UNIVERSITY OF BRADFORD

School:Management

Module Tutor/Supervisor:Dr. Aydin Ozkan

Module Number:MAN4214M

Module Name:Corporate Finance

Title of Essay Question:

Please provide the whole question:Equity valuation of Next Plc through P/E and Discount cash flow techniques and compare with competitors.

UB Number:14021365

Date of Submission:27 Apr 2015

Mode of Study (on site/distance Learner)On site

Word count (not including bibliography and appendices):2058

Statement of Authenticity:

By submitting this assignment through Blackboard, I confirm:

That this work is my own and that I have not plagiarised the work of others in any form whatsoever.

That I am aware of the Universitys definition of Plagiarism and understand how it can be avoided.

That this work, or any part of it, has not been previously submitted to the University of Bradford for assessment in any other module.

That I have read and understood the information provided below.Signed: Gurkeerat Singh Kalra Date: 27 Apr 2015_

IntroductionNext plc based in UK is a well known retailer for clothing and other casual accessories (Reuters 2015). As shown in Figure 1 business landscape, Next operates with its 3 mail distribution channels i.e. Next Retail (with around 500 stores), Next sourcing and Lispy in UK, Next Directory (Online channel with product catalogue and integrated delivery in 60 countries) and Next international with 200 franchises across world (HL, 2014). Figure 1: Business Landscape - Next Plc (Source: HL, 2014)Next was listed first on London stock exchange on March 12, 1948 and today it is listed on FTSE 100 Index as well (LSE, Next 2014). This assignment is focused on current company valuation of equity for Next Plc in UK and evaluating the value Next Plc has delivered to its shareholders since last five years. The 2 valuation techniques employed are Price/Earnings Ratio (P/E) analysis and Discounted Cash Flows (DCD). Where possible a reasonable justification over the difference in derived value from the valuation techniques is provided taking into account the facts and assumptions concerned. Value analysis of shareholder has been carried out using Total Shareholder Return (TSR) technique with focus on dividend and capital gain. The valuation figures are also compared with competitors of same industry sector i.e. M&S and Debenhams and almost same size, to evaluate future growth and market perception. Companys annual reports are utilized as a source of key figures from financial statements from various online database resources provided by university.Closest Competitors

As stated by Bloomberg Business (2012), it has grabbed the title Britains Largest Clothing Retailer from M & S Groups plc. Since the closest competitors are compared in terms of Industry sector (i.e. consumer goods retail), Gross Revenue or turnover and total assets, please refer to Appendix 1 for detailed comparison.As an Investor, Next holds a more attractive position than rival companies as it has well positioned its online sales with the shift of buying trend from retail store sales to online channel. As per a report in 2013, Next Directory Online and catalogue (mentioned in figure1) account to 35% of group sales and is growing at a good pace while M&Ss online offering accounted 6.5% of group sales, giving Next greater sales revenue and thus greater profit margin (Hargreaves, 2013). Also, since 35% (one third) of group sales are online, there is a significant saving in store running and staffing cost.

Table 1: Financial data of Next plc

(Source: FT, 2014)Table 1 mentions the financial highlights of Next Plc over the past 5 years and it is evident that there is steady increase in sales but since Asset turnover reached its lowest in 2014 due to larger portion of receivables included in current assets of Nexts balance sheet.

Valuation

Valuation of a company is a method of calculating the current worth of its assets, market shares and future expected cash flows and it is required by directors to understand the impact of financial decisions like acquisitions and mergers, investment analysis and capital budgeting (Pike and Neale 2009). Valuation is also important to measure company performance as it includes long term interest of company stakeholders (i.e. management and employees) and shareholders (Koller et al. 2010). According to Brealey and Myers (2000), the company valuation are used for a variety of purposes such as, for the buying and selling operations of the company; to compare the obtained value from the shares on the stock market; to choose the securities that are to be concentrated by the portfolio; to make comparative studies between the companies; to justify public offerings; to compare with the wills and inheritances (other assets); for quantifying compensation schemes; for stratifying and identifying main value drivers; for making strategic decisions for the existence of the company and for measuring the impacts of strategies and policies of company up on the creation and destruction of value.

