Weis Markets Equity Analysis and Valuation
Fall 2009
Analyst Team
Phylicia Castillo-phylicia.castillo@ttu.edu
Fabian Garcia II- fabian.garcia@ttu.edu
Marcia Ramos- marcia.ramos@ttu.edu
Jeremy Ruiz- Jeremy.m.ruiz@ttu.edu
Georgia Sanchez- georgia.sanchez@ttu.edu
Table of Contents
Executive Summary ………………………………………………………………………………………….7
Business & Industry Analysis………………………………………………………………………….15
Company Overview……………………………………………………………………………………15
Industry Overview……………………………………………………………………..……..........17
Five Forces Model……………………………………………………………………………………………19
Rivalry Among Existing Firms……………………………………………………………………..21
Introduction …………………………………………………………………………………..21
Industry Growth ……………………………………………………………………………..22
Concentration ………………………………………………………………………………..24
Differentiation ………………………………………………………………………………..26
Switching Costs ………………………………………………………………………………27
Economies of Scale …………………………………………………………………………28
Learning Economies ………………………………………………………………………..29
Fixed-Variable Costs ……………………………………………………………………….30
Excess Capacity ………………………………………………………………………………31
Exit Barriers ……………………………………………………………………………………32
Conclusion ……………………………………………………………………………………..32
Threat of New Entrants …………………………………………………………………………….33
Introduction …………………………………………………………………………………..33
Economies of Scale ………………………………………………………………...........34
First Mover Advantage …………………………………………………………………….35
Distribution Access ………………………………………………………………………….35
Relationships ………………………………………………………………………………….37
Legal Barriers …………………………………………………………………………………38
Conclusion ……………………………………………………………………………………..38
Threat of New Substitute Products …………………………………………………………….39
Introduction …………………………………………………………………………………..39
Relative Price and Performance ……………………………………………………….40
2 | P a g e Buyers’ Willingness to Switch …………………………………………………………..40
Conclusion ……………………………………………………………………………………..41
Bargaining Power of Customers …………………………………………………………………41
Switching Costs ……………………………………………………………………………..42
Differentiation ………………………………………………………………………………..42
Importance of Product for Costs and Quality …………………………………….42
Number of Consumers …………………………………………………………………….43
Volume per Consumer …………………………………………………………………….43
Conclusion ……………………………………………………………………………………..44
Bargaining Power of Suppliers ……………………………………………………………………44
Switching Costs ……………………………………………………………………………..45
Differentiation ………………………………………………………………………………..46
The Importance of Products for Costs and Quality …………………………….46
Number of Suppliers ……………………………………………………………………….47
Volume per Supplier ……………………………………………………………………….47
Conclusion ……………………………………………………………………………………..48
Overall Conclusions and Industry Classification ……………………………………………48
Strategies for Creating a Value Chain …………………………………………………………..49
Grocery Retail Industry Strategy…………………………………………………………………50
Cost Leadership ……………………………………………………………………………………….50
Economies of Scale and Scope …………………………………………………………51
Low Cost Distribution ………………………………………………………………………52
Differentiation…………………………………………………………………………………………..52
Superior Product Quality and Variety ………………………………………………..53
Superior Customer Service ………………………………………………………………54
Conclusion ……………………………………………………………………………………………….55
Firm Competitive Advantage Analysis …………………………………………………………..55
Economies of Scale …………………………………………………………………………………..56
Low Distribution Costs ………………………………………………………………………………56
3 | P a g e Superior Product Quality and Variety ………………………………………………………….57
Superior Customer Service ………………………………………………………………………..58
Conclusion ………………………………………………………………………………………………59
Formal Accounting Analysis …………………………………………………………………………..59 Key accounting policies ….................................................. ………………………..….61
Type 1 Accounting Policies ………………………………………………………………………..61
Type 2 Accounting Policies ………………………………………………………………………..64
Accounting Flexibility …………………………………………………………………………………….67
Accounting Strategy ……………………………………………………………………………………….70
Quality of Disclosure ………………………………………………………………………………………72
Qualitative Analysis ………………………………………………………………………………….72
Quantitative Analysis of Disclosure ……………………………………………………………….75
Sales Manipulation Diagnostics …………………………………………………………………….76
Net Sales/ Cash from Sales ……………………………………………………………………….76
Net Sales/ Account Receivables …………………………………………………………………79
Net Sales/ Inventory …………………………………………………………………………………81
Net Sales/ Unearned Revenue …………………………………………………………………..83
Net Sales/ Warranty Liabilities …………………………………………………………………..84
Expense Manipulation Diagnostics ………………………………………………………………..85
Asset Turnover …………………………………………………………………………………………86
CFFO/ Operating Income …………………………………………………………………………..87
CFFO/ Net Operating Assets ……………………………………………………………………..89
Accruals/ Sales …………………………………………………………………………………………91
Pension/ SG&A …………………………………………………………………………………………93
Red Flags ………………………………………………………………………………………………………..95
Undo Accounting Distortions …………………………………………………………………………96
Loan Amortization Table …………………………………………………………………………..98
Trial Balance: Income Statement …………………………………………………………….100
Trial Balance: Balance Sheet …………………………………………………………………..102
4 | P a g e Restated Income Statement …………………………………………………………………….104
Restated Balance Sheet …………………………………………………………………………..105
FINANCIAL RATIO ANALYSIS..................................................................... ….107
Liquidity Ratios………………………………………………………………………………………..107
Profitability Ratios…………………………………………………………………………………..118
Capital Structure Ratios…………………………………………………………………………..130
FINANCIAL FORECASTING……………………………………………………………………………136
Income Statement…………………………………………………………………………………..137
Restated Income Statement…………………………………………………………..138
Balance Sheet…………………………………………………………………………………………141
Restated Balance Sheet………………………………………………………………….143
Statement of Cash Flows………………………………………………………………………….148
Restated Statement of Cash Flows………………………………………………….150
Cost of Equity..................................................................................................155
Size Adjusted CAPM.................................................................................... ….157
Alternative cost of equity...............................................................................157
Cost of Debt................................................................................................. …158
Weighted Average Cost of Capital (WACC)....................................................160
Firm Valuation……………………………………………………………………………………………….161
Method of Comparables....................................................................................163
Price to Earnings Ratio (Trailing)................................................................163
Price to Earnings Ratio (Forward) ..............................................................164
Price / Book........................................................................................ ……165
Dividends / Price ......................................................................................165
Price / EBITDA ........................................................................................ 166
Price / Free Cash Flows ........................................................................ ….167
Enterprise Value/EBITDA ...................................................................... ….167
Enterprise Value / Free Cash Flows ...................................................... …..168
Intrinsic Valuation Models......................................................................... ……..169
5 | P a g e Discounted Dividends Model.......................................................................170
Residual Income Model ...........................................................................…171
Discounted Free Cash Flows Model ............................................................172
Abnormal Earnings Growth .....................................................................…174
Long Run Residual Income ........................................................................176
Conclusion................................................................................................179
Analyst Recommendation……………………………………………………………………………..180
Appendix .........................................................................................................182
6 | P a g e Executive Summary
Investor Recommendation: Overvalued – Hold (11/01/2009)
WMK - NYSE (11/01/2009) $34.98
52 Week Range:
$22.67- $37.87
Revenue:
$2.46 Billion
Market Capitalization:
$935.51 Million
Shares Outstanding:
26.90 Million
Initial Z-Score:
Adjusted Z-Score
Altman Z-scores
2004
2005
8.61
8.73
6.70
7.00
2006
8.41
6.74
2007
7.71
6.82
Current Market Share Price (11/01/2009) $34.98
Book Value Per Share:
Return on Equity:
Return on Assets
Estimated
3-month
1-year
2-year
5-year
10-year
Published Beta:
Estimated Beta:
Size Adj. Cost of Equity
Cost of debt (actual):
Cost of Debt (restated):
WACC (BT):
WACC (AT):
Stated
25.38
0.07
0.08
Restated
22.54
0.07
0.08
Cost of Capital
R-squared
0.25222
0.25124
0.25371
0.25299
0.25254
Beta
0.71443
0.71272
0.72234
0.72013
0.71591
0.65
0.72
0.10156
2.36%
4.76%
6.48%
6.25%
Trailing P/E:
Forward P/E:
Dividends to Price
Ke
Price to Book:
9.420% P.E.G. Ratio:
9.423% Price to EBITDA:
9.456% EV/EBITDA:
9.448% Price to FCF:
9.434%
Financial Based Valuations
As Stated
$
19.69 Overvalued
$
21.83 Overvalued
$
46.00 Undervalued
$
41.43 Undervalued
N/A
$
3.99 Overvalued
$
36.23 Fairly Valued
$
12.12 Overvalued
Intrinsic Valuations
As Stated
Restated
Discounted Dividends:
$
16.02 Overvalued
N/A
Free Cash Flows:
$ 120.10 Undervalued $ 51.82 Undervalued
Residual Income:
$
29.48 Overvalued $ 16.65 Overvalued
Long Run Residual Income $
29.58 Overvalued
N/A
Abnormal Earnings Growth: $
32.76 Fairly Valued $ 18.41 Overvalued
7 | P a g e 2008
8.1
6.84
8 | P a g e Industry Analysis
The retail grocery sector is a highly competitive industry. Weis Markets top
competitors are Safeway (SWY), Supervalu (SVU), and Kroger (KR). The grocery store
industry is highly competitive and profit margins are narrow. Each firm in the industry
offers just about the same goods, so firms in the industry must compete on price. In
order to be successful and gain market share, Weis Markets uses the strategy of cost
leadership. Weis Markets achieves cost leadership through economies of scale and
scope and low-cost distribution. Being that Weis Markets is the smallest firm compared
to its competitors it offers a variety of in store vendors such as banks and takeout food
to help bring in additional customers and keep old customers coming back. Below is a
table of the five forces that affect the degree of competition within this industry.
Grocery Retail Industry
Rivalry Among Existing Firms
Threat of New Entrants
Threat of Substitute Products
High
Moderate
Low
Bargaining Power of Customers
Moderate
Bargaining Power of Suppliers
Moderate
Since there is not a significant difference between the types of groceries that
each of the companies in this industry sell, the firms have to compete on price to
attract customers in this highly competitive industry. A firm must have a well planned
product mix as well as efficient operations to be profitable. The rivalry among existing
firms is considered high and leading firms in this industry are diversifying the types of
services that they offer in store to get more customers into the store. The smaller
grocers such as Weis Markets can be effective if they develop a niche product or offer
additional services to help attract customers. The threat of new entrants is moderate
because most firms who try to enter the market without an established name will fail.
Large companies and chains primarily dominate this industry. Companies that are
9 | P a g e already established within an industry have an advantage over new entrants due to the
large investments that are required to begin operations. Large economies of scale, first
mover advantages, access to distribution channels, and legal barriers are elements in
the industry that new entrants must evaluate before deciding upon entering this
industry. Finally, the bargaining power of customers and suppliers are classified as
moderate. The whole reason behind high competition and competing on prices is to
keep the consumers satisfied. If one grocery store such as Kroger offers cheaper prices
on the exact same grocery items sold at Weis, then of course the customer will start
shopping at Kroger. These cheap prices people see at the store all start with suppliers.
The cheaper you can buy items, the cheaper you can sell those items. The store with
the most bargaining power over its suppliers of any firm is Wal-Mart. Wal-Mart owns its
own supply chain and distribution centers allowing for the cheapest price. One firm
almost comparable to Wal-Marts bargaining power over suppliers and a direct
competitor to Weis Markets is Supervalu. Supervalu owns its own distribution centers as
well as their own supply chain management, and not only provide for their personal
stores, but to anyone willing to buy from them. Weis Markets does not own either of
these two things so at times can become a victim of buying some goods at higher price,
a disadvantage for the smaller firms.
Accounting Analysis
Accounting analysis plays a large role in valuing a company because it
determines whether or not the key accounting policies reflect the company’s true value.
Because accounting numbers are man-made, they are subject to errors and
manipulation, which can portray the financial status of a firm inaccurately. While
analyzing Weis Markets financial statements, we felt that their accounting strategy led
to financial reports that altered our opinion of the firm. After analyzing Weis Markets
accounting strategy, we felt that restating these accounts would better represent the
firm’s underlying business actuality. If an account seems out of place, or the numbers
may be wrong raises a red flag to analysts. The key areas that we targeted as red flags
10 | P a g e were their pension plans, and the SGA changes ratio chart raised a red flag because of
the sudden decrease throughout the year 2007 leading to a negative ratio in 2008.
Another red flag is the CFFO/ NOA changes ratio. From 2004 the ratio decreased into
2005, causing a negative value in 2005. Then increased into 2006, however, returned
to a negative value in 2007. These drastic changes could result in an increase in NOA
and not having sufficient cash flow activities to support NOA. Potential reasoning behind
this could be not capitalizing their operating leases. After computing amortization tables
we completed a trial balance which depicted the year by year adjustments that we
applied to actual financial statements in order to produce restated statements that we
felt were a better representation of the firm. After obtaining restated financials, we
were able to calculate a number of restated financial ratios which clearly represented
the impact that varying accounting strategies has a direct relation on investors’
perception of the firm.
Financial Analysis, Forecasting Financials, and Cost Estimations
The financial analysis is calculated to determine viability, profitability, and
stability of firm using financial ratios. These ratios are used to measure the overall
performance of a firm compared to their competitors. These ratios when compared
against other firms in the industry show company and industry trends. These trends are
used as guidelines in the forecasting of a firm’s financial statements. The three main
types of ratio categories firms’ use are liquidity, profitability, and capital structure.
Liquidity ratios are used to measure if a firm has enough cash to meets its future
debt obligations and determines the credit risk of a company Creditors and banks also
use these liquidity ratios to determine the credit risk of a company. In our evaluation
we used the following liquidity ratios: current ratio, quick asset ratio, working capital
turnover, accounts receivable turnover, days’ sales outstanding, inventory turnover,
days’ supply inventory, and cash to cash cycle. Weis Markets current ratio and quick
asset ratio are fairly high for being such a small firm; they are well above their
11 | P a g e competitors. In our evaluation of Weis Markets, we found that the liquidity ratios for
Weis were average when compared to the Industry.
The next major ratio is profitability and is used to see how efficient the firm
operates. Profitability ratios compare revenues and income to the amount of sales and
expenses a firm develops over a period of time. Profitability ratios essentially provide
key statistics which aid in determining a firm’s ability to generate a profit. The
profitability ratios used in our analysis are as follows: gross profit margin, operating
expense ratio, operating profit margin, net profit margin, asset turnover, and return on
equity. Weis Markets high gross profit margin, net profit margins, and return on assets
ratios demonstrate the Company’s financial strength over the last few years. In our
evaluation of Weis Markets profitability, we have concluded that overall Weis performs
average compared to the industry, but a slight slowdown may be occurring due to the
recession. The recession does not affect grocery markets to much since people do have
to eat but might make consumers choose the store that offers the lowest prices.
The third ratio is capital structure; this ratio provides insight into a firms default
risk. The capital structure ratios are an indicator of how a firm finances its investments
and operating activities. Firms finance their operations in one of two manners, either by
debt or equity. Capital structure ratios are different from the other two categories
because capital structure ratios don’t actually measure performance. Capital structure
ratios are important because they provide clarity and insight to a firms default risk. The
ratios used in our analysis are: debt to equity ratio, times interest earned ratio, debt
service margin ratio, and Altman’s Z-score. Overall, Weis Markets shows a great capital
structure and does not do a lot of financing through debt, the smallest of its
competitors.
The last and most important part of our financial analysis was the forecasting of
Weis Markets financial statements. When forecasting financial statements the most
important figure is the estimation of sales growth. Due to future sales growth being so
important, many assumptions and trends must be taken into consideration to produce
the most accurate sales growth percentage possible. We came up with a sales growth
12 | P a g e of 6% to calculate our financials from 2010 to 2018 to helps us get a better
understanding of how Weis Markets will look in the future.
Valuations
The last step in an equity evaluation is to determine the company’s appropriate
share price and to evaluate whether it is overvalued, undervalued, or fairly valued. This
step requires analyst to use several different methods to value the equity of a firm.
There are two models used for the valuation portion of a company the method of
comparables and the intrinsic valuation model. The first method is the method of
comparables which uses several different ratios to determine the stock price or value of
a firm. This method is not very reliable because it uses a wide array of numbers and
there is no theory to support it. The first two ratios the price to earnings (trailing) and
price to earnings (forward) both determined that Weis Markets stock price is
overvalued. The next two ratios the price to book and dividends to price suggested
Weis’ stock price is undervalued. The P.E.G ratio came out with a negative stock price,
since the stock price cannot go under zero this ratio was not used. The price to
EBITDA and price to FCF overvalued Weis Markets observed stock price of $34.98. The
last method of comparables ratio the EV to EBITDA indicated Weis Markets stock to be
fairly valued.
The next method is the intrinsic valuation model which is based on theory and
assumptions by analyst. There are five methods within this model; discounted
dividends, free cash flows, residual income, long-run residual income and abnormal
earnings growth. All these models provide a more accurate indication of the stock price
of a firm. Three of these models indicated that Weis Markets stock price is overvalued
and the other two indicated that it is undervalued and fairly valued. The abnormal
earnings growth model is the most accurate of the five methods because it uses the
forecasted net income and total dividends. This model has the highest explanatory
power of all the models it explains 75 to 85 percent of the stock price of a firm. Thus,
it is a reliable model and produces the most accurate stock price.
13 | P a g e Overall, the valuation of a firm is the last part in analyzing a company’s overall
value to its shareholders. By taking into account an observed stock price we are able to
determine the value of a firm through a number of methods. Utilizing a variety of
valuation methods increases the reliability of the firm’s market value of equity as it
correlates to the different variables used in each valuation model. The more extensive
the valuation model the more accurate it is; thus, it is more closely related to the firm’s
stock price. In doing sensitivity analysis we can input different factors to determine
what combination of variables we can use to achieve a fairly valued stock price.
Conclusively, valuation models are important to an analyst because it gives them a
more in depth look at the overall value of a firm’s ability to create or destroy market
value based on their business activities.
14 | P a g e Business and Industry Analysis
Company Overview
Weis Markets, Inc., a grocery retail chain based in Pennsylvania, which sells dairy
products, frozen foods, meats, seafood, fresh produce, but also includes floral,
pharmacy services, fuel, general merchandise items as well as household products.
Weis Markets has been around since 1912. Weis Markets headquarters is located in
Sunbury, Pennsylvania, and publicly traded on the New York Stock Exchange under the
symbol “WMK." “The Weis family currently owns approximately 65% of the outstanding
shares,” this allows the owners of the company to have more control over the day to
day company operations (Weis Markets 10-K).
A majority of the Weis Markets are located in the Northeastern part of the United
States; Pennsylvania, Maryland, New Jersey, New York, and West Virginia. The
company currently owns and operates 155 retail food stores and a chain of 27
SuperPetz; LLC pet supply stores (Figure 1.1). Figure 1.1 shows the number of stores
that reside in each of the 5 states. Out of the 155 stores 68 are between 45,000 Sq ft.
and 54,999 Sq ft. allowing shoppers to move around without feeling constricted as well
as having more of a product selection and inventory space.
Figure 1.1
State
Pennsylvania
Maryland
New Jersey
New York
West Virginia
Total
Total
125
24
3
1
2
155
(Form 10-K)
15 | P a g e The SuperPetz division operates 27 pet supply warehouse stores located in 9
eastern U.S. states and account for 3 percent of the total generated revenue of Weis
Markets. Weis Markets’s primary competitors include Kroger, Safeway, and Supervalu.
Weis Markets generates most of its sales from selling groceries followed by meat,
produce, pharmacy drugs, and pet supplies (Figure 1.2). Many Weis Markets locations
allow third parties to come in and provide in-store banks, laundry services and take-out
restaurants (Weis Markets 10-K).
Figure 1.2
Weis Markets Revenue by Segment
Pharmacy
10%
Pet Supply Other
2%
3%
Produce
15%
Meat
16%
Grocery
54%
(Data provided from www.wikiinvest.com)
The market cap for Weis is $879.83 million. The market cap for Kroger is $14.3
billion, Safeway has $8 billion, and Supervalu has $3.2 billion. Weis is comparatively
smaller than its three main competitors, Kroger, Safeway, and Supervalu. However,
Weis has had an increasing trend in net sales and total assets throughout the past five
years. Weis’ net sales from 2007-2008 increased by 4.5 percent. Their total assets
increased by about 1 percent. In addition, the stock price for Weis may seem like it has
a decreasing trend, but it has remained steady in the $30 and $40 dollar range, even
through this current economic recession.
16 | P a g e Figures (1.3) shows Weis’ total assets and net sales. Both assets and sales have
been increasing over the last five years allowing Weis to expand at a steady rate. The
bar graph clearly depicts its total assets and net sales growth.
Figure 1.3
Total Assets
Net Sales
2004
$745,479
$2,097,712
2005
$784,128
$2,222,598
2006
$814,062
$2,244,512
2007
$840,069
$2,318,551
2008
$848,214
$2,422,361
(Weis Markets 10-K)
2,500,000
2,000,000
2004
1,500,000
2005
2006
1,000,000
2007
500,000
2008
0
Total Assets
Net Sales
Industry Overview
The retail grocery business stands out as a highly competitive industry grossing
an estimated $40 billion a year with more than 70,000 grocery stores (Hoovers). The
grocery retail industry is operated by 40,000 companies with the top 50 largest chains
holding 70% of the market share, therefore concentrated (Hoovers). There are variety
types of stores in which firms may operate such as conventional supermarkets like
Weis, wholesalers such as Costco, Supercenters like Wal-mart, convenience stores, or
even internet grocery retailers like Peapod (FMI). In the grocery store industry, the
17 | P a g e stores have three different types of products to sell to its customers; perishable foods
(50 percent of industry sales), non-perishable foods (25 percent), and nonfood items
(20 percent). “Perishables include meats/poultry/fish, produce, dairy, frozen foods, and
deli items. Nonperishable foods (dry grocery products) include most packaged goods,
such as, cereals, snacks, and soft drinks. Nonfood items include health and beauty
products, general merchandise, and medication (First Research).”
Supply chain management is essential in the industry since firms depend on
many distribution channels to operate on a day to day basis. The larger companies buy
their products from wholesale distributors or directly from manufacturers. The choice
depends on the relationships and contracts set in place. When firms become large
enough they have the ability to have their own distribution centers and processing
plants. Furthermore, the use of computers and SKUs that grocery stores in the industry
use to keep track of its inventory are all basically the same. An SKU is the barcode on
the back of the package, and each SKU is unique to a specific product. Equally
important, recently in the grocery retail industry the trend has been to increase
customer convenience and satisfy consumer needs by introducing conveniences such as
fuel stations, banking services, and in some cases nail and hair salons. Introducing
these conveniences has become a growing trend in order to compete for customers.
For example, if someone is getting their hair cut they may decide to purchase hair
products within the store and in a matter time decide to purchase additional grocery
item. This falls in line with “one stop shopping,” giving the industry an opportunity to
bring in new customers and maintain regular customers.
Based on size and type of firm, Weis Markets can be compared with grocery
retailers that run as conventional supermarkets with third party services and located
along the Northeast region of the United States. Comparing Weis to firms such as WalMart would turn out segmented numbers when comparing financials; using a
convenience store such as seven eleven also wouldn’t work because Weis does not
solely operate as a convenience store. In order to make an efficient assessment it is
18 | P a g e important to compare Weis to firms that not only operate like Weis but perform at a
level that Weis does or is heading towards. Kroger, Safeway and Supervalu function as
conventional supermarkets and also have third party services such as Kroger’s jewelry
division, Supervalu’s logistics and distribution sector, and Safeway’s very successful
private label brands like Safeway Select and Lucerne. Another comparable would be
size; Weis Markets’ stores average 48,000 square feet, Safeway and Supervalu average
at approximately 46,000 and 40,000 square feet, and Kroger is slightly bigger at an
approximate average of 73,000 square feet. Although the chains are much larger and
have market caps that exceed that of Weis, all three companies have similar store sizes
and operate in a similar manner as Weis Markets.
Five Forces Model
Source: Google Images (labspace.open.ac.uk)
Michael E. Porter’s Five Forces Model is a well known framework that helps
analysts or third parties analyze companies, their respective industry, and how they
perform in it. By interpreting the actions and overall structure of a firm’s competitive
19 | P a g e environment analysts can project how a firm must compete to sustain a competitive
advantage over existing firms, surpass new entrants’ threats, and maintain bargaining
power over their suppliers and consumers. The five forces analysts or third parties
must consider are; rivalry among existing firms, threat of new entrants, threat of
substitute products, bargaining power of customers, and bargaining power of suppliers.
These factors can be further categorized into two main groups. The first group made of
the first three forces entails information regarding the complexities of competition
within an industry. Whereas, the second group consisting of the last two forces
describes the mechanics of the relationships that industries create with their consumers
and suppliers. In particular, the grocery retail industry uses the five forces model to
build an efficient business strategy that will help gain market share within the industry
which in return will increase profitability.
Grocery Retail Industry
Rivalry Among Existing Firms
Threat of New Entrants
Threat of Substitute Products
High
Moderate
Low
Bargaining Power of Customers
Moderate
Bargaining Power of Suppliers
Moderate
The above graph shows the levels of each force and the degree to which the
grocery retail industry functions on. Rivalry among existing firms is high because of the
number of firms existing in the market (70,000 plus) and competition driven by low
costs, quality and convenience. Threat of new entrants is moderate considering that it
is fairly easy for a new store to open in the market but success in the industry is not
guaranteed and therefore difficult to attain. Since the grocery retail industry is based on
consumer trend and driven by low cost and convenience, alternate products like
restaurant dining or internet grocers may provide a threat to the industry but not the
convenience or low cost factors that conventional supermarkets operate on, therefore
20 | P a g e the threat of substitute products is low. Finally, the bargaining power of customers and
suppliers are both moderate due to the give and take relationships between firms, their
customers, and their suppliers. An in-depth analysis of the above assessments can
explain just how complex the grocery retail environment is and how some firms
overcome these complexities.
Rivalry Among Existing Firms
Introduction
The grocery retail industry in the United States represents one of the largest
competitive markets. Rivalry among existing firms drives competition and is extremely
important to a company who wants to gain a competitive advantage over their
competitors. When rivalry among firms is high so is competition, meaning the level of
rivalry among firms is directly related to the degree of competition within the industry.
