Assignment on

Application of Strategic Value Analysis to make Value

investment decision.
(The case of IFAD Autos Limited)

Submitted By

Mahmud Kaiser
CMA Batch-3rd

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 Index

Sl Chapter/ Section Page no

1 Introduction 03

2 Theoretical Frame work 04

3 Methodology: 05

4 Calculation of Intrinsic Value of the Selected Companies 09

5 Result and Interpretation 16

6 Decision and Recommendation 17

7 Conclusion 18

8 Appendix 19

9 References 20

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 Introduction

“Long ago, Ben Graham taught me that price is what you pay; value is what you
get. Whether we’re talking about socks or stocks, I like buying quality merchandise
when it is marked down.”
-Warren Buffet,

Value investing is a strategic way to make investment in a quality company that

is undervalued based on its long-term growth potential. Value investing is a long
term investment strategy where value investor always buy stocks which trade at
a significant discount to their intrinsic value and hold it for reasonably a longer
period and sell it at a higher price. It pays attention to market overreactions to
current events and to which companies pay dividends. Value investing decisions
are depends on the strategic value analysis that a value investors do before make
investment.

I am working as Assistant General Manager in IFAD Autos Limited (IAL), a Public

Limited Company, runs commercial vehicle business in Bangladesh. Apart from
its core business, the company also invest in marketable securities listed in
Dhaka Stock Exchange. In the year 2019, the Company has portfolio of BDT
309.54 million only managed by separate department under treasury division.

In IAL, investment decision is made on the technical analysis that evaluates the
patterns of stock prices and statistical parameters, charts and graphs. IAL
focuses on patterns of price movements, trading signals, and various other
analytical charting tools to evaluate a security's strength or weakness.

Here, I will discuss how investment decisions can be taken based on the
outcomes of Strategic Value Analysis that I learn in CMA Course.

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 Theoretical Frame Work

Strategic Value Added (SVA) approach is a criteria of evaluating the shareholders’

value developed by Alfred Rappaport (1986), who is regarded as one of the most
prominent publicists in the field of shareholder value metrics. Strategic Value
Analysis is one of the important tools for Company analysis to calculate intrinsic
value of stock of a Company based on which a value investor make decision.

Intrinsic value is a measure of what a share or stock is worth. It is estimated by

calculating through some complex financial model as well as fundamental and
technical analysis, rather than using the currently trading market price of that
stock.

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 Methodology

Here, I have selected the following two well Known Pharmaceuticals Company of
Bangladesh to determine the Intrinsic Value by applying Strategic Value Added
approach developed by Alfred Rappaport (1986). The Companies are –

a. Square Pharmaceuticals Limited;

b. Renata Limited

Through SVA approach, intrinsic value of the stock of these two Companies are
measured using discounting cash flow (DCF) valuation model and SVA seven
drivers approach model of Alfred Rappaport (1999). These seven drivers are –

1. Sales Percentage of annual sales growth;

2. Operating Profit margin
3. Cash income tax rate
4. Incremental fixed capital investment rate
5. Investment in working capital rate
6. Planning horizon
7. Cost of Capital

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 Rappaport Seven Drivers

Initially the Enterprise Value of a stock is determined by discounting expected

future operating “free cash flows” within a plan horizon using the first five drivers
of Rappaport (1999) together with the cash flows occur beyond plan horizon i.e
the terminal value at weighted average cost of capital (WACC).

Later the Intrinsic Value of an asset is determined by adding cash and

marketable securities to and deducting total debts from the Enterprise Value.

The last six years historical data of these two Companies are collected from their
Annual Report along with the industry, market and economic data are analysed
to make the estimates the seven drivers of Rappaport (1999) more realistic and
reliable.

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The following table consists the formula that are used to measure the Drivers of
Rappaport (1999) and other useful measures:

Sl Driver Formula

1 Percentage of 𝐸𝑉 𝑛
1

𝐶𝐴𝐺𝑅 = ( ) − 1
annual sales growth 𝐵𝑉
where,
EV=Ending value
BV=Beginning value
n=Number of years

2 Operating Profit
Margin 𝑂𝑃 𝑜𝑓 𝑡ℎ𝑒 𝑌𝑒𝑎𝑟
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 = × 100
𝑆𝑎𝑙𝑒𝑠 𝑜𝑓 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟

3 Incremental Fixed 𝐹𝑖𝑥𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒

Capital Investment 𝐹𝑖𝑥𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
=
rate 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
&
𝐹𝑖𝑥𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑁𝑒𝑒𝑑
= 𝐼𝑛𝑐𝑟𝑒𝑚𝑒𝑛𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒
× 𝐹𝑖𝑥𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒

