CFA Institute Research Challenge Hosted by CFA Society of Melbourne Monash University
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CFA Institute Research Challenge
Hosted by
CFA Society of Melbourne
Monash UniversityMonash University
DuluxGroup
DLX AU/ DLX.AU (Bloomberg/Reuters) Price as of 22nd August 2013: $4.42
Australian Equities / Materials / Chemicals 12 Month Target price: $4.94
Recommendation: BUY Expected 52 week return 11.8%
Dulux Group at a Glance
Shares Outstanding 377,019,430
Highlights Market Capitalisation $1.67B
% of S&P 200 Index 0.12%
We initiate a coverage of Dulux with a BUY
recommendation with a target price of $4.94, an Free Float 100%
upside of 11.8% to the current price of $4.42 52 Week Trading Range 3.15 - 4.93
Net Debt $456.7M
DLX has outperformed the ASX200 by 20% over the Average Volume Traded
per day 1259508
last 12 months of trading and returned 72.66% since Institutional 41%
its initial public offering in July 2010. Shareholdings
Last Dividend Paid 8c 100% franked
14/06/2013
DuluxGroup is ideally positioned to gain further market 6 7000000
share and continue to outgrow its competitors through 5 6000000
5000000
a better brand recognition and superior distribution 4
3
4000000
network at Bunnings. 2
3000000
2000000
1 1000000
0 0
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DLX has higher margins than competitors, a ROE and
ROC significantly larger than the cost of capital as well
as a solid balance sheet with consistent interest Volume ASX200 Rebased
coverage. DLX Share Price
Dulux has outperformed the ASX 200 by 20%
over the last 12 months of trading
Source: ASX
Estimates (A$m)
Year End 2011A 2012A 2013E 2014E 2015E 2016E 2017E
Revenue 996.4 1067.8 1562.0 1618.1 1660.0 1703.8 1748.3
EBITDA 154.7 151.7 220.7 231.9 238.2 244.0 250.8
NPAT (excl significant items) 77.6 79.6 110.9 118.7 123.7 128.2 133.2
EPS (cents) 21.4 22.0 29.4 31.5 32.8 34.0 35.3
DPS (cents) 15 15.5 20.5 22 23 24 24.5
Dividend Yield 3.30% 3.40% 6.7% 7.1% 7.4% 7.7% 8.0%
PE Ratio 21.5 21 16.2 14.0 13.5 13.0 12.5
ROA 11.60% 11.22% 11.09% 11.58% 11.84% 12.04% 12.19%
ROE 56.05% 43.53% 66.32% 58.47% 51.53% 46.16% 41.83%Monash University CFA Institute Research Challenge: DuluxGroup
Business Description
DuluxGroup (DLX) is an ASX200 listed company that specialises in the manufacturing, marketing, sale and
Revenue by Geography FY12
distribution of paints, surface coatings, home improvement products and garden care products to
consumers and professionals. Although the group’s history can be traced back to 1918, DLX was properly
established after being demerged from Orica Group’s consumer products division and formally listed on
Other the ASX in July 2010. Since then, DLX has become the largest manufacturer of paint products in
Countries
10% Australia, and also holds the dominant market leading position for paints in New Zealand. Recently, the
New
Zealand group has expanded further into the home improvement market through its acquisition of Alesco Group
12% (ALS), a building products manufacturer.
The company has operations in Australia, New Zealand, Papua New Guinea, China and South East
Australia Asia, however, operations in Australia account for around 78% of total revenues.
78%
In total, DLX operates 12 manufacturing sites, 13 distribution centres and 73 trade centres, with products
being sold via 5,000 retail outlets and 230 trade distribution outlets.
Source: Dulux Annual Report
The four business segments that DLX operates in are outlined below:
1. Paints Australia (57% of Group FY12 revenues)
Revenue by Segment FY12
Manufactures and markets decorative paints, texture, protective and woodcare coatings products for
Paints New
both consumer and professional markets in Australia.
Zealand
7%
2. Paints New Zealand (22% of Group FY12 revenues)
Manufactures and markets decorative paints, texture, protective and woodcare coatings products for
both consumer and professional markets in New Zealand.
Offshore &
Other 3. Selleys Yates (14% of Group FY12 revenues)
14%
Manufactures and distributes home improvement and garden care products in Australia and New
Paints Zealand for both consumer and professional markets.
Sellers Yates Australia
22% 57% 4. Offshore and other (7% of Group FY12 revenues)
Manufactures and markets: powder, refinish, industrial coatings in Australia and New Zealand; DLX
paints in Papua New Guinea; incorporates DLX’s China and Hong Kong operations under the DGL Camel
International brand; and also DLX’s South East Asia coatings and home improvement business.
Source: Dulux Annual Report
We identify the following key strengths that drive continued market share growth and form the basis of
Revenue by Geography the company’s strong business fundamentals: continued investment into marketing, technical
innovation and customer service; a diverse product portfolio; operations on an international scale, with
100 global supply chain networks in Australia, New Zealand, Papua New Guinea, China, and South East Asia;
7.06 6.98 10.53
90 leading market positions in their existing decorative paint products; an already well-established strong
11.92 12.52 global brand name; and that over two thirds of the business is exposed to relatively stable drivers of
11.79
80
demand such as renovations and maintenance of existing homes.
70
60 The recent acquisition of Alesco has increased DLX’s business cycle risk. Originally, 10% of the group’s
% 50 revenues were derived from the cyclical ‘new housing’ sector, however, exposure has since doubled
81.02
from 10% to 20% post-acquisition. Further drawbacks in recent times include DLX’s lack of control over
40 80.5 77.68
input costs, specifically titanium dioxide, ALS’s Robinhood financial underperformance, and the higher
30 insurance premiums incurred as a result of the Rocklea, QLD flood in 2011.
20
10 DLX’s current strategy can be described under three umbrellas:
0
FY 2010 FY 2011 FY 2012 Continuing organic growth: increasing current market share positions in core businesses through
renovation trade channels with a focus on residential homes and a bias towards improving existing
Other Countries homes.
New Zealand
Establishing medium to long term growth options in high growth areas such as Asia: increasing
Australia
foothold positions in their DGL Camel International business in China and Hong Kong, and DGL
Source: Dulux Annual Report International in South East Asia; the strategic focus being on niche coatings and adhesives.
Adjacent category growth: leveraging current business strengths- particularly their established retail and
trade channels – to expand their product portfolio in the residential home improvement market.
22/08/2013 3MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Industry Overview and Competitive Positioning
Paint and Coatings
Australian GDP Growth Rate The Australian Paint and Coatings Industry is split into two major segments:
6.00%
Architectural and Decorative which incorporates 60% of paint sales and includes retail sales, trade sales
5.00% to tradesmen and master painters. Trade sales are larger and have historically grown faster than retail.
4.00%
3.00%
2.00%
Industrial encompassing 40% of sales which incorporates industrial coatings such as automotive. Dulux
exited this business in 1995 but holds a small operation in automotive refinish which contributes to
1.00% approximately 5% of Dulux sales. Manufacturing continues to leave Australian borders and Dulux is well
0.00% positioned in that they have slowly exited this market and holds less than its competitors.
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
The Australian decorative coatings market is mature with slow growth prospects. It is also highly
consolidated with the top 4 manufacturers controlling more than 90% of the market. Due to the
Source: ABS concentrated market, companies have focused on vertical integration of their business segments to
warn off other competitors.
Demand drivers
Economic growth and disposable income are leading drivers to demand for paint products. This is
particularly true of disposable income to premium paint brands which Dulux encompasses. The
Australian economy has been growing at a steady rate of over 2% per year over the last 5 years. As a
mature market, paints and coatings grows at a slower rate but is driven by Australian GDP growth.