Price- Earnings Ratio Analysis:According to Paulasset (2012), the Price Earnings ratio or the PE ratio is one of the common and most important stock valuation ratios. It can be defined as the ratio of the current market share price of the company to its annual earnings per share. Formula

P / E = Market Value per Share /Earnings per Share (EPS)

The PE ratio is considered significant as it points out how expensive or how cheaper a stock is (Research Desk, 2007). It is also claimed that, the PE ratio offers a good opportunity for buying stocks at cheaper price. The companies, which doesnt make profit or incur loss have a negative or zero PE ratio. Thus, the PE ratio is considered as a simple and good measure of stock valuation, supporting novice investors.

(Note: Please refer to detailed calculations and assumptions of P E Ratio in the Appendix 2) Table 2: P E Ratio of Next plc, Marks & Spencer Group plc and Debenhams

(Source: Annual Report Next, M &S, Debenhams, Fame, 2015)

The table above (table 2) presents the Price- Earnings ratio of Next plc, Marks & Spencer Group plc and Debenhams from 2010 to 2014. As of the year 2010, even though there has been a steady growth in all the 3 companies over the next consecutive years, Marks & Spencer Group plc has been the market leader with a maximum PE ratio of 11.27.

Figure 2: Price- Earnings ratio of Next Plc, Marks & Spencer Group plc and Debenhams

(Source: Annual Report Next, M&S, Debenhams)The year 2011 (Figure 2) can be explained as slowdown or crisis recovery year for all three companies where market price per share had a slow increase for Next and M&S. While for Debenhams, the price fall substantially i.e. 14.1 %. During the third quarter of year 2012, Next opened new outlets in UK high street and revenue boosted to 0.2 %. April and June 2012 had high rainfall and thus Nexts online Directory (Figure 1) witnessed a total jump in sales of 4.5% in 2012 (Trotman, 2012).

Table 3: NOPAT calculation for P/E value analysis

(Source: Annual Report Next)

The above table demonstrates the calculation of PER value for Next Plc and its comparison with Market Cap to measure accuracy (provided the assumptions and value comparison in Appendix 2). Year 2014 has been the best for Operating profit a value of 9.97 Billion .Discounted Cash Flow (DCF):

According to Harrison and David (2003), the technique of determining the status of business in future depending up on its current state is called as the Discounted Cash Flow (DCF) analysis. Mostly, the Discounted Cash Flow analysis is used routinely by people who are in a plan of buying a business (Inc 2015). Cash flow forms the basis of the business. According to Investing Answers (2001), one biggest advantage of Discounted Cash Flow is considered to be that it considers the fact of investing the money in business soon as we receive it. Presented below are the Discounted Cash Flow of the Next plc and its 2 competitors, the Marks & Spencer Group plc and the Debenhams.

Formula

Following table shows the calculation for Present value of free cash flows from 2015 to 2019.

Table 4 (a): Discounted cash flow of Next plc(Source: Self, table 4(b))

Note: Please refer appendix 3 for detailed DCF assumptions.Discount Rate (Cost of Capital or Ke) is calculated in Table 4 (b)Terminal valueTV = Free cash flow (2020) / (Wacc - Rate of growth) = 843525/ (4.28 2.4) = 448683.5 thousand GBP

NPV = 348926 thousand GBP

i.e. Value of Equity = 3693155 +348926 = 4042081 thousand GBP = 4.042 Billion GBPCost of EquityNet present value asserts on value of wealth to a particular forecasted time using the discount rate. Following table employs CAPM model to calculate cost of equity (Pike and Neale 2009).CAPM%Source

R(f) - Risk Free Rate0.22US Treasury 2015

Beta0.64Thomson Reuters 2015

R(M) - Risk Premium6.35Aswath Damodoran 2015

Discount Factor (WACC) 4.28

CAPM Equation

Ke = Rf + (Beta *Rm) where,

Ke = Cost of Equity Rf = Risk free rate

Beta = Risk Rate

Rm = Equity Risk Premium

Table 4 (b): Cost of Equity or discount Factor (Source: Mentioned in table, CAPM equation)

