Perform a complete business analysis (all four parts)

Student Example From A Prior Exam (Student A)

Cost of Equity Capital

I obtained the risk free rate of return (Rf) from the US Department of Treasury 30 year rate as of 7/15/2014 which is 3.37%. This is the interest rate that an investor would expect to receive on a risk free investment

I used the S&P Beta of .55, as given in the instructions. When the Beta is below 1 it indicates that the company is less risky than the stock market as a whole. A beta of .55 means that General Mills is fairly risk free, about 50% less risky than the stock market as a whole.

Finally, I decided to use a risk free premium of 6.5% since this is generally what investors would expect to receive on a risky asset.

To calculate the cost of equity I used the capital asset pricing model.

Required Rate of Return = Rf+ β (Rp)

= .0337 + (.55)(.065)

= 6.95%

Cost of Equity Capital for General Mills = 6.95%

http://www.treasury.gov/resource-center/data-chart-center/interest rates/Pages/TextView.aspx?data =yieldYear&year=2014

Forecasting / Valuation

Below is my sales forecast for the next five years.

In 2011 when General Mills acquired Yoplait, net sales grew 12 percent to $16.7 billion. The international Yoplait acquisition, which was completed in July 2011, contributed approximately 7 points of the total net sales growth. This is a very large jump, but this was also an international acquisition which is why I believe it made such a large spike. Yoplait is also a very well-known brand which already had a large amount of market penetration.

According to General Mills, “our Number One objective in the new fiscal year is to accelerate our topline growth…Our fiscal 2015 plans include a strong new-product lineup, compelling news or renovation on many existing brands, and a full slate of consumer-focused marketing initiatives” (News Release 2012). I believe that this initiative will raise sales slightly for 2015. I think that the larger growth will occur in 2016, due to the Acquisition of Annie’s, which was announced after the 10K was released. I believe that the acquisition of Annie’s, which took place after the 2014 10K was released in September 2014, will result in a sales increase slightly in 2015, but not by much. The acquisition of Annie’s will likely affect sales, but seeing that this acquisition will not be fully in effect until end of 2014, I do not think it will have a large effect on sales until after the 2015 10K is released. That is why I have a larger increase from 2015-2016 than from 2014-2015. I think sales will then continue to grow slightly, leveling off in the last few years. I do not think sales will spike the way that they did when General Mills acquired Yoplait. Annie’s does not have even close to the market penetration that Yoplait has, it does not have the same amount of brand recognition, and it is not an international company. If General Mills were to make other acquisitions or come out with new products in the future, I would expect even larger sales, but only knowing about the Annie’s acquisition this is what I project.

Below is my COGS forecast.

I have not increased cost of goods sold by much, only slightly. The biggest increase was from 2014 to 2015, where I project that it will increase by .6%. The cost of products that General Mills is using to produce their goods is rising, partly due to inflation. I think it will also rise due to the organic and natural foods market that General Mills is beginning to try to satisfy. These products are more expensive than non-organic products and will increase their cost of goods sold in the short term until they can get a handle on these expenses and find ways to reduce the cost. Below is a chart of inflation rates over a 10 year period.

Graph from http://www.usinflationcalculator.com/inflation/current-inflation-rates/

As you can see above, the biggest increase was in 2011. The May 27, 2012 cost of goods sold jumped 3.7% for that period, indicating that inflation played a role in the increase. I foresee the cost of goods sold rising slightly up to 2017. This is when I believe inflation rates will start to level off since we will be fully out of the recession at this point and back to a somewhat stable economy. From 2018 and after, I foresee the cost of goods sold slightly decreasing as the price of goods drops slightly, but not by much.

Below is my forecast for SG&A.

According to General Mills “it has begun a formal review of its North American manufacturing and distribution network with the goals of streamlining operations and identifying potential capacity reductions. The company also has initiated efforts focused on further reducing overhead costs. Together, the new cost-reduction initiatives are targeted to generate savings of $40 million pretax in fiscal 2015, with additional savings expected in fiscal 2016” (News Release 2014). Even with their initiative, I foresee SG&A expenses rising, but only slightly. I think that it will go up by .1% between 2014 and 2015, increasing more dramatically from 2015 to 2017 due to the future acquisition of Annie’s which will result in the acquisition of more employees from Annie’s. Once that acquisition is stabilized and they are better able to take a look at their SG&A to cut costs, I believe these costs will start to drop again.

For interest expense to average debt, I have raised it .4% from 2014 to 2015. During the acquisition of Yoplait, the interest expense and debt seemed to rise slightly, so I wanted to account for the possibility of this with the Annie’s acquisition. I think that the rate will then level off and drop. I think that interest rates will drop, as they are doing now. As the Federal Reserve prints more money, the interest rates drop. I think that this will continue for another couple years. This practice cannot continue forever, so around 2018-2019, I think that the interest rates will being to level off.

I have decided to keep non-operating income between .5% and .7% of sales. There is little to no movement in this number. I am expecting that this would remain relatively low because the majority of General Mills’ income comes from their operations and they do not seem to be making any initiative or effort to change this. Additionally, I have chosen to keep other income between 0% and 1% of net sales for the forecasting horizon. Based on their history, I believe the 0-1% to be conservative. Once again, there is no indication that this would increase at all over the forecast period. As far as minority interest/ after tax income, this seems to be on an upward trend. I continued this upward trend slightly over the course of the forecast, accounting for any potential increase in minority interest.