In order to compete, companies must analyze the following elements: industry growth,
concentration, differentiation, switching costs, economies of scale, learning economies,
fixed-variable costs, excess capacity, and exit barriers.
Industry growth accounts for a firms’ ability to compete on market share during
active industry growth, and price during stagnant growth cycles. Concentration
analyzes the amount of firms in the industry which could lead to high or low
concentration. Differentiation in the industry refers to competitive tactics besides cost
leadership, that help firms gain market share by providing products or services that are
unique to their individual company. Examining switching costs, allows firms to measure
the cost of switching to a new industry. When looking at economies of scale and
learning economies size and steep learning curves becomes a factor of cost and success
in the industry due “incentives to engage in aggressive competition for market
share”(Palepu & Healy). Fixed to variable costs relates to how firms utilize their costs in
relation to sales, where high ratios prove as a reason to reduce prices to utilize installed
capacity (Palepu & Healy). The final two factors, excess capacity and exit barriers,
21 | P a g e demonstrate that high exit barriers intensify excess capacity causing firms to cut
process to fill capacity. Together all these elements measure the ability for new and
existing firms to compete successfully within an industry; therefore, helping firms
maximize their shareholder wealth, every firm’s primary goal.
Industry Growth
In order for a firm to gain market share or compete they must be growing. “If an
industry is growing very rapidly, incumbent firms need not grab market share from each
other to grow (Palepu & Healy).” The grocery retail industry brings in close to $500
billion dollars annually providing a valuable source of economic input to the national
economy and proving that the grocery retail industry has sustainable sales that drive
supply and demand in the market. In the United States there are over 70,000 grocery
stores located nationally. The primary players in this industry are Kroger, Safeway, and
Supervalu, ranking 2nd, 5th, and 4th respectively on Supermarket News’s Top 75
Retailers of 2009, which also ranked Weis Markets as 50th. These four supermarkets
and forty-seven others represent 70 percent of the revenue generated in the grocery
retail market (www.firstresearch.com). As stated, when industries are not faring well,
their only option is to engage in price wars among other similar firms to stir up
competition. Therefore, small size grocery based companies must focus on other ways
to compete in this highly competitive industry.
22 | P a g e 5 Year Industry Sales Growth
2004
2005
2006
2007
2008
20.50%
7.80%
3.90%
4.11%
5.50%
Industry
The graph above shows the five year industry sales growth of Weis Markets,
Kroger, Safeway and Supervalu by calculating combined percentage sales growth
((current sales – previous sales)/ previous sales) of the four firms, to serve as a
representation of the industry. The graph mostly shows an increase in sales growth
over five years. In 2007, there is a significant increase in sales growth primarily
because Supervalu’s revenue increased 88 percent, due to its June 2006 acquisition of
Albertson’s increasing the overall industry sales growth to 20.5 percent (SVU 10-K).
Other than in 2007, the growth rate has continued to increase at a steady pace which
indicates an overall stable industry. The average industry sales growth, 8.36 percent,
shows there is little increase in sales which leads to higher price competition among the
firms. According to Palepu & Healy, “…in stagnant industries the only way existing
firms can grow is by taking share away from the other players.” This describes what
firms in the grocery retail industry must do to stay competitive in the industry.
23 | P a g e Concentration
In order to determine the degree of concentration in an industry, the number of
firms and their relative sizes must be taken into account. The flexibility of pricing
products a firm possesses is a direct reflection of the degree of concentration in the
industry. Therefore, if a firm has a monopoly in a particular industry it is easier for the
firm to dictate and set prices. This results in a high degree of concentration. On the
contrary, if an industry has a low degree of concentration, which means there are
several firms, then there is a high level of price competition (Palepu & Healy).
The grocery retail industry has been primarily dominated by larger companies
such as Supervalu, Safeway, and Kroger. But there are a vast amount of smaller
grocery companies that include Weis Markets. As a result, the grocery retail industry
has a low degree of concentration. The top 50 grocery retail firms account for 70
percent of the market share in this industry (www.firstresearch.com). This makes it
harder for companies like Weis Markets to compete on price. Large firms such as WalMart, Kroger, Safeway, and Supervalu have highly efficient distribution networking
systems and have greater purchasing power. This gives these companies the ability to
set prices relatively lower than smaller firms like Weis Markets.
24 | P a g e 5 Year Market Share of the Firms
50.00%
45.00%
40.00%
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
Supervalu
Safeway
Kroger
Weis Markets
2004
18.10%
32.00%
48.10%
1.90%
2005
16.70%
33%
48.40%
1.90%
2006
16.20%
32.70%
49.30%
1.80%
2007
25.30%
28.60%
44.60%
1.60%
2008
27.40%
27.40%
43.70%
1.50%
The graph above shows the five year market share of the primary players in the
grocery retail industry including Weis Markets. The graph above clearly depicts the
leader among these firms is Kroger with an average market share of 46.1 percent over
the past five years. The second leader is Safeway with an average market share of
30.7 percent, although it has decreased by about 6 percent since 2005. Supervalu has
an average market share of 20.7 percent followed, a significant increase from 2005 and
2006, which is in large part due to Supervalu’s acquisition of Albertson’s in mid 2006.
Weis Markets, a smaller firm, average at 1.7 percent due to its relative size compared
to the other firms in the industry. Consequently, the larger firms can easily set and
dictate prices. Overall, due to the low degree of concentration in the grocery retail
industry, smaller firms like Weis Markets must compete and rely on other capital
avenues such as excellent customer service and other differentiation techniques.
25 | P a g e Differentiation
The grocery retail industry relies heavily on their ability to differentiate their
products and services. In this industry mixed differentiation includes selling products
ranging from commodities to specialized goods, and service quality. For this reason, the
industry may have different divisions which would vary the level of price competition.
For example, some firms carry mostly commodity products which lead to a high level of
price competition. Whereas, firms that carry more specialized products like health
foods or organics lead to a lower level of price competition. There is a lower level of
price competition due to the small amount of firms that carry these specialized
products. In the grocery retail industry the majority of the firms’ revenue is generated
by commodity sales. Thus, when products are so similar the firms have to use other
methods to entice consumers.
In some cases firms add additional services for customers including pharmacies,
in-store banks, laundry services, and take-out restaurants. Third party services like
these have been adopted by Weis and its competitors, Kroger, Supervalu, and Safeway
who all account for fuel stations in their 10-Ks. These added customer conveniences
help draw in more sales. Kroger for example operates about 400 fine jewelry stores;
many of them are located within their combinations supermarkets (KR 10-K). Stores
like Whole Foods distinguish themselves by following modern consumer trends such as
organics, fine cuts of meats, or ethnic brands unfamiliar to general supermarkets in the
industry. Peapod, and internet grocery retailer, has really separated itself from the
industry by operating through the internet, and delivering groceries to their consumer;
although fairly new Peapod delivered to 330,000 customers in 2008
(www.peapod.com). Although some differentiation strategies may prove costly to the
retailers and customers, customers are willing to pay a higher premium for products
that are believed to be of better quality, uniqueness or convenience. When products
can not suffice as a clever differentiation tactic, firms look to superior customer services
such as “sackers” to carry out groceries or expert butchers to help customers in meat
26 | P a g e selection. These tactics have proven so successful that many smaller grocery retailers
continue to add additional services to compete with larger firms that have lower prices.
All in all, since there is level of mixed differentiation in the grocery retail industry,
companies may reduce prices and add additional services to gain customers.
Switching Costs
Switching costs primarily means how much it will cost a firm to switch into a
different industry. In the grocery retail industry the level of switching costs also adds to
the level of competition. When switching costs are high then firms are more reluctant
to change into a different industry, causing existing companies to stay and increase
concentration within the industry which of course would increase rivalry and
competition. This usually occurs when firms specialize in a certain product. In contrast,
the grocery retail industry has a low level of switching costs. Firms in the grocery retail
industry are more likely to be able to switch to another industry because they are able
to liquidate their assets more quickly compared to more specialized industries like the
automobile market. Of course underperforming firms would look to switching as an
option; whereas, high performing firms that are growing and expanding might have the
option but would more than likely not consider switching. Active and successful firms in
the industry like Kroger, Wal-mart, or even Weis have no need to switch industries
when they have acquired significant market share or are a growing and successful
company, because it would mean starting all over again as new entrants in another
industry. Therefore even thought switching costs are low in the grocery retail industry,
the cost of entering into a new industry could prove more costly for well developed
firms in the market but would provide an easier exit strategy for new entrants or rivalry
firms that are not faring well in the market, which could in turn reduce competition.
27 | P a g e Economies of Scale
In general, economies of scale reflect the cost compensation that a firm attains
due to expansion. As the scale increases the firms average cost per unit decreases.
Basically, as a firm maximizes production there is a reduction in unit costs. In the
grocery retail industry, the ability to reduce costs relies heavily on the efficiency of their
distribution and purchasing.
Sales/ PPE WMK SVU KR SWY 2004 4.76
9.47
4.81
4.12 2005 4.98
8.88
4.91
4.22 2006 4.56
10.09
5.33
4.11 2007 4.64
4.45
5.61
3.98 2008 4.74
5.85
5.62
4.14 28 | P a g e To efficiently analyze the relation between sales and expansion, simply compare
the ratios of sales to property, plant and equipment (Sales/PPE) and the total asset size
to correlate the affects of expansion from total assets in relation to the Sales/PPE ratio.
As the above graph shows for instance, Weis, Kroger and Safeway have remained
consistent in their Sales/PPE ratio staying within a 4.0 to 5.0 range which correlates
with their steady asset size along the five year period. In the case of Supervalu, their
acquisition of Albertson’s significantly augmented their total assets in 2007, which
increased their property, plant and equipment and overall sales, but because sales and
property, plant and equipment increased to the Sales/PPE ratio provided smaller
numbers and turned out to be more consistent with the industry trend. Overall
expansion in the grocery retail industry drives up sales which increases market gain and
ultimately increases a firm’s competitive hold in the market. As the firms in the industry
grow at a gradual pace with each other rivalry among existing firms will be high.
Learning Economies
Similarly, like economies of scale, learning economies can give firms a
competitive advantage by reducing production costs. This primarily relates to research
and development intensive companies and manufacturing companies who require
skilled and expert employees to produce products that may require highly developed
abilities. In contrast, the grocery retail industry does not employ research and
development; instead it is the suppliers and manufacturers that engage in research and
development rather than the actual grocery retail firms. The industry is not an industry
driven on innovation of products rather it provides the service of selling and providing
these products and services to the public; therefore, the majority of employees are not
hired based on superior skill sets compared to other industries. According to the Bureau
of Labor Statistics young workers age 16 to 24 hold one third of grocery store jobs and
cashiers and stock clerks account for half of all jobs. The grocery retail industry
primarily relies on on-the-job training or specialized training for positions such as
butchers and cashiers. Effectively, learning economies does not significantly impact
29 | P a g e competition in the market as economies of scales does because of the nature of the
business that takes place in the grocery retail market.
Fixed-Variable Costs
Whenever the ratio of fixed to variable costs increases dramatically, firms eagerly
reduce prices in order to utilize installed capacity (Palepu & Healy). In a growing
industry like grocery retail fixed costs are expected to increase based on expansion of
their property, plant, and equipment and variable costs are also expected to be
increasing as a result of increasing sales growth.
10.00
9.00
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
CGS/PPE
2004
2005
2006
2007
2008
WMK
3.51
3.66
3.34
3.44
3.51
SVU
8.14
7.58
8.62
3.48
4.51
KR
3.55
3.67
4.01
4.25
4.30
SWY
2.90
3.00
2.93
2.84
2.97
As seen above, the CGS/PPE ratio (Cost of goods sold divided by net PPE) for the
majority of the firms stay at steady levels whereas Supervalu maintained their levels
until 2007. As a result of their acquisition in 2006, Supervalu’s net property, plant and
equipment increased significantly as did the cost of goods sold due to increased sales.
When a firm’s fixed-variable cost ratio is high this leads to more competition primarily
because the higher the ratio the more fixed costs a company acquires. Therefore,
companies must produce enough products to cover their fixed costs. Specifically, in the
grocery retail sector firms usually own and operate their own distribution centers in
30 | P a g e order to reduce costs. In owning these centers, companies incur added fixed costs to
maintain these facilities and since they have a high level of fixed costs they must
control their variable cost of goods sold to cover fixed costs. Most firms in this industry
have to produce more goods in order to gain profitability since there tends to be a low
margin level leading to increased competition as firms may engage in price wars to
cover their fixed costs and gain sales from competitors.
Excess Capacity
Several industries go through levels of high demand for their goods or services
and levels of low demand. In the grocery retail industry the capacity tends to be
greater than the customer demand for their goods and services. In other words, supply
is greater than demand. In this case, this leads a firm to cut prices to offset the excess
capacity. Although this may be good for consumers because they have a greater
selection of goods and services this could affect a firm’s ability to continue growing.
5 yr Comparable Same Store Sales
100.00%
80.00%
60.00%
40.00%
20.00%
0.00%
‐20.00%
Weis Markets
Safeway
Kroger
SuperValu
2004
2.70%
0.76%
3.90%
5.50%
2005
5.90%
7.20%
4.90%
‐3.30%
2006
3.30%
4.60%
7.30%
1.60%
2007
3.30%
5.20%
9.20%
88.30%
2008
4.50%
4.30%
6.20%
17.80%
31 | P a g e The chart above shows the comparable same store sales growth of Weis Markets
and its main competitors in the grocery industry. This chart shows that most of the
firms have experienced some growth but some have continued to decline. This
indicates that the industry has not exceeded excess capacity yet, but if the growth
continues to decline that would indicate the contrary. Overall, the continued growth
within this industry reflects lower concentration among the firms which leads to a high
level of competition.
Exit Barriers
When a firm’s assets are specialized or there are regulations that make exiting
more costly, exit barriers are high. This would lead to a high level of competition
because it is not as easy for the firm to exit their industry. In contrast, the grocery
retail industry’s exit barriers do not tend to be as high. Their assets are not specialized
so they can be used in other industries. If a grocery based firm wanted to exit their
industry selling their assets it would not be as difficult as a firm with specialized assets.
In addition, the grocery retail industry does not have strict regulations that would set a
barrier for their exit. Hence, it is relatively easier for a grocery based firm to exit their
industry compared to a firm in the auto industry. Having a low level of exit barriers
reduces competition primarily because it’s easier for a firm to switch industries,
reducing rivalry among existing firms in the grocery retail industry.
Conclusion
Again, industry growth, concentration, differentiation, switching costs, economies
of scale, learning economies, fixed-variable costs, excess capacity, and exit barriers help
analyze the level of rivalry among firms in the industry. Rivalry among firms is due to
high competition which leads to price wars in the industry. High industry growth will
increase the amount of competitors making the grocery retail industry less concentrated
and increasing rivalry. Firms in the grocery retail industry must overcome differentiation
to gain market share and increase sales. Depending how firms can successfully
32 | P a g e compete against their rivals in the industry, some may look at the opportunity costs of
switching which tend to be low since grocery retailers can easily liquidate assets
compared to other industries. Economies of scales and learning economies factor in size
and skill; while size is an important factor to expansion, skill sets are not as valued.
Fixed-variable costs and excess capacity also take in to account how firms are
expanding within the industry and driving competition. Finally exit barriers in the
industry are low signifying that the industry is not specialized and therefore not as
costly to firms who wish to leave the industry. The primary source of competition highly
depends on the prices of the goods and services which is a result of high rivalry among
existing firms. In brief, when there are many firms in an industry this creates increased
rivalry among the firms which creates a competitive environment.
Threat of New Entrants
Introduction
The threat of new entrants primarily depends on the potential profitability a firm
would make if they entered into a particular industry. If a new firm wants to enter into
the grocery retail industry they have to take into consideration the potential amount of
profits and market share it could gain. However, in the grocery retail industry fifty of
the largest supermarket chains hold an astounding 70% of the market share. So other
potential firms who want to enter into this industry would have to compete against
established companies like Kroger, Whole Foods, Safeway and even the hypermarket
giant Wal-Mart. Therefore, in the grocery retail industry the threat of new entry is
moderate. Factors a company must consider before entering a market include
economies of scale, first mover advantage, distribution access, relationships and legal
barriers.
33 | P a g e Economies of Scale
If there is a high economy of scale, new firms must decide whether to invest in
large capacity which may be fully utilized or enter the market with less than optimal
capacity. Investing large capital is risky because new entrants may possibly suffer
initial losses because of other well established firms in the industry. These losses could
be significant. Therefore, new entrants must invest in other ways to gain profitability
including advertising, gaining additional plant and equipment or investing in research
and development (Palepu & Healy). In relation to the grocery retail industry there are
larger economies of scale which makes it harder for new entrants to compete
effectively. Small companies will need to strategize what approach they will take to gain
the most profitability and eliminate potential capital.
Asset Size (In Millions) 2004 2005 2006 2007 2008 WMK $ 748 $ 788 $ 814 $ 840 $ 848 SVU $ 6,153 $ 6,278 $ 6,038 $ 21,702 $ 21,062 KR $ 20,184 $ 20,491 $ 20,482 $ 21,215 $ 22,299 SWY $ 15,377 $ 15,757 $ 16,274 $ 17,651 $ 17,485 In the grocery retail industry the capital requirements to enter and yield success
are very high. The chart above clearly depicts Weis Markets and three other major
competitors’ capital assets. The three main competitors have a large amount of assets
which indicates how established they are in this industry. Also, it shows that over the
past five years they have continued to gain more assets. Entering this industry would
be very difficult because of firms like Supervalu, Safeway and Kroger but not totally
impossible. Nevertheless, these firms’ grounded establishment makes it more unlikely
for new firms to gain substantial profit.
34 | P a g e First Mover Advantage
Entering the industry earlier than other firms gives a firm a significant advantage
over late entrants. For example, Kroger, incorporated in 1902, has grown to be the
largest grocery retail chain in the United States with 2,500 supermarkets in 31 states
not including their jewelry and convenience stores. Kroger may attribute their success
to their early entry into the market in 1902, since top stores such as Safeway and
Supervalu incorporated in 1986 and 1925 respectively and Weis Markets incorporated in
1924 entered the market twenty years later giving Kroger enough time to set
sustainable position in the grocery retail market. Even a twenty year jumpstart like
Kroger’s can make it difficult for new entrants to enter the market because they have to
compete against standards already set in the industry leaving them to play catch up.
But first mover advantage is not limited to when a firm is incorporated into the market
but how and what they bring to the market that allows them to be first. Specialty stores
are one example of first mover advantage. Take for example organics and ethnic food,
both categories have become recently popular leaving room for first mover advantage
to go to firms who adopt these trends, but because they have a specialty focus gaining
market share is not as easily attained as their typical grocery retail firm counterparts.
Besides first mover advantage, there are no other major barriers, such as strict
regulations, a firm needs to overcome. Because concentration is low in the grocery
retail industry there is a low first mover advantage which leads to a high level of
competition.
Distribution Access
In the grocery retail industry distribution access refers to the relationship
between suppliers and industry buyers. There are numerous channels of distribution in
the industry which allow new entrants easier access into the grocery industry through
the variety of channels. Although, distribution access is high, establishing a distribution
channel usually requires a large amount of capital. Capital buys needed transportation,
distribution centers and processing plants that many of the firms utilize to cut costs and
35 | P a g e operate more efficiently. Below is a chart of exactly how much capital is held by Weis
Markets, Kroger, Safeway, and Supervalu throughout the past five years.
WMK SVU KR SWY Firm Capital: Cash and Cash Equivalents
2004 2005
2006
2007
2008
$ 58.2 $ 69.3 $ 27.5 $ 41.2 $ 59.4 $ 292.0 $ 463.9 $ 686.1 $ 285.0 $ 243.0 $ 159.0 $ 144.0 $ 210.0 $ 189.0 $ 242.0 $ 266.8 $ 373.3 $ 216.6 $ 277.8 $ 382.8 Because capital is a significant factor of how much a firm can afford, firms with
less capital might not have as many channels of distribution as others simply because it
would overwhelm their capital structure. This alone makes it fairly difficult for new
entrants who may not have a sufficient amount of capital to enter and compete with
established firms in the industry. As a consequence, the lack of capital can certainly
jeopardize a new firm’s ability to enter the grocery retail industry; however, it can be
achieved because of the amount of distribution channels available to the industry. For
example, a smaller firm like Weis Markets may not have enough capital to deal with
large distributors who expect their buyers to buy in bulk, for this reason they may turn
to smaller or lesser known distributors where the purchase quantity doesn’t have to be
as large. Smaller firms may also choose local or regional farmers for their produce and
meat selections to cut costs on transportation and increase quality. Another way for
firms to reduce their capital expenditures is by skillfully integrating its retail outlets
around a centrally located distribution center, processing plants, or even controlling
their own distribution channel, like Supervalu. “Supervalu manages the delivery logistics
of products from hundreds of manufacturers from more than 5,000 retail end points,”
operating one of the largest supply chain networks in the country
(www.supervalu.com). Conclusively, new entrants have many outlets and options to
look forward to when entering the market. With enough capital a new entrant is able to
36 | P a g e enter the market, but picking the right distribution channels and efficiently managing
them is what determines their success and competitive threat to the industry.
Relationships
Relationships are another barrier that new entrants face when entering a new
industry. These relationships relate among firms’ consumers and their networks, and
are significantly important to a firm’s success. Consumers in the industry not only make
business but help sustain it as well, making loyal and ongoing relationships with
consumers highly important in the market. Larger firms such as supercenters or
wholesale clubs tend to have vast amounts of consumers which increase the likelihood
of loyalty. This relationship was built from their ability to keep prices down and deliver
on quantity on many of their products and services. In order to compete for customers
smaller stores implement loyalty card programs. Customers may receive a preferred
shopper card that entices them with discounts, promotions and rewards. Other
techniques for retaining customers can fall under service and quality. Whether its
superior customer service or quality meats and produce, smaller firms can bypass low
cost retailers and retain customer loyalty.
In order for firms in the industry to provide consumers with superior service,
quality or low costs they must have well-built relationships with their networks (i.e.
distribution channels) so that they can afford to retain customers and attract more
potential customers. For example, wholesale clubs will buy in mass quantities from their
suppliers in order to cut costs for themselves and in turn share the savings with their
customers who feel they are getting more for their money. In the case of smaller firms
like supermarkets, tight relationships are more commonly formed with suppliers on a
smaller scale because unlike large firms they cannot afford to buy in bulk. To be able to
supply savings and cut costs smaller firms must work hard to maintain long and loyal
relationships with their distribution channels which may include local farmers, planters,
or suppliers of specialty or lesser known items. For example, according to
highbeam.com Weis Markets is the largest purchaser of Pennsylvania agricultural
37 | P a g e products. Although the costs may not be as low as the larger firms’, the service or
product that is exchanged from supplier to the firm is expected to make up in quality
rather than quantity. The time and effort spent on making lasting and successful
relationships with consumers and suppliers make it difficult for a new entrant to hastily
develop new relationships. Building relationships takes time but is vitally important to
the future success of a firm.
Legal Barriers
Another crucial deterrent that a new entrant faces are legal barriers. Legal
barriers such as obtaining patents, copyrights, and licensing regulations can lead to
additional costs (Palepu & Healy). Failure to abide to laws and regulations may put a
new entrant in a precarious situation. Specifically, in the grocery retail industry they
must adhere to the FDA standards in order to operate within the legal boundaries.
Larger firms have the capital to employ their own legal teams to address any legal
barrier that they may encounter. The lack of in house legal expertise may burden
smaller firms. Still, the grocery retail industry is not heavily burden with legal barriers so
that makes it easier for competitors to enter the industry. This can lead to heavier
competition within the industry.
Conclusion
In the grocery retail industry, the threat of new entrants is relatively moderate
due to the variety factors that determine the level of accessibility in the market. The
level of threat is moderate because new entrants can still enter this industry by
overcoming the five predominant threats but not high because success is not
guaranteed. When economies of scale are high new entrants must decide to invest to
utilize a large capacity structure or less than optimal capital structure, by taking the risk
or playing it safe new entrants still face many firms that have already been well
established making it less likely for new entrants to gain profit share. Low first mover
advantage increases the level of competition making it more difficult for new entrants
38 | P a g e to gain a foothold in the industry. Distribution access and relationships are very
important to the industry because of the costs it incurs on the firms and their
consumers; having well established relationships with distribution channels takes time
and a good amount of capital which can throw off new entrants but due to the amount
of channels available new entrants do have an advantage when entering in the market.
Legal barriers in the grocery retail industry are low making it a lot easier for new
entrants to enter the market and increase competition in the industry. Overall although
once in the industry new entrants have many outlets that can help them succeed, new
entrants have to overcome capital obligations to establish themselves in the grocery
retail industry.
Threat of Substitute Products
Introduction
Substitute products pose concerns to any industry, fortunately for the grocery
retail industry 5.7 percent of consumers’ disposable income is spent on food at home
(www.fmi.com). Although the grocery retail industry has one of the most reliable
consumer markets, when consumers choose to eat out, shop online, or even become
self sufficient, profits will decrease, causing firms to compete against an alternate
modes of how customers buy products or services. For example, customers may want
to buy their groceries online from a grocery retailer like Peapod or even Amazon rather
than at a supermarket. Existing grocery firms are adapting to this new form of
shopping by adding on the technologies needed to provide online grocery shopping. In
particular, Safeway, a major competitor, provides online grocery shopping with “FREE
Delivery on your first order” for online customers (www.safeway.com). When
overcoming the conveniences of restaurants, firms look to mimic the convenience of a
restaurant style meal buy offering restaurant style products in their frozen food sections
or even putting in-store eateries. Take for example Supervalu’s Bristol Farms division
not only do they offer readymade sushi but they also offer cooking classes for their
39 | P a g e customers (www.supervalu.com). Buy learning to overcome the alternate selections
that customers may choose over shopping at grocery supermarkets, the grocery retail
industry can still maintain their profits and increase their consumer exposure.
Relative Price and Performance
In the grocery industry there are two potential substitute threats such as
consumers choosing online shopping versus onsite shopping and consumers choosing
restaurants versus cooking. The first substitute threat firms must consider is the
availability and ease of online grocery shopping. Customers are able to buy goods
through online venues for convenience. However, shipping costs may affect customers’
decision to purchase groceries online. That adds to the relative price of the goods.
