The Oshawa
Group
Limited
The Financial Analysts
By: Melissa Gottschall, Scott Duggan, Blair MacLaughlin, Jillian Marchand,
Jacob Baker, & Cary Konopka
4/7/2014
Company Analysis:
Oshawa Group limited was found in 1951 by Ray Wolfe. It was a food retail, wholesale and
distribution company. The Wolfe family is still active in the operations of the firm. Through its 47 years of
business, Oshawa Group limited has grown and diversified itself through products and geographical locations.
Today, Oshawa Group limited offers 845 locations across Canada. Oshawa Group limited has a strong and
experience management team that is focuses on creating shareholder value for its current shareholders. Their
board of directors has grown to include such people as Charles Winograd (Deputy Chair of RBC Dominion
Securities), Lawrence Stevenson (President and CEO of Chapters) and Donald Carr (Partner of Goodman and
Carr). Oshawa currently boasted the second highest net sales within its industry, with a 12.7% market share.
Though the company has grown, they continue to offer their .10 no cumulative dividends.
Recently, Oshawa Group limited has undergone a restructuring to enhance shareholder value. The
restructuring included the sale of non-core holdings, such as the Pharma Plus drug store operation, Langs cold
storage facilities, and the non-strategic real estate. Oshawa furthered its expansion in the food business by
acquiring Scott National, concentrating on main stream food retailing.
Oshawa Group Limited is a family owned corporation, where all voting shares are owned by five Wolfe
family members. Though the company still offers publically traded shares, they are non-voting. Recently,
Oshawa Group has experienced decreased net earnings, and is currently yielding the lowest EBITDA margins in
the industry. They are also experiencing the lowest share price appreciation within their industry. Though the
company boasts high sales, they are lacking in net earnings, showing decreased value to shareholders.
Industry Analysis:
The grocery business in Canada is characterized by a highly competitive environment. With the threat of
competitors including other major grocers and discount retailers, the importance of market share cannot be
understated. Given the low margins of grocery businesses, acquiring market share becomes ever more important.
Acquisitions are the main form of expansion as it is often cheaper to acquire a competitor over opening new
stores.
Some key success factors of the grocery business in Canada include competitive pricing, customer
loyalty, and market share. To be a successful and competitive company in the Canadian grocery industry, a
company must engage in competitive pricing. Competitive pricing is important in gaining initial customers which
will result in an increase in market share. This not only helps the business gains new customer but also helps
generate loyal customers.
Revenue is generated through repeat customers. Customer loyalty can be generated through loyalty
programs such as reward programs and customer appreciation efforts. This will give the company an edge over
competition. Loyal customers will reduce marketing costs and create a more focused marketing strategy.
Therefore, it is cheaper to have loyal customers than acquiring new ones. Customer loyalty benefits both the
business and the customers. The company benefits from customer loyalty by saving money and time on
marketing efforts, while the customer is rewarded for their loyalty with reward programs and customer
appreciation efforts.
As mentioned earlier, the grocery industry is highly competitive and is a very low margin business.
This means that it is essential to have high market share. It is more cost effective to acquire market share than it
is to open a new store. Currently, Empire has 5.6% of industry sales and with the acquisition of The Oshawa
Group ltd., it would increase their grocery sales by $6.8 billion with a 12.7% increase in market share giving
them a total market share of 18.3%. To make up for low margins typically found in the grocery business, a
greater volume in sales is needed to offset these margins. This acquisition would fault empire into the number
two position in the grocery industry based on sales.
After reviewing the key success factors of the grocery business, we must turn our attention to the shape
of the economy if Empire hopes to confidently acquire Oshawa Group Inc.
Asian and Russian economies were suffering in economic crises, resulting from defaults on corporate
and government debt. These defaults lead to currency devaluations and ultimately lowered the supply of goods in
demand from major exporters including Canada. This crisis indirectly effected Canada by reducing the corporate
profit expectations for the year. Devaluation of the Canadian dollar was also attributed to the extremely low
interest rates employed by the Bank of Canada. The Canadian dollar at this time was worth a mere US$0.65.
Real gross domestic product (GDP) had substantially grown since 1992 and GDP forecasts currently
look promising in the future. This information however must be taken with a grain of salt as the increased risk
from negative global economic conditions will surely effect these GDP estimations.