As seen above CAPM model relies on market risk to derive discount factor. This method is globally conventional to derive cost of Equity.Valuation Result

Following is the resultant value of P/E and DCF models for Next Plc. As evident the P/E and Market value are close enough. DCF calculation result is higher than P/E as this valuation method employs future cash flows and thus potential future growth of the company. Market ValueP /E Multiple ValueDCF Valuations

9.48b9.97b4.04b

Table 4 (c): Valuation Summary (Source: table 3, 4(a) summary)

Shareholder Value AnalysisThere are various approaches to determine how the company is performing during the last five years and eventually adding value to its shareholders. We will go through TSR (Total shareholder return) in this paper. The total shareholder return (TSR) figure to an investor is the measure of performance a companys share and stock. It is a summation of dividends payable (as per companys dividend distribution policy) and share price appreciation (capital gain). Since the calculation involves share price when dividends are paid, an approximation of price average from start to end of the year has to be incorporated thus the TSR figure is not quite accurate or exact. Formula Figure 3: NEXT plc Performance Chart 2009-2014 Total Shareholder Return (Source: NEXT Plc) The graph above (Figure 3) shows the companys performance in last 5 years compared with FTSE All share and FTSE General Retailers index to compare companys TSR with a wide UK index and a sector specific index. Since the return dropped negative in 2008-09 as compared to 2009-10, the starting scale of year 2009 in figure 3 is taken as 100.

Table 5: NEXT plc Total Shareholder Return calculation

(Source: NEXT Plc Annual Report 2009-14, Share price calculator 2014) Next Plcs share price calculator and dividend history from financial statements were used as a source of Table 5. For a more consequential demonstration, the expected return can be compared with the risk of investment. Next Plcs TSR has been unstable since last 5 years. Since the dividend per share has been almost incremental from 15 to 23%, share price change or capital gain has been the main driver of TSR in past 5 years. As part of Nexts strategy for delivering sustainable long term growth in EPS, it has been returning capital to shareholders through share buybacks (in addition to dividends) which are accounted through both on-market and off-market share purchases (Next Corporate, 2015). As per Next, TSR is the growth in EPS added to dividend yield received. What the share price does in market is outside company's control, but Next believes that eventually share price is likely to reveal the growth in EPS (HL 2015). This is shown below in figure 4.

Figure 4 shows the share price movement of Next UK plc over the past 16 years and conveys how share price follows EPS historically. The high rating in 2014 imply that use of surplus cash, as special dividend or share buyback, gives less returns to shareholders than expected if rating was low or risk (Investigate 2015). Figure 4: Share price movement of Next UK plc

(Source: Investigate 2015) Shareholders particularly invest for either capital gain or earnings from dividend payouts. Next Plc has made profit (5 years) and rewarded a constantly increasing dividend and so is the share price increase each year. This has attributed to a positive TSR and displays deprived value for investors. The year 2010-11 can be explained as a fall in market price.Conclusion:

To conclude that if the results are overvalued or undervalued, a market benchmark is needed.

Although under or overvaluation makes a market inefficient, it is sometimes beneficial for the investor as it associates risk and return. Stocks with low declining PE ratio are believed to give higher risk adjusted return than those with high PE ratio (Bondt & Thaler, 1985). The higher the PE ratio of Next plc points out that they are growth stocks and investors expect better return in the next few years. Considering the market rate of return Next is valued 10.968 b, which is close to PE but since DCF employs future values, it is undervalued (almost 50%) with 4.04 b.