The second substitute threat firms must consider is customers’ preference of
dining out. In terms of price this would be very costly for the customer to maintain
over a long period of time. To address this threat the industry has responded by
providing customers with meal options at a lower cost but still similar to the dining out
experience. In addition, firms have added third party vendors that supply take out or
dining options within the store. Both threats of substitutes are minimal and do not pose
a long term effect in the industry. Nevertheless customers’ preferences should be taken
into consideration when competing in the grocery retail market.
Buyers’ Willingness to Switch
In the grocery retail industry consumers can either shop at a supermarket or buy
their groceries online. They can also choose to dine out rather than cook at home.
Many factors influence online shopping such as price, availability of products, and most
of all convenience. Although, these factors do exist customers still may favor to
physically take part in the shopping experience. For example, a consumer may not
want to purchase perishable foods online. Instead he or she may prefer to touch and
smell the food before making the purchase. Therefore, buyers’ willingness to switch
between online grocery shopping and onsite shopping is a low threat to firms.
40 | P a g e Since eating out can be expensive over a long period of time the consumer’s
willingness to switch is low. If a customer does switch they are likely to switch back
because it is not a sustainable substitute. The bottom line is determined by the
enticement of the price difference between the substitute threats and conventional
grocery shopping which will give consumers better savings. This savings will make the
buyers’ willingness to switch between industries more probable.
Conclusion
In conclusion, in the grocery retail industry, the threat of substitute products and
services are low. It is low because firms can quickly adapt to meet the needs of their
consumers. Utilizing technologies for online shopping helps counteract losing
customers to other firms. Also, the high price of eating out for customers can be easily
offset by in-store dining and meal options.
Finally, the firms in the grocery retail industry must take into account the factors
of the threat of substitute products including relative price and performance and buyers’
willingness to switch. By doing so, the firms will have a slight edge over their
competitors.
Bargaining Power of Customers
Everyday and every hour consumers are visiting and purchasing from retail
grocery chains. Unlike some industries the retail grocery industry will always have an
abundance of consumers made up of individuals, families and in some cases small
businesses ready to acquire their products and services. Because of this unfaltering
relationship, the negotiating power consumers have on driving down industry prices
greatly relates to the switching costs of the consumer, differentiation, the importance of
product cost and quality, number of buyers, and volume per buyer. The bargaining
power of consumers is what determines the industry’s ability to be flexible or hold
control in a large consumer market.
41 | P a g e Switching Costs
In an industry where consumers and products are plentiful, grocers must look at
the cost which consumers incur from switching from product to product and store to
store to help them maintain an efficient price level that still allows them to compete in
the industry. In the grocer industry the consumer’s switching costs are quite low,
meaning that any one customer may switch from one store to another for the same
product if they can find a cheaper price. This explains the price sensitivity of the
consumer in the grocer industry; with more information and coupon circulation
consumers have many resources to compare the prices in the industry therefore gaining
economic leverage over the industry and pressuring prices downward.
Differentiation
Differentiation in the industry is defined by the uniqueness of the product, but in
this case consumers have only to compare canned goods to canned goods, oranges to
oranges and so on. This lack of uniqueness in the product itself makes differentiation
fairly difficult in the industry but not impossible. While some stores, like Wal-Mart, have
the flexibility to compete on a cost basis and provide consumers with competitive prices
others must find their own niche in the industry. Whether it is superior customer
service, quality of products such as fresh produce or high quality meats, or organics,
stores in the industry can compensate for an undifferentiated selection of products.
Importance of Product for Costs and Quality
The importance of product for costs and quality describes the consumers’
conscious decisions over what a product is worth in terms of price and quality. In
today’s challenging economic state, consumers have grown fairly price conscious and in
many cases apply quality comparison as an investment than a preference. For
example, as multi-family income declines, households look to save on groceries, which
fulfills a significant part of their expenditures, by utilizing coupons, comparing prices or
cutting back on specialty items. In terms of quality, households may decide to invest in
42 | P a g e a utility of a product rather than satisfy quality tastes by choosing to buy in bulk at
wholesale grocers, in an effort to save and stretch costs. Besides economic trends, the
grocer industry must keep up with social trends like “going green” or the growing
health trends which would require specialty stores focusing on these trends to maintain
high quality levels of their products. This can prove to be sometimes costly to the stores
because the higher the quality, the higher the price. With our present looming
recession, not many consumers or stores can bear the costs of alternative living but for
those who can, the industry must be prepared by offering compatible items at still
competitive prices relative to the industry.
Number of Consumers
In the retail grocery industry there is a variety and numerous amounts of
consumers which results in an increased bargaining power but also allows the industry
to fulfill different needs to different segments of the consumer market. In cases of cost
leadership, stores may look to target single parent to multi-unit families, and in the case
of wholesalers, they rely on large families or small business to buy their products. As
long as the grocer industry exists the number of consumers will not vary greatly, but it’s
the trends and environment that drive the consumers that effect the industry’s strategic
developments. The bargaining power of consumers is thus high in the industry because
they outnumber the firms within it.
Volume per consumer
In the grocery retail industry, volume per consumer indicates the amount of
goods that each individual purchases at any given time. Variation in the volume per
consumer in the industry is high and can depend on the type of costumer since the
industry’s customer profile is highly diversified. Small businesses may decide to buy in
large quantities whereas single adults will consume relatively low quantities more fitting
to their lifestyle. Like most retail industries, the grocery retail industry is no exception to
the seasonal effects on consumers. Holidays like Thanksgiving for example would cause
43 | P a g e an increase in volume because of the short spike in demand for grocery products. Also,
in the family sector the industry may experience in increase in volume during the
summer months when families must support the needs of their household when school
is not in session. Because the volume per customer is not predictive in pattern, the
grocery industry can count on a level competing field in terms of the amount of
products that it carries from store to store. High volume per consumer results in
increased bargaining power because the higher the volume of goods purchased directly
correlates to higher revenue generated.
Conclusion
In the retail grocery industry low switching costs and undifferentiated products
result in higher bargaining power to the consumer. The importance of product for cost
and quality reflects the trends of the consumers and their ability to switch from product
to product based on price and quality which in turn affects the relative bargaining
power in the industry. Although the number of consumers and volume per consumer
tend to be a dependable factor, the grocery industry must still compete on the
segments of consumers and providing them with a well varied product market for a
highly diversified consumer market.
Bargaining Power of Suppliers
In an industry where variety and product are key factors to profitability, suppliers
and their supplier-buyer relationships are vital to the industry’s bottom line. While
some in the industry control their suppliers, others may not have the flexibility or
amount of resources to sustain supplier pressure on prices. This shift of balance
between suppliers and buyers is best known as the bargaining power of suppliers, or
simply the amount of control that the supplier can have on their product prices in
relation to the retailer. The suppliers bargaining power is usually a direct result of
factors such as switching costs, differentiation, importance of product for costs and
quality, number of suppliers, and volume per supplier.
44 | P a g e The retail grocery industry consists of many suppliers ranging from companies
such as Coca-Cola to local farmers and diversified wholesale distributors like ConAgra
Foods and Kraft, all of which provide an overwhelming amount of variety for the
industry. While the majority of suppliers provide commodity products others, which
come in few numbers, may provide specialized products. Depending on the needs of
the firms, suppliers can either negotiate or compromise with their buyers or they may
have to settle for price premiums. The following factors discussed can help evaluate the
effect and bargaining power of suppliers in the industry.
Switching Costs
Because of the large amount of suppliers available to the industry, switching
costs are maintained at low levels, since both supplier and buyer are not dependent on
one another when they easily have options to cover any willingness to switch. Some
suppliers may have the flexibility to switch industries such as focus on restaurant rather
than retail; this shift of focus could result in profit or could prove to be costly. Take for
example Heinz ketchup, which supplies products not only to grocery chains worldwide
but to restaurants as well. They may have an option to solely focus on providing their
product to restaurant chains but as of recently “Heinz did see improved profits in its
food-service business […] and expects no immediate rebound in the broad restaurant
industry, given high levels of unemployment in the U.S (which have resulted in) frugal
consumers swapping pricey restaurant dinners for cheaper meals made at home.”(WSJ-
Heinz, Hormel Buoyed by Frugal Consumers) Suppliers like Heinz, who profit in more
than one industry, have low switching costs due to the number of options they have.
But options are available to either side of the spectrum, supplier and buyer. As a result
of the low switching costs of suppliers and the industry, relationships are not binding
and therefore suppliers do not have the ability to set terms and prices within the
industry. Although in the long run having binding relationships with the supplier may
result in higher profit margins and low costs similar to that of Wal-Mart, which trickle
45 | P a g e down to their consumers, the rest of the industry must utilize their low switching costs
and take advantage of the numerous amount of suppliers accessible to them.
Differentiation
Many suppliers in the industry consist of everyday consumer products, or
commodities, ranging from canned goods to soft drinks, which essentially do not
provide a unique product to the industry. Commodities do not offer bargaining power to
the supplier because they lack uniqueness and can be easily replaced or swapped for
the next similar product. Suppliers that do provide unique products, such as organic or
environmentally friendly products which are fairly new to the market and supplied by
few, have a greater pull on the grocery industry since their product is different and can
demand a price premium which would then drive up the costs on the buyer. In essence
suppliers with unique brands or products have the bargaining power on price because
of their low supply and demand compared to commodity suppliers which are readily
found with consistent sales and cannot demand price premiums from the industry.
The Importance of Products for Costs and Quality
One significant facet of the grocery retail industry is reputation, which is
primarily built by their consumers’ perception of their products primarily in the meat
and produce sectors. It is highly important for grocers to be able to market their
products as high in quality and low on costs to generate revenues from consumers
looking for a good bargain, especially in challenging economic times. Meats and
produce are also the most costly items to the consumer as well as to the grocers which
increase trade and industry leverage to suppliers specializing in the meat and produce
markets. Take for example smaller, regional retail grocery chains that, to keep up with
the competition of big name grocery chains such like Costco or Wal-mart, who compete
on a cost-leadership basis, implement superior quality into their business strategy to
attract customers. To them the quality of their meats and seafood could mean a
difference of regular sales numbers and loyal sales to consumers shopping for quality.
46 | P a g e Quality though comes with a cost and grocers know that keeping quality products such
as high end meat cuts or organic fruits and vegetables on their consumers’ grocery lists
command price premiums from the suppliers, giving suppliers of fine products the
upper hand on the retail grocery industry. Currently though this strategy may result in
many “quality” grocers altering their suppliers for the rising number of consumers
looking more towards utility and lower costs rather than the finest quality of Kobe beef
from Japan or organic apples which can drive up their expenses. Suppliers’ ability to
provide good quality items at appropriate costs will benefit both the suppliers and their
consumers by establishing stronger relationships between the two. Those with higher
quality products gain higher bargaining power compared to suppliers who operate on
low cost and average quality production.
Number of Suppliers
No matter the product, each supplier strives for one goal, the power of price
setting, but with the supplier market growing more and more saturated; suppliers are
not able to demand the prices if they are outnumbered by suppliers willing to lower
prices for gaining business in the industry. In essence the more like suppliers there
exists in the industry the more power the industry gains over price setting.
Volume per Supplier
In an industry where cost and cost competence are vital to sales and profit
margins, suppliers must look to acquire a balance of quantity and quality if they want to
compete for lasting relationships with their retail grocery buyers. For this reason most
suppliers covet deals with large grocers to insure business and satisfy consumer needs.
Larger grocers capable of buying in bulk get the better deals and the suppliers involved
benefit by creating a business relationship that results in a balance of negotiating
power, whereas smaller grocers must buy in smaller quantities because of lack of
inventory room or shelving space, this may result in suppliers increasing costs and
47 | P a g e grocers missing out on deals that could reflect negatively on their profit margins due to
higher material costs.
Conclusion
Supplier bargaining power in the retail grocery industry is consistently steady at
a moderate level of leverage between the suppliers’ pressure on price and the firms’
pressure on costs. Overall the suppliers look for efficient supplier-buyer relationships
which benefit them in the long run in terms of loyalty and reliable profit share in the
market. In the majority of cases there is not a set controller more than there is
negotiation which in the end results in both parties benefitting.
Overall Conclusions and Industry Classification
In conclusion the Porter’s Five Forces Model helps classify the grocery retail
industry as a mixed competition market. After evaluating the five forces model of the
grocery retail industry one can conclude the following: rivalry among existing firms is
high, threat of new entrants is moderate, and threat of substitute products is low which
leads to high price competition and a low concentrated market. In addition, the
bargaining power of customers and suppliers is moderate meaning that there is no set
control within the industry between the inputs and outputs.
Overall, cost leadership and high price competition are common in the industry
ranging from low cost commodity products to organized supply chain management that
reduces overall costs levels. The grocery retail industry also includes differentiation in
some divisions, such as stores that focus on specialty good products like organics or
high-end meats. Some firms have even gone beyond their products by providing their
customers with additional services such as banking, takeout, and laundry services and
superior customer service. Also, the industry has taken on the trend of efficiency by
providing more conveniences to the customers in hopes of gaining or retaining
customer relationships. Overall the grocery retail industry profits from analyzing the five
48 | P a g e forces model because they are able to identify weaknesses and strengths that will allow
the firms to build efficient strategies that help them gain market share as well as
compete within the industry.
Strategies for Creating a Value Chain
“The profitability of a firm is influenced not only by its industry structure but also
by the strategic choices it makes in positioning itself in the industry” (Palepu & Healy).
In order to assess a competitive strategy it’s important to look at what can be
determined from Porter’s Five Forces Model. First, we can utilize Porter’s Five Forces
Model as a framework to classify and understand the industry and how it operates in
relation to its consumers, suppliers, competitors and new entrants. Second, based on
the five forces analyzed, rivalry among existing firms, threat of new entrants, threat of
substitute products, and bargaining power of suppliers and consumers we can assess
the types of competitive strategies that Weis Markets can adopt in order to be
successful and stay competitive in the industry. There are generally two key approaches
to a firm’s competitive advantage: 1) Cost leadership 2) Product/ service differentiation.
49 | P a g e Typically the type of industry is what determines what kind of strategy is more
appropriate, but a balance of both differentiation and cost leadership is more
predominant and when organized efficiently can help strengthen a firm’s competitive
advantage. Although the grocery retail industry is driven by price competition,
differentiation is one option that can offset cost competition in firms that may not be
big enough to compete on cost.
Grocery Retail Industry Strategy
The retail grocery industry also uses two strategies such as cost leadership and
differentiation to create a value chain. This industry primarily uses cost leadership in
order to gain a competitive advantage. As stated in Kroger’s 10-K, “the operating
environment for the food retailing industry continues to be characterized by intense
price competition” and Weis Market’s 10-K also says “the retail food industry is intensely
price competitive.” Because of this firms also need to incorporate some aspects of
differentiation in order to make them stand out because they all offer the same
products. The key success factors that the retail grocery industry uses are economies of
scale and scope and low-cost distribution under cost leadership and superior product
variety or quality and superior customer service under differentiation.
Cost Leadership
According to Palepu and Healy, an industry that is cost leadership is made up of
firms that supply the same product or service that must compete to have the lowest
price. In the grocery retail industry price competition is very prominent, due to the
variety of products, services, firms and consumers. Consumers are always looking for
the better buy and therefore tend to compare prices from firm to firm, resulting in firms
engaging in price wars to gain consumers. From Wal-Mart’s “everyday low price”
strategy to weekly specials offered by firms like Safeway, firms in the industry want to
emphasize to consumers that they have the better buy. Coupons, specials, discounts, or
loyalty card programs are just some ways firms in the grocery retail industry can spare
50 | P a g e the costs on consumers, but in order to do so firms must “focus on tight cost controls”
(Palepu & Healy). Some ways of becoming a cost leadership firm are through
economies of scale and scope, learning economies, efficient production, simpler product
design, better sourcing, lower input cost, and efficient organizational processes. Firms
that are cost leadership must tighten up their expense budget as their revenues are
minimal.
Economies of Scale and Scope
The purpose of using economies of scale is to reduce per unit cost of their
products. In order to reduce per unit cost, the retail grocery industry buys the products
they offer in bulk or mass quantities. Suppliers of retail products will very often offer
discounts to firms that purchase large quantities of their product. This helps to lower
per unit cost. A firm with lower total cost has a chance of making more profits.
Economies of scope state that the average total cost of production decreases as
a result of increasing the number of products. Although most grocery stores do not
produce products, they implement this by offering a variety of different products and
brands of each product. The larger the stores the more inventory and shelving space
that can be allotted for a greater number of products which enthuses consumers when
Kroger’s “price impact warehouse stores”, for example, offer “no-frills, low cost’ format
that offers their customers “everyday low prices plus promotions” for their wide
selection of grocery items (Kroger 10-K). In other circumstances firms utilize different
types of stores to get their array of products on the shelf. Firms like Weis who, like
Kroger, operate as primarily conventional supermarkets, own warehouses such as Giant
Weis stores, and Supervalu’s warehouse Bigg’s or high end retailer Bristol Farms, all
cater to different segments of the consumer market but still allow firms more outlets to
disperse their inventory. This gives them an advantage because it allows firms to
spread their inventory throughout their different divisions and reach more customers to
have a choice of the products and brands they purchase. By diversifying size, format,
and even type of store, firms in the industry can take advantage of the different outlets
51 | P a g e available for shelving space and inventory exposure which can lower inventory turnover
and inventory storing costs on the firms.
Low Cost Distribution
The shelves of a grocery store must be constantly restocked and in order to do
so grocery stores must have plenty of products on hand. They get their products
through the suppliers or through their own distribution centers. Firms that use their
own distribution centers save money because the suppliers ship all products to one
location instead of each individual store. According to Supervalu’s 10-K, their “network
is comprised of 5,000 retail end points from coast to coast [serviced by their] 22
product distribution facilities, nine of which supply the company’s own stores in addition
to stores of independent retail customers.” Distribution for Supervalu’s supply chain is
done by either third-party independent trucking companies or customer owned trucks
(Supervalu 10-k). Supervalu’s supply chain sector has proved quite successful
accounting for approximately 22 percent of their net sales; therefore, not only do they
distribute products to themselves, which saves money, they also have the opportunity
to make money by distributing to other businesses. By taking initiative and organizing
their supply chain firms look to save money by cutting out intermediaries that may drain
their resources. According to Weis’s 10-k, Weis Markets hopes to improve in their
supply chain management, stating “management will reshape and streamline its supply
chain by improving inventory turns, cost per case, in stock position and overall service
level, thereby building store sales capabilities.”
Differentiation
The other competitive strategy is differentiation in which firms in an industry that
use differentiation must supply a unique product or service at a cost lower than the
price premium customers will pay (Palepu & Healy). These firms seek to provide
something different then their competitors, something that will allow them to stand out.
In the grocery retail market, research and development is not common and therefore
52 | P a g e most firm’s use simple differentiation tactics to gain market share. This can range from
opening a specialty store that caters to certain consumer demographics; such
Supervalu’s Bristol Farms, which operates as a higher end grocery retailer specializing in
fresh produce, choice meats and organics. Weis’s company motto “where freshness
matter” is also another simple differentiation tactic because by simply distinguishing
themselves form everyday low prices they are also distinguishing their products from
other firms. Instead of lowest priced produce they are telling their consumers that
Weis’s produce market focus on freshness and quality.
But firms do not have to offer just unique products but also services can be
unique as well. Take for example Weis Markets, in order to combat online grocery
retailers Weis joined in and now offer “Weis i-shopping,” where customers may order
their groceries online and pick them up at their designated grocer where their “personal
shopper” will load their groceries (www.weis.com). These are among many examples
that shows how the grocery retail industry, an industry primarily focus on price
competition, can overcome cost leadership hurdles and stand out in the market. To
achieve differentiation a firm I the grocery retail industry may also provide superior
product quality or a variety or superior customer services that help enhance their stores
uniqueness and company image.
Superior Product Quality and Variety
Since the retail grocery industry offers many of the same products and is highly
price competitive, firms must offer something that makes them different than the other
stores. Two ways of doing this is through having a better quality product or a wider
variety of products. Safeway offers its customers “high-quality perishables” (Safeway’s
10-K). This helps them to stand out against other larger competitors within the industry
whose quality may not match that of smaller stores. Firms can also offer a wide variety
of products such as organic foods, generic brands, pharmaceuticals, and fuel.
53 | P a g e Many firms within the industry also provide additional services such as fuel to
their customers (Weis Markets’ and Safeway’s 10-K). Kroger and other big grocery
retails have tried for years to become the “one stop destination” by providing floral
shops, prepared meals and other offerings (WSJ Martin). Offering a wide variety of
goods is a key success factor in competing in this price competitive field because it will
give the customer more convenience compared to going to two or three stores for
goods. Variety can also come from offering private brands. Private brands tend to be
cheaper and people like saving money because of a tough economy. Both Supervalu
and Kroger offer their own private brand to their customers (Safeway’s and Kroger’s 10K). Product quality and variety both help firms to gain a competitive advantage in the
grocery retail industry because customers may enjoy better quality products or certain
brands/types of products that only that firm offers.
Superior Customer Service
Another way of standing out is by offering better customer service. Customer
service helps the company differentiate against other competitors. The industry
standard is to add third party services such as banks, coffee shops, and restaurants
which provide more convenience for customers. According to Weis Markets’ 10-K,
“customer convenience is addressed at many locations by offering services such as third
parties providing in-store banks, laundry service, and take-out restaurants” (Weis
Markets’ 10-K). With the internet becoming a bigger way of reaching customers, many
companies have turned to it to offer their products and additional information online.
Supervalu, Safeway, Kroger and Weis all offer online printable coupons and weekly
special offers for their customers. Safeway also offers its customers recipes and meal
ideas on its website. Customers have a better shopping experience when they have
friendly employees who can help them. Supervalu Inc. has even gone as far as training
their employees specifically on customer service. According to the Wall Street Journal,
Supervalu, “hands out black binders as thick as football playbooks,” that teach their
butchers how to cook so that they can inform customers who have questions (Timothy
54 | P a g e W. Martin, Wall Street Journal). Butchers do not normally have to deal with customers
so “included in Supervalu training kits are pocket cards detailing how to properly greet
customers” (Timothy W. Martin, Wall Street Journal). By doing this a firm can provide
the friendly service that many people like and can gain more customers. Providing extra
services helps firms to keep current customers and gain others.
Conclusion
The retail grocery industry is a highly competitive market, companies cannot set
prices as they wish. They must use the strategies under cost leadership to offer
products at a lower price and reduce cost. Companies must reduce as many costs as
possible in order to keep product price low and compete with other firms. Some ways of
achieving this is through buying products in bulk, manufacturing products themselves,
and using distribution centers to get the products to their stores. After using strategies
under cost leadership firms must differentiate themselves from other competitors. This
is attainable through offering better quality products and a variety of products and
offering a range of different services such as banks, restaurants, and internet services.
Companies in this industry who are capable of successfully managing expenses while
offering unique and quality products and services have the ability to gain the
competitive advantage over their competitors.
Firm Competitive Advantage Analysis
Recognizing the firm’s competitive advantage is an important factor for analyzing
the firm. It helps understand the firm and how it operates whether they compete in
cost leadership, differentiation or a mixture of both. Weis Markets competes in the
grocery retail industry and they apply a business strategy that helps them compete
against the other firms in the industry. Weis Markets competes against national,
regional, local food chains, independent food stores, convenience stores, membership
warehouse clubs, specialty retailers, supercenters, and large scale drug and
pharmaceutical chains (10-K). In order for Weis Markets to compete in this wide range
55 | P a g e field, they have been able to recognize some of the top competencies that allow them
to compete effectively. The firm states in their 10-K that they compete based on price,
quality, location, and service which proves that they compete in both cost leadership
and differentiation. Some of the competencies that allow Weis Markets to have a
competitive advantage include economies of scale, low distribution costs, superior
product quality/variety, and customer service. By distinguishing and improving on
these competencies, the firm will be able to compete aggressively in the grocery
industry.
Economies of Scale
As previously mentioned in the five forces model, as a firm maximizes their
options of store format size and type, they are able to organize their inventory more
efficiently by providing more shelving space. Weis Markets recently reopened Giant
Weis Markets, a wholesale, cost friendly store that is much larger than typical Weis
markets allowing them more space for inventory and shelving. Even opening more
stores helps disperse their inventory. According to Weis Markets 10-k, since 2004 Weis
has opened 6 new stores and has increased their total square feet from 7,183,000
square feet in 2004 to 7,402, 000 square feet in 2008, approximately a 3 percent
increase in square footage. Maintaining the economies of scale allows the firm to
reduce prices for customers and compete against the several other firms in the grocery
industry, buy offering more to their consumers, providing more shelving space and
exposure for their inventory, and allowing them to buy in bulk from suppliers which in
turn reduces their costs that they are able to relay to their consumers.
Low Distribution Costs
The distribution centers that Weis Markets owns and operates are very efficient
in helping reduce costs because they are centrally located to a majority of their retail
stores. Not only does the distribution center help maintain economies of scale, but it
helps reduce other costs such as distribution costs. Having its own transportation fleet
56 | P a g e and four manufacturing facilities have allowed Weis Markets to reduce costs. The four
manufacturing facilities include meat processing plant, ice cream plant, and milk
processing plant and each has given Weis Markets a competitive advantage through
cheaper distribution and quick production (Weis Markets 10-K).
Additionally Weis Markets states in their 10-K, “ The company is required to use
a significant amount of working capital to provide for the necessary amount of
inventory to meet demand for its products through efficient use of buying power and
effective utilization of space in warehouse facilities.” With that being said, the Wall
Street Journal reported in their article “Retailers Cut Back on Variety Once the Spice of
Marketing” that [Retailers] are trying to cater to budget-conscious shoppers who want
to simplify shopping trips and stick to familiar products. Retailers have found that
eliminating certain products can lift sales and profits in part by cutting excess
inventory…” Although several grocery retail stores are doing this, Weis Markets can
benefit from this by using their distribution center to get a more accurate estimate as to
how much excess inventory they are holding and how to reduce it.
Weis Markets will be able to compete on prices but at the same time provide
quick services in providing goods through the distribution center. Being able to provide
great services in the firm is another core competency that will be discussed later. The
distribution centers are important for Weis Markets because it is a key success factor
that allows them to be low price aggressive in the grocery industry.