Valuing Oshawa as a Stand-Alone Business:
Free Cash Flows (in millions)
Revenue
Less: Costs
EBITDA
Less: Depreciation
EBIT
1998
6813.1
6651.7
161.4
66.2
95.2
1999 E
7221.9
7034.1
187.8
72.2
115.6
2000 E
7655.2
7456.2
199.0
76.6
122.4
2001 E
8114.5
7903.5
211.0
81.1
129.9
2002 E
8601.4
8377.7
223.6
86.0
137.6
2003 E
9117.5
8880.4
237.1
91.2
145.9
Less: Taxes (40%)
Net Opetating After Taxes
38.1
57.1
46.2
69.3
49.0
73.5
52.0
77.9
55.1
82.6
58.3
87.5
Plus: Depreciation
Less: Changes in Working
Capital
Less: Capital Expenditures
Less: Changes in Other Assets
Plus: Changes in Other
Liabilities
66.2
72.2
76.6
81.1
86.0
91.2
-30
130.0
75.5
15
144.4
0
15
134.0
0
15
121.7
0
15
107.5
0
15
91.2
0
11.8
0.00
0.00
0.00
0.00
0.00
$(40.38)
$(17.88)
$1.05
$22.35
$46.08
1.0790
1.0790
$(16.57)
1.1642
$0.90
1.2562
$17.79
1.3555
$33.99
$72.51
$1,414.96
$1,487.47
1.4625
$1,017.05
Unlevered Free Cash Flow
Terminal Value
TV + CF5
Discount Value (WACC)
PV of FCF
EV
$1,053.17
When assessing the stand-alone value of Oshawa, we predicted the pro-forma 5-year revenue
projections based off a growth rate of 6%. We are maintaining an EBITDA margin of 2.6% of revenue for all
years. Depreciation for Oshawa has also had steady growth with sales, as it was approximately 1% of sales
annually.
Capital expenditures decreased from two to one percent of revenue over the 5-year period. We
assumed that other assets and other liabilities would remain constant. We also assumed that working capital
would change on average by 15 million a year based of our revenue projections (See Appendix 1). We than
calculated the present value of our free cash flows using our calculated terminal value and discount rate WACC.
For a final valuation of Oshawa alone, we got $1,053.17
Valuing Terminal Value:
When valuing our terminal value, we chose to use the value giving by our perpetuity method because we
believed it personify a more objective reasoning. There are two methods to valuing the terminal value of Oshawa
Group Limited.
1) Using the perpetuity method. This involves calculating the long term growth of Oshawa Group. We
determined that their long term growth would be estimated at 2.64%. We assumed a constant growth rate
within the firm because it is a mature company. To calculate the terminal value, we forecasted the free
cash flow for 2004, by multiplying our 2003 FCF by our growth rate, and dividing the value by our
WACC minus our growth rate. This gave us a terminal value of 1. 414.96 billion dollars at the end of
2003.
Net Reinvestment
NOPAT (1998)
Roc
Reinvestment rate
Estimated LT growth rate
g
WACC (r)
FCF(2003)
Terminal Value
Formula
CapEx + Change in WC - Dep
NOPRAT/total assets
Net Reinvestment/NOPAT
ROC*Reinvestment rate
$
2.64%
7.90%
72.51
1,414.96
39.8
57.12
3.79%
70%
2.64%
2) Using the method of comparables, we ranked the comparable companies EBITDA multiples. When
choosing a multiple, it is important to be aware of outliers that could skew the data. Therefore, we chose
a multiple of 6.8X. This multiple removes the data of Loblaws, which skews the data of the remaining
multiples.
Company
Empire
Loblaws
Metro-Richelieu
Provigo
Oshawa
Average Multiple
Median Multiple
AVG without Loblaws
Best Multiple
EBITDA(1998)
Terminal Value (EV)
EBITDA multiple
$
7.8
13.6
6.0
5.8
6.7
8.0
6.7
6.6
6.8
161.4
1,097.52
Valuing the Synergies with Empire:
As noted in the chart below, we look at two different types of changes in regards to new firm value from the
acquisition. The first of which is changes to EBITDA and the second being total operational cost savings.