Although, the shareholders are already getting good returns, undervaluation might even attract more investors to buy and since Next is sustaining its results in capital gain, dividend payout (returns), this situation calls investors for long term. Next has always been performing share buybacks and dividend correction, for adjusting the returns and increasing shareholders trust and might not be an issue to do again.AppendixAppendix 1 - Competitor ComparisonNext Plc

Financial data ( millions)20102011201220132014

Revenue3406.53453.73441.13562.83740

Gross profit996.91008.71045.31125.81240.1

Net income364.1401.1474.9508.6553.2

Total assets1693.51736.61819.118282074.3

Asset turnover Ratio3.643.823.203.523.02

M & S Group Plc

Financial data ( millions)20102011201220132014

Revenue9537974099341002710310

Gross profit36193725375537973871

Net income523599490458506

Total assets71537162718273627704

Asset turnover Ratio1.811.971.921.961.93

Debenhams

Financial data ( millions)20102011201220132014

Revenue2119.92209.82229.82282.22312.7

Gross profit281296.7302.3310.1279.3

Net income97117.2125.3127.987.2

Total assets2087.32014.32091.22128.22141.5

Asset turnover Ratio2.111.701.631.651.67

(Source: Fame, 2015)

Assumptions

1. Operating profit is without deductions including dilution due to discontinued operations.

2. No exceptional items deducted from profit after tax.

3. The affect of M&S year ending march every year is ignored (i.e. 2 months later than Next Plc)

Appendix 2 - Price Earnings Ratio Analysis

Next Plc

YearMarket value per share ()Earnings ( Million)(Profit after tax)Ordinary shares(Millions)Earnings per share ()PE ratio

201019.663641.93188.610.42

201119.94400.91.81221.59.00

201226.39474.81.86255.310.34

201340.59508.61.71297.413.65

201462.9553.21.51366.417.17

M&S

YearMarket value per share ()Earnings ( Million)(Profit after tax)Ordinary shares(Millions)Earnings per share ()PE ratio

2010377.5552315.6133.511.27

2011377.91598.615.4338.89.74

2012352.95489.615.0632.510.86

2013346.11444.815.7228.312.23

2014457.9350615.5732.514.09

Debenhams

YearMarket value per share ()Earnings ( Million)(Profit after tax)Ordinary shares(Millions)Earnings per share ()PE ratio

201058.79712.937.57.83

201151.42117.213.638.65.98

201296.53125.312.799.89.85

2013106.7115.912.609.211.60

20146687.212.287.19.30

(Source: Financial statements Next Plc, M&S, Debenhams)M&S || Debenhams valuation 2014Company2014

P/ENOPATValue

Next17.17580.89972.336

M&S14.094896890.01

Debenhams9.3687.2816.192

Source: Fame, 2015Assumptions1. Operating profit is without deductions including dilution due to discontinued operations.

3. The affect of M&S year ending march every year is ignored (i.e. 2 months later than Next Plc)

Appendix 3 Discounted Cash Flow (DCF)Assumptions

References:Pike R. and Neale B. (2009). Corporate finance and Investment. Decisions and Strategies. 6th edition. Pearson Education Limited. Essex.Koller T., Wessels D. and Goedhart M. (2010). Valuation: Measuring and Managing the Value of Companies. 5th edition. John Wiley & Sons. New Jersey.Brealey, R A. and Myers, S C. (2000), Principles of corporate Finance, 6th edition, McGraw Hill, New YorkFT (2014). Next PLC. Available online at:http://markets.ft.com/research/Markets/Tearsheets/Financials?s=nxt:lse[Accessed on: 19 Mar 2015]Next Corporate (2015). About Next. Available online at: http://www.nextplc.co.uk/about-next.aspx[Accessed on: 19 Mar 2015]Hargreaves, R. (2013). 3 Great Reasons Why NEXT plc Is Better Than Marks and Spencer Group Plc, 07/10/2013, The Motely Fool. Available online at: http://www.fool.co.uk/investing/2013/10/07/3-great-reasons-why-next-olc-is-better-than-marks-and-spencer-group-plc/[Accessed on: 27 Mar 2015]