Superior Product Quality/Variety
Weis Markets is in a highly competitive industry; however, they have applied
some differentiation that has allowed them to stand out from other firms in the
industry. Weis Markets, a smaller firm, provides high quality products to help establish
a competitive niche compared to other grocery firms. Weis Markets believes their
customers count on them to, “Provide them with wholesome food products. Concerns
regarding the safety of food products sold in stores could cause shoppers to avoid
57 | P a g e purchasing certain products from the company, or to seek alternative sources of supply
for all their food needs, even if the basis for the concern is outside of the company’s
control” (10-K). In order to prevent the risk of losing customers, Weis Markets strives
to provide a clean and efficient shopping experience on both brand and private label
products to meet and exceed customers’ expectation which allows the firm to provide
superior product quality within their stores (Weis Markets 10-K).
Superior product variety is just as important as product quality. Weis Markets is
able to utilize variety by offering several products. Weis Markets sells groceries, dairy
products, frozen foods, meats, seafood, fresh produce, floral, pharmacy services, deli
products, prepared foods, bakery products, fuel and general merchandise items such as
health and beauty care and house hold products (Weis 10-K). Providing a wide variety
of products and striving for customer’s satisfaction allows Weis Markets to compete in
differentiation and not rely solely on providing low prices. Superior product variety also
allows the firm to add to their competitive niche, which in turn, gives the customer a
great, comfortable, and efficient shopping experiment every time.
Customer Service
Customers rely on getting great service everywhere they shop. Some customers
are willing to pay a premium in order to receive additional services and are able to
compete on customer service in the grocery industry. Some of the additional services
Weis Markets provide is in store banks, laundry services, and take out restaurants (Weis
Markets 10-K). Since the Weis Markets is a smaller firm it cannot solely compete on
price, customer service is a core competency that has allowed them to compete against
much larger firms in the industry. Furthermore, the firm also provides recipes and easy
access to information online to help customers get a better understanding of the firm.
Firms within the grocery industry must take into account the amount of time a
customer spends in line. According to the Wall Street Journal the average wait times in
the east coast and between Pennsylvania and New York was between three minutes
and six minutes (Blalik). Weis Markets can use this to help make the customer’s
58 | P a g e shopping experience more efficient. Although the article did not exclusively mention
Weis Markets they can use it as a benchmark so they are able to gauge how they
compare to other firms within the industry. Another service previously mentioned is
using distribution centers to meet the demand of customers. Controlling inventory and
having the distribution center at a convenient location allows Weis Markets to provide
goods at a rapid pace in order to keep up with customer demand. Being able to
respond quickly and accurately will continue to give Weis Markets a competitive
advantage in customer service especially if they strive to improve on it every year.
Conclusion
Weis Markets uses a mixed business strategy of cost leadership and
differentiation to compete in the grocery industry. Economies of scale and low cost
distribution have helped Weis Markets reduce costs to compete on price in a price
competitive industry. Other core competencies include superior quality/variety and
customer service to help differentiate themselves from other firms in the industry. The
firm can use both cost leadership and differentiation to compete in the industry and
increase market share.
Formal Accounting Analysis
The accounting analysis is a six step process that helps analysts value a firm.
Having a firm’s accounting structure thoroughly evaluated helps the analysts to get a
better understanding of the inner workings of the firm and their overall business
activities. Firms must be held responsible to stakeholders and the government for the
financial operations of their business. Firms are required by law to report the operations
of their business to the government and public with records and documents that can be
found on a company’s 10-K. It is the firm who creates these documents and posts the
facts and numbers that are based on the firms’ financial evidence as well as their
assumptions and estimates. This can be problematic because there may be incentive for
firms to distort information in favor of the company’s financial outlook. This is why it is
59 | P a g e imperative for the six step accounting analysis to be run in order to manifest the real
value of the company. Palepu and Healy help explain the importance of accounting
analysis by stating, “The objective of accounting analysis is to evaluate the degree to
which a firm’s accounting captures its underlying business reality and to ‘undo’ any
accounting distortions.”
Palepu and Healy state six steps that help provide an accurate accounting
analysis. The first step is to identify Key Accounting Policies. This is identifying the
firm’s key accounting policies that directly relate to the firm’s key success factors. By
focusing on these related accounting policies, financial analysts have a basis to measure
the company’s risky components. The second step is to assess accounting flexibility. If a
firm has little flexibility, managers will be less informative, while a firm with lots of
flexibility has the ‘potential’ to be informative. Both steps involve using the key success
factors to help determine how accurate the estimates, policies and risks are being
measured. Evaluate accounting strategy is the third step which uses accounting
flexibility as a form of communication to explain the economic situation or hide the true
performance of a firm. The fourth step includes evaluating the quality of disclosure.
Evaluating the way a firm chooses to disclosure its accounting information and whether
the company used the disclosure to its benefit. Analysts must ask whether the
company’s choice of disclosure is helping or hurting the perception of the company. The
fifth step is to identify potential red flags. After analyzing flexibility, accounting strategy,
and quality of disclosures, analysts can point out outliers or other questionable
accounting. The red flags should be examined more closely and used to help unravel
the true performance of the firm, which leads to the sixth step; undoing accounting
distortions. To prevent people from mistakenly valuing the company based on
misleading strategies and accounting policies, analysts must undo misleading
distortions. By following these six steps, analysts can evaluate, find any distortions, and
make any changes necessary to get a better understanding of the firm.
60 | P a g e Key Accounting Policies
Identifying key accounting policies is the first step in accounting analysis. In
order to get a true understanding of the firm through accounting analysis, divide the
accounting policies into two types, Type One and Type Two. Type One accounting
policies involve the connection between key success factors which include disclosure of
economies of scale, low cost distribution, superior product quality/variety, and superior
customer service. Type Two key accounting policies involve goodwill, pension/post
retirement benefits and operating/capital leases. Since there is flexibility under GAAP,
firms have the potential to distort financial information and disclose little information.
This allows managers to report more in their favor which gives investors potentially
misleading information about the actual performance of the firm.
Having an in depth look into Weis Markets accounting policies will give us a
clear view as to how the key success factors are presented in accounting terms.
Managers have the responsibility of disclosing accurate information in regards to their
firm; however they get incentives to distort the information to their benefit. The
distortions cause misrepresentations of the firm’s performance and distort information
pertaining to key success factors. Completely understanding the key success factors will
give the opportunity to observe how a firm creates value through accounting policies.
The key accounting policies have a direct relationship as to what drives value for the
firm. “The analyst has to identify the accounting measures the firm uses to capture
these business constructs, the policies that determine how the measures are
implemented, and the important estimates embedded in these policies” (Palepu &
Healy).
Type 1 Accounting Policies
The retail grocery industry is classified as a mixed competitive industry because
it competes on price and differentiation. Firms within the industry can compete solely
on price if they are able to afford it. For firms like Weis Markets, they are not able to
61 | P a g e compete on just price such as economies of scale and low cost distribution but also
compete on differentiation characteristics such as customer service and superior quality
and variety. Due to the flexibility available when reporting information to the accounting
statements, Weis Market’s disclosure can be limited and hard to evaluate.
Economies of Scale
The economies of scale are an important factor because total size of the firm can
be a competitive factor. The total amount of assets can be used to help determine how
big the firm is compared to its competitors. This will also allow Weis Markets to
determine how it can compete with its competitors on price competition. Kroger,
Safeway, Supervalu and Weis Markets each mention in detail the value and amount of
their total property, plant and equipment that expand their economies of scale. Weis
Markets along with the top competitors in the industry, provide a large amount of
information in regards to its facilities and plants that they use and how they use them
in their operations.
Number of Retail Grocery Stores
2004
2005
2006
2007 2008 157
158
156
155 155 Kroger 2,532
2,507
2,468
2,486 2,481 Safeway 1,802
1,775
1,761
1,743 1,739 N/A N/A 1,620
1,601 1,559 Weis Markets Supervalu (All information derived from 10-K)
Each competitor stated the amount of stores they have operating at the end of
their fiscal year. Weis Markets did have the least amount however; we do not suspect
any misleading information when stating their property, plant and equipment.
Supervalu did not state the actual number of retail stores in years 2004-2005 but they
did provide the total square footage of their retail grocery stores. All competitors did
62 | P a g e provide the same information it is just stated differently, concluding that there is high
disclosure in regards to economies of scale.
Cost Distribution
Low cost distribution is also important factor for retail grocery firms. Since most
firms within the industry are not actual producers of the products they sell, shipping
costs can be an important factor to consider. Low cost distribution would then become
a type one accounting policy. Grocery firms have positioned warehouses, plants, and
distribution centers to help control inventory and maintain additional costs for handling
their products. In order for a firm to include high disclosure of information, they can
provide locations, size, and details of any additional expenses occurred. Furthermore,
they include cost of goods sold includes direct product costs, warehouse costs,
transportation costs, and manufacturing facility costs (Weis 10-K). Weis Markets and
the top competitors each provide all of the information in regards to their distribution
centers, plants, and other facilities previously mentioned.
Superior quality and variety is a key accounting policy because there are several
products a retail grocery firm can provide within their store. Due to the fact that there
are several brands and types of products the firm provide, they may not provide high
amounts of disclosure. Some firms will provide the amount of revenue they receive
from private labels because they usually play a large role in their firms. Weis Markets
disclosed little information about private labels, but they did provide a list of items they
provide in their firms such as groceries, meats, fresh produce, floral, and etc. Kroger,
Supervalu, and Safeway all mention the different products and services they offer
within their firm as well as any other additional services. In addition, some firms such
as Kroger and Safeway mentioned the percentage of sales they received from private
labels to other labels.
63 | P a g e Type 2 Accounting Policies
Goodwill
Goodwill is stated on the balance sheet as an asset and it represents the extra
amount paid beyond fair value of net assets resulting from a merger or acquisition. As a
firm acquires a new firm they have to consider the fair value of its assets and liabilities,
however they can also pay extra because they believe the market value is worth more.
It is an accounting number that has some flexibility that managers can use to distort
their financials. FASB requires firms to test goodwill for impairment every year, however
management gets to decide whether or not to write off or amortize any amount per
year. Amortization would be needed if the carrying value of goodwill begins to exceed
fair value.
Firms can use goodwill to their advantage and distort the asset. Our test of
significance states if goodwill counts for more than 20% of long term assets, then it will
have to be restated. The restatement will help determine if there is any distorting hiding
inside goodwill. However, if goodwill counts for less than 20% of long term assets, then
it is less of a concern the firms are misusing goodwill and will not require restatement.
Goodwill as a Percentage of LTA
2004 2005 2006 2007 2008 Weis Markets 3.40% 3.36% 3.06% 3.03% 2.96% Kroger 15.56% 15.64% 15.16% 14.12% 14.19% Safeway 20.42% 19.93% 18.83% 17.63% 17.69% Supervalu 39.21% 41.71% 34.34% 41.13% 27.77% (All information is derived from 10-Ks)
64 | P a g e Weis Markets goodwill accounts for about 3% of long term assets; therefore it is
a small percentage of their long term assets so no restatement is necessary. Since
Weis Markets goodwill is under 20% management cannot use goodwill to substantially
change the value of the company. Compared to the competitors, Weis Markets is the
company that we should not have a concern of reporting goodwill. Whereas,
Supervalu’s goodwill over five years accounts on average 36.83% which is well over the
20% threshold. This high percentage of goodwill could lead management to distort
their financial statements which would affect the overall value of the firm. Overall, a
high amount of goodwill can lead to red flags and lead to misrepresentation of financial
statements.
Pension/ Post Retirement Benefit
Pension/Post Retirement Benefit Plans are liabilities Weis Markets offers to their
retired employees. These liabilities will have to be paid in the future therefore the
amount of the liabilities is substantial to evaluating the value of the firm. If a company
has a high amount of retirement liabilities on their balance sheet then growth is
necessary to meet future payment obligations. Weis markets offers, “contributory
retirement savings plan (401 (K)) for full time associates, a noncontributory profit
sharing plan covering eligible associates, a noncontributory employee stock bonus plan
covering eligible associates, and three supplemental retirement plans covering highly
compensated employees of the company” (Weis 10-K). The benefits are offered to
certain salaried associates, store management, and administrative support personnel
(Weis 10-K). They are included as their present value in the “accrued expenses” and
“postretirement benefit obligation” sections of the balance sheet (Weis 10-K). Weis
Markets post retirement obligations liability at the end of 2008 was 12.4 million and for
2007 14.2 million accounting for approximately 40 % of long term liabilities each year.
Pension liabilities are calculated with a discount rate to handle cash flow. Management
is responsible for providing discount rates to use and they could affect the financial
65 | P a g e statements. Having a discount rate too high or too low can lead to liabilities being
understated or overstated respectively.
Pension Plan Discount Rates
2004 2005 2006 2007 2008 Weis Markets 7.50% 7.50% 7.50% 7.50% 7.50% Kroger 5.75% 5.70% 5.90% 6.50% 7.00% Safeway 5.80% 5.70% 6.0% 6.10% 6.30% SuperValu 6.25% 6.00% 5.75% 5.70% 6.75% (All information is derived from 10‐Ks) BAA Corporate Yield Bond
2004 2005 2006 2007 2008 8.06% 7.50% 7.09% 6.58% 6.31% (FREDS Eco Research) Weis Markets used the same discount rate over the past five years. Although
their rate is stable, the interest rate is higher than their competitors. Weis Markets is
being aggressive with their discount rates. This could be costly to Weis Markets if the
discount rate is incorrect; however compared to a BAA corporate yield bond, there rates
are in the same range, which shows that there is not a concern for Weis providing any
misleading information.
Operating and Capital Lease
Operating and/or capital lease is extremely flexible for managers to control.
Under GAAP companies can either purchase or lease assets that help create value.
Some companies can determine if they want to capitalize all long term assets, handle as
an operating lease or a mixture of both. Depending on the decision, the financial
66 | P a g e statements will be recorded differently. Capital leases will be recorded as a long term
asset on the balance sheet. Operating leases will be recorded as a regular expense on
the income statement.
The significant test for operating leases is whether the operating lease
commitment exceeds 10% of long term debt. Weis Markets states in their 10-k, “ The
company has no other commitment of capital resources as of December 27, 2008, other
than the lease commitments on its store facilities under operating leases…”
Furthermore, Weis Markets did not have the label “long term debt” or anything similar
on the balance sheet. Weis Markets does not capitalize any of its property which can
cause an understatement in assets and lead to an overstatement of equity. In terms of
the 10% threshold Weis Markets operating leases exceed 10% of their long term debt.
Therefore, restating their financial statements is essential in or to get a better indication
of their overall value. Since Weis Markets does not capitalize its operating leases this
leads to an overstatement of their financial statements. Additional expenses that can
be ignored from handling operating leases is depreciation expenses and interest
expenses, which could underestimate expense accounts and lead to overstatement of a
firms income statement. Operating/Capital leases will have to be restructured to help
determine a more accurate balance sheet and income statement for investors.
Accounting Flexibility
The degree of flexibility differs within accounting policies. Managers have the
option as to use the flexibility or not. An example of the degree of flexibility that exists
in accounting is current liabilities and research and development. Calculating the
present value of current liabilities is more flexible compared to reporting research and
development. GAAP has issued strict policies when reporting R&D which does not allow
managers much flexibility to manipulate numbers. A private organization known as
FASB (Financial Accounting Standard Board) has allowed GAAP the legal authority to
regulate and issue the financial statements. FASB regulates the amount of flexibility a
67 | P a g e firm has in regards to their balance sheet. Having high flexibility, allows the firm an
opportunity to misrepresent their current situation, which is usually in a positive way.
The following paragraphs will show how much accounting flexibility Weis Markets has in
regards to their key success factors.
Goodwill
Goodwill typically arises when one company purchases another company.
Goodwill is an intangible asset and is reported on the balance sheet. It shows the extra
amount paid for from an attainment of an asset. Managers can use flexibility to distort
the amount of goodwill reported because they can choose the amount to write off
goodwill every year. FSAS No. 142 states, “Goodwill and intangible assets that have
indefinite useful lives will not be amortized but rather will be tested at least annually for
impairment. Intangible assets that have finite useful lives will continue to be amortized
over their useful lives…” (www.FASB.org). A test for impairment must be done annually
and if there is an impairment, the impairment must be expensed that year. Managers
have to estimate the fair value of goodwill every year. Estimating the fair value allows
managers an opportunity to use goodwill to their advantage.
Generally, if goodwill is reported to be 20% of long-term assets, financial
statements will need to be restated. Although there is plenty of room for flexibility in
reporting goodwill, Weis Markets goodwill only accounts for less than 3% of long term
assets therefore we do not expect them to have any distorted information in this area.
Operating and Capital Leases
Capital and operating leases are very flexible for managers to control. All firms
have either operating leases, capital leases, or a mixture of both. Depending on what
type of lease a firm has will determine where it is recorded in financial statements.
Operating leases are a proof of rental property for an agreed amount and time. These
leases are not capitalized and are written down as an expense. Operating leases offer a
lot of flexibility to the management. They can choose to keep them as operating leases
68 | P a g e or they can choose to capitalize them. Whereas, capital leases give the firms the
benefits of owning the asset that is purchased and presenting it on the liabilities section
of the balance sheet.
As stated, Weis Markets does not have any capitalized leases. According to Weis
Markets 10-K, “The company has no other commitment of capital resources as of
December 27, 2008, other than the lease commitments on its store facilities under
operating leases that expire at various dates through 2028.” As previously mentioned,
Weis Markets does not have anything that is being capitalized so operating leases
account for all of their lease obligations. This means that all of Weis Market’s buildings,
facilities, and plants are not being accounted for on the balance sheet. By not
capitalizing their lease obligations, Weis Markets can appear to look credit worthy to
their creditors.
Pension/Post Retirement Benefits
Managers are given a wide range of flexibility when deciding how to report
pension/or post retirement benefits. These obligations are based off of manager’s
opinion and can be very sensitive to interest rates, life expectancy, inflation, medical
cost, and retirement dates. GAAP requires managers to provide discount rates that
correspond with the interest rates to measure the firm’s pension obligations.
In regards to the retail grocery industry, Weis Markets appeared to be the most
aggressive with their accounting strategy and is also aggressive with their discount
rates. Meaning, Weis Markets had the highest discount rate for the past five years
compared to its competitors. A deeper look into this will be explained in the quantitative
analysis.
69 | P a g e Accounting Strategy
Now that the accounting flexibility has been disclosed, the accounting strategy
can been determined. Managers can utilize the flexibility to decide on how much
information they decide to disclose and whether the firm wants to take an aggressive
approach or conservative approach. Aggressive accounting leads to higher earnings
due to overstating assets and understating expenses. Conservative accounting leads to
lower earnings due to understating assets and overstating expenses. Determining which
strategy is being used will allow us to get a real understanding and undo any potential
distortions.
Goodwill
Weis Markets discloses very little information pertaining to goodwill. According to
their balance sheet, goodwill accounts for 3% of long term assets so it does not pose a
threat for providing misleading information. Since Weis Markets does not have an
increase of goodwill that accounts for more than 20% of long term assets, we do not
have to determine if the goodwill is being tested for impairment properly.
Safeway provides high amounts of disclosure in regards to goodwill and their test
for impairment that they include every year. They also include how they are able to
determine if impairment is needed, which is beneficial. Kroger also provided high
amounts of disclosure in regards to goodwill and their method of test for impairment.
Supervalu provided the least amount of information in regards to goodwill, which poses
an alert because goodwill accounts for a large portion of their long term assets.
Aggressive accounting in goodwill would be not to impair goodwill in hopes of boosting
earnings. While the conservative approach is to impair large amounts of goodwill in
hopes of boosting earnings in the future and posing large loses in current earnings.
Supervalu impaired goodwill in 2008 but did not impair for the rest of the four years
prior. Since Supervalu did not impair a high amount in 2008, their strategy would be
more aggressive.
70 | P a g e Safeway, Kroger, and Weis Markets did not impair any of their goodwill for the
past five years so they are also using aggressive accounting. However, Weis Markets
had the least amount of goodwill on their balance sheet, which only accounts for 3% of
the assets. This small amount may not completely affect Weis Market’s earnings for not
testing for impairment.
Operating and Capital Leases
Weis Markets discloses a high amount of information in regards to operating
leases. They do not capitalize on any of its property or plants. Wes Markets displays a
schedule of the lease payments that are due within the next five-twenty years. Weis
Markets does not include a discount rate in connection with their operating leases.
Kroger, Safeway and Supervalu also include operating leases but they also do not
provide a discount rate. Supervalu does capitalize some of its leases however they are
more on remolding purposes. Other then the interest rates, all firms give enough
information about their operating leases. Since all firms use operating lease we could
say they use aggressive accounting. Operating leases allow firms to keep these assets
off the books and overstate expenses. There is not a strict regulation as to how a firm
decides to disclose or calculate their operating or capital leases so firms are able to use
this as an advantage.
Pension/Post Retirement Benefit Plans
Weis Markets discloses information openly regarding pension/post retirement
benefit plans and discount rates. The discount rate can be used to determine the type
of accounting strategy firms in the industry use. Higher discount rates lead to smaller
future liabilities and lower discount rates lead to higher future liabilities. When a
company uses a high discount rate they are using aggressive accounting. Vice versa,
when a company uses a low discount rate they are using conservative accounting. Weis
Markets, Kroger, Safeway, and Supervalu all have a high discount rate, as previously
shown, which means they all use aggressive accounting when it comes to determining
71 | P a g e their pension plans. Weis Markets has used a discount rate of 7.5% for the last five
years. They have also held the highest discount rate all these years. Therefore, Weis
Markets has the most aggressive accounting strategy compared to their competitors.
Quality of Disclosure
The quality of disclosure a firm uses to report its financial statements is essential
in determining the level of transparency and accuracy used in calculating the
statements. To determine the quality of disclosure for Weis Markets, we must first
analyze the firm’s managerial strategy as well as executive decisions regarding
accounting disclosures. Managers have mandatory items that must be reported on their
financial statements, but also have the capability to communicate their strategic
accounting methods. Managers can also make disclosure of their firm very
straightforward or complex to read thus resulting in the financial analysts having a hard
time valuing the firm. Evaluating a firm’s quality of disclosure can provide investors a
glance within the company giving them an improved idea of the firms operations and
financial situation; hence why some managers would want to make disclosure of their
firm hard to comprehend.
Qualitative Analysis
Operating and Capital Leases
Weis Markets discloses a large amount of information regarding their
commitments and involvements in operating and capital leases. The company openly
admits to using 55% of its open store facilities under operating leases (Weis10-K). The
footnotes exhibit the configuration of a general lease term. Weis Markets indicates the
range of life for a typical lease as well as including the option for renewal. Weis’10-K
thoroughly states its various expenses, funding methods, and other lease concessions.
Weis Markets discloses the calculations to determine minimum rent expenses and
payments for operating and capital leases. Weis’ 10-K reveals the economic
72 | P a g e consequences and benefits resulting from store closures. Weis Markets discloses the
necessary calculations of cash flows generated from discontinuing operations. Although
Weis Markets discloses information regarding operating and capital leases they fail to
mention the discount rate associated with these leases.
Post-Retirement Benefit Plan
Weis Markets shows their current and future benefit obligations that are owed to
their employees. In the grocery retail industry, the pension plan is a liability that affects
the cash flows of each firm. It is imperative that investors are able to make out the
financial consequences of individual employee’s pension plans. “Accounting rules
require that firms estimate the value of defined pension and post-retirement
commitments as the present value of future expected payouts under the plan” (Palepu
& Healy).
Analysis of Pension Discount Rate
Weis Markets selected the discount rate of 7.50% to measure the projected
pension benefit obligations. Weis Markets uses historical, current, and forecasted
allocations and returns to estimate the expected return. The company discloses the
methods used in determining the average life expectancy in the calculation of its
pension obligation. Over the past five years Weis Markets discount rate has remained
the same at 7.5%. All in all, Weis Markets 10-K does not disclose information about
their discount rates in great detail.
Disclosure of Inventory
Inventory valuation is an area where managers’ strategic accounting methods
can have a dramatic effect on a firm’s cash flows. Managers can manipulate the value
73 | P a g e of total inventory by implementing several different inventory valuation techniques.
Weis Markets does not disclose how it manages it inventory, and this may be so its
competitors do not gain an advantage over Weis Markets.
Ratio Analysis
The inventory turnover ratio measures the number of times a company sells its
inventory during the year. A high inventory turnover ratio indicated that the product is
selling well. The inventory turnover ratio should be done by inventory categories or by
individual product (Palepu & Healy). Weis Markets does not disclose its individual
categories or what their average inventory is therefore we must calculate it. We find
that Weis Markets has an average amount of cost of goods sold for the industry. In the
grocery industry when you have high levels of inventory it has the possibility of leading
to more lost, stolen, and damaged goods. Having an average level of inventory like
Weis Markets can be beneficial by preventing overstocking, and not letting perishable
food items spoil, having just enough on hand so the company loses less money.
Inventory Method Analysis
In the grocery industry, the way you catalog your inventory and the methods for
tracking inventory are crucial in the distribution process. These methods often require a
large technological investment and a steep learning curve. In the industry, it is not
common for a firm to disclose any data or comments regarding their personal inventory
methods. Weis Markets does not disclose its methods just like everyone else in the
industry. The reason a firm does not disclose how it keeps records of its inventory is
because you may have a precise and efficient way of tracking your inventory, which can
help decrease losses to the company in the long run. The way you track your inventory
may be one of your competitive advantages over another firm, and disclosing this
74 | P a g e information could put you at the tail end of business, especially if you are the smaller
firm.
Conclusion
Overall, Weis Markets quality of disclosure is minimal in most aspects including
operating leases, post-retirement benefit plan, analysis of pension discount rate, and
inventory. Therefore, Weis Markets does not provide enough transparency within their
10-K which makes it difficult for investors and analysts to evaluate the value of the firm.
Since Weis Markets is a small firm they may find it necessary to retain important
strategic methods involved in everyday operations. By doing so Weis Markets keeps
their competitive advantage over their competitors.
