This page is quite old hence its rather spartan appearance.
Why not check out our Latest Stories page for our newest articles or search our site for anything.
By Bruce Jackson (TMF Googly)
Baker Street, London -- Today I'm basking in a warm glow of success, having scooped the office sweepstake for predicting a 0.25% increase in interest rates. Christopher Spink (TMF Eagle) went for an outrageous 0.25% fall, whereas wimpy Stuart Watson (TMF Tiger) sat on the fence and stuck with the status quo. Editor Martin Wake (TMF Sorted) matter-of-factly said "I'm not bothered with short-term interest rate movements."
And you know, even though I'll be happy to take the pint of my writing colleagues, Martin's the one who deserves the prize. Sure, in the short-term money is getting slightly more expensive, and may get even more expensive in the reasonably near future. But it's not as if we're heading towards double digit interest and inflation rates, and in fact a pre-emptive strike today by the Bank of England may turn out to be a master stroke in the management of the UK economy. I mean, how many people are going to put a halt to their plans to buy a house just because interest rates have risen by 5%?
Yikes, hang on a second. 5%?!
Yep -- interest rates have risen by 5%, going from 5.00% to 5.25%. That makes it sound far worse than saying they rose by 0.25%. But, when a company such as EMAP (LSE: EMA) rises say 10p to 1050p, whilst that may look reasonably impressive, it is a rise of less than 1%, so in the whole scheme of things is relatively insignificant.
As for my take on all things interest rate related, apart from house price inflation, I can't see too much evidence of an over-heating economy. Of course, house price inflation is not to be ignored as a potential cause of a late 1980s/early 1990s-style economic boom and bust scenario. In fact on that front things could yet get more over-heated, in the relative short term. After all, not many people are thinking 'interest rates up 5%'.
My hope is that today's unexpected interest rate rise will provoke an irrational stock market sell-off, providing long-term investors with some short-term bargains. Mind, the market may have to fall a fair way yet for some of the high flying shares (e.g. Sage (LSE: SGE), Vodafone AirTouch (LSE: VOD), Orange (LSE: ORA) or Guardian iT (LSE: GRD)) to suddenly become cheap, but it's good to be prepared. Sadly, the market is reacting rather calmly at the moment.
This is Chief Economist Googly signing out for today's riveting report.
On Monday, I finished off by talking about PizzaExpress (LSE: PIZ) and a discounted cash flow (DCF) valuation. With such a company, which is in a continuous state of expansion (shouldn't they all be?), the difficulty comes when trying to assess how much free cash flow a company generates. Why free cash flow? Because if you bought the whole of PizzaExpress with the express intention of running it as purely a cash machine (i.e. not investing any more expansionary cash into the business), the free cash flow is the amount you'd be able to take out of the business.
The company will of course have to invest some capital into the business, on general upkeep items and the occasional refurbishment, but it will be reasonably minimal.
Using the 1998 PizzaExpress annual report, free cash flow can be calculated as;
£000's
Operating Profit 22,561
Depreciation 3,837
Increase in Stocks (689)
Increase in Debtors (688)
Increase in Creditors 2,966
= Net Cash from operations 27,987
Net Interest Expense (287)
Taxation (576)
Capital Maintenance* (3,837)
= Free cash flow 23,287
* This number is not reported separately in the accounts. I've used the annual depreciation number as a proxy for the capital required to keep the business ticking over in its steady state.
Free cash flow is the amount of money a company generates for its owners, and if you owned PizzaExpress, is the amount of cash you'd be able to take out of the business in 1998, presuming you didn't have any expansionary plans. So, how much would you be prepared to pay for this business?
You could do a full DCF, extrapolating out growth rates for 10 years, and then place a value on the residual. For example, say PizzaExpress can grow its free cash flow to £79.2m by 2010. If you capitalise that at 11% (£79.2m / 11% = £720m), then discount it back to the present (using 11% as your discount rate, or by a factor of 0.3522), the present value of the residual is £254m (£720m x 0.3522 = £254m).
But of course over the intervening 10 years between now and 2010, your cash machine has churned out a lot of money. You would hope it could grow its free cash flow over the years, and could throw off, for argument's sake, £520m, which when discounted back (on a year by year basis) to the present gives a value of £282m.
Add £282m to the residual of £254m and you've got a potential intrinsic value for PizzaExpress of £536m, compared to a current market capitalisation of about £500m. Pretty damn close if you ask me.
Confused, or baffled by seemingly vapour numbers? I use a relatively simple spreadsheet to generate many of the numbers used above. The principles are pretty much as described in numbers 11 and 12 in the How To Value Shares series. But of course, garbage in/garbage out applies. If you put duff or unrealistic figures into a spreadsheet, the end number will be relatively meaningless.
One thing I haven't explicitly mentioned, although I've incorporated the fact into the £520m actual free cash flow generated in the next 10 years, is that PizzaExpress will keep expanding, and will hopefully generate additional free-cash flow from those investments. For example, and this number is not included in the £22,387,000 1998 free cash flow as per the table above, in that same year PizzaExpress spent a net £33,589,000 on expansion capital and acquisitions. In the coming years, shareholders will obviously be wanting to see them generate a decent return, in the form of free cash flow, from that money.
So much for DCF. It is just one way to value a company, and undoubtedly has its flaws. Next week I want to start looking at some Economic Added Value (EVA) principles, again using PizzaExpress as a model. However, next Monday PizzaExpress announces its 1999 results, which could see valuation models drastically change, although I doubt it, as the company has very predictable and consistent earnings. For the record, earnings per share (EPS) of about 32.6p are forecast.
Rob's back from holiday, and back here on Friday. I'll see you on the Qualiport message board.
Company Change Bid DELL(US)-0.10 49.30 EMA +0.04 10.55 IIG +0.08 2.78 MSY -0.07 5.98 PIZ +0.18 7.38 RTO -0.08 2.51 ULVR -0.08 5.86 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 27/01/99 74 Dell (US) 44.63 49.30 10.5% 27/10/98 755 Indep Ins 2.58 2.78 7.8% 22/04/99 347 Misys 5.76 5.98 3.8% 19/12/97 783 Rentokil 2.55 2.51 (1.6%) 04/11/98 245 Pizza Exp 7.93 7.38 (6.9%) 17/04/98 169 EMAP 11.34 10.55 (7.0%) 17/07/98 266 Unilever 7.53 5.86 (22.1%) Last Rec'd Total # Company In At Value Change 27/01/99 74 Dell (US) 2007.42 2211.03 203.61 27/10/98 755 Indep Ins 1972.64 2098.90 126.26 22/04/99 347 Misys 2028.71 2075.06 46.35 19/12/97 783 Rentokil 2046.53 1965.33 (81.20) 04/11/98 245 Pizza Exp 1966.34 1808.10 (158.24) 17/04/98 169 EMAP 2341.32 2131.10 (210.22) 17/07/98 266 Unilever 2052.00 1558.76 (493.24) Cash: £3,433.46 Current Total : £17,281.74 Total Invested: £18,184.62 Profit/(Loss) : (£ 902.88) Value Per Share Day Month Year Qualiport 0.00% 2.72% -8.11% FTSE 100 -0.89% 0.12% 6.31% FTSE All Share -0.79% 0.42% 10.38%