In 2014, income taxes were higher than they were in 2013. In 2013 the tax rate was 28.3%, which in 2014 it was 32.4%. The reason for this decrease was attributed to restructuring costs of their GMC subsidiary. The restructuring resulted in a “$63 million decrease to deferred income tax liabilities related to the tax basis of the investment in GMC and certain distributed assets, with a corresponding discrete non-cash reduction to income taxes”. Since this decrease was due mainly to restructuring, it is expected that the income tax expense will go back up to around 32% for future years. My forecast is shown below.

For 2015, I set income taxes to 32%, which is their relative range. I increased this slightly over the course of the forecast to account for any possible tax law modifications that could result in slightly higher tax rates. I do not believe that there will be any large changes to the tax law, which is why I kept this increase within the range in which it has been in the last few years, peaking at 32.4%.

The result of my forecast yielded a stock price of $57.92. According to Yahoo Finance, the actual closing price on 7/15/14 was 52.93. Currently, as of 11/5/14, the stock is trading at $53.17. I think that my stock price is slightly high relative to both the current trading value and the historic trading value. After looking through General Mills 10K and analyzing their ratios, I feel General Mills is a strong company and is relatively stable. Like other consumer companies, General Mills has struggled to manufacture growth. Breakfast cereal is a mature market in all economies and markets (Allison). I do not foresee major gross profit increases in the near future and as long as they continue to be innovative in their product growth and participate in acquisitions, I feel they will be fine in the future. Their products are worldwide and brand names are very strong. I would buy General Mills’ stock and hold it for the long run.

Sensitivity Analysis

I began my analysis by changing the cost of capital. Instead of using a risk premium of 6.5%, I bumped it up to 7%, which resulted in a cost of capital of 7.22%. This increase lowered my stock price to 54.75%, which is very close to the current trading value of $53.17.

My next adjustment was to go back to the financials and change some of the forecasted sales and expenses. I changed my sales increase for 2016 from 2.5% to 2.0% and 2017 from 2.7% to 2.5%. This dropped the stock price to $54.47. I then adjusted my SG&A expenses to consistently 20%, lowering the stock price further to $52.49. Small changes to the sales and expense growth lowered the stock price to about where it is today. However, I still think that General Mills has the opportunity to reach $57.92 in the future if their new products and acquisitions achieve the goals I believe they will.

Works Cited

Allison, Kevin. “The Risk In General Mills Deal for Annie’s”. New York Times. <http://dealbook.nyt

imes.com/2014/09/09/the-risk-in-the-general-mills-deal-for-annies/?_r=0>

“Current US Inflation Rates: 2004-2014” US Inflation Calculator. <http://www.usinflationcalculator.com

/inflation/current-inflation-rates/>

“Debt to Equity”. Investopedia. <http://www.investopedia.com/terms/d/debtequityratio.asp>

“Financial Leverage”. Investopedia. <http://www.investopedia.com/walkthrough/corporate-

finance/5/capital-structure/financial-leverage.aspx>

General Mills, Inc Form 10K. PDF

“GIS Historical Prices”. Yahoo Finance. <http://finance.yahoo.com/q/hp?s=GIS&d=10&e=6&f=2014&g=

d&a=5&b=10&c=1983&z=66&y=66>

Harper, David. “Financial Statements: Pension Plans”. Investopedia.

<http://www.investopedia.com/university/financialstatements/financialstatements9.asp>

IBIS World Industry Report: Cereal. PDF

IBIS World Industry Report: Yogurt. PDF

“Kellogg Co”. MorningStar. <http://financials.morningstar.com/ratios/r.html?t=K>

Muller, Alan. “A detailed review of every contaminated site in Minnesota is urgently needed….”.

<http://www.alanmuller.com/355/>

“Net Profit Margin”. Investing Answers. <http://www.investinganswers.com/financialdictionary/financi

al-statement-analysis/net-profit-margin-2233>

“News Release”. General Mills.

<http://www.generalmills.com/en/ChannelG/NewsReleases/Library/2014/September/Annies.aspx>

“News Release 2012”. General Mills. <http://www.generalmills.com/en/ChannelG/NewsReleases/Librar

y/2012/June/earnings_6_27.aspx>

“News Release 2014”. General Mills. <http://www.generalmills.com/en/ChannelG/NewsReleases/Li

brary/2014/June/fourth_earnings_14.aspx>

Oliver, Joseph R. “Accounting and Tax Treatment of R&D: An Update”. The CPA Journal.

<http://www.nysscpa.org/cpajournal/2003/0703/dept/d074603.htm>

Peavler, Rosemary. “What is the long-term debt to total capitalization ratio? How is it calculated?”.

<http://bizfinance.about.com/od/financialratios/f/LTDebt_Total_Cap.htm>

“Pension/OPEB 2014 assumption and disclosure survey”. PwC. PDF

“Return on Assets”. Investopedia. <http://www.investopedia.com/terms/r/returnonassets.asp>

“Return on Net Assets”. Investopedia. <http://www.investopedia.com/terms/r/rona.asp>

S&P Industry Survey: Foods & Non-Alcoholic Beverages. PDF