Quantitative Analysis
Quantitative analysis is a crucial part of analyzing a company’s financial
statements because it can help present the current status of the firm. Therefore, the
primary concern that analyst and investors have in evaluating the credibility of a firm’s
financial statements is to address whether a firm overstated their earnings or net
income. In order for a firm to overstate its earnings they either have to overstate
revenue or understate their expenses. GAAP provides managers with flexibility that
allows them to distort the firm’s financials, and allow the firm to look more profitable
than their actual performance for the year. Being able to identify the firm’s accounting
techniques and understanding their financials will allow investors to calculate the firm
more accurately.
By using a series of sales manipulation diagnostics and expense manipulation
diagnostics an analyst or investor can access the credibility of a firms reported
revenues. The sales manipulation diagnostic contains five ratios that compare net sales
to cash from sales, account receivables, inventory, unearned revenue and warranty
liabilities. The expense manipulation diagnostic contains ratios pertaining to asset
turnover, expenses, and accruals. Both these diagnostics will show if a firm has
75 | P a g e overstated its earnings. When evaluating the sales manipulation diagnostic ratios an
investor or analyst is looking for unexplained increases in the ratios which could indicate
a potential “red flag.” Whereas, evaluating the expense manipulation diagnostic ratios
analyst are looking for unexplained decreases within the ratios. Unexplained increases
and decreases within these ratios will indicate “red flags” which signals a company is
overstating their net income.
Sales Manipulation Diagnostic
In any industry there are two ways a company can increase their net income
either by overstating their revenues or understating their expenses. The sales
manipulation diagnostic of a company will show if revenue has been overstated. By
following the firm’s performance over the past five years will determine if there are any
abnormal trends that can cause a potential “red flag.” Revenue that companies
generate every year is the single most significant part of any firm. Therefore, the sales
manipulation diagnostic will indicate if there are any discrepancies among a firm’s
financial statements. These diagnostics will compare the company’s net sales to cash
from sales, net account receivables, inventory, unearned revenue and warranty
liabilities. Analyzing these ratios in raw (t) form and change (t1-t) form will give
investors and analysts a better insight into the credibility of the reported revenue. In
addition, it will show if the amount of sales is in direct proportion with the various
activities such as net accounts receivables, inventory, unearned revenue and so forth.
These ratios will be evaluated in detail below.
Net Sales / Cash from Sales
The ratio of net sales to cash from sales represents whether a firm’s net sales
are supported by their cash collection. If a company has unexplained increases in this
ratio then this may signal a “red flag.” Cash from sales can be calculated but taking new
sales and subtracting the change in net account receivables over the years. If there is
an increase in account receivables then that number is subtracted from net sales to get
76 | P a g e cash from sales. If there is a decrease in account receivables then that number is added
to net sales. Once the cash from sales number is calculated then you simply divide a
company’s net sales to cash from sales. The net sales to cash from sales ratio should be
close to 1 but some companies will deviate slightly. In the grocery retail industry most
purchases by consumers are made on a cash basis. The chart below shows the
relationship of net sales to cash from sales for Weis Markets (WMK), Supervalu (SVU),
Kroger (KR) and Safeway (SWY).
Net Sales/Cash from Sales (Raw)
1.05
1.04
1.03
1.02
WMK
1.01
SVU
1
KR
0.99
SWY
0.98
0.97
0.96
2004
2005
2006
2007
2008
The chart above shows Weis Markets and its competitors Supervalu, Kroger, and
Safeway’s ratio of net sales to cash from sales ranges from .99 to 1.01. This ratio is
very close to the 1:1 ratio described earlier. The companies that dropped slightly under
1 show there was a slight decrease in sales. Since the drop was very small then there
is no reason for concern because in the grocery retail industry companies have periods
of high sales and periods of low sales. In the grocery retail industry, companies
primarily deal with cash sales so a 1 to 1 ratio is typical. This signifies that these
companies’ net sales are supported by their cash collection. In addition, this chart
77 | P a g e above indicates there is an industry trend within the grocery retail sector. All the
companies have a ratio around 1. Other than Supervalu’s slight increase around 2005
and 2007 the companies have maintained a ratio of 1:1. No significant increases signal
no potential “red flags.”
Also, in order to take a deeper look into the relationship between net sales and
cash from sales. The change of net sales to cash collected is shown in the chart
below. These ratios where calculated by taking the change in net sales divided by the
change in cash collection. When looking at a change chart it is important to just focus
on whether a company has a positive or negative sign. This sign should be positive and
around zero.
Net Sales/Cash from Sales (Change)
2.45
1.95
1.45
WMK
SVU
0.95
KR
SWY
0.45
‐0.05
2004
2005
2006
2007
2008
‐0.55
The chart above shows the change of net sales to the change of cash from sales
from Weis Markets and its competitors. This chart clearly indicates that all the
companies’ ratios are positive and relatively close to zero. Since no companies have a
negative ratio then this signifies that there are no “red flags” within this industry in
regards to this ratio.
78 | P a g e The raw chart shows no dramatic increases in this ratio and the change chart
shows no companies have a negative ratio so therefore; these companies’ net sales are
supported by their cash collection. These companies are able to sustain their
businesses because they are collecting enough cash to operate. Consequently, if the
ratios had been over 1.1 throughout the five years then this would have signaled a
company’s inability to sustain operations due to a decrease in cash flow.
Net Sales / Account Receivables
The ratio of net sales to account receivables is calculated by dividing net sales by
net account receivables. This ratio should indicate whether a company’s net sales is
supported by their account receivables. An increasing ratio could indicate the firm is
collecting more cash and less accounts receivable. A small ratio would indicate
collecting accounts receivable at a faster rate. If there are unexplained increases within
the ratios then this may signal a “red flag.”
Net Sales/Net Account Receivables (Raw)
120
100
80
WMK
60
SVU
KR
40
SWY
20
0
2004
2005
2006
2007
2008
79 | P a g e In the grocery retail industry, the amount of account receivables that firms have
on their books can be relatively low compared to other industries. This is primarily due
to the fact that some customers use other forms of payment besides cash to make their
purchases. But since their net sales tend to be high as well this leads to low net sales to
accounts receivable ratios. The chart above shows Weis Markets ratio of net sales to
accounts receivables and its three primary competitor’s ratios. The majorities of the
ratios range between 40 and 90 and remain stable throughout the past five years. It
shows that as a company’s sales goes up their account receivables should go up.
Other than Safeway, the chart above shows a steady and stable ratio for Weis Markets
and its competitors from 2004 to 2008. The chart clearly depicts an industry structure
within the grocery retail sector. Since this ratio tends to be stable throughout the past
five years this signals no “red flag.” There is no significant increase of this ratio
throughout the past five years.
Net Sales/Net Account Receivables (Change)
400
200
0
‐200
‐400
‐600
2004
2005
2006
2007
2008
WMK
SVU
KR
SWY
‐800
‐1000
‐1200
The chart above shows the change of net sales to the change in net account
receivables over the past five years. For the most part the companies maintain a
positive ratio. However, Kroger and Supervalu show negative ratios throughout some
80 | P a g e of the five years. Kroger from 2003 to 2005 had a negative change in its account
receivables and a small increase in sales which caused its ratio to be negative. As far
as Weis Markets there ratios throughout the five years have been mostly positive which
indicates no “red flag.”
Overall, the ratios for net sales to account receivables are relatively low and
there are no significant increases in this ratio within the past five years. This results
from a majority of purchases being on a cash basis. Also, the high amount of net sales
for each company drives down the ratio. These charts indicate that for the most part
these companies’ net sales are supported by their net account receivables which imply
that they are not overstating their earnings.
Net Sales / Inventory
The ratio of net sales to inventory is another ratio that can be evaluated to see if
a company is overstating their revenue. In order to meet the demand of customers, this
ratio should show that as a company’s net sales go up, the company’s inventory should
go up also. A high ratio would indicate the firm is properly utilizing and managing their
inventory. While a firm with a low ratio would indicate the firm is not efficiently turning
inventory into sales. The chart below shows an industry trend of net sales to inventory.
Weis Markets and its competitors have very similar ratios ranging from 11 to 22. Other
than Supervalu’s ratios, there are no dramatic decreases between a customer’s net
sales and inventory. If there was a big decrease throughout the past five years then
this would indicate that sales are going up but inventory is going down which would
signal a “red flag.” But in this case net sales are supported by inventory. As the firms
net sales increase the inventory is increasing as well.
81 | P a g e Net Sales/Inventory (Raw)
25
20
15
WMK
SVU
10
KR
SWY
5
0
2004
2005
2006
2007
2008
In addition, the chart below shows the change of net sales to the change of
inventory over the past five years for Weis Markets and its competitors. For the most
part the chart shows that these companies have a positive change between the past
five years. Therefore, these charts show that these companies are not overstating their
revenues.
82 | P a g e Net Sales/Inventory (Change)
300
200
100
WMK
0
SVU
2004
2005
2006
2007
2008
KR
‐100
SWY
‐200
‐300
‐400
The ratio of net sales to inventory indicates that in the grocery retail industry it is
vital that firms manage their inventories well in order to have enough supply for the
demand of customers. There are so many periods throughout the year that generate
large amount of sales and stores must be prepared for the high amounts of traffic.
Overall, the net sales to inventory ratio shows that Weis Markets and these other firms
have maintained enough inventory to offset the high amount of sales. As there net
sales go up there inventory goes up which signals that their net sales support their
amount of inventory. Since in the raw chart there are not any significant decreases
and in the change chart most companies have maintained a positive ratio then there is
no “red flag.”
Net Sales / Unearned Revenue
The ratio of net sales to unearned revenue is another diagnostic that can indicate
if a firm is overstating its earnings. However, in the grocery retail industry, unearned
revenue does not exist on a company’s balance sheet primarily because in this industry
sales are recorded at point of sale. Once the customer purchases items the transaction
is complete and it’s recorded as revenue. Unearned revenue is typically seen in
83 | P a g e companies that provide services. In these industries managers tend to use this ploy to
manipulate revenue by recording earnings before they are earned. This usually
indicates a “red flag” among analyst and investors. But in the grocery retail industry
this ratio is not relevant in determining if sales are overstated.
Net Sales / Warranty Liabilities
The last ratio that can be used to see if a firm has overstated their revenue is
evaluating the relationship between net sales and warranty liabilities. This ratio is
calculated by taking the net sales and dividing it by the amount of warranty liabilities.
This ratio should show a direct relationship between the net sales and warranty
liabilities. If not then a “red flag” may exist if there is unexplained increases within this
ratio. However, in the grocery retail industry, warranty liabilities are not an issue.
Firms do not issue warranties for their products and services. Weis Markets and its
competitors are protected by the manufactures warranty. When a customer buys a
good the warranty is included with the product from the manufacturer and the store
has no liability. Therefore, an investor or analyst cannot calculate the ratio of net sales
to warranty liabilities of these firms.
Conclusion
All in all, the sales manipulation diagnostics can signal potential “red flags”
among firms. Indicating some sort of manipulation to their generated revenue figures.
As far as Weis Markets goes no “red flags” where found in comparing their net sales to
various activities such as cash from sales, accounts receivables, and inventory. In
terms of the three ratios calculated for each firm over the past five years there tends to
be a steady trend and no significant increases or decreases. In the grocery retail
industry, evaluating net sales to other components of a firm is critical due to the high
importance put on producing high volumes of sales. All these companies showed that
their net sales supported these activities.
84 | P a g e Expense Manipulation Diagnostic
The expense manipulation tests serve two primary functions. First, they can help
us identify consistency within the firm and its industry competitors. Second, they let us
know of potential “Red Flags.” The expense manipulation diagnostics helps determine if
the firm has manipulated expenses on their financial statements to help alter its value.
Consistency is measured by the raw ratios, meaning the information is presented on a
yearly basis so that consistency in annual activities is better measured. A firm’s
consistency is largely relative to their inconsistency, staggered and volatile declining
ratios can indicate understatements in expenses and overstatements in net income. The
change ratios are “Red Flag” indicators resulting from the negative ratios of the firm
and not relative to the actual amount. Asset Turnover
Asset Turnover (Raw)
7.00
6.00
5.00
WMK
4.00
SVU
3.00
KR
SWY
2.00
1.00
0.00
2004
2005
2006
2007
2008
Above is the Raw Asset Turnover ratio chart, which is calculated by dividing the
current year’s sales (revenue) by the previous year’s ending total assets. Declining asset
85 | P a g e turnover ratios signify that expenses are being deferred and therefore overstating net
income. As seen above, Weis, Kroger, and Safeway are fairly consistent throughout the
five years, but Supervalu has a significant spike in 2006 and rapidly declines from 2007
onto 2008. Supervalu’s volatile behavior from 2006 to 2008 shows their inconsistency in
expense recognition, primarily in the rapid decrease from 2007 meaning net income
was significantly overstated due to deferred expenses.
Asset Turnover (Change)
100.00
0.00
‐100.00
‐200.00
‐300.00
‐400.00
2004
2005
2006
2007
2008
WMK
SVU
KR
SWY
‐500.00
‐600.00
‐700.00
The change chart above shows that Weis and its other competitors, with the
exception of Kroger, remain positive and very similar throughout the five years,
signifying there is no potential red flags. The asset turnover ratio must also take into
account the restatements due to operating leases which alter total asset measures,
which can be seen in the chart below. When the ratio is adjusted to account for leases
the ratio, in general, decreases meaning that the actual total assets were understated.
The addition of capitalizing operating leases adds an additional asset account to the
balance sheet that increased Weis Markets total assets significantly while their sales
remained the same. Therefore, Weis Markets adjusted asset turnover ratio for the past
86 | P a g e five years decreased since the assets increased and sales remained the same. The chart
below depicts this change in the restated asset turnover for Weis Markets.
Restated Asset Turnover 2004
2005 2006
2007
2008 Adjusted 2.82
2.42 2.41
2.44
2.55 Actual 2.82
2.97 2.85
2.85
2.88 Restated Asset Turnover
2.90
2.80
2.70
2.60
2.50
WMK
2.40
2.30
2.20
2004
2005
2006
2007
2008
CFFO/Operating Income
Another useful tool for identifying expense manipulation is through the CFFO/OI
ratio, because it connects the income statement and statement of cash flows. The ratio
is calculated by dividing the operating income into the cash flows for operations. This
ratio determines how the cash is handled within a firm. More specifically, the ratio
87 | P a g e describes the cash received from operating activities in relation to operating income. If
a firm were to understate expenses, the CFFO/OI ratio would increase unexpectedly.
CFFO/OI (Raw)
3
2.5
2
WMK
1.5
SVU
KR
1
SWY
0.5
0
2004
2005
2006
2007
2008
The chart above shows the raw numbers of the CFFO/OI ratio for Weis Markets
and its competitors. For the most part Weis and Safeway have stayed fairly consistent
in their numbers and like Kroger and Supervalu, experienced in increase in 2007 which
could potentially mean that they were overstating their expenses and in turn decreasing
net income and owner’s equity. But compared to Kroger their behavior is overall
consistent in measures and not unstable. Looking at the change ratios; on the other
hand, we see a different picture.
88 | P a g e CFFO/OI (Change)
10
8
6
4
WMK
2
SVU
0
‐2
2004
2005
2006
2007
‐4
2008
KR
SWY
‐6
‐8
‐10
In the change CFFO/OI ratio chart above we see that Weis, along with its
competitors, have been in the negative range at least once in the five year period. Weis
start 2004 strong with high positive measures until 2006 and again in 2008. Although
Weis made a good recovery after 2006 they seem to have fallen short and went back
into a deeper negative range, surpassing -4. This raises a red flag about Weis’s recent
cash flows and their adverse affect on their net income.
CFFO/Net Operating Assets
The CFFO/NOA ratio is calculated by taking the firm’s operating cash flows and
dividing by their net PP&E. This ratio helps evaluate the firm’s depreciating practices. A
higher ratio results from overstating depreciation, however, an increasing ratio could
mean that the firm is utilizing its PP&E. The cash generated within the firm is compared
to PP&E to help determine how much equipment is worth after depreciation, which can
also be used for forecasting later on. The following charts show how the retail grocery
industry measures using the CFFO/Net Operating Assets.
89 | P a g e CFFO/NOA
0.4
0.35
0.3
0.25
WMK
0.2
SVU
0.15
KR
0.1
SWY
0.05
0
2004
2005
2006
2007
2008
Above you can see the raw ratios for CFFO/NOA, which show that there is an
industry trend in the market with most of them ranging from .15 to .3 in the five years
presented. There is not much of an increase in east of the firm’s cash flow from
operating activities, which shows that the industry overall had been pretty stable for the
past five years.
CFFO/NOA (Change)
4
3
2
WMK
1
SVU
0
‐1
2004
2005
2006
2007
2008
KR
SWY
‐2
‐3
‐4
90 | P a g e The change ratios above still follow a similar trend within the five years, but Weis’s
negative ratios could cause some concern on Weis’s expense manipulation regarding
operating assets and cash flow from operations. The chart above implies the changes in
CFFO are occurring at a faster rate compared to change in PP&E, which can help
explain the negative results.
Accruals/Sales
The accruals/sales ratio helps determine how efficient a firm’s receivables are
compared to total sales. The ratio could be calculated by starting with cash flows from
operations subtracting net earnings and then dividing the total accrual by total sales. A
high ratio would indicate the firm is dependent on receivables.
Accruals/Sales (Raw)
0
‐0.005
2004
2005
2006
2007
2008
‐0.01
‐0.015
‐0.02
‐0.025
‐0.03
‐0.035
WMK
SVU
KR
SWY
‐0.04
‐0.045
‐0.05
91 | P a g e Accruals/Sales (Change)
1
0.5
0
‐0.5
‐1
‐1.5
‐2
‐2.5
2004
2005
2006
2007
2008
WMK
SVU
KR
SWY
‐3
‐3.5
‐4
By taking the difference of net income and operating cash flows we can calculate
total accruals and then divide by sales to determine the Accruals/Sales ratio which
determines if sales are supporting total accruals. This ratio is especially important in the
retail grocery industry since it primarily relies on cash transactions. As seen above Weis
moves along the same direction as its competitors, unfortunately this is in the form of
negative ratios reflected by the negative differences of net income and cash flow from
operations. As stated, the industry’s reliance on cash sales and non-credit transactions
could account for this trend which is also seen in the change ratios. As seen above
Kroger deviates from the rest in both raw and change ratios. This could be explained by
some of Kroger’s operations, such as its fine jewelry division which would account for
credit transactions, therefore, separating it from the other three firms. Weis, Supervalu,
and Safeway are in sync throughout the five years and not too negative to raise any red
flags.
92 | P a g e Pension Expense/SG&A
Along with operations numbers and cash flows we also need to examine the
“people” numbers incurred by the firm and its competitors. For this we look at the
Pension Expense/SG&A ratio, determined by taking the annual service and interest cost
of the firms’ Employee Benefit Plan and dividing it by the SG&A from the income
statement.
Pension/SG&A (Raw) WMK SVU KR SWY 2004 1.360
0.024
0.021
0.023 2005 1.152
0.026
0.022
0.024 2006 1.245
0.025
0.024
0.023 2007 1.414
0.019
0.016
0.021 2008 1.231
0.018
0.017
0.019 Pension/SG&A (Raw)
1.600
1.400
1.200
1.000
WMK
0.800
SVU
0.600
KR
0.400
SWY
0.200
0.000
2004
2005
2006
2007
2008
93 | P a g e As seen above, Weis is noticeably above its competitors and highly segmented
from the market pool; whereas the rest are almost identical in trend and measures.
This unusual deviation from the pool is also supported by Weis’s change ratios shown
below. Supervalu and Kroger are depicted in the graph above but are not shown
because their ratios are approximately the same as Safeway. While the rest of the firms
continue on trend and fairly positive throughout the five years, Weis shows infrequent
behavior having almost reached -4 in 2004 and -2 in 2008, which may raise a red flag
on how the firm could be manipulating benefit expenses, which is probable since their
benefit expenses are not clearly defined on their income statements.
Pension/SG&A (Change) WMK SVU KR SWY 2004 ‐3.274
0.010
0.020 0.103 2005 ‐2.196
0.465
0.062 0.033 2006 6.591
0.023
0.055 ‐0.037 2007 8.889
0.016
‐0.083 ‐0.031 2008 ‐1.776
0.012
0.025 ‐0.050 Pension/SG&A(Change)
10.000
8.000
6.000
WMK
4.000
SVU
2.000
KR
0.000
SWY
‐2.000
2004
2005
2006
2007
2008
‐4.000
94 | P a g e Conclusion
Overall Weis typically correlates positively with their competitors, meaning that
there is not significant adverse manipulation in their expenses and net income. In the
raw Asset Turnover, CFFO/OI, CFFO/NOA, and Accruals/Sales ratios, Weis follows trend
with its competitors and had consistent measures throughout the five years. This means
that Weis is not overstating their expenses and therefore understating their net income.
In the raw and change Pension/SG&A ratios Weis strayed from its competitors ratio
patterns, which depicts segmentation from Weis and the rest of the market. In
conclusion, Weis Markets shows that they can maintain relatively healthy ratio numbers
and transparency and lack any major red flags.
Red Flags
Red flags are outliers that can raise concern over the firm financial statements.
Some concerns involve drastic changes in accounting such as unusual increases of total
accruals in relation to sales. Not all outliers signal red flags but they do need more
attention to help undo any potential distortions. In the event of catching a red flag,
analyst will have to restate the financial documents that are affected. Weis Markets has
some potential red flags that may have caused some misleading information on the
financial statements.
Pension plans and the SGA changes ratio chart raised a red flag because of the
sudden decrease throughout the year 2007 leading to a negative ratio in 2008. Weis
Markets used a higher discount rate for five consecutive years causing them to use a
more aggressive accounting strategy. Since Weis Markets took a more aggressive
approach they caused lower liabilities. While SGA stayed stable throughout the years,
Weis Markets did not adjust the discount rate to current economic conditions, thus
leading to a negative ratio in 2008.
Another red flag is the CFFO/ NOA changes ratio. From 2004 the ratio decreased
into 2005, causing a negative value in 2005. Then increased into 2006, however,
95 | P a g e returned to a negative value in 2007. These drastic changes could result in an increase
in NOA and not having sufficient cash flow activities to support NOA. Potential
reasoning behind this could be not capitalizing their operating leases. So capitalizing
their operating leases could cause an increase in cash flow activity, which would help
improve the changes of CFFO/ NOA throughout the past five years.
Undo Accounting Distortions
As Palepu and Healy states, “If the accounting analysis suggests that the firm’s
reported numbers are misleading, analysts should attempt to restate the reported
numbers to reduce the distortion to the extent possible.” Footnotes provided by the
company can help outsiders to gain a better understanding of the firm and where it
stands. After determining level of disclosure, flexibility, accounting strategy, and
recognizing red flags, the analyst can undo any potential distortions and restate the
appropriate financials and determine the real performance of the firm. In the case of
Weis Markets the only red flag that was identified was in regards to operating leases
which account for more that 10% of their long term debt. Weis Markets failure to
capitalize these operating leases could distort their financial statements. Therefore, it is
necessary to restate Weis Markets financial statements including capitalized leases. The
restated financials will show a clearer picture of the financial health of the company and
overall value.
Operating Leases
After evaluating Weis Markets financial statements it became evident that they
do not capitalize their leases. By doing so Weis Markets does not report any additional
assets or long term liabilities on their balance sheet. Weis Markets only recognizes
lease expense. Without the reinstatement of operating leases Weis Markets has a small
amount of liabilities. This makes Weis Markets look more financially healthy than if they
where to capitalize their leases. Therefore, reinstating their financial statements with
capitalized leases is essential in determining the underlying value of the firm.
96 | P a g e The first step in determining whether operating leases need to be capitalized for
a particular firm is to assess the operating lease test. The operating lease test states
that if the present value of the firms operating leases is more than 10% of their total
long term debt then restatement of the firm’s financials is necessary. In the case of
Weis Markets there is a need to capitalize their operating leases and restate their past
financial statements. In order to restate Weis Markets financials a loan amortization
schedule must be calculated for the past five years. By doing so the amount of interest
expense, depreciation expense, leased assets, and long term lease liability is calculated.
Without capitalizing leases, Weis Markets only recognizes lease expense on their income
statement. After capitalizing their leases an additional asset and liability will be added
to their balance sheet.
In order to formulate a loan amortization schedule for a firm several steps must
be taken. The first step is to determine what discount rate is used to calculate the
present value of a firm’s operating leases. Weis Markets fails to mention the discount
rate used in their 10-K. Weis Markets had the highest pension discount rate compared
to their competitors which would make it a risky rate. Therefore, we used a rate of
7.5% which is Weis Markets pension discount rate. To acquire the amount of interest
and depreciation expense we went back to year 2004 to find the expenses for years
2005 to 2008. In order to determine the payment for the year we took the beginning
balance of the operating leases plus interest minus the payment which equals the
ending balance. The amount of depreciation was calculated by dividing the operating
leases by 10 years. We determined that 10 years was the appropriate life span for the
lease amortization. Below is a table showing the process we used to derive the
numbers we used to restate Weis Markets financial statements.