Hardware, Building and Garden
Supplies Retail Turnover Australia is still consuming less than average paint per capita compared to other developed nations
showing a potential to grow given higher levels of marketing.
1400.0
1200.0 Industry sales are expected to grow over the next two years and remain stable going forward.
1000.0
800.0
$M
600.0 New housing makes up a significant but lesser proportion of (under 30%) Dulux paint sales which show a
400.0 strong positive between housing approvals and Dulux paint sales.
200.0
0.0
Given the rest of Dulux paint sales are through renovation activity (over 70%) Alterations and Additions
indicator is positively correlated to Dulux paint sales at .74. Retail turnover also paints a good picture of
Aug-1994
May-1985
Oct-2000
Nov-2003
Jul-1991
Sep-1997
Feb-2010
Jun-1988
Jan-2007
Apr-1982
Dulux sales having a correlation coefficient of .78.
Pricing power of retailers is rising due to a consolidated market with fewer suppliers.
Source: ABS
Supply Drivers
Technological changes to the paints and coatings industry have been fairly minor as it is a mature
industry. Research and development still plays a part but is mainly spent on mix, colour, gloss and
consistency of batches.
Other technological improvements are focused on environmentally friendly paints to reduce exposure to
environmental liabilities such as remediation at paint manufacturing sites.
Water based paints instead of solvent based paints help to reduce costs and hazards, water based paints
Additions and Alterations now account for 90% of decorative paints globally.
14000000 Raw materials account for 70-85% of manufacturing costs and are driven by petrochemical and crude oil
12000000 prices, these include:
10000000 Pigments (Titanium Dioxide), Fillers, Solvents, Film formers (acrylics, alkyds, vinyls, polyester), Thinners
Vlaue
8000000
6000000
4000000 Titanium Dixoxide (TiO2) is the key raw input
2000000 The TiO2 Industry is dominated by a few large players accounting for 70% of production
0
DuPont is the largest supplier, followed by Cristal, Tronox, Huntsman, Kronos
May-1983
May-1996
May-2009
Sep-1974
Sep-1987
Sep-2000
Jan-1979
Jan-1992
Jan-2005
The rise in raw materials have historically been passed onto consumers successfully which minimises the
impact on margins
Source: ABS
TiO2 is expected to increase at average levels despite the short term volatility and a recent price
correction.
20-30% of the raw material suppliers are located in the U.S. giving Dulux exposure to some USD risk
22/08/2013 4MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Industry Overview and Competitive Positioning
Market Share Forecasted
Dulux has a brand portfolio of over 8 paint brands ranging in price and shelf space including:
Dulux, Berger, British Paints, Walpamur, Cabot’s, Intergrain, Feast Watson and AcraTex.
Dulux PPG Azko Nobel Valspar Other
Dulux, the only major Australian competitor, is the dominant leader of market share with 34% of the
100%
90% current market. PPG through its acquisition of Taubman’s has gained significant market share now
80% standing at 26% from Wattyl. Wattyl, now owned by Valspar Holdings, holds 19% of the market. Azko
70%
60% Nobel trails with under 14% whilst all others such as Coates brothers hold less than 7% of market share.
50%
40% Dulux is the only remaining major Australian paint manufacturer after the acquisition of Taubman’s by
30% PPG and Wattyl by Valspar.
20%
10%
0%
Dulux is likely to acquire market share in the short to medium term and maintain it thereafter due to a
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
strong brand position, this is also a protection against price wars between competitors. Historically
Dulux has been able to fend off price wars due to an elevated brand name. It will take some time for
Source: Team Estimates competitors such as Wattyl and Valspar to establish the same premium brand positioning as Dulux. If
major competitors are able to compete at the premium level Dulux will lose a major advantage but will
sill have the largest distribution network compared to all other paint manufacturers.
Distribution channels have recently been strengthened at Bunnings with the removal of Dulux products
at Master’s Trade stores. As Bunnings is the leading retail hardware store chain in Australia, Dulux will
continue to receive large amounts of shelf space and premium brand recognition compared to its
competitors. Currently Dulux is estimated to have 60% shelf space at Bunnings stores.
Distribution Store Forecast
International competition is a potential but low risk threat. However, imports and exports of coatings
500 and paints are small and declining due to higher freight on board costs, strict paint quality regulations
400 and high transport risk.
300
200
100 A substitute for paint and coating products are not a threat as there are no real alternative coating
0 products and the risk of any such product developing a grasp over the paint market is relatively low. The
only true substitute comes from pre-painted building materials such as coated steel or fibre cement.
In the trade space, Dulux continues to dominate with its market presence. There is a preference for
Bunnings Stores Masters Stores trade and master painters to choose Dulux over competitors as the paint cost relative to the labour cost
of a master painter is low, leading to a preference in a more premium product that is trusted and better
Source: Team Estimates
satisfies the customer.
Dulux also has the ability to distribute and retail its own paint at Dulux trade stores making the threat
from bargaining power of buyers low.
Input cost increases are less of a concern to margins as DLX has 3 different raw materials suppliers, giving
some flexibility in terms of pricing and volume. Historically these input cost increases have also been
Rivalry passed onto consumers thus maintaining current margins for Dulux. As a large purchaser, Dulux has a
Among
Competitors reasonable level of power since its suppliers provide a commoditised product. Dulux Group also has its
High
own manufacturing and in-house resin development capabilities which provide additional leverage
Barriers to Threat of when dealing with suppliers.
Entry Substitutes
High Low
DuluxGroup
Although the physical barriers to entry such as production plans and machinery are not significant, new
entrants have historically been unsuccessful in the market due to the lack of established brand trust with
Bargaining Bargaining
customers as well as a well placed distribution channel through retail and trade merchants. This is
Power of
Suppliers
Power of
Buyers evidenced by international competitor Nippon paint’s unsuccessful attempt to penetrate the Australian
Low Medium
paint and coatings market and its exit in 2010.
22/08/2013 5MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Investment Summary
DLX Cashflow Breakdown ($m) Good entry Point
We issue a BUY recommendation for DLX with a target price of 4.94 and 11.8% upside
200.0 from current price level. DLX has a strong domestic position with further growth prospects
100.0 internationally and cross selling capabilities through the recent acquisition of Alesco. Investors have
reacted enthusiastically to the Alesco acquisition with the share price up 6%. Since its IPO on 13th July
0.0 2010 the share price is up 73.8% versus an increase in the ASX200 of 16%. Projected steady growth and
-100.0 advantageous business prospects should enable further strengthening of the Company’s position.
-200.0
Valuation methods
-300.0
Our 12 Month target price is weighted 25% to a DCF, 25% to domestic forward P/E and 50% to global
forward P/E. We have emphasised P/E as it is the standard measure for Australian small cap
Operating Cash Flow industrials, with the DCF providing an alternative cross check.
Investing Cash Flow
DLX delivered solid results amidst difficult market conditions: Statutory Net Profit declined 12% in FY12.
Financing Cash Flow Difficult market conditions were reflected in the rising input costs and shrinking market size. However
we believe input costs will stabilise moving forward. Furthermore, DLX’s ability to grow market share in a
Source: Team Estimates shrinking environment indicates strong brand equity.
DLX Margins
Consolidation amongst existing businesses and acquisitions to drive earnings
2000.0 18.0% Post acquisition will see Dulux focusing on building brand equity and competitive advantages in their
16.0% current businesses. The company plans on using its market leading position to build brand equity and
14.0%
1500.0 increase market share of the fragmented garden supplies market. Continued marketing expense coupled
12.0%
10.0%
with pricing controls will see Paints Australia margins stabilise to 14%. As the new housing market
1000.0
8.0%
improves Dulux should see further market share gains and increased revenue from their Alesco
6.0% businesses. Cross-pollination of products and cost synergies will aid in the earnings recovery as the
500.0 4.0% businesses are integrated.
