Valuation of Bakkafrost Copenhagen Business School Master Thesis, May 2018 Stian Hiljar Larsen – Jonas Edvard Mustorp Supervisor: Ole Vagn Sørensen Pages: 120 Characters: 249,612 Executive summary Bakkafrost has experienced tremendous growth in the recent years and has established itself as the 10th largest salmon producer in the world. The company is well-renowned in the industry and has for many years been a profitability leader. From April 6rd 2017 to April 6th 2018 its stock price has increased from 272,30 NOK to 454,5 NOK per share. The scope of this thesis is to examine the underlying fundamentals of Bakkafrost and perform a valuation to estimate its intrinsic value. To arrive at an estimate of Bakkafrost’s value, tools associated with a fundamental valuation has been applied. The thesis follows Penman’s (2012) 5 steps of a fundamental analysis. The first step of knowing the business will provide the reader with an insight of the industry’s history and the current business environment. The second step, analyzing strategic information, will apply the strategic tools of a PESTEL-analysis, Porter Five forces, a Value Chain Analysis and VRIO-Analysis to explore sources of competitive advantage, and investigate the future direction of the industry. The third step entails Analyzing financial information where data from financial statements will be examined, to understand drivers of profitability. The fourth step is concerned with Developing forecasts, where the insight from the previous steps are combined to forecast the future payoffs of Bakkafrost. The last step entails the Valuation, where a cost of capital is estimated, and the Residual operating income model is applied in order to arrive at a fundamental value. Moreover, the result from the fundamental analysis is critically assessed with a multiple valuation, a scenario- and a sensitivity analysis. The results from the fundamental valuation was a value of 372,6 NOK per share, which was 20% below the listed stock price at 454,6 NOK on the cut-off date. Thus indicating an overpricing in the market. In short, the main findings were that the drivers of profitability in the industry mainly derived from the salmon price, and the firms’ ability to control production costs. The analysis indicate that Bakkafrost’s competitive advantage has been sustained by its fully-integrated value chain, which has allowed high cost-control and premium prices. Moreover, favorable geopolitical positioning has led to increased demand for Bakkafrost’s produce in periods when sanctions restricted competition's trade. The thesis concludes that these drivers of profitability are not sustainable in the future, and that Bakkafrost’s current level of profitability will revert toward an industry average. Table of contents 1. INTRODUCTION ........................................................................................................................................................ 3 2. PROBLEM STATEMENT .......................................................................................................................................... 4 2.1 SUB-QUESTIONS ........................................................................................................................................................ 4 3. METHODOLOGY AND STRUCTURE .................................................................................................................... 5 3.1 THEORETICAL APPROACH .......................................................................................................................................... 6 3.2 DATA COLLECTION .................................................................................................................................................... 7 3.3 CRITICISM OF SOURCES ............................................................................................................................................. 7 3.4 DELIMITATIONS AND ASSUMPTIONS .......................................................................................................................... 8 4. INDUSTRY AND COMPANY OVERVIEW ............................................................................................................. 8 4.1 AQUACULTURE AND THE SALMON FARMING INDUSTRY ............................................................................................ 9 4.2 BAKKAFROST .......................................................................................................................................................... 15 5. STRATEGIC ANALYSIS .......................................................................................................................................... 19 5.1 PESTEL .................................................................................................................................................................. 19 5.2 PORTER’S FIVE FORCES ............................................................................................................................................ 28 5.3 VALUE CHAIN ANALYSIS ......................................................................................................................................... 37 5.4 VRIO ANALYSIS ..................................................................................................................................................... 40 6. ACCOUNTING QUALITY ....................................................................................................................................... 43 6.1 FAIR VALUE ACCOUNTING FOR BIOLOGICAL ASSETS ............................................................................................. 43 6.2 PROPERTY, PLANT AND EQUIPMENT ........................................................................................................................ 44 6.3 ACCOUNTING FOR LEASES ....................................................................................................................................... 45 7. REFORMULATION OF FINANCIAL STATEMENTS ........................................................................................ 46 7.1 BALANCE SHEET ..................................................................................................................................................... 46 7.2 FINANCIAL ITEMS: ................................................................................................................................................... 49 7.3 REFORMULATION OF THE INCOME STATEMENT ....................................................................................................... 49 8. PROFITABILITY ANALYSIS ................................................................................................................................. 51 8.1 FIRST LEVEL BREAKDOWN ....................................................................................................................................... 52 8.2 SECOND AND THIRD LEVEL BREAKDOWN ................................................................................................................ 53 8.4 PEER GROUP PROFITABILITY ................................................................................................................................... 57 9. QUANTITATIVE INDUSTRY ANALYSIS ............................................................................................................ 62 10. FORECASTING ....................................................................................................................................................... 67 10.1 THE RESIDUAL OPERATING INCOME MODEL ........................................................................................................... 68 1 10.2 PRO-FORMA FINANCIAL STATEMENT .................................................................................................................... 69 10.3 EXPLICIT FORECAST PERIOD: 2018-2022 ............................................................................................................... 70 10.3.4 INCOME STATEMENT ITEMS ............................................................................................................................... 82 10.4 FADE PERIOD: 2023-2027 ..................................................................................................................................... 92 10.5 CONTINUING VALUE .............................................................................................................................................. 93 11. TERM STRUCTURE OF INTEREST RATES ..................................................................................................... 94 11.1 ESTIMATION OF THE TERM STRUCTURE ................................................................................................................. 95 12. COST OF CAPITAL ................................................................................................................................................ 97 12.1 COST OF CAPITAL FOR OPERATIONS ....................................................................................................................... 97 12.2 COST OF EQUITY .................................................................................................................................................... 98 12.3 COST OF CAPITAL TERM STRUCTURE ................................................................................................................... 104 13. VALUATION .........................................................................................................................................................