97 | P a g e 0.075
year
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
0.075
year
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
0.075
year
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
0.075
year
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
0.075
year
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Weis Markets 10-Yr. Loan Amortization Schedule
OI Payment
t
1
2
3
4
5
6
7
8
9
10
27543
26806
24142
23125
21212
24468
24468
24468
24468
24468
OI Payment
1
2
3
4
5
6
7
8
9
10
27700
25769
25769
21272
21272
21558
21558
21558
21558
21558
OI Payment
1
2
3
4
5
6
7
8
9
10
28551
27333
27333
20331
20331
23891
23891
23891
23891
23891
OI Payment
1
2
3
4
5
6
7
8
9
10
28900
25731
25731
18694
18694
21761
21761
21761
21761
21761
OI Payment
1
2
3
4
5
6
7
8
9
10
28066
23736
23736
18734
18734
21022
21022
21022
21022
21022
t
t
t
t
PV Factor PV Payment
0.930233
25,621
0.865333
23,196
0.804961
19,433
0.748801
17,316
0.696559
14,775
0.647962
15,854
0.602755
14,748
0.560702
13,719
0.521583
12,762
0.485194
11,872
PV Factor PV Payment
0.930233
25,767
0.865333
22,299
0.804961
20,743
0.748801
15,928
0.696559
14,817
0.647962
13,969
0.602755
12,994
0.560702
12,088
0.521583
11,244
0.485194
10,460
PV Factor PV Payment
0.930233
26,559
0.865333
23,652
0.804961
22,002
0.748801
15,224
0.696559
14,162
0.647962
15,480
0.602755
14,400
0.560702
13,396
0.521583
12,461
0.485194
11,592
PV Factor PV Payment
0.930233
26,884
0.865333
22,266
0.804961
20,712
0.748801
13,998
0.696559
13,021
0.647962
14,100
0.602755
13,117
0.560702
12,201
0.521583
11,350
0.485194
10,558
PV Factor PV Payment
0.930233
26,108
0.865333
20,540
0.804961
19,107
0.748801
14,028
0.696559
13,049
0.647962
13,621
0.602755
12,671
0.560702
11,787
0.521583
10,965
0.485194
10,200
Loan Amortization Table
BB
2005
1 169,298
2006
2 154,452
2007
3 139,230
2008
4 125,530
2009
5 111,820
2010
6 98,995
2011
7 81,951
2012
8 63,630
2013
9 43,934
2014
10 22,761
Loan Amortization Table
BB
2006
1 160,310
2007
2 144,633
2008
3 129,711
2009
4 113,671
2010
5 100,924
2011
6 87,221
2012
7 72,205
2013
8 56,062
2014
9 38,709
2015
10 20,054
Loan Amortization Table
BB
2007
1 168,928
2008
2 153,047
2009
3 137,193
2010
4 120,149
2011
5 108,829
2012
6 96,660
2013
7 80,019
2014
8 62,129
2015
9 42,898
2016
10 22,224
Loan Amortization Table
BB
2008
1 158,208
2009
2 141,174
2010
3 126,031
2011
4 109,752
2012
5 99,290
2013
6 88,043
2014
7 72,885
2015
8 56,590
2016
9 39,073
2017
10 20,243
Loan Amortization Table
BB
2009
1 152,076
2010
2 135,415
2011
3 121,835
2012
4 107,237
2013
5 96,546
2014
6 85,053
2015
7 70,410
2016
8 54,668
2017
9 37,746
2018
10 19,555
- 2004
Interest
12,697
11,584
10,442
9,415
8,387
7,425
6,146
4,772
3,295
1,707
- 2005
Interest
12,023
10,847
9,728
8,525
7,569
6,542
5,415
4,205
2,903
1,504
- 2006
Interest
12,670
11,479
10,289
9,011
8,162
7,250
6,001
4,660
3,217
1,667
- 2007
Interest
11,866
10,588
9,452
8,231
7,447
6,603
5,466
4,244
2,931
1,518
- 2008
Interest
11,406
10,156
9,138
8,043
7,241
6,379
5,281
4,100
2,831
1,467
Payment
27,543
26,806
24,142
23,125
21,212
24,468
24,468
24,468
24,468
24,468
EB
Change in Loan Depreciation Total CL Exp.
154,452
(14,846)
16,930
29,627
139,230
(15,222)
16,930
28,514
125,530
(13,700)
16,930
27,372
111,820
(13,710)
16,930
26,345
98,995
(12,825)
16,930
25,317
81,951
(17,043)
16,930
24,355
63,630
(18,322)
16,930
23,076
43,934
(19,696)
16,930
21,702
22,761
(21,173)
16,930
20,225
0
(22,761)
16,930
18,637
Payment
27,700
25,769
25,769
21,272
21,272
21,558
21,558
21,558
21,558
21,558
EB
Change in Loan Depreciation Total CL Exp.
144,633
(15,677)
16,031
28,054
129,711
(14,922)
16,031
26,878
113,671
(16,041)
16,031
25,759
100,924
(12,747)
16,031
24,556
87,221
(13,703)
16,031
23,600
72,205
(15,016)
16,031
22,573
56,062
(16,143)
16,031
21,446
38,709
(17,353)
16,031
20,236
20,054
(18,655)
16,031
18,934
0
(20,054)
16,031
17,535
Payment
28551
27333
27333
20331
20331
23891
23891
23891
23891
23891
EB
Change in Loan Depreciation Total CL Exp.
153,047
(15,881)
16,893
29,562
137,193
(15,854)
16,893
28,372
120,149
(17,044)
16,893
27,182
108,829
(11,320)
16,893
25,904
96,660
(12,169)
16,893
25,055
80,019
(16,641)
16,893
24,143
62,129
(17,890)
16,893
22,894
42,898
(19,231)
16,893
21,553
22,224
(20,674)
16,893
20,110
0
(22,224)
16,893
18,560
Payment
28900
25731
25731
18694
18694
21761
21761
21761
21761
21761
EB
Change in Loan Depreciation Total CL Exp.
141,174
(17,034)
15,821
27,686
126,031
(15,143)
15,821
26,409
109,752
(16,279)
15,821
25,273
99,290
(10,463)
15,821
24,052
(11,247)
15,821
23,268
88,043
72,885
(15,158)
15,821
22,424
56,590
(16,295)
15,821
21,287
39,073
(17,517)
15,821
20,065
20,243
(18,830)
15,821
18,752
0
(20,243)
15,821
17,339
Payment
28066
23736
23736
18734
18734
21022
21022
21022
21022
21022
EB
Change in Loan Depreciation Total CL Exp.
135,415
(16,660)
15,208
26,613
121,835
(13,580)
13,542
23,698
107,237
(14,598)
12,184
21,321
96,546
(10,691)
10,724
18,766
85,053
(11,493)
9,655
16,896
70,410
(14,643)
8,505
14,884
54,668
(15,741)
7,041
12,322
37,746
(16,922)
5,467
9,567
19,555
(18,191)
3,775
6,606
0
(19,555)
1,956
3,422
98 | P a g e Restated Financial Statements
Trial Balance
After analyzing Weis Markets financial statements it became evident that
restatement of their financials was important because they do not capitalize their
operating leases. In order to restate Weis Markets financials an amortization table was
created. The table provided the necessary financial numbers need to begin the
restatement process. In order to ensure the validity of the financial numbers a trial
balance was created to make sure the appropriate amounts were debited or credited to
the various line items. By creating these debit and credit columns we were able to
accurately apply the correct debits and credits to each line item and carry over any
values such as accrued deprecation on capital lease assets and accrued amortization of
lease liabilities over the past five years. By doing so we were able to generate restated
income statements and balance sheets for capitalized leases from 2004 to 2008. These
restatements show a clearer image of Weis Markets and its overall financial stability.
Below is a table of Weis Markets trial balance from 2004 to 2008.
99 | P a g e Trial Balance
2004
2004
Income Statement
As Stated Debits Credits Adjusted
Revenue
2,097,712
1,546,783
550,929
464,548
CGS
Gross Profit
SG&A
Lease Expense
Depreciation Expense
Income from Operations
Investment Income
Interest Expense
Income before provision for income taxes
Provision for income taxes
NET INCOME (LOSS)
2005
As Stated
2005
Debits Credits
2,097,712 2,222,598
1,546,783 1,636,137
550,929 587,724
464,548 491,499
27,543 27,543
27,700
16,930
16,930
16,031
86,381
41,908 96,225
1,222
1,222
3,081
12,697
12,697
12,023
87,603
30,433
99,306
30,412
30,412
35,885
57,191
21 63,421
2006
2006
Adjusted
As Stated Debits Credits Adjusted
2,222,598
1,636,137
587,724
491,499
27,700
16,031
52,494
3,081
12,023
43,552
35,885
7,667
2,244,512
1,647,233
597,279
515,675
2,244,512
1,647,233
597,279
515,675
28,551 28,551
16,893
16,893
81,604
36,160
4,484
4,484
12,670
12,670
86,088
27,974
30,078
30,078
56,010
(2,104)
100 | P a g e Trial Balance (Cont.)
2007
Income Statement
As Stated
Revenue
2,318,551
1,716,424
602,127
527,378
CGS
Gross Profit
SG&A
Debits
28,900
Lease Expense
15,821
Depreciation Expense
Income from Operations
Investment Income
74,749
3,010
11,866
Interest Expense
Income before provision for income taxes
Provision for income taxes
NET INCOME (LOSS)
Credits
77,759
26,769
50,990
2007
2008
Adjusted
As Stated
2,318,551
1,716,424
602,127
527,378
28,900
15,821
30,028
3,010
11,866
21,172
26,769
(5597)
2008
Debits
Credits
2,422,361
1,795,404
626,957
559,519
28,066
15,208
67,438
2,675
11,406
70,113
23,118
46995
Adjusted
2,422,361
1,795,404
626,957
559,519
28,066
15,208
24,164
2,675
11,406
15,433
23,118
(7685)
101 | P a g e Trial Balance Sheet
2004
As Stated
2004
Debits
Credits
Adjusted
2005
Carryover
As Stated
2005
Debits
Credits
Adjusted
2006
Carryover
As Stated
2006
Debits
Credits
Adjusted
Assets
Current:
Cash and Cash Equivalents
Marketable Securities
Account Recievables, net
Inventories
Pre-paid Expenses
Income taxes recoverable
Deferred income taxes
Total Current Assets:
Property and Equipment,net
58,234
16,212
36,058
165,044
4,970
1,729
3,003
58,234
16,212
36,058
165,044
4,970
1,729
3,003
69,300
23,210
38,376
179,382
6,076
69,300
23,210
38,376
179,382
6,076
4,359
4,359
285,250
441,074
285,250
441,074
169,298
320,703
446,517
Total Assets: $
300,993
492,543
300,993
492,543
168,928
(32,961)
15,722
4,804
950,029
15,731
6,427
748,482
15,731
6,427
$ 917,780
15,731
5,536
$ 788,487
95,743
20,637
20,172
10,826
95,743
20,637
20,172
10,826
100,895
20,079
21,553
12,487
100,895
20,079
21,553
12,487
105,859
22,307
22,778
1,435
105,859
22,307
22,778
1,435
2,020
2,020
147,378
157,034
157,034
27,596
176,782
29,404
169,298
346,080
865
298
153,542
12,912
18,445
184,630
865
298
153,542
12,912
18,445
168,928
353,827
8,199
702,714
4,747
(143,960)
571,700
748,482
8,199
702,714
4,747
(143,960)
571,700
$ 917,780
8,371
735,865
4,296
(144,675)
603,857
$ 788,487
169,298
160,310
Accrued amortization of lease rights
Intangible and other assets,net
27,545
38,163
41,885
189,468
3,932
320,703
446,517
160,310
16,930
(16,930)
15,731
5,536
$ 931,867
Capitalized leased rights assets
Goodwill
27,545
38,163
41,885
189,468
3,932
168,928
(16,930)
16,031
$
15,722
4,804
814,062
$
Liabilities
Current:
Accounts payable
Accrued expenses
Accrued self-insurance
Payable to employee benefit plans
Deferred Revenue, net
₋
Income taxes payable
Deferred income taxes
Total Current Liabilities:
147,378
Postretirement benefit obligations
29,404
Deferred income taxes
169,298
Capitalized leased rights liabilities
Total Liabilities:
160,310
27,596
160,310
344,940
168,928
Shareholders' Equity
Common Stock
Retained earnings
Accumulated Other Comprehensive Income,net
Treasury Stock
Total Shareholders' Equity:
Total Liabilities and Equity: $
16,930
8,371
718,935
4,296
(144,675)
586,927
$ 931,867
$
8,595
760,531
6,084
(146,047)
629,163
814,062
32,961
$
8,595
727,570
6,084
(146,047)
596,202
950,029
102 | P a g e Trial Balance Sheet (Cont.)
2007
Carryover
As Stated
2007
Debits
Credits
Adjusted
2008
Carryover
As Stated
2008
Debits
Credits
Adjusted
Assets
Current:
41,187
26,182
48,460
193,732
3,317
8,074
Cash and Cash Equivalents
Marketable Securities
Account Recievables, net
Inventories
Pre-paid Expenses
Income taxes recoverable
41,187
26,182
48,460
193,732
3,317
8,074
59,351
20,128
45,318
187,433
5,025
59,351
20,128
45,318
187,433
5,025
Deferred income taxes
320,952
499,246
Total Current Assets:
Property and Equipment,net
158,208
Capitalized leased rights assets
(32,961)
Accrued amortization of lease rights
Goodwill
Intangible and other assets,net
Total Assets:
16,893
15,722
4,149
$ 840,069
320,952
499,246
158,208
(49,854)
15,722
4,149
$ 948,423
317,255
511,113
152,076
(49,854)
15,821
15,722
4,124
$ 848,214
317,255
511,113
152,076
(65,675)
15,722
4,124
$ 934,615
Liabilities
Current:
111,555
23,036
23,442
1,400
Accounts payable
Accrued expenses
Accrued self-insurance
Payable to employee benefit plans
111,555
23,036
23,442
1,400
Deferred Revenue, net
Income taxes payable
Deferred income taxes
Total Current Liabilities:
Postretirement benefit obligations
Deferred income taxes
4,134
163,567
14,027
14,247
158,208
Capitalized leased rights liabilities
Total Liabilities:
191,841
4,134
163,567
14,027
14,247
158,208
350,049
95,128
28,173
23,344
95,128
28,173
23,344
6,920
738
4,020
6,920
738
4,020
158,323
12,454
16,337
152,076
339,190
12,454
16,337
152,076
187,114
Shareholders' Equity
Common Stock
Retained earnings
Accumulated Other Comprehensive Income,net
Treasury Stock
Total Shareholders' Equity:
Total Liabilities and Equity:
9,830
779,760
7,339
(148,701)
648,228
$ 840,069
49,854
9,830
729,906
7,339
(148,701)
598,374
$ 948,423
9,949
795,473
4,560
(148,882)
661,100
$ 848,214
65,675
9,949
729,798
4,560
(148,882)
595,425
$ 934,615
103 | P a g e Weis Markets: Restated Income Statement
2004
2005
2006
2007
2008
$ 2,097,712 $ 2,222,598 $ 2,244,512 $ 2,318,551 $ 2,422,361
1,546,783
1,636,137
1,647,233
1,716,424
1,795,404
CGS
Gross Profit
550,929
587,724
597,279
602,127
626,957
SG&A
464,548
491,499
515,675
527,378
559,519
27,543
27,700
28,551
28,900
28,066
Lease Expense
16,930
16,031
16,893
15,821
15,208
Depreciation Expense
Income from Operations $ 41,908 $ 52,494 $ 36,160 $ 30,028 $ 24,164
1,222
3,081
4,484
3,010
2,675
Investment Income
12,697
12,023
12,670
11,866
11,406
Interest Expense
Income before income taxes
30,433
43,552
27,974
21,172
15,433
Provision for income taxes
30,412
35,885
30,078
26,769
23,118
Revenue
NET INCOME $
21 $
7,667 $
(2,104) $
(5,597) $
(7,685)
104 | P a g e Weis Markets: Restated Balance Sheet
2004
2005
2006
2007
2008
Assets
Current:
58,234
16,212
36,058
165,044
4,970
1,729
3,003
Cash and Cash Equivalents
Marketable Securities
Account Recievables, net
Inventories
Pre-paid Expenses
Income taxes recoverable
Deferred income taxes
69,300
23,210
38,376
179,382
6,076
Property and Equipment,net
Capitalized leased rights assets
Accrued amortization of lease rights
Goodwill
Intangible and other assets,net
Total Assets
$
15,731
6,427
917,780
41,187
26,182
48,460
193,732
3,317
8,074
59,351
20,128
45,318
187,433
5,025
4,359
285,250
441,074
169,298
Total Current Assets
27,545
38,163
41,885
189,468
3,932
$
320,703
446,517
160,310
(16,930)
15,731
5,536
931,867 $
300,993
492,543
168,928
(32,961)
15,722
4,804
950,029 $
320,952
499,246
158,208
(49,854)
15,722
4,149
948,423 $
317,255
511,113
152,076
(65,675)
15,722
4,124
934,615
Liabilities
Current:
95,743
20,637
20,172
10,826
Accounts payable
Accrued expenses
Accrued self-insurance
Payable to employee benefit plans
100,895
20,079
21,553
12,487
105,859
22,307
22,778
1,435
2,020
111,555
23,036
23,442
1,400
95,128
28,173
23,344
Deferred Revenue, net
147,378
157,034
29,404
169,298
346,080 $
27,596
160,310
344,940 $
865
298
153,542
12,912
18,445
168,928
353,827
$
4,134
163,567
14,027
14,247
158,208
350,049 $
8,199
702,714
4,747
(143,960)
571,700 $
917,780 $
8,371
718,935
4,296
(144,675)
586,927 $
931,867 $
8,595
727,570
6,084
(146,047)
596,202 $
950,029 $
9,830
729,906
7,339
(148,701)
598,374 $
948,423 $
Income taxes payable
Deferred income taxes
Total Current Liabilities
Postretirement benefit obligations
Deferred
income taxes
Capitalized leased rights liabilities
Total Liabilities $
6,920
738
4,020
158,323
12,454
16,337
152,076
339,190
9,949
729,798
4,560
(148,882)
595,425
934,615
Shareholders' Equity
Common Stock
Retained earnings
Accumulated Other Comprehensive Income,net
Treasury Stock
Total Shareholders' Equity
Total Liabilities and Equity
$
$
105 | P a g e Conclusion
After restating Weis Markets financial statements from 2004 through 2008 due to
capitalizing their operating leases there were extreme differences from their actual
statements compared to the restated statements. Before the restatement of Weis
Markets financial statements the company seemed financially healthy with steady
growth. After capitalizing their operating leases Weis Market financial standpoint
changed significantly. Basically, Weis Markets went from being financially health to not
being financially sustainable.
In regards to Weis Markets restated income statement there are significant
differences in net income from the actual financial statements. In 2004 and 2005 even
with the addition of capitalizing their operating leases Weis Markets still was able to
maintain positive net income. Whereas, in 2006 through 2008 Weis Markets net income
was negative. In 2004 Weis Markets reported net income of $57,191,000 million with
the restatement their net income decreased dramatically to $21,000 thousand dollars.
In 2005 Weis Markets reported net income of $63,421,000 million compared to
$7,667,000 million after the restatement of capitalized operating leases. In years 2006
through 2008 Weis Markets reported positive net income but after capitalizing their
operating leases for these three years their net income became negative. So in 2006
through 2008 Weis Markets restated income statement reported net income loss.
Overall, the restatement of Weis Markets income statement showed significant
decreases in their net income. This is primarily due to the addition of capitalizing their
operating leases which added lease expense and depreciation expense.
Lastly, the restatement of Weis Markets balance sheet also showed differences
from their actual statement. By capitalizing Weis Markets operating leases additional
accounts were added to the balance sheet. In the asset section two new accounts were
added capitalized leased rights and accrued amortization of lease rights. In the liabilities
section one new account was added the capitalized leased rights liabilities. These three
new accounts were needed to make the appropriate adjustments to the restated
106 | P a g e balance sheet. By doing so Weis Markets assets and liabilities nearly doubled each of
the past five years. Overall, by capitalizing Weis Markets operating leases their assets
and liabilities increased dramatically. With these capitalized leases reported Weis
Markets adds a high amount of debt to their balance sheet which may be the reason
they do not capitalize their leases. Without the leases capitalized Weis Markets seems
financially health because they have minimal long term debt. If Weis Markets
capitalized their leases they may not be as financially stable. All in all, the restatements
do change the image of Weis Markets and makes the company less stable.
Financial Ratio Analysis and Forecasting
After completing the accounting analysis, financial analysis is the next major
segment which includes a three step process that helps evaluate a firm against its
competitors in the industry. The three steps include ratio analysis, forecasting analysis,
and determining the cost of capital of the firm. The ratio analysis includes liquidity,
profitability and capital structure ratios which help provide a starting point for
forecasting the income statement, balance sheet, and statement of cash flows. In
addition, these ratios will be vital in evaluating the financial condition of Weis Markets
and its competitors. The forecasting will consist of a ten year period using the past five
years of information. This will help predict the firms’ future performance within the
retail grocery industry.
Liquidity Ratios
Liquidity ratios are used to measure the cash resources that are available from a
firm to help meet their current obligations. The ratios are used to assess how easy a
firm will be able to convert assets into cash in order to cover its own short term
liabilities. Firms should aim at achieving high liquidity ratios to prove that they are not
struggling and able to cover their short term debt. However, maintaining an extremely
high ratio could prove that the firm is not investing properly to expand and grow in
their business. The liquidity ratios are further broken down into two groups, liquidity
107 | P a g e and operation efficiency. Liquidity ratios include the current ratio and quick asset ratio.
Operation efficiency ratios include inventory turnover, days’ supply of inventory,
receivables turnover, days’ sales outstanding, cash to cash cycle and working capital
turnover. Operating efficiency ratios help evaluate the firm’s assets such as inventory to
show how effective they are utilizing their resources and receiving revenue. Each ratio
will be discussed and analyzed for Weis Markets and its top competitors to help
evaluate how liquid the firm is.
Current Ratio
The current ratio measures a firm’s liquidity. Basically, it shows if a firm is able
to pay off their current liabilities using their current assets. By taking a firm’s current
assets and dividing it by a firm’s current liabilities we can calculate the firm’s current
asset ratio. This will indicate if a company is able to cover its short-term liabilities with
its current assets. If the result of the ratio is less than one, then a firm has more shortterm liabilities than current assets. Therefore, a firm would be less liquid than a firm
with a ratio greater than one. When evaluating the current ratio firms with an
increasing ratio would signify a firm has more coverage therefore, is more liquid.
Current Ratio
3.00
WMK
2.00
SVU
1.00
KR
0.00
2004
2005
2006
2007
2008
SWY
The chart above shows Weis Markets’ current ratio compared to its competitors
over the past five years. The chart clearly depicts that Weis Markets’ current ratio over
the past five years has been relatively constant ranging from 1.94 to 2.04. This
indicates that for every dollar of liabilities Weis Markets has about two dollars of
resources or assets on hand. On the other hand, Weis Markets’ competitor’s current
108 | P a g e ratios range from .77 to 1.44. This indicates Weis Markets’ competitors are less liquid
and have fewer resources on hand to cover their liabilities. Therefore, Weis Markets has
a greater current ratio indicating the firm has more coverage compared to its
competitors. But for the most part all the firms have current ratios around one which
indicates that the firms have enough assets on hand to cover their liabilities.
Current Ratio WMK SVU KR 2004
2005
2006
2007
2008
SWY 1.94
1.09
1.01
0.95
2.04
1.30
1.01
0.87
1.96
1.44
0.96
0.77
1.96
0.95
0.89
0.78
2.00
0.90
0.82
0.88
Overall, the current ratio is a measure of liquidity which shows if a firm is able to
cover its current liabilities with its current assets. Over the past five years Weis Markets
has maintained a current ratio greater than one which shows the firm is more liquid
than its competitors. This means that Weis Markets has enough assets to meet its
current debt. Therefore, Weis Markets has more of a cushion in the case of unexpected
decreases in assets.
Quick Asset Ratio
The quick asset ratio is another measure of a firm’s liquidity. It is a more specific
test of liquidity. The quick asset ratio is calculated by adding a firm’s most liquid assets
which include cash, market securities, and accounts receivable. Then you divide the
firm’s liquid assets by a firm’s current liabilities. A firm’s inventory is not used in this
calculation because it takes a longer time to convert inventory into cash. Most of the
time the quick asset ratio is below 1 because companies do not carry as much liquid
109 | P a g e assets compared to their current liabilities. The closer a firm’s quick asset ratio is to
one indicates a company is able to cover its current debt with its most liquid assets.
Quick Asset Ratio
1.00
WMK
0.50
SVU
KR
0.00
2004
2005
2006
2007
2008
SWY
The chart above shows Weis Markets’ quick asset ratio compared to its
competitors over the past five years. Overall there is a steady trend among the
companies. Other than Supervalu, the firms have maintained stable quick asset ratios
over the past five years. Weis Markets’ quick asset ratio ranges from .70 to .83. This
indicates that for every dollar of current liabilities, on average $0.76 in quick assets
existed to cover the debt. All the companies have a quick asset ratio lower than one
which indicates none of these firms are able to cover their current debt with their most
liquid assets. But out of all the firms once again Weis Markets has the highest ratio
indicating it’s more liquid. Over the past five years there hasn’t been a substantial
change in Weis Markets’ quick asset ratio.
Quick Asset Ratio WMK SVU KR 2004 2005 2006 2007 2008 SWY 0.75
0.40
0.15
0.16
0.83
0.57
0.13
0.17
0.70
0.75
0.13
0.15
0.71
0.26
0.13
0.17
0.79
0.26
0.12
0.20
110 | P a g e Overall, Weis Markets has a higher quick asset ratio than its competitors
indicating its more liquid whereas, Safeway has a very low quick asset ratio, therefore,
their less liquid and will have a harder time paying off current debt with their most
liquid assets. In addition, Safeway may have a harder time borrowing short-term funds
because a low ratio indicates they may not be able to meet their short-term debt
payments in the future. Since all the companies ratios are less than one they are
unable to pay off their bills or liabilities by using their current resources or assets. But
compared to Supervalu, Kroger and Safeway, Weis Markets is in better shape and more
liquid which will help Weis if they need to borrow money in the future.
Receivables Turnover
The receivables turnover ratio is one indication of the efficiency of a firm’s
operations. In particular the receivables turnover ratio shows the efficiency of a firm’s
assets to generate revenue. In order to calculate this ratio, one must take a firm’s
sales divided by a firm’s accounts receivable. The more turns or the greater the ratio
indicates more liquidity whereas, a lower ratio would indicate less liquidity which is
unfavorable. Overall, a higher ratio shows a company’s ability to manage their assets
effectively.
Receivables Turnover
150.00
WMK
100.00
SVU
50.00
KR
0.00
2004
2005
2006
2007
2008
SWY
The chart above shows Weis Markets’ and its competitor’s receivables turnover
ratios for the past five years. The chart depicts a steady and stable trend of the
companies’ ratio for the past five years. Weis Markets’ ratio ranges from 47.84 to 58.18.
Compared to Supervalu, Weis Markets is more liquid and operates its assets more
111 | P a g e effectively. Kroger and Safeway are much larger than Weis Markets so their ratios are
larger ranging from 73.17 to 109.57. But overall the grocery industry seems to have a
receivables turnover ratio between 45 and 100. This is expected in the grocery industry
because most transactions are done on a cash basis not credit. Therefore, this ratio is
not a great indication of liquidity in the grocery retail industry.