2.0%
0.0 0.0%
Main price growth drivers moving forward:
2011A 2012A 2013E 2014E 2015E 2016E 2017E Continuing organic growth: increasing current market share positions in core businesses through
renovation trade channels with a focus on residential homes and home improvements.
Revenue EBITDA Margin Establishing medium to long term growth options in high growth areas such as Asia: increasing
foothold positions in their DGL Camel International business in China and Hong Kong, and DGL
EBIT Margin NPAT Margin International in South East Asia; the strategic focus being on niche coatings and adhesives.
Source: Team Estimates Adjacent category growth: leveraging current business strengths- particularly their established retail and
trade channels – to expand their product portfolio in the residential home improvement market.
DLX Dividend Payout Ratio
Strong financial position and high dividends
100.0 80% DLX has increased net debt significantly from the Alesco acquisition, however lower interest rates have
80.0 60% kept interest expenses to a minimum, leaving the company with strong liquidity and cash coverage
60.0
40%
ratios. As a result of the one-off nature of acquisition costs and debt repayments ,the target D/A Ratio is
40.0 forecast at 36%. DLX will aim to reinforce its strong financial position and high overall cash generation
20.0 20% ability. This will enable the Company to continue its current dividend payout ratio of 70% (divends paid
0.0 0% 2012 54.4 2011 38.6). With no more projected outlays for acquisition DLX will able to concentrate
resources on the growth of Alesco and offshore businesses while building the strength of core business
1 2 3 4 5 6 7 8 brands.
Dividends Paid Payout Ratio Housing market/Industry prospects
Source: Team Estimates Paints and coatings industry has had sluggish but positive revenue growth of 1.4% due to a weaker new
housing market over the last 12 months. On the upside renovations revenue growth has outstripped
demand for new housing with 6.6% growth over 2012 and is forecasted to remain strong over the next
year. Given that 40% of Dulux’s revenue comes from renovations alone this is a positive sign for the
upcoming months. The most important input titanium dioxide price has stabilised in the medium term
New Housing Approvals and is expected be steady in the long term. Crude petroleum, another vital input has also had a volatile
month peaking at over $100 per barrel but is not expected to rise further in the near future. Gardening
18000
supplies retailing, a highly fragmented and competitive industry has had relatively slow growth
16000
averaging 1.5% over the last 3 year period, the water restriction ban lifting has helped to lift the industry
14000 out of a shrinking position. Growth prospects remain small but positive in Paints and Coatings as well as
12000 Gardening supplies.
Units
10000
8000
6000
Possible investment risks
4000 As DLX is a stable business, the immediate risks to the company are small and unlikely. A further drop in
2000 new housing construction would have a negative impact on earnings, however this only makes up 20%
0 of earnings, with the rest centred on renovation and additional housing investment. Any spikes in input
cost prices can be moved through to customers as seen in the past year, minimising margin damages.
Jul-1983
Jul-1986
Jul-1989
Jul-1992
Jul-1995
Jul-1998
Jul-2001
Jul-2004
Jul-2007
Jul-2010
However longer term there are distribution channel risks, growth strategy risks and potential changes in
the competitive landscape.
Source: ABS
22/08/2013 6MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Valuation $ Weighting
Valuation
Current Share Price $4.42 We valued DuluxGroup by utilising two standard approaches: Multiples Analysis and Discounted Cash
Flow Analysis. The primary weighting is given to forward PER as it is the standard approach used
DCF $5.55 25% for Australian small-cap industrial companies and takes into account the capital structure, and
Forward PE (Global Paint dividend policy of the firm for which we believe is appropriate in assessing DLX’s forward market
Competitors) $4.83 50% value.
Forward PE (Domestic
Housing-related stocks) $4.55 25%
The incorporation of the DCF valuation provides a secondary valuation technique which we believed was
necessary as DLX’s future cash flows are relatively stable and capable of being accurately
Blended (target price) $4.94 captured. The DCF also provides an alternative cross-check that enables us to neutralise the
distortion that using a pure P/E ratio might have, as different companies have different funding
structures.
PE Multiples Valuation
Currently, DLX trades at a NTM forward P/E multiple of 17.14x, which is a 1.46% premium over the
DLX NTM Forward P/E median global paint competitors’ P/E multiple, and a 21.41% premium over the median
Multiple 17.14x domestic housing-related stocks P/E multiple. We believe that, after weighing up factors
Median Global Paint mentioned below, it is justified for DLX to trade at 10% and 30% premiums to the comparable
Competitors P/E Multiple 16.89x sets respectively.
Implied Premium 1.46% Valuation – Peer Group Analysis
Expected Premium 10.00%
P/E Multiple 18.579 We have segregated comparables analysis into two segments:
(1) Comparable global paint competitors
NTM EPS 0.26 Although the Dulux, Wattyl and Taubman brands control ~90% of the Australian consumer paints
market, Wattyl is owned by The Valspar Corporation and Taubman is owned by PPG
Equity Value (A$m) 1821.207 Industries, both offshore companies listed on the NYSE. As most of DLX’s other competitors are
also listed overseas, we grouped and compared multiples across global paint companies as part
Target value per share $4.83 of our comparables valuation.
(2) Domestic housing-related stocks
We made comparisons to domestic housing related stocks as we view them as an indirect comparison to
Global Paint Competitors: Forward P/E
DLX in terms of their operations in housing-related products.
ratio
Factors to consider when comparing DLX to global paint competitors:
35.00x They have different business compositions with varying end-markets, product ranges, mix between retail
30.00x and industrial consumers, and capital structures.
25.00x
20.00x They are at different points in their respective business cycles; the US housing market is recovering from
15.00x a cyclical trough, whilst the Australian housing market is at a cyclical low with near-to-medium
10.00x
5.00x growth prospects (eg. Australian renovation expenditure is growing faster than new housing).
0.00x DLX operates in a coatings industry that is highly consolidated and mature; 90% of the market is
dominated by three main competitors, and there has been a history of mergers between
companies being rejected by the ACCC (Wattyl and Taubmans merger was unsuccessful in 1996).
Factors to consider when comparing DLX to domestic housing-related stocks:
We believe DLX has a longer business cycle with less volatility than domestic housing-related companies
Source: Team Estimates
as the majority (64%) of their revenue is driven by maintenance and home renovation end-
consumers rather than new housing expenditure, which only accounts for 16% of the end
PE Multiples Valuation market sales post-acquisition of Alesco.
DLX NTM Forward P/E DLX also has a dominant lead in market share, owning ~40% of the market share in consumer
paints, which isn’t reflected in similar fashion by domestic housing-related stocks.
Multiple 17.14x
Median Domestic Housing-
Key justifications for why DLX is trading at a premium to comparable companies:
Related Stocks P/E Multiple 13.47x
Leading market position: DLX has the number one position in terms of market share across its key
Implied Premium 21.41% market segments (decorative coatings, woodcare coatings, powder coatings, DIY
adhesives, consumer garden care products) in Australia and New Zealand. The group has gained
Expected Premium 30.00% market share in its core Australian decorative paints business every year since 2005. It is
estimated DLX holds 40% of the market share in architectural and decorative paints alone. These
P/E Multiple 17.511 factors give DLX significant scale and ability to outspend competitors on marketing, research and
development and innovation.
NTM EPS 0.26 Strong brand equity: DLX has a competitive brand name; with 80% recognition in the consumer paints
markets. This allows DLX to maintain high market share, pass on high input costs to
Equity Value (A$m) 1716.517 consumers, and maintain profitability due to the loyal and trusted image painted in consumer’s
minds. However, it should be noted that international expansion can only able to be carried out
Target value per share $4.55 through acquisition or creating a new brand as Akzo Nobel NV own the Dulux brand name
offshore.
