EVA Training.ppt

new york chicago los angeles london paris milan munich tokyo sao paulo singapore sydney johannesburg shanghai introduction to eva management system contents v what is eva? v the calculation of eva v the eva management system contents v what is eva? v the calculation of eva v the eva management system eva is earnings after the cost of capital revenues - operating costs - depreciation -/+ adjustments - taxes = operating income after tax (nopat) - capital x c% capital charge = eva objective: objective: continuous improvement in evacontinuous improvement in eva p/l b/s the intrinsic value is the determinant of the market value in efficient capital market intrinsic intrinsic valuevalue financial financial measuresmeasures operating operating metricsmetrics mva, stock price eva roi, capital turnover, margin market share, unit cost, scrap rate, delivery time competitive strategy business model management system operating efficiency market market valuevalue us as example 50% 40% 30% 20% 10% correlation with stock price eva roe cash flow eps revenue as a measure of business intrinsic value, eva correlates with stock price better than other measures eva measure gives more insights into the business from enrons 2000 annual report (letter to shareholders): enrons performance in 2000 was a success by any measurethe companys net income reached a record in 2000. enron is laser-focused on earnings per share, and we expect to continue strong earnings performance. (in mil) net inceps eva (in mil) contents v what is eva? v the calculation of eva v the eva management system 9 from the traditional accounting model to the economic model of the firm accounting framework eva framework adjustments p other financing) in the eva framework, we must turn the accounting model into an economic model 13 cost of debt cost of capital ? % + cost of equity ? %? % the cost of capital comprises both debt & equity costs risk free rate equity risk premiumdebt premium (credit spread) 14 cost of equity capital (required return by equity holders) risk () risk-free rate rf market risk premium mrp (rm - rf ) relationship between risk and return market risk = 1 cost of equity = rf + (beta x mrp) a beta value is required to determine cost of equity 15 in general, a higher business risk implies higher beta value, hence higher cost of equity 16 to calculate beta, a list of peers need to be identified for client v a peer company is not necessarily a competitor, but rather a company engaged in principally similar business subject to the same underlying economic forces. they may be competitors or companies in similar industries and business environments. v peer comparisons are used to : derive betas for the respective business units and the corporation to facilitate cost of capital (coc) calculations. non-listed companies, wholly-owned subsidiaries and business units do not have publicly traded shares from which to measure the levered betas. where possible, a pure-play analysis of publicly traded peer companies is used to estimate the unlevered beta, or bri. this is then translated into the levered beta for that company, using the capital structure and the cost of debt. benchmark eva performance and identify value drivers. contents v what is eva? v the calculation of eva v the eva management system 18 strategystrategy formationformationgoal settinggoal setting planning &planning & budgetingbudgeting executionexecutionevaluationevaluationmotivationmotivation evaevaevaevaeva value value basedbased managementmanagement eva provides a comprehensive value management framework to translate strategy into action 19 from eva goal setting to execution eps consensus estimates industry data benchmarking internal forecasts simulations of past history client strategic goals consolidated eva growth goal business unit eva growth goals operating plans capital plans results/outlook reporting eva plans reasonableness check market expectations internal forecasts accuracy check goal setting is not an issue of the right number, but one of alignment alignment 20 goal setting and benchmarking 21 in the eva framework, market value can be broken down into future growth value and current operations value capital pv of current eva in perpetuity pv of eva improvement mva = present value of current eva + present value of expected improvements to current eva future growth value (fgv) current operations value (cov) market value market value added (mva) capital 22 future growth value represents an expectation of increase in eva market value current operations value (cov) future growth value (fgv) expected improvements in eva qfuture growth value represents the premium on the value of current operations (capital + eva/c*). qthe presence of a