Introduction
Company valuation is an essential area when it comes to determining the value of an organization or business. Such information helps a company to plan its future investments. Additionally, potential investors can rely on company valuation information to determine whether it will be beneficial to invest in a company. This paper seeks to look into a number of company valuation techniques based on the Royal Dutch Shell Company. Furthermore, it provides information on how the efficient market hypothesis affects price movements with reference to Royal Dutch Shell Company.
The stock market is especially advantageous because of the liquidity of the securities and high levels of safety in trading. Listing a company in the stock market enhances the company’s financial status. This also acts as an advertising tool for the company’s products.
However, the stock market is quite unpredictable, and cases of stocks markets crushing are now a harsh reality. This method of financing the company’s activities increases the accountability to public shareholders. In some instances, unforeseen takeovers may occur because of a majority rule of the shareholders. The company’s incurs extra expenses in the form of dividends and costs in complying with higher levels of financial reporting (Bull, 2007).
Section 1(a) Total Share Value (TSR)
Generally, total shareholder return is the ratio of the change in stock prices to that of the change in earnings per share. However, consideration of other returns received by shareholders such as dividends paid are equally crucial in determination of TSR. TSR may be calculated on the ex-dividend date, the payable date, or the record date. Ex dividend date is conventionally taken to be two business days before the record date. Record date is the day of release of the list of investors who will receive dividends for a particular year.
TSR should include the dividends paid and the change in stock price. There are several steps involved in determination of TSR. The change in stock price is first determined by obtaining the difference in the share price at the beginning and the price of shares at the end of a financial period. The total dividends paid out to shareholders are then determined since they will be used in determination of TSR. The total dividends are then added to the change in stock price. This is the equivalent value of what a shareholder receives by owning the stock. To obtain the TSR, this equivalent value is divided by the stock price at the beginning of the year. If the stock price at end of the financial year is less than that at beginning of the year, the TSR may be a negative value. This will only be so if the change in stock price is higher than the dividends paid to shareholders.
Dividends per share for 2009: (1.44*9204)*9979=1.68
Dividends per share for 2010: (1.44/9204)*9979=1.56
Dividends per share for 2011 :( 1.44/9204)*7315=1.14
Section 1(b) Economic Value Added (EVA)
Economic value added is a measure of the surplus amount of money arising due to investment. EVA is generally calculated using the formula: EVA = (Return on Capital – Cost of capital) (Capital Invested in Project). Return on capital is the actual cash inflows that a certain investment earns. According to Arlbjorn (2010), the return on capital is also the operating profit (profit that is adjusted for taxes on a cash basis). The cost of capital refers to the weighted average costs (WACC) involved in financing the investment. EVA is different from other measures of performance since it measures all running costs of business operations. It is, therefore, a measure of the economic profits earned by a company in a given year. This means that positive values of EVA indicate increase in economic profits while negative values indicate decrease in economic profit.
Therefore, EVA is a measure of true economic profit and shareholder value. Determination of EVA requires calculation of earnings before interest and taxes (EBIT). EBIT is calculated as follows: total sales revenues- total sales expenses. Alternatively, EBIT= Net sales-selling, administrative and general expenses- depreciation. The net operating profit after taxes (NOPAT) is then determined. NOPAT= EBIT-(interest +tax expenses). Taking the cost of capital into consideration gives the EVA as EVA = NOPAT- cost of capital. The cost of capital is the aggregate of economic costs of equity and debt. Cost of capital =Invested capital* weighted average cost of capital (WACC).
Calculation of WACC
Weighted average cost of capital is an average figure, which indicates the cost of raising a firm’s capital or financing the acquisition of a firm’s assets. Its determination requires the derivation of the company’s debt and equity value. The debt and equity value constitute the total value of the firm. It also requires separate determination of the equity cost and the cost of debt. For this calculation the WACC to be used will be 11.1 % (Valuentum, 2012).
Section 1(c) Market Value Added (MVA)
According to Brigham and Ehrhardt (2010), MVA is calculated as the difference between the market value of a company’s stock and the capital supplied by shareholders. MVA= Market value capital- Equity capital supplied by shareholders. This means that MVA= (Shares outstanding) *(Stock Price) +Total debt - Total common equity.
MVA can also be determined as the difference between the total market value of a company and the total amount invested by shareholders (Friedlob, 2003). Important to note is that the market value of a firm is a sum of the equity and the debt. A higher value of MVA is preferred since negative values of MVA imply that the firm has reduced its value as opposed to increase its value (Gibson, 2010). MVA enables investors to determine whether a company is utilizing its resources effectively.
MVA= (Market value of stock +Market value of debt) –Investor supplied capital.
Calculation of market value of stock
According to Harder (2010), efficient market hypothesis states that prices of financial assets reflect all relevant information. Subsequently, the market values are considered true and future values randomly depend on randomly incoming news or information. According to Malkiel (2003), random walk hypothesis is used as a basis to support the efficient market hypothesis. The random walk idea explains that the flow of information is unimpeded and that it instantly influences the stock prices. That is price changes today will not affect tomorrows price change. Tomorrow’s price change will only be influenced by tomorrow’s news (Malkiel, 2003). Consequently, prices will represent the known information, thus, uninformed investors seeking to purchase a diversified portfolio will have a rate of return as similar to the one being used by the experts (Malkiel, 2003).