Established relationships with retail distribution channels: DLX holds ~60% shelf-space in Bunnings, and
Domestic Housing-Related Stocks: Forward P/E
with DLX’s recent decision to sever their tie with Masters, it is expected that they will be able to
ratio
leverage their existing relationship with Bunnings and garner more shelf-space for distribution.
The decision to withdraw from Masters’ and Danks’ corporate stores demonstrates DLX’s
significant market power and brand strength
25.00x
20.00x Higher profitability: DLX’s scale and market dominance have allowed the company to generate
15.00x
10.00x
competitive profit margins, being 7.5% last year and in the year prior to that – higher than Azko
5.00x Nobel’s profit margins of 6.5% and more than double Taubman’s profit margins of 2.99%.
0.00x Stability of earnings: DLX has had an average revenue growth of 8% over the last three years, and
exposure to the new housing development and construction is not exceedingly high, increasing
from 10% to only 20% following the acquisition of Alesco. Revenue is driven mainly by housing
renovations, which is much less volatile than new housing development and construction. In our
opinion, this translates into DLX offering greater earnings certainty.
Source: Team Estimates
22/08/2013 7MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Valuation – DCF
Forecasting assumptions:
Revenue growth was forecasted by business segment with consideration to industry and macroeconomic factors. We have
assumed EBIT margins to remain relatively stable. However the paints businesses will have slightly reduced margins as we have
forecasted higher raw material input costs. Alesco margins have also been forecasted to improve as DLX management has
identified Alesco as an area of improvement.
Capex has been forecasted to remain close to historical levels in proportion to revenues. Apart from the Alesco acquisition
completed in January, there does not seem to be any other major acquisitions in the pipeline. While international acquisitions
may be a possibility, it appears unlikely in the short to medium term as management is still focused on turning around
performance of DGL Camel – the most recent international acquisition of DLX.
Inventory, receivables and payables have been forecasted at historical levels of revenues to calculate working capital balances.
The terminal growth rate was calculated with the standard industry growth rate and long term average forecasted revenue
growth for DLX. Consideration was also given to DLX’s relatively limited international organic growth prospects.
Our earnings estimates are shown below:
Estimates (A$m)
Year End 2013E 2014E 2015E 2016E 2017E
Revenue
Paints Australia 639.7 658.9 672.1 688.2 706.8
Paints NZ 82.2 88.5 92.9 95.8 97.1
Selleys/Yates 253.9 261.5 268.8 273.7 279.7
Garage Doors & Openers (pro-forma) 161.2 165.4 168.7 173.4 176.9
Parchem (pro-forma) 121.1 124.2 127.6 130.7 134.6
Lincoln Sentry (pro-forma) 168.2 174.5 177.4 182.8 187.1
Offshore & Other 162.8 173.4 181.4 189.1 196.6
Eliminations -27.1 -28.2 -28.9 -29.7 -30.5
Total Revenue 1562.0 1618.1 1660.0 1703.8 1748.3
EBITDA 220.7 231.9 238.2 244.0 250.8
EPS (cents) 29.4 31.6 33.0 34.1 35.5
WACC:
The cost of equity was calculated using the CAPM. The model assumes a risk free rate of 5.0 % as a long-term estimate for the 10 Year Australian
Government Bond rate, a market risk premium of 5.8% sourced from A. Damodaran’s calculations and a levered beta of 0.71. The cost of debt is
6.3% which is DLX’s average interest rate on borrowings. The tax rate is 30%. These assumptions give us a WACC of 7.80%
DCF Valuation:
Using the assumptions stated above our DCF values DLX at A$5.55 per share. This values DLX at a forward P/E of 18.9x for financial year ending
2013.
22/08/2013 8MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Financial Analysis
Debt to Equity Ratio
Alesco Acquisition
3.00 The acquisition of Alesco saw the net debt-equity ratio increase to 2.5 in 2013 from 1.26 in 2012, which
2.50 will distort ROE moving forward. As this debt ratio is higher than historical periods (2010: 2.41) we
2.00
predict deleveraging moving forward as debt is paid off. Management has reported that cost synergies
from the acquisitions are greater than expected due to improvement in raw material and freight cost
1.50
procurement. We expect these acquisitions to begin to have material positive impact on earnings going
1.00 forward due to abovementioned cost synergies and the accompanying revenue growth when the
0.50 housing market rebounds.
0.00
2011A 2012A 2013F 2014F 2015F 2016F 2017F Cash Flows:
Source: Team Estimates
Operations
DLX has a strong capacity to generate cash flows from operations, with free cash conversion forecasted
to stabilise at over 60% in the long term (2017E:64.3%). In the analysed historical period DLX has
presented positive operating cash flow. Investing cash flow was negative last period due to higher
investments (Alesco), while capex dropped significantly. Historically capex has been relatively low, with
spending coming in lumps. DLX presented negative financing cash flow which was due to high level of
dividends.
Cash flow coverage
Gross Profit Margins DLX has been unable to internally generate all the necessary cash for covering investments and paying
out consistently increasing dividends. In previous years DLX has used outside sources of funding for any
Dulux PPG Azko Nobel company needs where cash flows are insufficient .Therefore DLX may potentially have trouble paying
consistent dividends at the planned payout ratio of 70% with operating cash, although we do believe this
2010 69% 48% 43% is unlikely. Unlike this year they will have no acquisition to fund. Operating cash flow has risen and with
the acquisition completed, cash flow will go to paying dividends and repaying debt. We predict the
2011 58% 48% 42% strong cash flow generating capacity of DLX will be able to support the additional interest payments, its
balance sheet, and also the dividend outlook. Overall cash sufficiency will be above 1 moving forward
2012 60% 51% 44% (2017E:1.52), enough to cover financing and capital maintenance. DLX liquidity ratios remained at
Source: Annual Reports relatively high levels (Current ratio 2012: 1.4 2011:1.47 ). We expect future level of liquidity ratios to be
sufficient in the projected period (Current ratio 2013E: 1.47) in the case that possible external sources of
financing will be needed for sustaining robust dividend policy. Earnings quality indicator has now moved
above one and we forecast it to stay stable in the future.
Margins
Industry Margins
Net Profit Margins DLX margins have been considerably stable over the long term, as well as significantly higher than
peers, indicating strong brand equity. Dulux has been resilient in the face of price competition and the
Dulux PPG Azko Nobel efforts of international brands (e.g Nippon Paints), as it continues to gain market share.
Pricing Power
2010 7.13% 5.15% 7.28%
While on paper DLX profit margins declined from 9.4% to 8.4%, the previous year’s profit included an
2011 7.47% 3.62% 7.16% insurance uplift, with like for like profit margins only dropping from 7.47% to 7.46%. Furthermore, the
gross margin (2012: 59.8%, 2011: 58.1%) actually increased. The stability of margins during adverse
2012 7.46% 2.98% 6.50% market conditions and rising input costs indicate the extent of DLX’s pricing power and the ability to pass
on costs to consumers. While input costs have trended upward DLX has kept margins stable, indicating
Source: Annual Reports the pattern of Tio2 prices in the future should have a minimal effect on profit margins. We expect
EBITDA margins to stabilise at 14%, due to the flow on of input costs, continued marketing effort and
stabilising cost inputs.
Segment Margins
However EBIT margins for the segments differ vastly . The Paints Australia division has a stable EBIT
margin of 17%, while NZ has stayed around 12%, Selleys Yates dropped from 12% to 10% this year, and
the Offshore businesses experienced a slight drop from 7% to 6%. We believe Selleys Yates will
DuPont Ratio 2012 contribute to the margin increases as they become less reliant on low margin products and Bunning’s
increases shelf space due to range reviews.
