The paper is commissioned to conduct a numerical evaluation of the intrinsic stock price of Royal Mail and comparing it with the offer price. As part of this analysis, we will be using Price Multiple Method and Discount Cash Flow Method to arrive at a conclusion.
Price- Multiple Method
Also known as the method of comparables, this equity valuation method values a stock based on the average price multiples of stock of similar companies. The economic rationale behind using this valuation method is the Law of One Price which asserts that two similar assets should sell at similar prices.
Henceforth, for this purpose, we have sourced financial figures of companies such as Austrian Post, FedEx, UPS and Deustche Post(DHL) in order to ascertain comparable price of Royal Mail’s IPO. It is considerable that we have not included TNT and Bpost SA as these companies were not trading at the time of IPO issue. Below we have discussed the other two parameters that we relied on before selecting these companies for valuation purpose:
i) Similar Industry
ii) Similar Business Model
(Yahoo Finance.com)
Future Payoff and Growth Rate
As we may refer to the DCF model, we have used some assumptions relating to the EBIT growth rate and working capital investment of the company. We believe that considering the analyst’s expectations and future growth of the postal service business, the assumptions and DCF model based on it is strongly valid. Our calculation revealed that the stock price of the company on the basis of DCF approach is £3.30, i.e. in alignment with IPO price.
As for the growth rate, the assumption related with it was appropriate as it gave us an oversight relating with the future operating income of the company based on past performance and future outlook of the postal and courier service industry. The most influential factor here was the blooming online industry which is consequently benefiting the courier industry and with large section of world population continues to get connected through online platform and taking the benefit of online deals, postal and courier service industry is expected to witness a massive surge in operating income over the years.We have forecasted growth rate to be 5.50% for Year 1-5 and 6.10% for Year 6-10.
Just like the growth rate, even future payoff is also a crucial element of DCF modeling as it helped us in gaining insight into the future operating income of the company. Strong future perspectives for the industry and growth of online sales will foster the increase in stock price of the company. The increase in stock price will help the company in accumulating capital for expansion and introduce further innovation in its business model.
Restatement of Key Assumptions
Following any change in growth rate assumptions, our results will also change. For instance, if the economy enters recessionary phase or if online industry fails to register growth, this will negatively affect the stock price and the value will drift away from the IPO price. It is considerable that the growth rate in DCF model endows high stake on expected growth of the e-commerce industry and associated benefits for the postal and courier service industry. However, if the e-commerce bubble burst because of some unforeseen circumstances, in that case the growth rate will be trimmed and stock price will decrease and turn less than the IPO offering price. For instance, if the growth rate for year 6-10 is decreased to 3.5%, the stock price falls to £2.92/share.
Similarly,changes in the assumptions related with future payoff are related to the restatement of free cash flow amount on a reasonable basis. Any change in future capital expenditure will also alter the results significantly. On the other hand, owing to the business architecture of the company, we have assumed the working capital investment at 30%. However, any increase or decrease in this percentage will also alter the amount of free cash flows . For instance, increase in working capital investment to 40% reduce the stock price to £2.71/share.