According to Palan (2007), since stock prices vary randomly, it becomes hard to predict price movements. For the past twelve months, Royal Dutch Shell has experienced challenges because of the constantly changing energy prices. Based on the efficient market hypothesis, information such as those from the political world has greatly had a negative impact on the energy prices. Information such as occurrences of oil spills can cause a reduction in the share prices. For instance, in April 2012, Royal Dutch Shell shares dropped after the company reported that they were sending a response vessel for spill reported in the Gulf of Mexico (Telegraph, 2012).
There some key financial highlights for the past 12 months. This includes basic current cost of supplies earnings per share increasing by 15 % from quarter one in 2011 to quarter one in 2012. Royal Dutch Services also reported earnings on a current cost of supplies basis of $7.7 billion in the first quarter of 2012 compared $6.9 billion in the first quarter of 2011. In 2012, gearing was reported to have decreased to 9.9 % in the first quarter. In 2011, the fourth quarter earnings on the current cost of supplies basis were recorded as $6.5 billion. This was an increase from $5.7 billion reported in the same quarter the previous year. In 2011, the total current cost of supplies earnings was $28.6 billion, which was an increase by $10 billion from the previous year. Additionally, the current cost of supplies earnings for the fourth quarter of 2011 excluding identified items was reported as $4.8 billion, an 18% percent increase from the $4.1 billion reported in the fourth quarter of 2010. Excluding the identified items, the full year current cost of supplies earnings was $24.7 billion for the year 2011, a $6.6 billion increase from the previous year earnings.
Another financial highlight was the 16% increase in the basic current cost of supplies earnings per share excluding identified items for the fourth quarter of 2011. For the whole year of 2011, this amount translated to an overall increase by 35 percent. Operating activities generated cash flow worth $6.5 billion for the fourth quarter of 2011 and $36.8 billion for the whole 2011 year. Disregarding net working capital movements, the operating activities generated cash flow amounting to $7.2 billion for the fourth quarter and $43.2 billion for the whole year of 2011. Gearing decreased by 4 % in 2011. This decreased from 17.1 % at the end of 2010 to 13.1% at the end of 2011. The fourth quarter divided was announced at $0.42 per ordinary share and $0.84 per American Depositary Share.
According to Zack’s analyst blog (2012), another significant financial highlight is the new shell GTL plant in Louisiana. The plant is expected to produce $2million gallons per day worth $10 billion. Such a project is expected to be significant since it is expected to have huge returns. This information is based on a similar plant, Pearl GTL, located in Qatar.
Royal Dutch Shell Chairman indicates that there has been an increase in demand for oil and gas resources. However, the access to these resources is limited by the high cost of developing new projects. Furthermore, the high-energy prices influence the development of these projects. The increase in unpredictable events has the potential of causing a shift in the cost and energy prices. For example, natural disasters, populist revolt or sudden changes in regulatory decisions influence energy prices significantly. Additionally, the increased in earnings, continues to give the Royal Dutch Shell more capacity in terms of financial means to be able to foster and support projects such as deep drilling of oil and gas in climates such as those in the Arctic. The chief executive officer, Peter Voser, reports that there has been an increase in the amount of cash generated from Upstream and Downstream segments. This is has been significantly been positively influenced by the high oil prices and asset sales.
A number of positive scenarios have been experienced in Royal Dutch Shell for the first quarter of 2012. The continued increase in dividend growth continues to boost the both operational and financial performance. Capital investment in 2012 is expected to be about $30 million for supporting more than 80% in exploration and production, especially in North America and Australia. Additionally, the Royal Dutch Shell group assets are being adjusted to as a means on improving the performance of the company. This includes divestments in an LPG business in Asia Pacific and retail stations in North America. Of the projects that the Royal Dutch Shell is developing in different parts of the world, the Pluto LNG project located in Australia and the Caesar project located in Gulf of Mexico are expected to produce 0.9 million tons per annum of LNG and 40 thousand barrels of oil per day respectively.
The new developments in Royal Dutch are expected to increase its share price value. The developments act as new information that based on the efficient market hypothesis is expected to increase the share price value since it increase the confidence of the shareholders in the company. The chairman of Royal Dutch shell indicates that they are planning on using their creativity in discovering new energy resources and enhance the current ones to be more viable. Royal Dutch has decided to invest a large amount of finances to make sure that there is energy production in the future. The company has also decided to venture more into gas production since most of the energy they produce from the wells is in gaseous form. Through this they can be able to reduce environmental pollution by replacing their coal-fired plants with gas-fired ones. Financially, Royal Dutch Shell is seeking to raise a net capital of about $30 billion, in 2012, as a way of maintaining and enhancing their investment program. Future cash flows are expected to be 50% more for the next coming four years excluding the working capital movements.