Profit Margin
7.46%
ROA 11.22%
DuPont Ratio
Asset Within the analysed period, Dulux has earned a high return on equity (2012: 43.5%, 2011: 53.7%). The
ROE 43.53% Turnover decrease in ROE can be attributed to the slight drop in profit margins and leverage from 2011 to 2012.
1.51% The stability of sales turnover indicates that leverage and profit margins will have the most significant
Asset/Equity impact on future ROE. The acquisition of Alesco has increased leverage and therefore lifted ROE in the
3.88 interim, however we believe DLX will deleverage moving forward. As the Alesco debt is paid off and
operating cash flow increases, we expect leverage to drop and therefore ROE to decrease. Our analysis
Source: Annual Reports
indicate ROE forecasts 2013E: 66.3% to 2017E: 41.8%. ROIC has followed a similar path to ROE dropping
from 2011: 26.7% to 2012: 22.1%, however it is still comfortably higher than the cost of capital (7.8%)
indicating the company is creating value for shareholders.
$230M New Debt from Alesco Acquisition: The all cash acquisition of Alesco will increase DLX’s leverage
significantly, lifting Net Debt/EBITDA from 2012: 1.52 to 2013: 2.20. However, interest payments have
only slightly increased for the half (13.3 to 10.6) due to the lower interest rates on new debt. EBITDA and
Profit coverage ratios are still strong enough to cover the increased interest expense. Strong cash flow
derived from the business negates the possibility of liquidity issues from the increased debt, with cash
flow more than adequate to cover interest payments. Although cash flow will be estimated to drop in
2013 this is due to net working capital movements from the merger. Therefore while leverage has
increased, due to the low cost of debt, predicted margin strength and stable coverage ratios, DLX will
most likely be able to begin paying off debt.
22/08/2013 9MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Corporate Governance and Social Responsibility
Management
The management team is composed of:
Patrick Houlihan: the CEO of DLX since 2007, has been with DLX for 24 years.
Stuart Boxer: CFO of DLX since 2008, and the five divisional general managers, with an average of 10 years’ tenure at DLX.
Given the time spent and expertise in the industry across the management team, we believe DLX is well managed. In addition to the
management team, DLX has also introduced the Company’s own audit and risk, remuneration, and safety and sustainability
committees, and provides high quality, transparent, and detailed annual reports, indicating that DLX values its communication relationship
with stakeholders.
Board
5 of DLX’s 7 board members are non-executive directors, indicating board independence is maintained. In addition, the board Chairman is a
non-executive director; in accordance with the Board Charter, non-executive directors on the board must be free from any business that
interferes with their ability to remain impartial, and that fetters or materially affects the judgment of their decisions. We believe the
Board’s adherence to the ASX principles and Board Charter, the company’s own code of ethics, show that DLX values board independence
and a firm relationship with shareholders, employees, and clients in every decision made.
Remuneration
Remuneration of non-executive directors, executive directors, and other key management personnel is composed of a fixed and ‘at-risk’
component to ensure incentives are aligned with shareholders best interests. The fixed component is based on
skills, knowledge, experience, individual performance, and the market median. Non-executive fixed pay was increased 3% last year, with
the maximum aggregate amount constant at $1.5m. The at-risk component rewards managers for achieving financial and business targets
linked to the company’s annual business objectives and increasing shareholder value through quantitatively measured hurdles, comprising
both a short-term and long-term equity incentive plan.
The short-term incentive (STI) requires that DLX’s NPAT is higher than a threshold figure, in 2012 the minimum performance level was set at
adjusted NPAT $77.6m. The long-term equity incentive plan (LTEIP) requires share price appreciation (TSR) and an EPS gateway to be
achieved. The gateway for the LTEIP in 2012 was for EPS growth over a 3 year period to equal or exceed 4% per annum. The reward is paid
out as in interest-free, vesting, non-recourse loan to purchase shares.
Given the structure of remuneration at DLX, it is likely management and directors will act in a manner that does not conflict with the
interest of shareholders and employees.
Social Responsibility
DLX has a proven track record of being involved in improving the corporate , environmental landscape through their focus on social
responsibility. DLX was the first to introduce water-based paints in the 1960s; offer low-VOC (volatile organic compounds) paint in the early
1990s; and the first to manufacture a line of carbon neutral paints certified by the Australian Greenhouse office; all due to major
environmental considerations in the paints manufacturing industry outlined by the Australian Paints Manufacturing Federation.
The move from solvent-based chemicals to water based chemicals has been a proven success, as DLX is currently the largest manufacturer
of water-based paints in Australia.
To compensate for waste production, DLX also realises the importance of allowing for an environmental provision in their balance sheet.
DLX’s exposure to environmental liabilities is assessed with estimation to their remediation of soil and untreated waste. DLX also has a
safety and sustainability committee to monitor operations and keep DLX’s business practices aligned with broader environmental concerns
and making sure social impacts are being mitigated. There are several external regulatory bodies that also ensure compliance to legislation
is being met. In light of the strong support that DLX has in maintaining social responsibility, in addition to their historic actions reflective
upon their environmental concerns, we believe DLX’s future operations will always reflect sustainable practices in support of its vision of ‘a
future without harm’.
22/08/2013 10MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Investment Risks
MARKET: Unexpected downturn in renovation spend: 64% of DLX’s sales are driven by maintenance and home improvement, making it the
key driver of the business. However, the RBA has recently cut the cash rate by 25 basis points to 2.5%, which could see a rise in new
housing as well as renovations spending, which would contribute to DLX sales.
MARKET: Decline in consumer confidence: a drop in consumer confidence will result in a drop in revenues of Dulux’ major segments as
consumers will be less inclined to purchase housing improvement products, hardware, and garden supplies. Major purchases and
renovations will decline as consumers will be less likely to spend disposable income.
OPERATIONAL: Distribution risks: the recent decision in withdrawing DLX’s premium paint and woodcare products out of Masters’ and
Danks’ corporate stores could negatively impact market position and overall sales. This may be justified by DLX’s reduction in Masters
and Danks stores’ servicing costs in, and the re-allocation of time and resources on improving focus on existing distributors (namely
Bunnings, Mitre 10, DLX trade centres, 3D inspiration).
OPERATIONAL: Key personnel risk: DLX’s price could take an unfavorable plunge if any of the key personnel were to leave their respective
positions. The fact that key management personnel have all been long serving industry professionals (current CEO has been at DLX
for over 20 years and other key management personnel have been at DLX for an average of 10 years each) is indicative of their loyalty
to the firm and highlights the unlikelihood that they will leave the Group.
FINANCIAL: Fluctuation in exchange rates: a portion of DLX’s raw material inputs are imported from overseas, making DLX particularly
vulnerable to a fall in the AUD/USD. DLX’s revenues are also sensitive to NZD, PGK and RMB exchange fluctuations through their
Paints NZ segment and operations in Papa New Guinea and China.
FINANCIAL: Change in market interest rates: DLX has exposure to interest rate risk primarily on their outstanding interest-bearing liabilities.
DLX’s net financial liabilities are currently estimated to be in excess of $450m.
FINANCIAL: Rise in input costs: DLX is susceptible to commodity price risk. The main ingredients influencing the cost of paint are titanium
dioxide, latex and resin. Increase in key inputs such as TiO2 (25% of DLX’s paint production costs) and crude petroleum can negatively
influence margins if costs cannot be passed onto customers. Historically, as a premium paint brand DLX has been able to pass these
costs on to consumers and their position in the market allows for a higher pricing structure leaving DLX’s competitors more
susceptible to this risk. Furthermore, DLX has a diversified range of suppliers domestically and internationally, increasing the breadth
of their input cost options, thereby further decreasing the financial burden of the risk. However, it should be noted that in recent
months titanium dioxide prices have eased, falling ~10% on average in FY13.