Bloomberg Business (2012). M&S Loses Britains Largest Clothing Retailer Title to Next. Available online at: http://www.bloomberg.com/news/articles/2012-06-29/m-s-loses-britain-s-largest-clothing-retailer-title-to-next-1-[Accessed on: 19 Mar 2015]Reuters (2015). Next PLC (NXT.L). Available Online at:http://www.reuters.com/finance/stocks/companyProfile?rpc=66&symbol=NXT.L[Accessed on: 7 Mar 2015]

Paulasset (2012). Price to earnings ratio (P.E ratio) Significance,Usage and limitations. Available online at: http://www.paulasset.com/articles/price-to-earning-ratio-significance/[Accessed on: 21 Mar 2015]

Research Desk (2007). Significance of PE Ratio. Available online at: https://www.valueresearchonline.com/story/h2_storyView.asp?str=10087[Accessed on: 21 Mar 2015]

Investing Answers (2001). Discounted Cash Flow Analysis. Available online at: http://www.investinganswers.com/financial-dictionary/stock-valuation/discounted-cash-flow-dcf-analysis-1318[Accessed on: 19 Mar 2015]

Inc (2015). Discounted Cash Flow. Available online at:

http://www.inc.com/encyclopedia/discounted-cash-flow.html[Accessed on: 19 Mar 2015]Harrison and David, S. (2003). Business Valuation Made Simple: It's all about cash.Strategic Finance. Trotman, A. (2012). Next raises profits guidance as online sales jump, 01/08/2012, The Telegraph. Available online at: http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/9443117/Next-raises-profits-guidance-as-online-sales-jump.html[Accessed on: 25 April 2015]

Bondt, W. F., & Thaler, R. (1985). Does the stock market overreact?.The Journal of finance,40(3), 793-805.

Fame (2015). Next PLC Company Report. Retrieved from: https://fame.bvdinfo.com/version-2015418/Report.serv?_CID=63&context=18M5AGCJP55RLPD&SeqNr=0[Accessed: 14 Mar 2015]

Fame (2015). Debenhams PLC Company Report. Retrieved from: https://fame.bvdinfo.com/version-2015418/Report.serv?_CID=63&context=2PEVAGCJPHK8AX6&SeqNr=0[Accessed: 14 Mar 2015]Fame (2015). Marks and Spencer Group P.L.C. Company Report. Retrieved from: https://fame.bvdinfo.com/version-2015418/Report.serv?_CID=201&context=18M5AGCJP55RLPD&SeqNr=1 [Accessed: 17 Mar 2015]

OC&C; Google (2012). E-commerce sales revenue of retailers in the United Kingdom (UK) from 2012 to 2020 (in billion GBP), Statista. Available online at:

http://www.statista.com/statistics/284560/e-commerce-sales-of-retailers-in-the-united-kingdom/[Accessed: 18 Mar 2015]HL (2015). Next plc (NXT) Financial Statement and Reports. Available Online at:

http://www.hl.co.uk/shares/shares-search-results/n/next-plc-ordinary-10p-shares/financial-statements-and-reports[Accessed: 18 Apr 2015]HL (2014). Next plc (NXT) Company Information. Available Online at:

http://www.hl.co.uk/shares/shares-search-results/n/next-plc-ordinary-10p-shares/company-information[Accessed: 11 Mar 2015]LSE (2014). NXT NEXT PLC ORD 10P. Available Online at:http://www.londonstockexchange.com/exchange/prices-and-markets/stocks/summary/company-summary.html?fourWayKey=GB0032089863GBGBXSET1[Accessed: 17 Mar 2015]US Treasury (2015). Daily Treasury Bill Rates Data. Available Online at:

http://www.treasury.gov/resource-center/data-chart-center/interest rates/Pages/TextView.aspx?data=billRatesYear&year=2015[Accessed: 19 Apr 2015]Thomson Reuters (2015). Next PLC (NXT.L). Available Online at:

http://in.reuters.com/finance/stocks/overview?symbol=NXT.L[Accessed: 19 Apr 2015]Aswath Damodoran (2015). Country Default Spreads and Risk Premiums. Available online at:

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html[Accessed: 19 Apr 2015]