Master Thesis MSc Accounting, Strategy and Control Copenhagen Business School 2013 A Valuation of Norske Skogindustrier - A Strategic and Financial Analysis Student: Henrik Hartwig Hand-in-date: 11.11.2013 Characters incl. spaces: 156.562 (79 pages) Signature: Supervisor: Kay Sun Park Department of Finance Acknowledgements In memory of Jacob August Hartwig This thesis is dedicated to my grandfather who sadly passed away in July 2013. His kind support and encouragements helped me through a period in life which could be characterized as challenging. He encouraged me to work hard in order to reach great things in life. He will never be forgotten. I would like to thank my supervisor, Kay Sun Park, for her support and challenging thoughts as the thesis progressed. Her proven knowledge within the field of corporate finance and valuable feedback has stimulated the workflow of this paper. I wish her the best in the upcoming future. Finally, a special thanks to family and friends which have supported me through this period. I hope that the future will bring us closer together, and I apologize for my none-existence during the latest months of hard work. 2 Executive Summary The objective of this thesis was to assess the fair value of the NSG stock per 17.07.2013. The fair value assessment was facilitated through the establishment of a strategic and financial analysis, enabling the provision of a reliable forecast budget. NSG is recognized as a world leader in the paper industry, yet the shareholders of the company have experienced an immense decline in equity since mid 2007. The cyclical characteristics of the industry combined with the recent financial crisis affected publishers earnings potential due to lower circulation as well as ad-spending levels, thereby influencing NSG’ total supply of newsprint and magazine paper. The company has been forced to discard the global playing field, rather emphasize Europe and Australasia as main markets of interest. These are characterized as advanced economies where positive growth in demand is not expected to occur. Mainly this is supported by the rise of digital mediums and where the competition in Europe is considered to put NSG at test. However, even though it is reasonable to expect that demand for newsprint and magazine paper will decline in the nearest future, it is believed that printed and digital media will live side by side in the future, thereby signaling a minimum need for NSG’ product range. The European reference price for newsprint has proven to be strongly market driven, seen in light of few possibilities to diversify as well as the current state of oversupply. However, some of NSG’ closest competitors have announced capacity closures and potential seeking in growth markets, which is believed to stimulate price improvements for NSG in Europe. Announced efficiency programs, low future capital expenditure frame, as well as witnessed capital efficiency improvements, are some of the key elements defining the expected model of the company. This is opposed to the “as 2012” model where NSG will end up in bankruptcy if necessary initiatives and actions are not taken forward. The valuation of NSG was primarily conducted based on a present value approach, supplemented by a sensitivity analysis which proved that the estimated market value of equity is quite sensitive to different levels of WACC. The present value approach was also supplemented by a relative valuation approach based on the application of multiples, however the main findings derived from the DCF- model was not supported. This may stem from the lack of comparability among the selected peers, which is considered to be an important criterion when applying such a valuation technique. Among others it was proven that NSG has a less diversified product portfolio compared to their peers. The theoretical equity value was found to be NOK 9.43, based on the findings presented in the expected model. The NSG stock was traded at Oslo Børs on the 17.07.2013 at NOK 2.85. This signals a significantly optimistic assessment of NSG’ future cash flow potential and risk compared to the expectations of the market at the time, indicating an underrated stock in the market. 