Receivables Turnover WMK SVU KR 2004 2005 2006 2007 2008 SWY 58.18
45.12
79.81
105.67
57.92
41.71
85.38
109.57
53.59
45.23
89.05
87.13
47.84
39.09
85.53
73.17
53.45
46.32
89.36
85.62
Overall, in terms of the receivables turnover ratio firms in the grocery retail
industry tend to have a high ratio because they have fewer receivables than other
industries. Since the firms have greater sales and few receivables their ratios tend to
be high. Therefore, this ratio doesn’t evaluate a grocery based firm’s liquidity as well as
the other ratios.
Days Sales Outstanding
The days sales outstanding ratio is an extension of the receivables ratio. It
further dissects the receivables ratio and measures the average collection period of
receivables. This ratio is calculated by dividing 365 days by the accounts receivable
turnover ratio. In the grocery retail industry this ratio is going to be low because they
primarily deal with cash verses credit. Therefore, this ratio doesn’t pertain to the
grocery retail industry.
112 | P a g e Days Sales Outstanding
10.00
WMK
5.00
SVU
KR
0.00
2004
2005
2006
2007
2008
SWY
The chart above shows Weis Markets’ and its competitor’s days sales outstanding
ratio over the past five years. The ratio for the companies is very low and stable over
the past five years. Weis Markets’ days sales outstanding ratio ranges from 6.3 to 7.63.
This indicates that it takes about 7 days for Weis Markets to collect their money. In the
grocery retail industry the average amount of days it takes for firms to receive their
money ranges from 3 to 9 days. Therefore account receivables are not valued in the
industry because majority of the customers pay cash. This is very low compared to
other industries that are based on credit.
Days Sales Outstanding WMK SVU KR 2004 2005 2006 2007 2008 SWY 6.27
8.09
4.57
3.45
6.30
8.75
4.28
3.33
6.81
8.07
4.10
4.19
7.63
9.34
4.27
4.99
6.83
7.88
4.08
4.26
Inventory Turnover
The inventory turnover ratio is one of many ratios used to observe operating
efficiency, calculating the number of times inventory must be replenished, or sold and
replaced, over a period. The ratio is a result of dividing the current year’s inventory,
recorded at cost, into the costs of goods sold, which is also recorded at cost. A firm’s
inventory ratio can help determine the efficiency of its operation by its numbers, the
113 | P a g e bigger the number the more sales that are being generated and the faster inventory
must be replenished. In the grocery retail industry we look for consistency at higher
numbers since sales are predictable and occur with cash transactions.
Inventory Turnover
20.00
15.00
10.00
5.00
0.00
WMK
SVU
KR
2004
2005
2006
2007
2008
SWY
The chart above compares Weis Markets’ inventory ratio with its top three
competitors. As expected Weis operates on consistent levels that have gradually been
increasing since 2007. Compared to its competitors, Weis Markets has followed trend
with Kroger and Safeway throughout the past five years. As of late 2007, all of the
above firms have taken on a positive trend as sales seem to be increasing. This
increase could be a result of higher sales which would increase costs of goods sold and
in turn would have to increase the inventory on hand. Because the numbers are
gradually moving in a positive direction this shows increasing operating efficiency in
Weis Markets and even their competitors.
Inventory Turnover WMK SVU KR 2004 2005 2006 2007 2008 SWY 9.38
16.11
9.51
9.20
9.12
16.16
8.91
9.87
8.69
17.79
9.33
10.82
8.86
10.65
9.91
10.77
9.58
12.23
11.08
12.19
114 | P a g e Days’ Supply of Inventory
Another way to evaluate a firms operating efficiency with its inventory is by using
the inventory turnover ratio to measure days supply of inventory, or the amount of days
inventory is on the shelves. By simply taking the inventory turnover ratio and dividing it
into the number of days in a year, 365, we can see the amount of “shelf” days for a
firm’s inventory. Whereas, we look for higher numbers in the inventory turnover ratio,
we look for smaller outcomes in the days supply of inventory. Smaller numbers mean
the less time inventory spends on the shelf, as a result of increasing sales.
Days Supply of Inventory
60.00
WMK
40.00
SVU
20.00
KR
0.00
2004
2005
2006
2007
2008
SWY
Above we see that again Weis Markets is moving along with its competitors in a
consistent trend. Since the inventory turnover ratios started increasing from 2007
onward, it is expected that the days supply of inventory would be decreasing since
higher sales means less shelf time for products. The chart above shows that Weis is
being aggressive in the industry and maintaining healthy levels of operating efficiency in
regards to their inventory management.
115 | P a g e Days Supply of Inventory WMK SVU KR 2004 2005 2006 2007 2008 SWY 38.91
22.66
38.39
39.65
40.02
22.58
40.96
36.98
41.98
20.51
39.14
33.72
41.20
34.28
36.85
33.89
38.10
29.85
32.95
29.94
Cash to Cash Cycle (Days)
The cash to cash cycle ratio describes a firm’s operating efficiency based on a
firms operating capital. Each firms’ operations work as a wheel, the cash to cash cycle
ratio shows the speed of the efficiency wheel from start to finish, or when cash enters
the cycle to the point we receive revenue. To calculate this ratio we simply add the
days supply of inventory and the days sales outstanding to reveal how fast a firm’s
sales are moving through the system. Overall, we look for low numbers which can not
only conclude higher operating efficiency but increasing liquidity as well.
Cash to Cash Cycle
60.00
WMK
40.00
SVU
20.00
KR
0.00
2004
2005
2006
2007
2008
SWY
As we can see Weis has slightly larger numbers than its competitors meaning
their sales are being generated at a slower pace than that of their competitors. But as
proof of their increasing operating efficiency, their numbers have also been gradually
declining since 2007, keeping on trend with the other firms.
116 | P a g e 2004 2005 2006 2007 2008 Cash to Cash Cycle WMK SVU KR SWY 45.18
30.74
42.96
43.11
46.32
31.33
45.24
40.31
48.79
28.58
43.24
37.91
48.83
43.62
41.11
38.88
44.93
37.73
37.04
34.21
Working Capital Turnover
The working capital turnover ratio, derived by dividing a firm’s working capital
(current assets minus current liabilities) into a firm’s sales, is used to evaluate the
efficiency of a firm’s correlation between operating capital and the sales generated from
operating capital. The higher the working capital turnover, the better because it means
that the firm is generating more sales compared to the money it uses to fund the sales.
Essentially it means that for every dollar spent they are getting more than that dollar in
revenue.
Working Capital Turnover
2000.00
WMK
1000.00
SVU
KR
0.00
2004
2005
2006
2007
2008
SWY
‐1000.00
As shown above we can see that Weis has maintained very stable ratios and has
remained at a consistent and competitive level with its competitors. Kroger’s very high
numbers in the first couple of years compared to other firms could be evidence of
Kroger’s larger size in comparison to Weis and the others. Along with Supervalu and
Safeway, Weis has been increasing its size in the past few years which accounts for
117 | P a g e increased assets, working capital and of course sales growth, hence explaining the even
“playing field” established in 2006 with Kroger. Overall, it seems that in the grocery
retail industry every capital dollar spent returns a regular amount of revenue in return.
Working Capital Turnover WMK SVU KR 2004 2005 2006 2007 2008 SWY 15.21
122.41
1630.03
-184.27
13.58
39.49
627.04
-68.42
15.22
30.04
-243.18
-38.80
14.73
-152.68
-80.04
-37.46
15.24
-95.76
-44.59
-84.33
Conclusion
After completing the liquidity ratios, we can conclude that Weis Markets is more
liquid than its competitors and maintains a high level of operation efficiency. Most of
Weis Markets liquidity ratios show increasing trends such as the quick asset ratio and
inventory turnover. As the retail grocery industry faced recession in 2008, they all
moved in the same direction, and Weis Markets was able to stay about average with its
competitors. Weis Markets had the highest current and quick ratio, which proves Weis
Markets could invest in long term investments that will allow the firm to expand. Overall
Weis Markets has been more liquid with a pretty stable trend over the past five years.
Profitability Ratios
In order to operate in a business successfully, having adequate coverage of
expenses with revenues is an important factor to consider. Profitability ratios help
determines a firm’s ability to generate profit. In order to calculate profitability ratios, we
will incorporate the firm’s income statement, balance sheet, and statement of cash
flows. After gathering the information needed for profitability ratios, we will analyze and
118 | P a g e use the ratios to help generate a forecast for the future and see how they compare to
other firms within the industry. The profitability ratios that will be analyzed include:
gross profit margin, operating profit margin, net profit margin, asset turnover, return on
assets, return on equity, operating expense ratio, internal growth rate, and sustainable
growth rate.
Gross Profit Margin
The gross profit margin is found by dividing the gross profit of a firm by its
current period sales. This calculation indicates how profitable the firm is. The gross
profit is first found by subtracting the cost of goods sold from the sales. A more
profitable firm has a higher gross profit margin which shows that a company has the
ability to have a higher net income. Also, a high ratio shows that the company
generated enough revenue to cover their fixed and variable cost as well as overhead
expenses. Comparing gross profit margins with other companies allows a firm to see
how profitable they are compared to their competitors regardless of size.
As shown in the graph above, Weis Markets has done a good job maintaining
practically the same gross profit margin all the way into 2008; in fact it has the second
highest gross profit margin at 26%. Safeway, Kroger, Supervalu, and Weis Markets all
have gross profit margins between 20% and 30%. However, Supervalu did not reach
this range until 2007. From 2004 until 2007 Supervalu was in the 10% to 20% range,
whereas Weis Markets, Safeway, and Kroger have been in the same range since 2004.
119 | P a g e Supervalu’s gross profit margin began to rise in 2006 which could possibly be as a result
of a merger with Albertson’s and an increase in sales (Supervalu’s 10-K). Weis Markets’
gross profit margin has remained stable since 2004, at 26% only changing once in 2006
to 27%. Weis’s stability in its gross profit margin will be beneficial when forecasting the
firm’s future values.
Gross Profit Margin WMK SVU KR 2004 2005 2006 2007 2008 SWY 0.26
0.14
0.26
0.30
0.26
0.15
0.25
0.29
0.27
0.15
0.25
0.29
0.26
0.22
0.24
0.29
0.26
0.23
0.23
0.28
Operating Profit Margin
The operating profit margin is found by dividing operating income by sales. Like
the gross profit margin, a higher operating profit margin shows a more profitable firm.
The ratio will help evaluate a company’s operating activities as part of their revenues. A
firm’s operating activities include the day to day activities completed on a regular basis
throughout the year. A higher margin is preferred by firms because it shows a higher
operating income compared to overall sales.
Operating Profit Margin
0.06
WMK
0.04
WMK Adj 0.02
SVU
0.00
KR
2004
2005
2006
2007
2008
SWY
120 | P a g e Since 2005, Weis Markets has seen a decrease in their operating profit margin.
When compared to its competitors, Weis Markets has the lowest operating profit margin
at just below 3%. Weis Markets operating income is low due to their expense incurred
by operating leases which lead to them having the low operating profit margin. Weis
Markets’ adjusted rate is below 2%. This decline is due to capitalizing leases. Safeway is
the industry leader amongst its competitors with an operating profit margin of 4.2%.
Weis Market’s adjusted financials caused a decrease in their operating profit margin
Operating Profit Margin WMK WMK Adj SVU KR 2004 2005 2006 2007 2008 SWY 0.04
0.02
0.03
0.03
0.03
0.04
0.02
0.04
0.02
0.03
0.04
0.02
0.02
0.03
0.04
0.03
0.01
0.03
0.04
0.04
0.03
0.01
0.04
0.03
0.04
Net Profit Margin
One of the most important ratios computed is the net profit margin, because it
serves as the overall business profitability. This is found by dividing the net income by
the total sales. This ratio shows us the complete profitability percentage from sales a
firm made for that period and how much of every dollar made it into net income. The
net income is found after all other expenses and revenues have been added in or
subtracted out such as interest expense or income tax. The more a company can
minimize its expenses, the higher the net income, the higher the net profit margin will
be. The higher the net income, the more money can go back to a firm’s shareholders or
to more investments.
121 | P a g e Net Profit Margin
0.04
0.03
0.02
0.01
0.00
‐0.01
WMK
WMK Adj SVU
KR
2004
2005
2006
2007
2008
SWY
As shown in the graphs above, Weis Markets’ net profit margin is second
compared to its competitors. However, Weis Markets has seen a slow decrease since
2005 whereas Safeway, Supervalu, and Kroger have all seen an increase in their net
profit margin. If this trend is to continue, Weis Markets will end up at the bottom of this
as well. After the adjusted amounts, Weis Markets’ Net Profit Margin declined to zero.
Net Income declined substantially because of expenses incurred for capitalizing
operating leases.
WMK 2004 2005 2006 2007 2008 Net Profit Margin WMK Adj SVU KR SWY 0.03
0.00001
0.01
0.01
0.02
0.03
0.00345
0.02
0.00
0.01
0.02
-0.00094
0.01
0.02
0.02
0.02
-0.00231
0.01
0.02
0.02
0.02
0.01940
0.01
0.02
0.02
Asset Turnover
The key ratio linking the income statement and balance sheet for forecasting is
the asset turnover ratio. A high ratio would imply the firm is successfully generating
sales from its assets. The asset turnover ratio is calculated by dividing net sales by the
previous year’s total assets. Having a turnover above one is a successful ratio to have,
while having a low ratio would imply that the assets are not being utilized properly.
122 | P a g e Asset Turnover
8.00
6.00
4.00
2.00
0.00
WMK
WMK Adj SVU
KR
2004
2005
2006
2007
2008
SWY
The chart above shows all top competitors have an asset turnover ratio of above
two, which would imply all firms are utilizing their assets properly. Furthermore, Weis
Markets, Kroger, and Safeway were able to keep a steady ratio over the past five years.
Supervalu had a different issue, their acquisition with Albertsons caused an increase in
asset turnover ratio but they were able to adjust to their normal ratio range in 2008.
The top competitors are able to utilize all assets, including long term assets, to help
generate sales. Weis Markets’ adjusted asset turnover did change significantly because
total assets increased while sales remained the same.
WMK 2004 2005 2006 2007 2008 Asset Turnover WMK Adj SVU KR SWY 2.82
2.29
3.43
2.68
2.37
2.97
2.42
3.18
2.80
2.50
2.85
2.41
3.16
2.96
2.55
2.85
2.44
6.19
3.23
2.60
2.88
2.55
2.03
3.31
2.50
Return on Assets
Return on assets (ROA) helps determine how the assets affect profits from within
the firm. The ratio helps show how efficient the company is utilizing its assets. An
investment is highly considered when there is a strong chance that the asset will
generate a return greater than that of other possible projects; furthermore, earn a
discount rate higher than the risk free interest rate. The calculation for return on assets
123 | P a g e is total assets from the previous year divided by net income for the current year. This is
known as lagged because the income earned for the year is from investing and utilizing
the assets from the previous year. The lagged ratio helps get a better understating of
the return ratio and also help make a better decision with investments.
Return on Assets
0.10
WMK
0.05
WMK Adj SVU
0.00
KR
2004
‐0.05
2005
2006
2007
2008
SWY
According to the chart above, Weis Markets has a higher ROA ratio compared to
their competitors and it is decreasing slightly over time. As the decreasing is occurring,
Weis Markets is starting to even out with Kroger and Safeway. Weis Markets does not
capitalize on their buildings and other long term assets; instead they classify them as
operating leases. This can have an effect on return on assets because interest expense
and other expenses are not being considered in net income which could lead to
overstating earnings. In the grocery retail industry, majority of the firms use operating
leases so their income statements and balance sheets all have about the same
outcome. Although bankers would recommend a ratio of close to one Weis Markets had
a higher ratio and would be more eligible to invest if they were interested. The adjusted
net income caused Weis Markets’ Return on Assets to decrease rapidly. The decreased
did make a difference in the Return on Assets ratio because Weis went from having the
highest ratio to the lowest ratio. This is caused due to a decrease in net income and a
slight increase in total assets.
124 | P a g e WMK 2004 2005 2006 2007 2008 Return on Assets WMK Adj SVU KR SWY 0.08
0.0000
0.05
0.02
0.04
0.08
0.0084
0.06
0.00
0.04
0.07
-0.0024
0.03
0.05
0.06
0.06
-0.0059
0.07
0.05
0.05
0.06
-0.0081
0.03
0.06
0.05
Return on Equity
The return on equity is similar to return on assets helps determine how much
profit is earned using share holder’s equity. The ratio is computed as the previous year’s
equity divided by current year’s net income. The lagged years help evaluate the
performance throughout the year, which helps get a better understanding of the firm’s
actual performance. The return on equity ratio shares a significant relationship with the
firm’s financial leverage. Some assets are acquired through equity funding so the return
on equity ratio will help determine if the firm is utilizing its assets. A high ratio would
imply a high profit margin with low investment in debt financing.
Return on Equity
0.30
WMK
0.20
WMK Adj 0.10
SVU
0.00
KR
‐0.10
2004
2005
2006
2007
2008
SWY
According to the chart above, Weis Market’s return on equity market has
decreased since 2005, but has still managed to stay about average with its competitors.
Although Weis Markets return on equity ratio has decreased over the past five years,
they are decreasing at a slower rate than the competitors. Supervalu, Safeway and
125 | P a g e Kroger are all volatile year to year. Compared to return on assets, Weis Markets has a
slightly higher percentage of return on equity than return on assets. Weis Markets,
along with the top competitors, have been more aggressive with equity compared to
assets. Again, a decrease in net income caused Weis Markets’ adjusted Return on
Equity to around zero. Also, this decrease in net income had an effect on retained
earnings which decrease total equity. Having a higher return on equity can attract
investors because investors are interested in rate of return. Although, asset turnover,
profit margin, and firm capital structure affect return on equity, having extreme
changes from year to year will require more information. For Kroger’s drastic changes
from 2005 to 2006 is a perfect example. In 2005, Kroger was able to repurchase $147
million of stock, which reduced equity causing a higher return on equity for 2006. As for
the other top competitors, their return on equity was stable from 2004 to 2008.
WMK 2004 2005 2006 2007 2008 Return on Equity WMK Adj SVU KR SWY 0.10
0.000037
0.14
0.08
0.15
0.11
0.013411
0.17
-0.02
0.13
0.09
-0.003585
0.08
0.27
0.18
0.08
-0.009388
0.17
0.25
0.16
0.07
-0.012843
0.11
0.24
0.14
Operating Expense
The operating expense ratio is calculated as dividing selling and administrative
expenses by sales. The ratio will help distinguish the amount of selling and
administrative expenses account for every dollar of sales. Firms will try to minimize
expenses, especially in a cost competitive industry, and this will help evaluate some of
the expenses within the firm.
126 | P a g e Operating Expense Ratio
0.30
WMK
0.20
SVU
0.10
KR
0.00
2004
2005
2006
2007
2008
SWY
Weis Markets, Safeway, and Kroger are stable from 2004 to 2008 (from chart
above). Supervalu had some changes from 2006 to 2007 but was able to move into the
same range as the other competitors. Since the industry deals with price competition
and maintaining strong relationships with customers, minimizing these costs can benefit
firms. Supervalu mentions in their 10-K, that the increase in selling and administrative
expenses was due to the acquisition with Albertsons. Although Weis Markets does not
have the highest operating expense ratio, they can reduce some expenses to help
reduce the ratio to less than 20% like Supervalu and Kroger.
Operating Expense Ratio WMK SVU KR 2004 2005 2006 2007 2008 SWY 0.23
0.11
0.19
0.26
0.23
0.11
0.19
0.26
0.23
0.12
0.18
0.25
0.23
0.18
0.18
0.25
0.23
0.19
0.17
0.24
Internal Growth Rate
Internal Growth Rate (IGR) is a help formula to help determine the maximum
potential growth rate of a company under the assumption that it does not borrow or
repay debt. Only cash from cash flow will be used to invest in future growth projects.
The plowback ratio, or dividend payout ratio, is calculated as subtracting one from
127 | P a g e dividends divided by net income (1-(dividends/net income)). Since the IGR involves
dividends, if the firm does not pay dividends then the IGR would equal return on assets.
The IGR can be calculated as multiplying the return on assets by the plowback ratio as
the formula below shows.
Internal Growth Rate = ROA x (1- [Dividends/Net Income])
Internal Growth Rate
1.5000
WMK
1.0000
WMK Adj 0.5000
SVU
0.0000
KR
‐0.5000
2004 2005 2006 2007 2008
SWY
The chart above shows a volatile and unstable trend among all the firms
analyzed throughout the five years. Weis had a small negative IGR of -.0003 in 2004
and took a sudden increase in 2005 to .044 and began decreasing again into 2008.
While Weis Markets adjusted value had a IGR ranging from -.236 to 1.11. The wide
range comes from capitalizing their operating assets and having a decrease in net
income. Starting in 2006, the adjusted net incomes for Weis Markets were negative
value thus causing an increase in IGR. All the firms (Weis, Kroger, Safeway, and
SuperValu) delivered IGRs ranging from -.0003 to .056. As previously explained for
years that dividends were not paid the IGR would equal the firm’s ROA which is the
case with Kroger from 2004 through 2007 and Safeway in 2004 as there were no
dividends paid for those years. It is evident that any internal growth incurred is very
small and irregular which would make forecasting quite difficult based on the volatility.
128 | P a g e Internal Growth Rate WMK WMK Adj SVU KR SWY 2004 2005 2006 2007 -0.0003
-0.14
0.034
0.016
0.037
0.044
-0.236
0.050
-0.005
0.034
0.031
1.11
0.019
0.047
0.049
0.022
0.40
0.056
0.048
0.048
2008 0.019
0.30
0.021
0.046
0.047
Sustainable Growth Rate
The sustainable growth rate of a firm measures the maximum growth rate we
sustain with a constant debt to equity ratio. It is important to take into account a
constant debt to equity ratio in order to account a firm’s capital structure. We can
calculate the sustainable growth rate by multiplying a firm’s IGR to 1 plus a firm’s debt
to equity ratio.
Sustainable Growth Rate= IGR x (1+ (Debt/Equity))
Sustainable Growth Rate
3.0000
WMK
2.0000
WMK Adj 1.0000
SVU
0.0000
KR
‐1.0000
2004 2005 2006 2007 2008
SWY
Just like the IGRs from the previous graph, the sustainable growth rate for Weis
Markets and its competitors is also irregular. All the above firms with the exception of
Safeway and Weis from 2005 onward have experienced volatile increases and
decreases throughout the five years; Kroger especially, with a -.029 in 2005 to a
sudden .247 jump into 2006. Weis markets shows to have a more constant SGR since
2005 compared to its competitors; although, they are the lowest rates among the firms.
129 | P a g e The adjusted values for Weis Markets are more volatile than any of the other
competitors. Capitalizing operating leases caused Weis Markets a drastic change to
their capital structure which leads to a drastic change to their SGR.
Sustainable Growth Rate WMK WMK Adj SVU KR 2004 2005 2006 2007 2008 SWY -0.0004
-0.22
0.096
0.079
0.132
0.058
-0.534
0.124
-0.029
0.108
0.040
2.11
0.044
0.218
0.141
0.029
0.64
0.230
0.205
0.126
0.024
0.47
0.074
0.209
0.122
Conclusion
Profitability ratios for Weis Markets have followed industry trends and for the
most part have remained average and stable over the past five years. Also, Weis
Markets has a higher return on equity compared to return on assets which could benefit
investors and allow them to have a higher rate of return. Weis’ profit margins have
been fairly constant and followed trend with its top competitors; however, the same
cannot be said for Weis’ internal and sustainable growth rates. Even though Weis
seemed to have stable return and profit margin ratios that were either on par or better
than their competitors, Weis’ growth rates show uncertainty and volatility. Overall Weis
shows that it can compete with its competitors and like them they can show
inconsistent measures, as seen in the sustainable and internal growth rates.
Capital Structure Ratios
Capital Structure Ratios are helpful in providing information on how risky the firm
is. These ratios help determine how much debt is used to finance assets and other
operations. Capital Structure can also determine leverage which is an important factor
to consider in a firm. A firm with a high leverage has a risk of going bankrupt if they are
130 | P a g e not able to make the payments of their liabilities. However, leverage can increase the
stockholder’s return on investment and become a tax advantage for the firm by
borrowing. With that being said, a firm must try to use financial leverage to benefit
investors but also minimize risk at the same time. Capital structure ratios include debt
to equity, times interest earned, and debt service margin.
Debt to Equity
The debt to equity ratio can be calculated by taking your total liabilities
and dividing by owner’s equity. This ratio shows how much of debt financing the firm is
applying for every dollar that the shareholders have invested. The debt to equity ratio is
a strong indicator in determining a firm’s financial leverage. Most firms use only the
long term portion of debt or liabilities. In fact, some quoted ratios tend to leave out the
current portion of long term debt. Other subjective decisions are whether to include
preferred shares as part of debt or equity. If this ratio is greater than 1, it means assets
are primarily financed through debt. This could cause revenue to be volatile because of
the additional interest costs. In contrast, if the ratio is smaller than 1, assets are
financed mostly through equity. When a firm has a high debt to equity ratio they are
seen as risky, especially in periods with high interest rates. In these time periods, high
interest rates will cause extra interest to be paid out of debt.
Debt to Equity
6.00
WMK
4.00
WMK Adj
2.00
SVU
0.00
KR
2004
2005
2006
2007
2008
SWY
The chart above shows Weis Markets ratio remains constant at about .31
meaning Weis finances its assets through equity. Safeway is showing to decrease at a
stable rate where at Supervalu and Kroger has been a bit more volatile within the past
131 | P a g e five years. Throughout the past five years, Kroger and Supervalu have had the higher
D/E ratio which shows that they have been the riskier firms. While Weis Markets has
been able to stay in the range of .28 and .31, it is concluded that have been stable and
constant over the past five years. The adjusted debt to equity ratio for Weis Markets
increased due to a decrease in total equity. The decrease in total equity, once again,
was caused due to the decrease in net income. This decrease in net income came about
due to the capitalization of Weis’ operating leases. Capitalizing the leases caused more
interest expense therefore lowering net income. Although a decrease in equity could be
concerning, Weis Markets is better off than its competitors because its ratio is not as
large as its competitor’s ratio. Supervalu was in the lower range of D/E ratio from 2004
to 2006 but after their acquisition their D/E increased substantially. Weis Markets is able
to control its financial leverage better compared to its other competitors especially
Supervalu and Kroger.