Maximum Potential Synergistic Savings
(in millions)
Initial Charges= 80 million
Improvement on EBITDA Margins
EBITDA Margins
EBITDA Margins after improvement
Savings:
Savings from EBITDA Margin Improvement
WACC =
1
0%
0.026
0.026
7.90%
Years after acquisition
2
3
4
0.15%
0.25%
0.50%
0.026
0.026
0.026
0.0265
0.0275
0.03
5
0.50%
0.026
0.03
0
11.5
20.3
43.0
45.6
Savings from elimination of duplicate administration,
merchandising, buying, pricing and accounting
39.5
39.5
39.5
39.5
39.5
Savings from Distribution and divisional management
Savings from merged advertising
Total Savings
4.1
2
45.6
4.1
2
57.1
4.1
2
65.9
4.1
2
88.6
4.1
2
91.2
0
37.50%
21.4
75%
49.4
75%
66.5
75%
68.4
Percentage of Potential Synergies
Expected Synergies
PV of Expected Synergies
153.5
Empire management believes that with the acquisition, they will eventually realize buyer power synergies,
leading to improvements in EBITDA margins because of lower competition in the market and the ability to
charge higher prices. In terms of savings, Empire will eliminate duplicate administration, distribution and
additional operational costs such as advertising. By looking at both the EBITDA changes and cost savings, we
found total savings due to synergies of the acquisition for years afterwards and found the present value. This
present value of synergies can be added to the combined enterprise value of Empire and Oshawa to see the affect
of the acquisition itself (See Appendix).
Recommendation for Acquisition Bid:
We would recommend making a bid for the acquisition of Oshawa Group limited. We would
recommend a bid of 1.158 billion dollars. This would include a 10% premium over the stand alone value
of Oshawa of 1.053 billion dollars.
A distinction between the shares would be needed, as the Class A shares do hold the voting
rights of the company. The 10% premium would be offered for the common shares, which are the voting
shares, owned by the Wolfe family. The class A shares of Oshawa Group would be bought at a price of
27.29 dollars each, and the common share stocks would be bought for a price of 181 dollars.
Type of Share
Oshawa Group class A shares
Oshawa Group common share
Offer Price
$27.29
$181
We recommend Empire to go through with the acquisition because NPV of the project
outweighs the acquisition cost. This means that the gain received by Empire from the acquisition of
Oshawa Group limited will create higher gains for their shareholders
Enterprise Values
Value of Empire
Value of Oshawa Group
Synergy Value*
Value of Empire + Oshawa
(Reference appendix for synergy values)
(in millions)
1,695
1,053.17
153.5
2901.67
Our recommendation for financing the acquisition of Oshawa Group is for a combined cash and
stock spin-off option. We have taken the Sobey family's reservations about the use of debt into
consideration and therefore we have kept debt to a minimum in our finance recommendation. Although
the spinoff of the grocery business would create a pure play, we do not believe would realize maximum
value for this approach.
The value of Oshawa Group limited is valued at 1.053 billion dollars. We added a 10% premium
on the business, valuing the transaction at 1.158 billion dollars. To fund the expenditure, we would offer a
35% spin-off stock valued at 1.015 billion dollars, take 100 million debt, and finance the remaining 43
million via cash.
By offering the spin off option, we would be offering 35% of the new companies stock to
Oshawa Group limited. This would cause the price of the new business to fall to a price of 51 dollars per
share. After this transaction we would still have an NPV of 48 million, and a new stock price of 51
dollars.
Appendix:
Appendix 1: (Net Working Capital)
1994
CA
CL
NWC
Change in NWC ($)
Growth Rate of NWC
Average change in NWC
201
1995
1996
223
22
10.95%
193
-30
-13.45%
1997
707
415
292
99
51.30%
1998
709
447
262
-30
-10.27%
15
Assumption:

The annual change in net working capital was found using the average changes in NWC from
1994-1998. The reason we cannot project a growth rate for this is because of the volatility from
year to year, where it fluctuates form positive to negative annually.
Appendix 2: CAPM Calculation
Company
MV of Equity (E)
Total Debt (D)
Beta
Beta (asset)
Avg Beta (asset) (u)
D-to-E
V/E
D-to-V
B(equity)
r(f)
r(e)
r(d) (Credit RatingAA)
WACC
Empire
778
918
0.74
Oshawa
951
135
0.77
Loblaws
6735
876
0.55
MetroRichelleu
850
77
0.59
0.339
0.674
0.487
0.541
1.18
2.18
0.54
0.67
5.80%
9.50%
0.14
1.14
0.12
0.13
1.13
0.12
0.09
1.09
0.08
6.80%
0.0790
Provigo
990
327
1.2
7.90%
Assumptions:

This calculation assumes that Empire will maintain their capital structure over the next 5 years.

In order to find the cost of capital, we needed to include a few assumptions into the model. The
calculation is done using the longest government treasury bill rate given in the case, of 5.8%(for a
ten year bond) and assuming a market risk premium (MRP) of 5.5%. An important assumption is
also made to find the cost of debt. Having a rating of AA, Oshawa's risk premium over
government yields are 100 base pointsor 1.00% (as given in the case). This would result in a 6.8%
cost of debt (risk free rate of 5.8% plus 1% risk premium).
0.902
0.589
0.33
1.33
0.25