OTHER: Entry of new global player either domestically or from abroad: As seen by Nippon paints, there have been attempts from foreign
paint companies to break into the Australian paints market with little success, even though physical barriers to entry are low, there is
a high barrier to success in the coatings market, as it is difficult to compete without an existing and active brand name that is trusted
and well-developed by consumers.
If the impact of any of the risks highlighted above is more adverse than predicted, the stock will have some difficulty in achieving our target
price. Conversely, if the risks prove to be less than anticipated, the stock could trade above the target price we expect.
DLX’s principal risks are financial risks, and are mitigated by policies introduced by the Treasury department and approved by DLX’s Board of
Directors. They mainly involve investing excess liquidity, and using derivative and non-derivative financial instruments to hedge
against price and rate movements. We believe many of the financial risks are inherent in all globally diversified business settings and
are non-Dulux-specific.
RISK MATRIX
Entry of new
global player
high
either
domestically
Entry of new
global player Fluctuation in
Rise in input costs
either exchange rates
PROBABILITY
domestically
moderate
Entry of new
Unexpected
global player Change in market
downturn in
either interest rates
renovations spend
domestically
Entry of new Entry of new
Decline in
global player global player
Consumer Distribution Risk
either either
confidence
domestically domestically
Entry of new
Entry of new
global player
global player Key personnel Risk
low
either
either abroad
domestically
insignificant moderate severe
IMPACT
Market risk Operational risk Financial risk Other risk
22/08/2013 11MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Appendix I - Financials
Profit & Loss (A$m)
Year End 2011A 2012A 2013E 2014E 2015E 2016E 2017E
Revenue 996.4 1067.8 1562.0 1618.1 1660.0 1703.8 1748.3
EBITDA (excl significant items) 154.7 151.7 220.7 231.9 238.2 244.0 250.8
Depreciation & Amortisation 20.0 23.3 30.6 31.7 32.6 33.4 34.3
EBIT (excl significant items) 134.7 128.4 190.1 200.2 205.7 210.6 216.5
Net Interest 23.1 21.4 31.6 30.0 28.2 26.7 25.4
Pre-Tax Profit 111.6 107.0 158.5 170.2 177.5 183.9 191.1
Tax Expense 34.0 24.1 47.5 51.1 53.2 55.2 57.3
NPAT (incl significant items) 74.4 89.5 103.0 119.2 1.0 128.7 133.8
ESP cents (incl significant items) 25.7 24.3 27.3 31.6 0.3 34.1 35.5
NPAT (excl significant items) 74.4 79.6 110.9 119.2 124.2 128.7 133.8
EPS cents (excl significant items) 21.4 22.0 29.4 31.6 33.0 34.1 35.5
Sales Growth 3.4% 7.2% 46.3% 3.6% 2.6% 2.6% 2.6%
EBITDA Growth -0.8% -1.9% 45.5% 5.1% 2.7% 2.4% 2.8%
NPAT Growth (excl significant items) -14.5% 7.0% 39.3% 7.4% 4.3% 3.6% 3.9%
EPS Growth 26.6% 12.1% 22.6% 7.4% 4.3% 3.6% 3.9%
EBITDA Margin 15.5% 14.2% 14.1% 14.3% 14.4% 14.3% 14.3%
EBIT Margin 13.5% 12.0% 12.2% 12.4% 12.4% 12.4% 12.4%
NPAT Margin (excl significant items) 7.5% 7.5% 7.1% 7.4% 7.5% 7.6% 7.7%
Intereset Coverage - EBIT 5.1 7.2 5.4 6.7 7.3 7.9 8.5
Tax Rate 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0%
Return on Equity 53.7% 43.5% 66.3% 58.6% 51.6% 46.1% 41.7%
Return on Total Assets 11.1% 11.2% 11.1% 11.7% 12.1% 12.2% 12.4%
ROIC 26.7% 22.1% 24.4% 21.1% 21.4% 21.6% 21.7%
Dividends
Dividends per share (cents 15.0 15.5 20.5 22.0 23.0 24.0 24.5
Payout ratio 70.1% 64.6% 69.7% 69.9% 70.1% 70.6% 69.3%
Dividend Cover 1.4 1.4 1.4 1.4 1.4 1.4 1.4
Yield 3.3% 3.4% 6.7% 7.1% 7.4% 7.7% 8.0%
PE Ratio 21.5 21 16.2 14.0 13.5 13.0 12.5
Cash Flow Statement (A$m)
Year End 2011A 2012A 2013E 2014E 2015E 2016E 2017E
EBITDA 154.7 151.7 220.7 231.9 238.2 244.0 250.8
Changes in Working Capital -36.6 11.8 -50.1 -5.6 -4.1 -4.2 -4.3
Net Interest Received / (Paid) -26.2 -17.8 -35.2 -30.0 -28.2 -26.7 -25.4
Tax Paid -25.6 -27.5 -47.5 -51.1 -53.2 -55.2 -57.3
Other 19.7 -1.7 -14.0 0.0 0.0 0.0 0.0
Operating Cash Flow 86.1 116.5 73.9 145.3 152.7 157.9 163.7
Maintenance Capex -23.1 -18.2 -39.1 -40.5 -41.5 -42.6 -43.8
Net acquisitions/Growth Capex -42.9 -11.3 -258.0 0.0 0.0 0.0 0.0
Other 0.2 -34.5 35.0 0.0 0.0 0.0 0.0
Investing Cash Flow -65.9 -64.0 -262.1 -40.5 -41.5 -42.6 -43.8
Dividends Paid -38.6 -54.4 -77.3 -82.9 -86.7 -90.5 -92.4
Equity Issued 1.3 4.6 0.9 0.0 0.0 0.0 0.0
Net Borrowings 11.1 -6.3 250.0 -30.0 -30.0 -25.0 -20.0
Other 0.0 -7.1 0.0 0.0 0.0 0.0 0.0
Financing Cash Flow -26.2 -63.2 173.6 -112.9 -116.7 -115.5 -112.4
Effect of FX Translation 0.9 -0.3 0.0 0.0 0.0 0.0 0.0
Net change in cash -5.1 -11.0 -14.6 -8.2 -5.5 -0.2 7.6
22/08/2013 12MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Appendix II - Financials
Divisional Analysis (A$m)
Year End 2011A 2012A 2013E 2014E 2015E 2016E 2017E
Revenue
Paints Australia 580.6 613.9 639.7 658.9 672.1 688.2 706.8
Paints NZ 82.5 72.3 82.2 88.5 92.9 95.8 97.1
Selleys/Yates 248.9 244.6 253.9 261.5 268.8 273.7 279.7
Garage Doors & Openers (pro-forma) 161.2 165.4 168.7 173.4 176.9
Parchem (pro-forma) 121.1 124.2 127.6 130.7 134.6
Lincoln Sentry (pro-forma) 168.2 174.5 177.4 182.8 187.1
Offshore & Other 113.8 154.6 162.8 173.4 181.4 189.1 196.6
Change in Revenue
Paints Australia 4.3% 5.7% 4.2% 3.0% 2.0% 2.4% 2.7%
Paints NZ 3.9% -12.4% 13.7% 7.6% 5.0% 3.1% 1.4%
Selleys/Yates 7.8% -1.7% 3.8% 3.0% 2.8% 1.8% 2.2%
Garage Doors & Openers (pro-forma) 2.6% 2.0% 2.8% 2.0%
Parchem (pro-forma) 2.6% 2.7% 2.4% 3.0%
Lincoln Sentry (pro-forma) 3.7% 1.7% 3.0% 2.4%
Offshore & Other -7.9% 35.9% 5.3% 6.5% 4.7% 4.2% 4.0%
EBIT
Paints Australia 102.4 101.0 106.8 109.4 110.2 112.2 115.2
Paints NZ 9.7 8.1 9.5 10.0 10.5 10.8 11.2
Selleys/Yates 30.5 24.9 30.7 32.7 33.6 34.2 35.0
Garage Doors & Openers (pro-forma) 23.7 25.1 25.8 26.5 27.1
