Applicability of Free Cash Flow to Equity

model for equity valuation; evidence from

Pakistan Tobacco Company Limited
Team Members

Taleya Fatima (02-112162-048)

Farah Nadeem Khan (02-112162-050)

Ayesha (02-112162-008)

BAHRIA UNIVERSITY – KARACHI CAMPUS

BS (A&F) – 8
  In this project, we provided a comprehensive example of how
free cash flow to equity valuation model can be applied to a
company to determine its intrinsic value and then compare it
with its market value to check if the firm’s share is underpriced
or overpriced.
 Intrinsic value of equity securities is estimated to confirm how

Introduction accurate the market price is as an estimate of value of the

security.
 Free Cash flow to equity model (FCFE) shows how much cash
can be distributed to the equity holders of the company as
dividends or stock buybacks after all the expenses such as non-
cash expenses (depreciation and/or amortization) , capital
expenditures, debt repayments and working capital
requirements have been taken care off.
 To analyze the stock valuation of Pakistan Tobacco Company
Limited by using Free Cash flow to Equity valuation method.

Specific Objectives:
Problem  To learn how free cash flow to equity valuation model can be
applied to a company to make decisions for investment on any
Definition stock
 To determine its intrinsic value which is computed by using
FCFE model.
 To compare the intrinsic value with its market value.
 After comparison, to determine if the firm’s share is
underpriced or overpriced.
Sources  Annual Reports of Pakistan Tobacco Company Limited
 Website of the Pakistan Tobacco Company Limited
of data  Website of Pakistan Stock Exchange
  Pakistan Tobacco Company Limited is a Pakistani tobacco
manufacturing company, a subsidiary of British American
Tobacco.
 It is headquartered in Islamabad.
 Over 94% of PAKT shareholding continues to rest with British
About the American Tobacco (Investments) Ltd.
 It has 3 product lines:
Company  Premium products
 Aspirational premium products
 Value for money products.
 It has 2 major competitors:
 Philip Morris (Pakistan)Ltd.
 Khyber Tobacco Co. Ltd.
 Market leader with 71% of market share in the legitimate
cigarette market as of 2018.
Valuation of stock using Free Cash
Flow to Equity (FCFE) Model

Formula for free cashflow to equity:

Free Cash Flow to Equity (FCFE) = Net Income - (Capital Expenditures - Depreciation) -
(Change in Non-cash Working Capital) + (New Debt Issued - Debt Repayments)
  Sustainable growth rate is assumed to be 14.8%
 Long term growth rate is assumed to be 7.15%
Assumptions  Rate of return of equity which is 9.33% is calculated with the
of FCFE help of CAPM equation.

model  The risk-free rate, 11.51%, is the rate of 5-year Pakistan

Investment Bond.
 Beta of PAKT is taken from Business Insider which is 0.192
 Rate of return of market is calculated by taking the average of
KSE-100 Weekly returns which is 0.14%.
Calculations
2019 2018 2017 2016 2015
Cash Flow From Operations Free Cash Flow to Equity
Net Income 12,889,229 10,337,992 9,573,562 10,361,352 7,046,434
Adjustment non-cash items - Depreciation 1,570,029 975,551 1,168,680 1,133,063 1,060,491
Changes in working capital
Stock in trade (2,940,355) (4,018,990) (834,448) 368,431 (2,043,029)
Stores and spare (45,093) 23,971 11,893 93,570 (286,546)
Trade Debts (2,707) 1,083 (797) (933) 2,319
Loans and advances (27,684) (25,275) 105,876 3,033 (114,902)
Short term prepayments 234,014 (37,188) (28,889) (13,560) 12,847
Other Receivables (181,189) (884,657) (43,577) (602,626) (21,155)
Trade and other Payables (2,898,684) 7,695,567 2,402,505 (1,322,058) (849,459)
Other Iiabilities 567,124 199,213 1,053,210 - -
(5,294,574) 2,953,724 2,665,773 (1,474,143) (3,299,925)
Cash Flow From Operations 19,753,832 14,267,267 13,408,015 12,968,558 11,406,850
Fixed Capital Investment 1,947,345 2,275,139 1,162,779 579,413 1,490,676
Net borrowing - - - - -
Free Cash Flow to Equity 17,806,487 11,992,128 12,245,236 12,389,145 9,916,174
Average FCFE 12,869,834
Projections and Present Value for the super normal growth period
2020 2021
  Rs. ‘000 Rs. ‘000
Projected FCFE 14,778,339 16,969,862
PV2019 13,517,327 14,197,397

Calculating the Terminal Value

  FCFE2023
T erminal Value 2022 =
Requity − Longterm growth

  Rs ‘000
FCFE2023 15,212,510
Terminal Value2022 698,188,877
PV2019 of Terminal Value2022 584,121,700
Calculating the Intrinsic Value
PV of FCFE 27,714,724,000
PV of Terminal Value 584,121,700,000
Intrinsic Value 611,836,424,000
Intrinsic Value per share 2394.72

Calculating the Market Value of the firm

Market price per share = Rs. 2440.55
Number of shares = 255,493,792
Market Value = Rs. 623,545,374,066
  Market value of Pakistan Tobacco Company Limited is Rs.
623,545,374,066.
 The closer the intrinsic value is to the market value, the more
accurate our predictions for the future will be.
Findings  Difference of Rs.45.83 exists between the market value of Rs.
2440.55 per share and the intrinsic value of Rs. 2394.72 per
share.
 The share is therefore trading at a price that is above its
intrinsic value.
 From this valuation model, we can say that the share is
overvalued.
 We recommend to calculate the Intrinsic Value through different
models of equity valuation which would add support to our
Recommendations calculated intrinsic value through Free Cash Flow to Equity
model. We are highly optimistic that we will continue our work in
our higher studies thesis report and will reveal new
methodological findings and seek to establish new metrics for
firm’s equity value calculation.
 
 We chose to value cash flows by Free Cash flow to equity model
due to several advantages attached to it:
 Include the information of all the future funds that would be
inflows and outflows.
 Projected balance can represent actual future balances.
Conclusion  The terminal value is more realistic when the results of
estimates are based on projected cash flows.
 The value of the firm is better estimated by the FCFE model.
 In our model, the intrinsic value per share was Rs. 45.83 less
than the market value which means that the stock was
overvalued. This overvaluation came mainly from the external
environment that affected the stock prices.
Thank You