future growth value, which equals pv of all future eva improvements, signals the managers that owners/investors expect increases in eva. qincreases in eva will also drive increases in mva. as a result investor wealth will go up as well. 23 applying “industry average growth expectations” to clients 1999 eva, we estimate an fgv of $691m fgv 39% cov 61% 1999 client eva 1999 cov 1,069m fgv ? vif we know clients 1999 cov is $1060m (cov = 1999 capital + 1999 eva / wacc) then we can calculate fgv based on the industry average cov:fgv ratio of 69:31 v1999 eva could be considered an abnormally good year for client, so applying an average eva from 97-00 (a lower eva), the fgv for client would come out to $319m estimated fgv (using 1999 eva) fgv 691m conservative clients industry ratio 1999 cov 1,069m capital 526m eva / c 544m estimated fgv (using avg. 97-00 eva) fgv 319m 97-00 cov 493m 24 taking clients fgv of $691m, we convert it into implied annual expected improvements in eva (ei) 2000 cov $(18m) fgv $691m 20012003200220042005 . 2010 expected improvement (ei) $26 million market value $673m assuming client were to achieve this eva growth over a 10 year period, annual eva improvements would have to be $26 million a year. fgvei (for 10 years) aggressive$691m$26m per year conservative$319m$12m per year 25 to achieve eis, management should first understand the current eva by focusing on return on capital margin xturnover=roc scenario a 20%x0.75= 15% scenario b 5%x3.0= 15% nopat capital profit margin capital turnover x return return on capitalon capital nopat sales sales capital x or dissecting the rate of return brings to light the trade-offs between profit margin and capital efficiency. = a company could achieve a 15% return by either: 26 a company can use roc curves to understand and map out its strategy to improve returns 27 client 1999 client 2000 client peers use fundamentally different business strategies to create value in the industry 28 total operation expense margin 0% 20% 40% 60% 80% 100% 120% baltrans egl exped. client 1999 client 2000 airborne atlas cnf fedex ups average % of sales nopat margin -5% 0% 5% 10% 15% 20% 25% 30% 35% baltrans egl exped. client 1999 client 2000 airborne atlas cnf fedex ups average % of sales variable expenses margin 0% 10% 20% 30% 40% 50% 60% 70% 80% egl exped. client 1999 client 2000 airborne atlas fedex ups average % of sales fixed expenses margin 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% egl exped. client 1999 client 2000 airborne atlas fedex ups average % of sales benchmarking nopat margins give client a sense of how it falls in terms of operating efficiency note: baltrans and cnf removed from variable and fixed expense drivers analysis due to insufficient data 29 capital charge margin 0% 5% 10% 15% 20% 25% 30% 35% 40% baltrans egl exped. client 1999 client 2000 airborne atlas cnf fedex ups average % of sales nwc capital charge margin 0% 1% 2% 3% 4% 5% 6% 7% baltrans egl exped. client 1999 client 2000 airborne atlas cnf fedex ups average % of sales fixed assets charge margin 0% 5% 10% 15% 20% 25% baltrans egl exped. client 1999 client 2000 airborne atlas cnf fedex ups average % of sales other capital charge margin -2% 0% 2% 4% 6% 8% 10% 12% baltrans egl exped. client 1999 client 2000 airborne atlas cnf fedex ups average % of sales capital benchmarking points to working capital and fixed assets as an opportunity for client to drive eva upwards 30 summary of benchmarking study 1999 data in thousands of usd company / itemsbaltranseglexped. client 1999client 2000 airborneatlascnffedexupsaveragebest in class sales100%100%100%100%100%100%100%100%100%100%100%100% var. exp / sales97%62%69%34%54%34%11%n/a14%8%17%8% fixed exp / salesn/a16%23%45%45%58%59%94%79%78%74%16% selling / sales n/a15%1%1%1%2%0%n/a0%0%1%0% - operation expenses / sales97%92%94% 80%101%95%71%94%93%85%88%23% - tax / sales 0%3%1%1%0%2%12%2%5%4%5%0% + other income / sales2% 1%0%0%0%1%15%1%4%-6%3%15% = nopat margin 5%5%5%20%-1%4%32%5%7%5%7% nwc charge / sales1%1%1%6%6%0%5%0%0%1%1%0% fixed assets charge / sales1%0%1%2%3%3%21%2%4%5%7%2% other assets charge / sales0%1%0%-1%3%1%10%2%5%0%4%0% - capital charge / sales3% 3%2%8%12%5%36%4%9%6%12% = net margin 2%2%3%11%-13%-1%-4%1%-2%-1%-5% x sales 172,127595,1731,444,57519,53413,4183,140,226637,0815,592,81016,773,47027,052,000 =eva3,25912,63845,4452,240(1,726)(24,340)(22,405)68,874(361,190)(261,400) 31 looking at best in class margin and turnover, we can chart the eva of client under different scenarios (b) achieve best in class turns (d) achieve best in class roc (a) achieve best in class nopat margin (c) also best in class turns historypeer benchmarkclient forecast client 97-99best in class 97-99companyclient, inc. 2000-2005 nopat margin1