Section 3
(a)Net Asset Value
According to Loader (2006), The NAV of a fund is the total value of assets less the total value of liabilities. From this value of NAV, the NAV per share can be easily determined. NAV helps to determine the price per unit of a fund (Pinto, Robinson &Stowe, 2010).
(b)Price/Earnings ratios
According to Healy and Palepu (2008), price to earnings ratio is the quotient relationship between a company’s stock price and its earnings. P/E= Stock price/EPS. It acts as an indicator on the willingness of the market to pay for a firm’s earnings (Pereiro, 2002). A high P/E indicates willingness on the part of the market to purchase a firm’s earnings. It may also be due to an overpriced stock.
(c)Discounted Cash Flow
According to Pratt (2009), discounted cash flow analysis involves the discounting of cash flows for different period and discounts them to the present moment. The discount rate is calculated in a similar manner with the WACC. WACC is the weighted cost of debt (D) and equity (E) based on the debt and equity proportions -D/V and E/Vin the firm’s capital (Investopedia, 2010). WACC is determined using the formula:
WACC= Re* E/V + Rd*(1-corporate tax rate)*D/V
Using the discounted rate similar to the WACC, 11.1 % (Valuentum, 2012).
Section 4
The discounted cash flow method is best suited for valuation of Royal Dutch Shell. This method is effective in ascertain the true value of a company worth expected in the future based on its ability to generated cash for the running of its operations. Consequently, the discounted cash flow analysis is not dependent on historical results, thus allows targeted operational strategies to be taken into account (Campbell & Brown, 2003). A discounted cash flow analysis provides an overview of the total value of the business.
References
Brigham, E.F. & Ehrhardt, E.C. 2010. Financial Management: Theory and Practice. OH:
Cengage Learning.
Bull, R. 2007. Financial Ratios: How to Use Financial Ratios to Maximize Value and Success for
Campbell, H. F., & Brown, R. P. (2003). Benefit-cost analysis: financial and economic appraisal
Using spreadsheets. Cambridge, UK: Cambridge University Press.
Loader, D. 2006. Fundamental of Fund Administration. Burlington: Butterworth-Heinemann.
Investopedia, 2010. Financial Ratios Tutorials [pdf]. Available at:
<http://i.investopedia.com/inv/pdf/tutorials/financialratio.pdf>
Grossman, T. & Livingstone, J.L. 2009. The Portable MBA in Finance and Accounting. New
Jersey: John Wiley and Sons.
Graham, J., Smart, S.B. and Megginson, W.L. 2009. Corporate Finance: Linking Theory to What
Companies Do. Mason: Cengage Learning.
Gibson, C.H. 2010. Financial Reporting and Analysis. Connecticut: Cengage Learning.
Friedlob, G.T. 2003. Essentials of Financial Analysis. New Jersey: John Wiley & Sons.
Harder, S. 2010. The Efficient Market Hypothesis and its Application to Stock Markets.
München: GRIN Verlag GmbH. Top of Form
Malkiel, B.G. 2003. The Efficient Market Hypothesis and Its Critics. Available at
<http://www.vixek.com/Efficient%20Market%20Hypothesis%20and%20its%20Critics%20-%20Malkiel.pdf>
Kent, S. 2012. Shell Acquires Norwegian LNG Fuel Company Gasnor for $74 Million – Royal
Dutch Shell plc .com. Royal Dutch Shell plc .com. Available at http://royaldutchshellplc.com/2012/07/11/shell-acquires-norwegian-lng-fuel-company-gasnor-for-74-million/>
Palepu, K. G. and Healy, P.M. 2008. Business Analysis & Valuation: Using Financial
Statements. Connecticut: Cengage Learning.
Pereiro, L.E. 2002. Valuation of Companies in Emerging Markets: A Practical Approach. New
Jersey: John Wiley & Sons.
Pinto, J. E., Henry, E., Robinson, T.R., and Stowe, J.D. 2010. Equity Asset Valuation. New
Jersey: John Wiley & Sons.
Pratt, S.P. 2009. Business Valuation Discounts and Premiums. New Jersey: John Wiley & Sons.
Sheeba, K. 2011. Financial Management. Mumbai: Pearson Education India.
Shell shares drop on Gulf of Mexico 'oil sheen' fears - Telegraph. 2012. Telegraph.co.uk –
Telegraph online, Daily Telegraph, Sunday Telegraph - Telegraph. Available at http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/9199576/Shell-shares-drop-on-Gulf-of-Mexico-oil-sheen-fears.html
Valuentum. (2012). Shell's Fair Value Is the Mid-$80s per Share - Seeking Alpha. Stock Market
News & Financial Analysis - Seeking Alpha. Retrieved July 18, 2012, from http://seekingalpha.com/article/617501-shell-s-fair-value-is-the-mid-80s-per-share
The Zacks Analyst Blog Highlights: Royal Dutch Shell, Sasol, BP, Chevron and Bank of
America - Yahoo! Finance. 2012. Yahoo! Finance - Business Finance, Stock Market, Quotes, News. Available at http://finance.yahoo.com/news/zacks-analyst-blog-highlights-royal-095236998.html>