4 Investment in 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑖𝑛 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑟𝑎𝑡𝑒

working capital rate 𝐺𝑟𝑜𝑤𝑡ℎ 𝑜𝑓 𝑁𝑒𝑡 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙
=
𝐺𝑟𝑜𝑤𝑡ℎ 𝑜𝑓 𝑟𝑒𝑣𝑒𝑛𝑢𝑒

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 Sl Driver Formula

5 Weighted Average 𝐸 𝐷
𝑊𝐴𝐶𝐶 = × 𝑅𝐸 + × 𝑅𝐷 × (1 − 𝑡)
Cost of Capital 𝐸+𝐷 𝐸+𝐷
Where,
(WACC)
 E is the market value of Equity;
 D is the market value of Debt;
 RE is the required rate of return on equity;
 RD is the cost of debt, or the yield to
maturity on existing debt;
 t is the applicable tax rate.

5a Cost of Equity 𝑅𝐸 = 𝑅𝑓 + 𝛽 × (𝑅𝑚 − 𝑅𝑓 )

under Capital Asset Where,
Pricing Model
RE = Cost of Equity;
(CAPM)
Rf = Risk free return;
β = Beta;
Rm = Market Return

5b Beta (𝛽) Traditional formula:

Beta = 𝐶𝑜𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 (𝑅𝑖, 𝑅𝑚) / 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 (𝑅𝑚)

Slope Function =
𝑆𝐿𝑂𝑃𝐸 (𝑒𝑥𝑐𝑒𝑠𝑠 𝑠𝑡𝑜𝑐𝑘 𝑟𝑒𝑡𝑢𝑟𝑛𝑠, 𝑒𝑥𝑐𝑒𝑠𝑠 𝑚𝑎𝑟𝑘𝑒𝑡 𝑟𝑒𝑡𝑢𝑟𝑛𝑠)

5c Market Return CAGR formula on 16 years data of Dhaka Stock

Exchange Market index.

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 Calculation of Intrinsic Value of the Selected Companies

Here, I determined the Intrinsic Value and the Equity Value of the stock and
compare with each other. If the Intrinsic value is higher, the stock is
undervalued. Intrinsic value and Equity Value is calculated according to the
following manner:

Intrinsic Value = Enterprise Value + cash and marketable securities - total debts

Where,

𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑣𝑎𝑙𝑢𝑒
= (𝐹𝐶𝐹 𝑤𝑖𝑡ℎ𝑖𝑛 𝑝𝑙𝑎𝑛𝑛𝑖𝑛𝑔 ℎ𝑜𝑟𝑖𝑧𝑜𝑛 + 𝑇𝑒𝑟𝑚𝑖𝑛𝑎𝑙 𝑉𝑎𝑙𝑢𝑒) × 𝑋𝑁𝑃𝑉 𝑎𝑡 𝑊𝐴𝐶𝐶

𝑁
𝑃𝑖
𝑋𝑁𝑃𝑉 = ∑ 𝑑𝑖−𝑑1
𝑖=𝑖 (1 + 𝑟𝑎𝑡𝑒) 365

Where,

di = the “i” th payment date

d1 = the 0’th payment date

Pi = the “i” payment

Here, we use XNPV function in excel.

Equity Value = Market Capitalization + Total Market value of debts - cash and
marketable securities.

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We have estimates the measures of seven drivers by analyzing the historical data,
market, industry economic (Appendix 2) and Porter’s Market Position Analysis
(Appendix 3). The outcome of seven drivers of these two Companies are given
hereunder:

Drivers Renata Ltd Square

Pharmaceuticals
Ltd
Percentage of annual sales growth; 14.36% 13.64%
Operating Profit margin 26.28% 34.29%
Fixed capital investment rate 9.62% 7.87%
Investment in working capital rate 15.80% 15.51%
Planning horizon 5 Years 5 years
Cost of Capital (WACC) 5.53% 6.64%

Percentage of annual sales growth

Here, the calculated value of CAGR of Renata Ltd and Square Pharmaceuticals
Ltd of 17.47% and 16.59% respectively are considered to determine the free cash
flow. Detail calculation is shown in Appendix 4.

Year wise Sales in Million BDT

2013- 2014- 2015- 2016- 2017- 2018-
Particular CAGR
2014 2015 2016 2017 2018 2019
Renata 9,932.34 11,551.86 10,317.21 16,043.43 18,603.71 22,220.89 14.36%
Square 17,959.49 20,910.77 28,640.68 28,885.94 30,004.97 38,685.66 13.64%

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 YEAR WISE REVENUE
45,000.00 Renata Pharmaceuticals Limited Square Pharmaceuticals Limited
40,000.00
35,000.00
30,000.00
25,000.00
20,000.00
15,000.00
10,000.00
5,000.00
0.00
2013-2014 2014-2015 2015-2016 2016-2017 2017-2018 2018-2019

Year wise CAGR

30.00%

25.00%

20.00%

15.00% Renata
Square
10.00%

5.00%

0.00%
2014-2015 2015-2016 2016-2017 2017-2018 2018-2019

Operating Profit Margin

Here, calculated Operating Profit Margin of 26.28% and 34.29% of Renata Ltd
and Square Pharmaceuticals Ltd respectively are considered for calculation of
free cash flow. Detail calculation is shown in Appendix 5.