Parchem (pro-forma) 13.3 14.9 15.8 16.2 16.7
Lincoln Sentry (pro-forma) 10.1 11.3 12.4 12.8 13.1
Offshore & Other 7.7 9.8 11.4 12.1 12.7 13.2 13.8
EBIT Margins
Paints Australia 17.6% 16.5% 16.7% 16.6% 16.4% 16.3% 16.3%
Paints NZ 11.8% 11.2% 11.5% 11.3% 11.3% 11.3% 11.5%
Selleys/Yates 12.3% 11.0% 12.1% 12.5% 12.5% 12.5% 12.5%
Garage Doors & Openers (pro-forma) 14.7% 15.2% 15.3% 15.3% 15.3%
Parchem (pro-forma) 11.0% 12.0% 12.4% 12.4% 12.4%
Lincoln Sentry (pro-forma) 6.0% 6.5% 7.0% 7.0% 7.0%
Offshore & Other 6.8% 6.3% 7.0% 7.0% 7.0% 7.0% 7.0%
22/08/2013 13MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Appendix III - Financials
Balance Sheet (A$m)
Year End 2011A 2012A 2013E 2014E 2015E 2016E 2017E
Assets
Current Assets
Cash 39.5 28.5 13.9 15.3 14.2 13.5 20.6
Net Recievables 169.7 170.7 238.5 247.1 253.5 260.2 267.0
Inventories 135.7 129.2 186.9 193.1 198.1 203.4 208.6
Other 3.3 3.6 3.6 3.6 3.6 3.6 3.6
Total Current Assets 348.2 332.1 442.9 459.1 469.4 480.7 499.8
Non-current Assets
Property, Plant and Equipment 196.4 199.1 285.4 297.0 308.9 321.1 333.6
Intangibles 87.0 96.8 225.7 222.9 220.0 217.0 213.9
Other 37.1 81.8 46.1 46.1 46.1 46.1 46.1
Total Non-Current Assets 320.5 377.7 557.2 566.0 574.9 584.2 593.6
Total Assets 668.7 709.8 1000.1 1025.1 1044.3 1064.9 1093.5
Liabilities
Current Liabilities
Accounts Payable 193.4 199.7 275.1 284.3 291.6 299.4 307.1
Borrowings 15.7 13.5 13.5 13.5 13.5 13.5 13.5
Provisions/Other 28.5 24.4 24.4 24.4 24.4 24.4 24.4
Total Current Liabilities 237.6 237.6 313.0 322.2 329.5 337.3 345.0
Non-current Liabilities
Borrowings 245.9 245.2 495.2 475.2 450.2 425.2 405.2
Provisions/Other 46.7 44.1 24.4 24.4 24.4 24.4 24.4
Total Non-current Liabilities 292.7 289.3 519.6 499.6 474.6 449.6 429.6
Total Liabilities 530.3 526.9 832.6 821.8 804.1 786.9 774.6
Equity
Shareholder Capital 175.6 172.7 173.6 173.6 173.6 173.6 173.6
Reserves/Retained Profts -105.2 -105.3 -105.3 -105.3 -105.3 -105.3 -105.3
Retained Profits 68.1 102.5 86.3 122.0 159.0 196.7 237.6
Outside Equity Interests 0.0 13.0 13.0 13.0 13.0 13.0 13.0
Total Equity 138.5 182.9 167.5 203.3 240.2 277.9 318.8
Total Liabilities and Equity 668.7 709.8 1000.1 1025.1 1044.3 1064.9 1093.5
22/08/2013 14MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Appendix IV - Financials
Key Financial Ratios
Year End 2011A 2012A 2013E 2014E 2015E 2016E 2017E
Liquidity Ratios
Cash Ratio 0.17 0.12 0.04 0.05 0.04 0.04 0.06
Quick Ratio 0.89 0.85 0.82 0.82 0.82 0.82 0.84
Current Ratio 1.47 1.40 1.41 1.42 1.42 1.42 1.45
Efficiency Ratios
Asset Turnover 1.49 1.51 1.56 1.58 1.59 1.60 1.60
NWC Turnover 9.01 11.34 13.67 13.40 12.87 12.31 11.73
Accounts Receivable Turnover 6.45 6.27 7.63 6.66 6.63 6.63 6.63
Days Receivable Outstanding 62.16 58.35 55.74 55.74 55.74 55.74 55.74
Accounts Payable Turnover 2.54 2.19 2.70 2.38 2.37 2.37 2.37
Days Payable Oustanding 83.86 79.57 74.87 74.87 74.87 74.87 74.87
Cash Cycle 37.14 30.26 31.72 31.72 31.72 31.72 31.72
Profitability Ratios
Gross Profit Margin 58.05% 59.77% 58.91% 58.91% 58.91% 58.91% 58.91%
EBITDA Margin 15.5% 14.2% 14.1% 14.3% 14.4% 14.3% 14.3%
EBIT Margin 13.5% 12.0% 12.2% 12.4% 12.4% 12.4% 12.4%
NPAT Margin (excl significant items) 7.8% 7.5% 7.1% 7.3% 7.5% 7.5% 7.6%
Assets/Equity (Leverage Financing) 4.83 3.88 5.98 5.05 4.35 3.83 3.43
Return on Equity 56.0% 43.5% 66.3% 58.5% 51.5% 46.2% 41.8%
Return on Total
Assets 11.6% 11.2% 11.1% 11.6% 11.8% 12.0% 12.2%
ROIC 26.7% 22.1% 24.4% 20.9% 21.0% 21.2% 21.2%
Solvency Ratios
Debt Ratio (Liabilities/Assets) 0.79 0.74 0.83 0.80 0.77 0.74 0.71
Debt/Assets Ratio 0.39 0.36 0.51 0.48 0.44 0.41 0.38
Debt to Equity Ratio 1.89 1.41 3.04 2.41 1.93 1.58 1.31
Net Debt to Equity Ratio 1.60 1.26 2.96 2.33 1.87 1.53 1.25
Net Debt to EBITDA 1.44 1.52 2.24 2.04 1.89 1.74 1.59
Times Interest Earned Ratio (EBIT) 5.83 6.00 6.01 6.54 7.09 7.67 8.27
Times Interest Earned Ratio (EBITDA) 5.90 8.52 6.27 7.58 8.22 8.89 9.58
Cash Flow Interest Coverage Ratio 5.1 6.47 7.5 6.43 7.18 7.8 8.44
Profit Interest Coverage Ratio 3.36 3.72 3.51 3.88 4.26 4.67 5.09
Debt to Operating Cash Flow 3.04 2.22 6.88 3.37 3.05 2.79 2.57
Cash Flow Ratios
Internal Financing of Capex (CFO/CAPEX) 1.79 4.70 0.80 4.71 4.82 4.83 4.83
Overall Ratio of Cash Sufficiency 0.85 1.40 0.37 1.60 1.61 1.57 1.52
Earnings Quality CFO(NI+DA+ΔNWC) 0.90 1.52 1.26 1.24 1.25 1.24 1.23
Free Cash Flow Conversion -7.09% 79.71% -127.62% 60.49% 62.98% 63.53% 63.99%
Cash Flow Conversion (CFO/EBITDA) 76.16% 91.30% 109.64% 83.62% 84.49% 84.53% 84.57%
Operating Cash Flow to NPAT 1.11 1.30 0.72 1.22 1.23 1.23 1.22
22/08/2013 15MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Appendix V – DCF Valuation
Discounted Cash Flows - DuluxGroup (A$m)
2013 2014 2015 2016 2017 2018
EBITDA 220.7 231.9 238.2 244.0 250.8 255.1
Less: Depreciation and Amortisation (30.6) (31.7) (32.6) (33.4) (34.3) (35.2)
EBIT 190.1 200.2 205.7 210.6 216.5 219.9
Less: Taxes (47.5) (50.9) (53.0) (54.9) (57.1) (58.5)
Add: Depreciation and Amortisation 30.6 31.7 32.6 33.4 34.3 35.2
Less: Change in Net Working Capital (50.1) (5.6) (4.1) (4.2) (4.3) (4.2)
Less: Capex (262.1) (40.5) (41.5) (42.6) (43.8) (44.9)
Unlevered free cash flow to firm (139.0) 134.9 139.6 142.2 145.7 147.5
Discount Period 0.05 1.05 2.05 3.05 4.05 5.05
Discounted Cash Flows (14.4) 124.8 119.9 113.4 107.8 101.4
Beta Regression of
DLX- DCF Assumptions and Output 0.06
Stock Return
DLX on ASX200
Discount Rate (A$m) 7.71%
Terminal Growth Rate 2.50% 0.05
Terminal Value (A$m) 2905
PV of Terminal Value (A$m) 1,996
0.04
Sum of PV of Cash Flows (A$m) 553
Enterprise Value (A$m) 2,549
0.03
less Net Debt (A$m) (457)
Implied Equity Value (A$m) 2,092
Shares Outstanding (m) 377 0.02
Implied Share price (A$) 5.55
0.01
WACC Calculation
Target Capital Structure
Debt weighting 30% 0 Market Return
