.98 3 Month 0.4047 1.50 15.59% 6 Month 0.4054 1.50 15.59% Intrinsic Valuations Revised 2 Year 0.4079 1.51 15.67% Discount Dividend$ 2.72 5 Year 0.4076 1.50 15.59% Free Cash Flow$ 29.10 10 Year 0.4062 1.49 15.51% Residual Income$ 10.42 Abnormal Earnings Growth$ 9.00 Published Beta 1.59 Long Run RI Perp$ 12.22 Cost of Debt (BT) 5.89% Cost of Debt (AT) 3.65% WACC (BT) 10.07% WACC (AT) 8.85% http://moneycentral.msn.com 3 Industry Analysis Hasbro is a toy company and is one of the top leaders in the toys and games industry. The company was organized in 1926 in Rhode Island and has products under brand names such as Playskool, Tonka, Milton Bradley, Scrabble, Jenga, Mr. Potato Head, Easy Bake, etc. The target market is mainly young children under the age of 12 and Hasbro is experiencing what it deems to be the “children growing older younger” effect as is much of the toy and games industry. The industry as a whole is losing some young customers to the video/computer games industry, one that is fundamentally different (no action figures, board games, or dolls) but, one that reflects a change in consumer culture. Rivalry among existing firms is quite low as there are many barriers to entry and exit. The industry is dominated by Mattel, followed closely by Hasbro, there is not much else or much excitement in the industry past these two. This is quite a concentrated market despite what is disclosed in Hasbro’s 10-k which takes the opposite opinion. The only other competitor below these two is JAKKS which produces educational toys and games, if this were a competitive market then children love educational toys and games. Among Hasbro and Mattel, the product lines are diverse, have brand images, and are well known to everyone that is young or a parent. Entering a market such as these is difficult, the two top firms are known to buy out emerging toy and game makers to add to their portfolio of products they currently sell. There is however, the threat of substitute products since everyone can sell dolls and action figures but, in order to land the rights to produce the action figures or dolls for the next upcoming movie you’re out of luck; those go to Mattel or Hasbro, because no other firm could compete. The threat of substitute products is average at best. Key performance measures or Key Success Factors were Brand Image, Cost Control, and good R&D expenditures. Industry growth is something to look out for as the credit crunch and inflation pressures are hurting the U.S. consumer, that is high gas prices, high diesel prices that push up transportation costs, and burdening grocery bills. The Wall Street Journal has reported that “Hasbro Inc.'s (HAS) first-quarter net income rose 14% as the international business returned to profitability and more than offset declining domestic earnings.” This small bit of information about the international nature of the industry 4 certainly displays the ability of firms to offset losses in the credit crunch among other areas of the world. The growth potential of this industry is not grounded in the U.S. anymore; the next big market may be Latin America or India and that shows an international industry in a global economy that has enormous profit potential. Accounting Analysis To view the true economic and financial position of the firm in its industry an analysis in accounting measures should display the accounting methods used by the firm and should convey its distortions. The Key Success Factors identified earlier and the accounting policies on that subject are targeted for examination. A better economic and financial position should be shown by undoing these distortions to display how well the firm is meeting its Key Success Factors. The firm Hasbro had a number of distortions from accounting practices pertaining to Key Success Factors which are both common in the industry and a requirement by GAAP. The Key Success Factor, brand Image, would be shown under advertising expenses. These are not capitalized into any intangible asset such as brand names or well known products, however this was reasonable given the unpredictability with a successful marketing expenditure and GAAP requirements are correct. The operating lease arrangement is standard industry practice and allowable under GAAP rules however, this does not show an accurate view of the firm economic or financial because of the ability to inflate key ratios like return on assets and debt-to- equity that measure performance. These leases were capitalized with information given in Hasbro’s 10-Ks and the result displayed more assets and liabilities than Hasbro would have preferred to disclose. Net income showed no net change overall but did show a gain or loss in specific years. These new numbers to the bottom line made a forecast more troubling and were not included in a restatement but were shown separately to show the effect on the balance sheet and income statement. The capitalization did 5 show a net reduction in new leases and displays the firm’s commitment to efficiency through cost control, a Key Success Factor. R&D expenditures are expensed under GAAP however; they were capitalized to give a different view of the firm not shown in the financials. The capitalization displayed a benefit to net income in the most recent of the past years after amortizing the R&D “assets”. The result showed a strong commitment to a Key Success Factor and meeting that with good expenditures initially with a benefit after capitalization. Financial Analysis, Forecast Financials, and Cost of Capital Estimation When valuing a firm it was necessary to look at the ratios of liquidity, profitability and capital structure. With the liquidity ratios we decided that the past three years was more reasonable then the past five years because the calculations were approximately the same. When considering profitability ratios, the operating profit margin for Hasbro were at a steady increase over the past years but still similar to the industry. This shows its ability in creating profit after deducting operating expenses. As for capital structure ratios, Hasbro is outperforming in the debt to service margin ratio which shows their ability to pay short term notes with operating cash flows. After determining the ratios for Hasbro as well as its competitors we were able to determine what would be best to forecast. This is also important in valuing the firm and in our calculations we forecasted the statements out a total of 10 years. Major forecasts include net income, CFFO, CFFI, retained earnings, and book value of equity. Also included are other parts of the financial statements such as total assets were we used an asset turnover rate of 1.25. This number was determined by looking at the asset turnover ratios from the past five years and seeing that there was a steady increase. Also, retained earnings and stockholder’s equity were adjusted each year by the amount of net income earned and the amount of dividends paid. Cash flows were forecast based on an average CFFO/sales ratio of 13.67%. 6 To find the cost of capital, we need to find the cost of equity and the cost of debt. In order to find our cost of equity, we need to find our beta, which is found by doing different regression analysis. We found out that by using the 2 year treasury constant maturity rate at 36 months gives us the highest adjusted R^2 of .4079 causing our beta to be 1.51, which says that Hasbro is a volatile company.