3 Table of Contents CHAPTER 1 – INTRODUCTION 6 1.2 METHODOLOGY 7 1.2.1 DATA COLLECTION 7 1.2.2 RESEARCH DESIGN 7 1.3 LIMITATIONS 9 CHAPTER 2 – THE NSG STORY 10 2.1 HISTORICAL OVERVIEW 10 2.2 VISION, GOAL AND STRATEGY 12 2.3 OWNERSHIP STRUCTURE 12 2.4 PRODUCT RANGE 13 2.5 MAIN MARKETS 14 2.6 GLOBAL DEMAND – NEWSPRINT 15 2.7 GLOBAL DEMAND – MAGAZINE PAPER 17 2.8 PEER GROUP 17 2.8.1 UPM (FINLAND) 18 2.8.2 STORA ENSO (FINLAND) 19 2.8.3 RESOLUTE FOREST PRODUCTS (CANADA) 19 2.8.4 NIPPON PAPER (JAPAN) 19 2.8.5 OJI HOLDINGS CORPORATION (JAPAN) 20 2.8.6 HOLMEN (SWEDEN) 20 CHAPTER 3 – STRATEGIC ANALYSIS 21 3.1 MACRO FACTORS INFLUENCING CASH FLOW GENERATION AND RISK 22 3.1.1 POLITICAL FACTORS 22 3.1.2 ECONOMICAL FACTORS – NEWSPRINT DEMAND AND REAL GDP 23 3.1.3 ECONOMICAL FACTORS – GDP OUTLOOK 26 3.1.4 ECONOMICAL FACTORS – PRICING MECHANISMS 29 3.1.5 ECONOMICAL FACTORS – COST OF MATERIALS 31 3.2 INDUSTRY FACTORS INFLUENCING CASH FLOW GENERATION AND RISK 31 3.2.1 THREAT OF NEW ENTRIES 32 3.2.2 EXISTING RIVALRY AMONG COMPETITORS 33 3.2.3 BUYERS BARGAINING POWER 34 3.2.4 SUPPLIERS BARGAINING POWER 35 3.2.5 THREAT OF SUBSTITUTES 36 3.3 COMPANY SPECIFIC FACTORS INFLUENCING CASH FLOW GENERATION AND RISK 38 3.3.1 ADAPTED VALUE CHAIN ANALYSIS 38 CHAPTER 4 - FINANCIAL ANALYSIS 39 4.1 SECURING THE QUALITY OF FINANCIAL STATEMENTS 39 4.2 SHARE PRICE ANALYSIS 40 4.3 RESTRUCTURING NORSKE SKOG`S FINANCIAL STATEMENTS 40 4.3.1 BALANCE SHEET - INVESTED CAPITAL 41 4.3.2 INCOME STATEMENT – NOPAT 43 4.4 HISTORICAL PROFITABILITY 43 4.4.1 PROFIT MARGIN 44 4.4.2 TURNOVER RATE OF INVESTED CAPITAL 49 4.5 INVESTED CAPITAL ENTRIES AND RESPECTIVE DEVELOPMENT 49 4 4.5.1 INTANGIBLE AND TANGIBLE ASSETS 50 4.5.2 NET WORKING CAPITAL 51 4.5.3 NET INTEREST BEARING DEBT 52 4.5.3.1 NET BORROWING COST 53 CHAPTER 5 – WEIGHTED AVERAGE COST OF CAPITAL 55 5.1 CAPITAL STRUCTURE 55 5.2 REQUIRED RATE OF RETURN ON NIBD 57 5.2.1 RISK-FREE INTEREST RATE 58 5.2.2 COMPANY SPECIFIC RISK 58 5.4 REQUIRED RATE OF RETURN ON EQUITY 59 5.4.1 SYSTEMATIC RISK (BETA) 60 5.4.2 MARKET RISK PREMIUM 61 CHAPTER 6 – FORECAST AND VALUATION 63 6.1 DISCOUNTED CASH FLOW MODEL (DCF) 64 6.1.1 DISCOUNTED CASH FLOW MODEL STRUCTURE 65 6.1.1.1 “AS 2012” - MODEL 66 6.1.1.2 EXPECTED - MODEL 67 6.1.2 SENSITIVITY ANALYSIS 75 6.2 THE RELATIVE VALUATION APPROACH 76 CHAPTER 7 - CONCLUSION 78 7.1 CONCLUSIVE REMARKS 78 REFERENCES 80 APPENDIX 87 5 CHAPTER 1 – INTRODUCTION “Demand for newsprint and magazine paper has been characterized by weak economic conditions…” (NSG, 2012, p. 6) Publishers of newspapers and magazines operate in a tough market threatened by a decline in circulation and less ad spending. This clearly affects Norske Skogindustrier, hereby known as NSG, which supply a variety of publishers’ physical paper. Many publishers have been forced to shut down or supplement existing operations with digital offerings. The growing popularity and accessibility of digital devices such as tablets and smartphones cannot be ignored. Recent years of operations have troubled NSG, leading to poor results and an immense decline in market value of equity. Several initiatives have been made along the way, among others, cost-cutting initiatives and mill-closures in order to improve utilization rates as well as selected conversion of newsprint to magazine paper production. Targeted investments have been announced which seek to modernize and streamline current production processes. In addition these investments seek to strengthen the competitive power of NSG, especially in the European market. However, it is announced that investments will maintain at a low level in the future (NSG, 2012). The historical development of NSG’ equity value combined with shifting media habits among the growing population motivates a strategic and financial analysis of the company. It is questioned whether NSG will be able to survive in what is believed to be a challenged industry in a challenged market. This leads to the main problem statement: What is the fair value of the NSG stock pr. 17.07.2013? Approaching the main problem statement it seems reasonable to examine the competitive environment of NSG, as well as to provide some ideas for the future. This leads to the following sub-questions: What characterizes the competitive environment of the industry? What must happen in order for NSG to secure future survival? 6 1.2 Methodology This section aims to provide the reader reasonable assumption to how the main problem statement is intended to be answered by the author of this thesis. It aims to present a clear and logical step-by-step approach with the objective of facilitating a sound conclusion. 1.2.1 Data collection NSG’ financial statements serve as an important reference when estimating the future earnings potential of the company. However, additional information must be collected and analyzed in order to grasp the competitive environment in which a company operates (Petersen and Plenborg, 2012). This thesis is written from the perspective of an external investor, which limits to publicly known information based on the application of secondary data. The inputs to the main valuation model are based on data extracted from the strategic and financial analysis.