Equity weighting 70%
-0.03 -0.01 0.01 0.03
Cost of Debt
-0.01
Cost of Debt 6.30%
Tax rate 30%
After-tax cost of debt 4.41% -0.02
Cost of Equity
Risk-free rate 5.00%
Equity market risk premium 5.80% -0.03
DLX levered beta 0.71
y = 0.7135x
Cost of Equity 9%
-0.04
WACC 7.71%
DLX DCF Sensitivity Analysis (A$)
WACC
5.55 6.30% 6.80% 7.30% 7.80% 8.30% 8.80% 9.30%
Terminal Growth
1.50% 6.40 5.67 5.07 4.57 4.14 3.77 3.44
2.00% 7.14 6.26 5.55 4.96 4.47 4.05 3.68
Rate
2.5% 8.07 6.99 6.13 5.43 4.86 4.37 3.96
3.00% 9.29 7.91 6.84 6.00 5.32 4.75 4.28
3.50% 10.95 9.10 7.74 6.70 5.88 5.20 4.65
22/08/2013 16MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Appendix VI – Dulux’s Brand Portfolio
Coatings
Home Improvement
Construction Products & Equipment
Garage Doors & Openers
Garden Care
Cabinets, Window Products & Appliances
Source: Dulux website
22/08/2013 17MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Appendix VII – Dulux’s Asia Pacific Reach
Source: Dulux Presentation
22/08/2013 18MonashTeamC2013
University CFA Institute Research Challenge: DuluxGroup
Appendix VIII - Economic Outlook
Key Economic The Australian economic outlook is an important factor to consider when looking to invest in Dulux.
Information Dulux segment revenues are all closely related and are impacted by economic growth, inflation and
employment. It is less sensitive to global market forces as the majority of its segments are positioned
Target Cash Rate 2.50% and focused in the Australian and New Zealand area. It is to be noted however, that the input costs for
many of Dulux’s major segments are in USD and there is a risk of further AUD drops leading to higher
Inflation Rate 2.40% costs.
GDP Growth 2013 to
date 2.60% Australian GDP
The Australian economy is still growing at below historical rates at 2.4% over 2012 but is showing signs
Unemployment Rate 5.70% of acceleration growing 2.6% for 2013 up to June. The rate cuts have been an attempt by the RBA to
attract increase international competitiveness and continue the expansion of Australia’s output.
LFPR 65.10%
Exchange Rate AU/US $ 0.8991 Inflation
The June inflation numbers of 2.4% CPI signalled that inflation is well contained as price levels have
M1 as of July 2013 ($B) 276.6 stabilised this year. This is further evidenced by the cutting of the target cash rate in August.
M3 as of July 2013 ($B) 1572.7
Employment
Source: RBA The labour force is relatively unchanged with participation rates not dropping blow 65% and
unemployment edging higher up to 5.7% in July. If unemployment continues to move upward, it will be
Number of New Dwellings Approved a focus for the RBA to target a more active labour force along with a growing economy.
since Dulux's IPO
Availability of Credit and Exchange Rate
10000
8000
With the target cash rate at 2.5% an all time low, the RBA is taking a highly expansionary monetary policy
6000 to target spending in interest sensitive spending. The repercussions of this have also been felt in the
4000
2000 AUD dropping 15% since April. The decision to leave the cash rate at 2.5% may lead to a further drop
0 which may incentivise growth in exports and other domestic investment.
Nov-2010
Nov-2011
Nov-2012
Jul-2010
Jul-2011
Jul-2012
Mar-2011
Mar-2012
Mar-2013
More specifically Dulux sales are particularly sensitive to:
Source: ABS
The building and approvals of new dwellings
Dwelling approvals have been stable and on the rebound after a substantial hit in mid 2012. Although it
is yet to hit the levels at Dulux’s IPO, it is a positive sign of recovery on the housing market as a whole.
Weekly Average Equivalised Disposable
Income
Disposable Income
As inflationary pressures stabilise and interest rates are lowered to all time lows, disposable income has
2,000 eased and is at it’s highest index point showing that consumers are more willing to spend on renovations
or other discretionary purchases including paint, gardening products and other home renovation
1,500 Lowest quintile products.
1,000 Second quintile
Renovation Activity
500 Third quintile
With the RBA’s target cash rate at all time lows, the housing market has seen major improvements and it
0
Fourth quintile is likely that further capital will move to property in the form of building and renovation of houses.
Given that the majority of DuluxGroup’s revenue arises from new housing and renovations alone, this is
Highest quintile seen as a potential driver of new and growing demand for paint products, gardening products, home
maintenance, garden care, garage doors and openers, cabinets, windows & appliances, and specialty
coatings.
Source: ABS
Consumer Sentiment
Westpac’s consumer sentiment index has hit 105.7 as of August 14th 2013, 4 points above the 3 year
average, showing in particular that households are 23% more confident about their finances in the
upcoming 12 months compared to last year, and are 14.7% more confident in buying a dwelling
compared to August last year. This is a positive sign for Dulux’s coming year as consumers are more
willing to spend in general particularly housing due to financial security
Westpac Consumer Sentiment Report
Average Aug-11 Aug-12 Jul-13 Aug-13 % Month % Year
Consumer Sentiment Index 101.7 89.6 96.6 102.1 105.7 3.5 9.4
Family Finances a year ago 89.8 71.8 78.2 78.6 88.8 13 13.5
Family Finances next 12 months 108.5 87 91.8 103 113 9.7 23
Economic Conditions next 12 months 90.4 73.2 92.8 95.1 100.3 5.5 8
Economic Conditions next 5 years 90.9 88.3 94.9 103 102.5 -0.4 8
Time to buy a major household item 128 127.7 125.4 131.1 123.9 -5.5 -1.2
Time to buy a dwelling 123.2 114.6 118.5 131.3 136.2 3.7 14.9
Time to buy a vehicle 122.5 120.8 126.3 124.2 130.9 5.4 3.7
Source: Westpac
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