2013- 2014- 2015- 2016- 2017- 2018-

Particulars Average
2014 2015 2016 2017 2018 2019
Renata 26.88% 26.51% 28.00% 25.40% 25.57% 25.32% 26.28%
Square 28.58% 28.45% 35.21% 37.68% 37.88% 37.90% 34.29%

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 Operating Profit Margin
Renata Square

120.00%
100.00%
80.00%
60.00%
40.00%
20.00%
0.00%
2013-2014 2014-2015 2015-2016 2016-2017 2017-2018 2018-2019

Cash Income Tax rate

Cash income tax is determined ignoring the impact of deferred tax. Here, the tax
rate of 25.00% is considered for both of the Company that imposed by the
national Board of Revenue of Bangladesh on a Listed Publicly Traded Company.

Incremental Fixed Capital Investment rate

Here, calculated Fixed Capital Investment rate of 9.62% and 7.87% of Renata
Ltd and Square Pharmaceuticals Ltd respectively are considered for calculation
of free cash flow.

2013- 2014- 2015- 2016- 2017- 2018-

Particular Average
2014 2015 2016 2017 2018 2019
Renata Ltd
investment in
1,688.50 903.88 1,127.07 1,204.95 1,202.39 1,779.77
PPE
Fixed Capital
investment 17.00% 7.82% 10.92% 7.51% 6.46% 8.01% 9.62%
rate
Square Pharmaceuticals Ltd
investment in
857.84 2,625.08 1,895.03 2,310.47 3,033.21 1,988.63
PPE
Fixed Capital
investment 4.78% 12.55% 6.62% 8.00% 10.11% 5.14% 7.87%
rate

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 Fixed Capiatal Investment rate
Renata Pharmaceuticals Ltd Square Pharmaceuticals Ltd

20.00%
18.00%
16.00%
14.00%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
2013-2014 2014-2015 2015-2016 2016-2017 2017-2018 2018-2019

Detail calculation is shown in Appendix 6.

Investment in working capital rate:

Here, Average of NWC ratio of Renata Ltd ignoring the negative value in the year
2015-2016 are considered. Whereas only the NWC ratio of Square
Pharmaceuticals Ltd in the year 2018-2019 is considered for our projection due
to abnormal outcomes in the 2016-2017 and 2017-2018. Detail calculation and
explanation are given in the Appendix 7.

Particular 2014-2015 2015-2016 2016-2017 2017-2018 2018-2019

Square 32.83% 14.51% -115.80% -125.76% 15.51%

Renata 29.76% -84.34% 9.20% 12.85% 11.40%

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 NWC Ratio on sales growth
50.00%

0.00%
2014-2015 2015-2016 2016-2017 2017-2018 2018-2019

-50.00%

-100.00%

-150.00%

Square Renata

Planning horizon:
The most important value driver of SVA methodology is to determine the perfect
planning horizon i.e., number of years, for which free cash flows are to be
forecasted and discounted to present values as well as determine the point at
which the perpetuity cash flow started. Here, Considering Porter’s Competitive
position analysis of pharmaceuticals industry, I think set up of five years
planning horizon will be logical. Detail Competitive Position Analysis in
Appendix-3.

Cost of Capital:

Here, we considered the calculation value of WACC of Renata Ltd and Square
Pharmaceuticals Limited 5.53% and 6.84% respectively. Detail calculation and
explanation are shown in Appendix 8.

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Free Cash Flow:

The future free cash flows within the planning horizon are forecasted using the
measure of the first five drivers of Rappaport (1999). It reflects the Net operating
cash flow within a plan horizon deducted by investment in fixed capital and
investment in working capital during the same time frame.

Discounted Cash Flow Amount

Operating Profit xxxxx
Less: Cash Taxes xxxxx
Net Cash Flow xxxxx
Less: Capex xxxxx
Less: Changes in NWC xxxxx
Free Cash Flow xxxxx

Terminal Value:

We determine the cash flows occur beyond plan horizon i.e the terminal value
through dividing the net cash flow after tax of the last year of planning horizon
divided by the WACC. Then the value we get is discounted by the WACC. Here,
we also determine some other important ratios that helps to take investment
decisions.

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 Result and Interpretation

Based on above information and drivers value, we have determined the Intrinsic
Value and Equity Value of the two companies and compared with each other.
The results are shown in the following table:

Square
Pharmaceuticals
Particulars Renata Ltd Ltd

Intrinsic Value Per Share BDT 1679.75 BDT 288.48

Equity Value Per share BDT 1152.10 BDT 204.00

Upside/(Down side) BDT 527.65 BDT 84.48

Internal Rate of Return 15.37% 22.28%

Detail calculation of SVA of Renata Limited and Square Pharmaceuticals Limited

are shown in Appendix 9 and Appendix 10 respectively.

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 Decision and Recommendation

Here, we see the intrinsic value of both of the companies are much higher than
the market value. These indicate that the shares of these two - companies are
under-valued. IRR of both Companies are also more than the WACC indicates
positive inflow of cash in future. According to our SVA analysis both companies
will be profitable if we make investment in the stock.

Cash Flow - Renata Cash Flow -Square

9,303
21,751
7,919
18,656
6,741 16,002
5,738 13,725

2,442 5,886

2021 2022 2023 2024 2025 2021 2022 2023 2024 2025

However, if we consider other above Company size, business opportunities and

analyse financial ratios (Appendix 1) as well as analysis of market, industry and
overall economy (Appendix -2), we have perceived that investment in the stocks
of Square Pharmaceuticals Ltd will be better option than Renata Ltd.

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 Conclusion

I think Strategic Value Analysis give better result than the technical analysis
based on market data and price trends which can be distorted as those data can
be changed due to market panic or other issues that completely irrelevant to the
stock. So I think IFAD Autos Limited should adopt SVA method to take
investment decision.

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Appendix

No. Particular

Appendix 01 Company Information

Appendix 02 Pharmaceuticals Industry, Market and economic analysis.

Appendix 03 Porter’s five forces theory of Competitive Position Analysis.

Appendix 04 Calculation of cumulative average growth of sales;

Appendix 05 Percentage of operational margin;

Appendix 06 Calculation of Fixed Capital Investment Rate on Sales

Appendix 07 Calculation of Net Working Capital Need

Appendix 08 Calculation of Weighted Average Cost of Capital (WACC)

Appendix 09 SVA Calculation of Renata Ltd

Appendix 10 SVA Calculation 0f Square Pharmaceuticals Ltd

Appendix 11 Ratio Analysis

Appendix 12 Comparative Balance Sheet of Square Pharmaceuticals Ltd

Comparative Income Statement of Square Pharmaceuticals

Appendix 13
Ltd

Appendix 14 Comparative Balance Sheet of Renata Ltd

Appendix 14 Comparative Income Statement of Renata Ltd

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 References:

Books and Articles:

1. The Importance of Shareholder Value in Decision-Making –By Miia
Mäenpää

2. Rappaport A. Creating shareholder value: The new standard for business

performance. New York Free Press 1986.

3. Porter, M.E, Competitive Strategy: Techniques for Analyzing Industries

and Competitors, the Free Press, 1980.

4. Pharmaceutical Industry of Bangladesh-A multi billion dollars industry-

Md. Abdullah Al Faisal, Reasearch Associates, Eastern Bank Limited

5. Maximising Shareholder Value -Achieving clarity in decision-making -

Technical Report of CIMA

6. Measuring Shareholder Value – The Metrics- written by Stuart

Cooper, Lecturer in finance and accounting, Aston Business School;
and
Matt Davies, senior consultant of The Financial Training Company

7. Course book on Strategic Business Analysis (Part –Two) CMA Australia

8. Annual Report of Square Pharmeceuticals Limited

9. Annual Reports of Beximco Pharmaceuticals Limited

10. Annual Reports of Renata Limited

11. A review of the application of the concept of Shareholder Value Added

(SVA) in financial decisions -
Mahmoud Samadi Largani ,Department of Accounting,
Tonekabon Branch, Islamic Azad University, Tonekabon, Iran

Meysam Kaviani, Department of Accounting, Science and

Research Branch, Islamic Azad University, Tehran, Iran

Amirreza Abdollahpour, Accounting and Management

Faculty, Shahid Beheshti University, Tehran, Iran

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 12. A handful of companies dominate pharma market by Munira Munni,
The Financial Express, published on Published: February 06, 2019
09:48:15

Websites:

www.sixsenses.com

www.hbsp.harvard.edu/

www.bam.ac.uk

www.2GC.co.uk

http://www.economist.com/

https://corporatefinanceinstitute.com/

https://www.researchgate.net/publication/261662252_Corporate_performanc
e_and_the_measures_of_value_added

https://tradingeconomics.com/bangladesh

https://www.thefinancialexpress.com.bd

https://wealthyeducation.com/how-to-calc...

https://www.investopedia.com/terms/w/wac...

https://sba.thehartford.com/finance/cash-flow/cash-flow-statement/

https://stockbangladesh.com/beta-coefficient

http://www.dsebd.org

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