WMK 2004 2005 2006 2007 2008 Debt to Equity WMK Adj
SVU KR SWY 0.31
0.61
1.78
4.03
2.57
0.31
0.59
1.50
4.79
2.20
0.29
0.90
1.31
3.67
1.87
0.30
0.59
3.09
3.31
1.63
0.28
0.57
2.54
3.54
1.58
Times Interest Earned
A helpful tool in measuring a firm’s ability to meet its debt obligations is the
times interest earned ratio. It is also known as the interest coverage ratio or fixedcharged coverage. The ratio is calculated by using a company’s operating income and
dividing by total interest payable or the interest expense on contractual debt. This ratio
shows how many times a firm can cover its interest expenses by taking money out of
earnings. A high times interest earned ratio indicates that a firm either has plenty of
operating income to cover its interest expenses or very little interest expense. A high
132 | P a g e times interest earned ratio leads to a low interest burden and less risk. The philosophy
of the Times Interest Ratio is that firms would receive greater returns by investing
income into different projects and financing at a lower cost of capital then what is
presently expensed for the current debt to meet debt obligations.
Times Interest Earned
8.00
6.00
4.00
2.00
0.00
WMK
WMK Adj
SVU
KR
2004
2005
2006
2007
2008
SWY
Weis Markets has a 0 Times interest earned ratio, which is far from the normal,
seeing how high their competitor’s ratios are. Weis Markets does not finance any of its
long term investments, instead they use operating leases. By not capitalizing the
operating investments, Weis Markets does not having to pay as much interest, almost
0, as they would have had to pay if the operating leases had been capitalized. With the
operating leases capitalized, Weis Markets’ Times Interest Earned ratio increased to
equal in the same range as their competitors. As for the competitors, Safeway was able
to maintain the higher ratio which shows that they are able to pay back investors at a
better rate compared to the other competitors.
WMK 2004 2005 2006 2007 2008 Times Interest Earned WMK Adj SVU KR SWY 0.00
3.30
4.11
2.27
3.10
0.00
4.37
6.23
1.52
3.32
0.00
3.05
4.11
3.99
4.45
0.00
2.53
2.34
2.54
4.81
0.00
2.12
2.38
4.85
5.32
133 | P a g e Debt Service Margin
The debt service margin ratio can be computed by taking total available cash
flow and dividing it by the current notes payable. This measures the ability of a
business to meet its regular debt obligations. The cash flow available for debt
repayment to its total debt service indicates a margin of safety available if the business
makes a profit, and its cash flows temporarily decrease. Any smart investor will insist on
having a debt service margin ratio greater than 1. The higher the ratio is, the easier it is
to finance projects through borrowing. If the ratio is below 1, that means there is
negative cash flow which is a serious problem for any firm looking to be successful. The
Debt Service Margin Ratio can also be used to find the minimal amount that a lender is
willing to accept. This ratio is seen as a useful indicator of financial strength.
Debt Service Margin
40.00
30.00
20.00
10.00
0.00
WMK
WMK Adj SVU
KR
2004
2005
2006
2007
2008
SWY
According to the chart above Weis Markets has had a Debt Service Margin of 0
because they do not have any currents note payable. After capitalizing lease
obligations, Weis Markets adjusted throughout the past five years increased
significantly. For example, in 2004 Weis Markets debt service margin increased from 0
to 4.29. Using WMK adjusted values, all firms operate over 1.0 ratio, signifying they are
capable of paying off their current portion of debt. In 2006, Kroger repurchased $633
million of stock which is the highest compared to $252 million repurchased in 2005.
These repurchases of stock lowered repayment of debt for these two years. Kroger
134 | P a g e used the cash flow to repurchase stock so in 2007, their current notes payable
increased 63%. Kroger’s repurchasing of stocks caused majority of their ratios to be
volatile. As for the other competitors, Supervalu and Safeway have remained stable
over the past five years. All of which have a debt service margin of over 1.0.
Debt Service Margin WMK WMK Adj SVU 2004 2005 2006 2007 2008 KR SWY 0.00
4.29
7.49
6.29
3.18
0.00
3.77
2.89
9.40
3.15
0.00
3.48
10.48
30.87
3.05
0.00
2.96
10.72
4.24
2.77
0.00
4.03
7.66
2.85
2.36
Altman’s Z Score
Atman’s Z score is an accurate way of computing bankruptcy scores. This is
useful for risk adverse shareholders because they can use this to ensure that the firm is
not on the verge of bankruptcy. The Z score can also be used to compare credit risk
among other firms. If the firm’s credit score is below 1.81, then the model is predicting
high chances of bankruptcy. A score between 1.81 and 2.67 is considered to be in the
“grey area,” and a score above 2.67 is considered to be healthy credit rating. Having a
higher Z score rating can also allow the firm to have lower interest rates. The formula
can be computed as:
1.2(Net Working Capital/Total Assets)
+1.4(Retained Earnings/Total Assets)
+ 3.3(Earnings before Interest and Taxes/Total Assets)
+ 0.6(Market Value of Equity/Book Value of Liabilities)
+ 1.0(Sales/Total Assets)
= Altman’s Z-Score
135 | P a g e Altman's Z‐Scores
10.00
8.00
WMK
6.00
WMK adj.
4.00
SVU
2.00
KR
0.00
SWY
2004
2005
2006
2007
2008
The chart above shows both Weis Markets actual and adjusted values are above
their compeitiors. Weis Markets has a Z score of around 8.53 which is considered
healthy. Even after the adjustments for capitalized leases, Weis Markets still maintained
a Z score above 2.67. All firms are are in the healthy credit range. Supervalu had the
lowest score in 2006- 2007 which would give them highest interest rates during that
time. Since Weis Markets has the highest score, they may get the advanatage of having
lower rates, which could be useful if the firm decides to finance more projects.
Altman's Z‐Scores WMK WMK adj. SVU 2004 2005 2006 2007 2008 KR SWY 8.61
6.70
5.87
3.52
4.65
8.73
7.00
6.16
4.67
4.69
8.41
6.74
6.58
5.22
4.78
7.71
6.82
3.40
5.42
4.96
8.10
6.84
3.90
5.42
5.23
Financial Statements Forecasting
The financial statements forecasting will allow a more understanding of the firms’
future performance. When forecasting Weis Markets, we made assumptions and found
trends using the ratios and growth rates to help predict their future performance.
136 | P a g e Current economic situations and other trends within the industry are also considered to
help provide a more accurate prediction for over the next ten years.
Income Statement
The income statement is the most important to forecast because it directly
effects the balance sheet and cash flow statements. The first step is to forecast the
future sales growth of a firm. This is important because this growth helps forecast
future sales. In 2008, Weis Markets had a sales growth of 4%. At the end of the third
quarter of 2009 (through September), Weis Markets had a sales growth of 2.32%. This
is prior to the industry facing the holidays including Thanksgiving and Christmas. To
end the year of 2009, we assume Weis Markets will have a sales growth rate of 4%.
Even though we are in the midst of a recession, we assume Weis Markets will continue
to grow to 6% from 2010 to 2013. This recession does not impact the grocery retail
industry, because consumers still need commodity items such as food, gasoline, and
other goods and services they provide. Although there are other stores to shop for
these goods such as Walmart, Weis Markets will not have to suffer as much as a
clothing retail store would. From 2014 to 2018, we predict Weis Markets to have a
growth rate of 7%. This is based more on the assumption that the recession has ended
resulting in an increase in consumer spending.
Next, in terms of forecasting cost of goods sold, Weis Markets had a stable trend
of 74% of sales from 2004-2008. Therefore, we used 74% of our forecasted sales to
generate the cost of goods sold from 2009-2018. Also, gross profit had a stable trend of
26% of sales from 2004-2008, so we used the same percentage rate to estimate the
forecasted gross profit for the next ten years. As for income from operations, we used a
stable rate of 3% of sales for the next ten years. Finally, for net income we used a
stable rate of 2.3% of sales to estimate the next ten years of Weis Markets’
performance. 137 | P a g e Weis Markets Income Statement
Actual Financials
2005
2006
2009
2010
2011
Forecasted Financials
2013 2014
2015
2012
2016
2017
2018
** All in thousands!!
Sales Growth
Net Sales $ 2,097,712 $ 2,222,598 $ 2,244,512 $ 2,318,551 $ 2,422,361 $ 2,518,044 $ 2,696,088 $ 2,857,853 $ 3,029,324 $ 3,211,084 $ 3,435,860 $ 3,676,370 $ 3,933,716 $ 4,209,076 $ 4,503,711
COGS
Gross Profit Op, Gen and Adm Exp
Income from Operations
Investment Income Income before taxes Provision for income taxes
Net Income 1,548,210
549,502
477,317
86,381
1,222
87,603
30,412
$ 57,191
2004
1,636,137
586,461
506,900
96,225
3,081
99,306
35,885
$ 63,421
1,647,233
597,279
515,675
81,604
4,484
86,088
30,079
$ 56,010
2007
1,716,424
602,127
527,378
74,749
3,010
77,759
26,769
$ 50,990
2008
1,795,404
626,957
559,519
67,438
2,675
70,113
23,118
$ 46,995
Income Statement
Sales Growth Revenue
CGS
Gross Profit
SG&A
Income from Operations
Investment Income
Interest Expense
Income before income taxes
NET INCOME
1,989,474
706,614
616,756
97,549
2,114,811
743,042
657,306
85,736
2,241,700
787,624
696,745
90,880
2,376,202
834,882
738,549
96,333
2,542,536
893,323
790,248
103,076
2,720,514
955,856
845,565
110,291
2,910,950
1,022,766
904,755
118,011
3,114,716
1,094,360
968,087
126,272
3,332,746
1,170,965
1,035,854
135,111
$ 45,115 $ 65,863 $ 65,731 $ 69,674 $ 73,855 $ 79,025 $ 84,557 $ 90,475 $ 96,809 $ 103,585
Forcasted Common Size Income Statement 2004
Common Size
1,863,353
654,692
537,138
69,692
2005
2006
2007
2008
2009
2010
2011
2012
100%
74%
26%
23%
3%
0%
3%
1%
100.00%
74.00%
26.00%
23.00%
3.00%
26.00%
23.00%
3.00%
100.00%
74.00%
26.00%
23.00%
74.00%
26.00%
23.00%
3.00%
100.00%
74.00%
26.00%
23.00%
74.00%
26.00%
23.00%
3.00%
100.00% 100.00%
74.00% 74.00%
26.00% 26.00%
23.00% 23.00%
74.00% 74.00%
26.00% 26.00%
23.00% 23.00%
3.00%
3.00%
2%
2.30%
2.30%
2.30%
3%
6%
1%
3%
4%
100%
74%
26%
23%
4%
0%
4%
1%
100%
74%
26%
23%
4%
0%
4%
2%
100%
73%
27%
23%
4%
0%
4%
1%
100%
74%
26%
23%
3%
0%
3%
1%
3%
3%
2%
2%
2.30%
2013
2.30%
2014
2015
2016
2017
2018
100.00%
74.00%
26.00%
23.00%
74.00%
26.00%
23.00%
3.00%
100.00%
74.00%
26.00%
23.00%
74.00%
26.00%
23.00%
3.00%
100.00%
74.00%
26.00%
23.00%
74.00%
26.00%
23.00%
3.00%
100.00%
74.00%
26.00%
23.00%
74.00%
26.00%
23.00%
3.00%
100.00%
74.00%
26.00%
23.00%
74.00%
26.00%
23.00%
3.00%
2.30%
2.30%
2.30%
2.30%
2.30%
138 | P a g e Overall, Weis Markets had a stable trend in the past five years, which allowed us
to predict a stable trend for the next ten years. Predicting the income statement, gave
us a basis for forecasting the balance sheet and statement of cash flows.
Restated Income Statement
Weis Markets’ restated income statement is fairly similar to their actual income
statement. The restated income statement was completed in the accounting analysis
and was more focused on capitalizing their operating leases. By having Weis Markets
capitalize their operating leases; their income statement will have an increase in lease
expense and depreciation which leads to a decrease in net income for the past five
years. Due to the decrease in net income, the net profit margin ratio will help forecast
the restated income statement for the next ten years. Over the past five years, Weis
Markets had a adjusted Net Profit Margin range from -0.00094 to 0.09140 there were
two outliers in the ratio over the past five years. So to calculate the average, we did not
include the two lowest values. We decided to use .00762 as an adequate net profit
margin to forecast the restated net income. By multiplying our forecasted sales by
.00762, the net income will be calculated and useful for forecasting.
Capitalizing operating leases caused Weis Markets to also have a change in
income from operations. To help forecast the income from operations we took the
adjusted Operating Profit Margin and found the average. In 2004-2006, Weis Markets
had a value of 0.02 and in 2007-2008 they had a value of 0.01. The average of
Operating Profit Margin for Weis Markets adjusted values equaled 0.016. We will use
0.016 to multiplied it by forecasted sales to help find the forecasted operating income.
139 | P a g e Weis Markets: Restated Income Statement
Revenue
CGS
Gross Profit
SG&A
Lease Expense
Depreciation Expense
Income from Operations
Investment Income
Interest Expense
Income before income taxes
Provision for income taxes 2004
2005
2006
2007
2008
$ 2,097,712
1,546,783
550,929
464,548
27,543
16,930
$ 41,908
1,222
12,697
30,433
30,412
$ 2,222,598
1,636,137
587,724
491,499
27,700
16,031
$ 52,494
3,081
12,023
43,552
35,885
$ 2,244,512
1,647,233
597,279
515,675
28,551
16,893
$ 36,160
4,484
12,670
27,974
30,078
$ 2,318,551
1,716,424
602,127
527,378
28,900
15,821
$ 30,028
3,010
11,866
21,172
26,769
$ 2,422,361
1,795,404
626,957
559,519
28,066
15,208
$ 24,164
2,675
11,406
15,433
23,118
2009
2010
2011
$ 2,518,044
1,863,353
654,692
579,150
31,476
$ 2,696,088
1,989,474
706,614
620,100
33,701
$ 2,857,853
2,114,811
743,042
657,306
35,723
Restated Forecasted Financials
2012
2013
2014
$ 3,029,324
2,241,700
787,624
696,745
37,867
$ 3,211,084
2,376,202
834,882
738,549
40,139
$ 3,435,860
2,542,536
893,323
790,248
42,948
2015
2016
2017
2018
$ 3,676,370
2,720,514
955,856
845,565
45,955
$ 3,933,716
2,910,950
1,022,766
904,755
49,171
$ 4,209,076
3,114,716
1,094,360
968,087
52,613
$ 4,503,711
3,332,746
1,170,965
1,035,854
56,296
40,289 43,137 45,726 48,469 51,377 54,974 58,822 62,939 67,345 72,059
NET INCOME $ 21 $ 7,667 $ (2,104) $ (5,597) $ (7,685) $ 19,187 $ 20,544 $ 21,777 $ 23,083 $ 24,468 $ 26,181 $ 28,014 $ 29,975 $ 32,073 $ 34,318
Weis Markets: Common Sized Restated Income Statement
Fiscal Year 2004
2005
2006
2007
Sales Growth Revenue
100.00%
100.00%
100.00% 100.00%
CGS
73.74%
73.61%
73.39%
74.03%
Gross Profit
26.26%
26.44%
26.61%
25.97%
SG&A
22.15%
22.11%
22.97%
22.75%
Lease Expense
1.31%
1.25%
1.27%
1.25%
Depreciation Expense
0.81%
0.72%
0.75%
0.68%
Income from Operations
2.00%
2.36%
1.61%
1.30%
Investment Income
0.06%
0.14%
0.20%
0.13%
Interest Expense
0.61%
0.54%
0.56%
0.51%
Income before income taxes
1.45%
1.96%
1.25%
0.91%
Provision for income taxes 1.45%
1.61%
1.34%
1.15%
NET INCOME 0.001%
0.345%
‐0.094%
‐0.241%
Restated Forecasted Financials
2012
2013
2014
2008
2009
2010
2011
2015
2016
2017
2018
100.00%
74.12%
25.88%
23.10%
1.16%
0.63%
1.00%
0.11%
0.47%
0.64%
0.95%
100.00%
74.00%
26.00%
23.00%
1.25%
100.00%
74.00%
26.00%
23.00%
1.25%
100.00%
74.00%
26.00%
23.00%
1.25%
100.00%
74.00%
26.00%
23.00%
1.25%
100.00%
74.00%
26.00%
23.00%
1.25%
100.00%
74.00%
26.00%
23.00%
1.25%
100.00%
74.00%
26.00%
23.00%
1.25%
100.00%
74.00%
26.00%
23.00%
1.25%
100.00%
74.00%
26.00%
23.00%
1.25%
100.00%
74.00%
26.00%
23.00%
1.25%
1.60%
1.60%
1.60%
1.60%
1.60%
1.60%
1.60%
1.60%
1.60%
1.60%
‐0.317%
0.76%
0.76%
0.76%
0.76%
0.76%
0.76%
0.76%
0.76%
0.76%
0.76%
140 | P a g e Balance Sheet
The balance sheet is the next financial statement that needs to be forecasted. A
forecasted balance sheet helps show a firm how assets, liabilities and equity are
affected in the future. By forecasting the firm’s balance sheet you can find out how
retained earnings will do in the future. In order to provide an accurate forecast of the
balance sheet, the forecasted sales must be accurate due to the fact that it is the base
of many of the ratios used to forecast important line items on the balance sheet.
The first line item to be forecasted on the balance sheet is total assets. To
forecast total assets you must use the asset turnover ratio, which connects the income
statement and balance sheet together. To be able to forecast total assets you must find
the asset turnover for the last five years as well as the average asset turnover for those
five years. We found a pretty steady average of 2.8 over this time period. We decided
to use 2.8 as an accurate forecast of asset turnover. To find forecasted total assets we
divided 2.8 by the forecasted sales for the next ten years.
Our next step in forecasting the balance sheet is to forecast the line item long
term or non-current assets. To forecast long term assets we must find long term assets
as a percentage of total assets over the last six years. This ratio is very stable over this
time period with an average of 61.7% of long term assets to total assets. We decided
to round up and use 62% as an accurate forecast of long term assets. We multiplied
the forecasted total assets by 62% to find an accurate view of long term assets over
the next ten years.
The next line item to be forecasted on the balance sheet is current assets. The
rules of accounting state that total assets minus long term assets equal current assets.
We used this to forecast our current assets over the next ten years. To double check
this line item we found the average of current assets to total assets over the past five
years was 37.50%. We multiplied total assets by the 37.50% over the next ten years
and it was the same as total assets minus long term assets which is the equivalent of
our total assets adding up to 100%.
141 | P a g e After we found current assets we can now begin to start forecasting the liabilities
section of the balance sheet. Our first liability to be forecasted on the balance sheet is
current liabilities. In order to find forecasted current liabilities, we found out our current
ratio over the last five years as well as the average over this period. Over the last five
years the current ratio’s average was 1.98. We used the average of 2.0 as an accurate
base to forecast current liabilities. We divided 2.0 from our forecasted current assets to
find our current liabilities over the next ten years.
Our next step in forecasting the balance sheet takes us to the stockholder’s
equity portion of the balance sheet. First, we must forecast retained earnings before we
are able to forecast total stockholder’s equity. When forecasting retained earnings the
following method is used: beginning balance of retained earnings plus net income
minus dividends paid. We followed this method for the next ten years to be able to
provide an accurate forecast of retained earnings. To find stockholders equity we use
the same method used to find forecasted retained earnings. The method we used to
find total stockholder’s equity is beginning balance of stockholders equity plus net
income dividends paid. This calculation represents the change in the previous year’s
retained earnings added into stockholders equity. We then use this calculation to
forecast the next ten years.
After finding total assets and total stockholder’s equity we are now able to
forecast total liabilities for the next ten years. We use the calculation Assets = Liabilities
+ Stockholders Equity to find total liabilities. We subtract our forecasted total
stockholder’s equity from our forecasted total assets to find our total liabilities for the
next ten years. After we found total liabilities we now forecast our long term liabilities.
We then calculated total liabilities minus current liabilities to find our long term
liabilities. We followed this method for the next ten years to find our forecasted long
term liabilities.
142 | P a g e Balance Sheet Assets Current Cash and Cash equivalents
Marketable Securities Accounts Receivable, net
Inventories
Prepaid Expenses Income Taxes recoverable Total Current Assets Property and Equip Goodwill Intangible and other assets
Total Non Current Assets
Total Assets Liabilities and Stockholders Equity
Actual Financials (in thousands)
Forcasted Financials (in thousands)
2004
2005
2006
2007
2008
$ 58,234
16,212
36,058
165,044
4,970
1,729
285,250
441,074
15,731
6,427
463,232
$ 69,300
23,210
38,376
179,382
6,076
‐
320,703
446,517
15,731
5,536
467,784
$ 27,545
38,163
41,885
189,468
3,932
‐
300,993
492,543
15,722
4,804
513,069
$ 41,187
26,182
48,460
193,732
3,317
8,074
320,952
499,246
15,722
4,149
519,117
$ 59,351
20,128
45,318
187,433
5,025
‐
317,255
511,113
15,772
4,124
531,009
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
45,782.62 $ 49,019.78 51,961 55,079 58,383 62,470 66,843 71,522 76,529 81,886
209,130 221,052.68 234,979 249,078 264,022 282,504 302,279 323,439 346,080 370,305
326,140 345,708.03 405,713 430,056 460,160 492,371 526,837 563,715 603,176 651,430
539,218 569,063 670,779 711,026 760,797 814,053 871,037 932,010 997,250 1,077,030
748,482 788,487
814,062 840,069
848,214 869,706 921,888 1,081,902 1,146,816 1,227,093
1,312,989 1,404,898 1,503,241 1,608,468 1,737,146
Liabilities Current Accounts Payable Accrued Exp
Accrued self‐ins
Deferred Rev, net
Income taxes payable Deeferred Income taxes Total Current Liabilities Postretirement Benefit obligations
Deferred Income Taxes
Total Non Current Liabilities
95,743
20,637
20,172
10,826
‐
29,404
147,378
‐
29,404
29,404
Total Liabilities 176,782 184,630
184,899 191,841
187,114 183,031 202,277 329,485 358,748 399,193 440,088 482,561 525,549 569,088 630,398
Shareholder's Equity Common Stock, no par value
Retained Earnings Accumulated other compreh income Treasury Stock 8,199
702,714
4,747
(143,960)
Total Equity
Total Liabilities and Equity 571,700 603,857 629,163 648,228 661,100 686,674 719,612 752,417 788,068 827,900 872,901 922,337 977,692 1,039,380 1,106,747
748,482 788,487
814,062 840,069
848,214 869,706 921,888 1,081,902 1,146,816 1,227,093
1,312,989 1,404,898 1,503,241 1,608,468 1,737,146
100,895
20,079
21,553
12,487
2,020
27,596
157,034
‐
27,596
27,596
8,371
735,865
4,296
(144,675)
105,859
22,307
22,778
1,435
865
298
153,542
12,912
18,445
31,357
8,595
760,531
6,084
(146,047)
103,712
24,436
23,442
7,843
‐
4,134
163,567
14,027
14,247
28,274
9,830
779,760
7,339
(148,701)
95,128
28,173
23,344
6,920
738
4,020
158,323 163,070 172,854.02 202,857 215,028 230,080 246,185 263,418 281,858 301,588 325,715
12,454
16,337
28,791 19,961 25,858 126,628 143,720 169,113 193,902 219,143 243,692 267,500 304,684
9,949
795,473 821,047 853,985 886,790 922,441 962,273 1,007,274 1,056,710 1,112,065 1,173,753 1,241,120
4,560
(148,882)
143 | P a g e Balance Sheet Common Size
Assets Actual Financials (in thousands)
Forcasted Financials (in thousands)
2004
2005
2006
2007
2008
7.78%
2.17%
4.82%
22.05%
0.66%
0.23%
38.11%
58.93%
2.10%
0.86%
61.89%
8.79%
2.94%
4.87%
22.75%
0.77%
‐
40.67%
56.63%
2.00%
0.70%
59.33%
3.38%
4.69%
5.15%
23.27%
0.48%
‐
36.97%
60.50%
1.93%
0.59%
63.03%
4.90%
3.12%
5.77%
23.06%
0.39%
0.96%
38.21%
59.43%
1.87%
0.49%
61.79%
7.00%
2.37%
5.34%
22.10%
0.59%
‐
37.40%
60.26%
1.86%
0.49%
62.60%
100%
100%
100%
100%
100%
Current Accounts Payable Accrued Exp
Accrued self‐ins
Deferred Rev, net
Income taxes payable Deeferred Income taxes Total Current Liabilities Postretirement Benefit obligations
Deferred Income Taxes
Total Non Current Liabilities
12.79%
2.76%
2.70%
1.45%
‐
3.93%
19.69%
‐
3.93%
3.93%
12.80%
2.55%
2.73%
1.58%
0.26%
3.50%
19.92%
‐
3.50%
3.50%
13.00%
2.74%
2.80%
0.18%
0.11%
0.04%
18.86%
1.59%
2.27%
3.85%
12.35%
2.91%
2.79%
0.93%
‐
0.49%
19.47%
1.67%
1.70%
3.37%
11.22%
3.32%
2.75%
0.82%
0.09%
0.47%
18.67%
1.47%
1.93%
3.39%
Total Liabilities 23.62%
23.42%
22.71%
22.84%
22.06%
Shareholder's Equity Common Stock, no par value
Retained Earnings Accumulated other compreh income Treasury Stock 1.10%
93.89%
0.63%
‐19.23%
1.06%
93.33%
0.54%
‐18.35%
1.06%
93.42%
0.75%
‐17.94%
1.17%
92.82%
0.87%
‐17.70%
1.17%
93.78%
0.54%
‐17.55%
76.38%
76.58%
77.29%
77.16%
77.94%
Current Cash and Cash equivalents
Marketable Securities Accounts Receivable, net
Inventories
Prepaid Expenses Income Taxes recoverable Total Current Assets Property and Equip Goodwill Intangible and other assets
Total Non Current Assets
Total Assets Liabilities and Stockholders Equity
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
5.26%
24.05%
5.32%
23.98%
4.80%
21.72%
4.80%
21.72%
4.76%
21.52%
4.76%
21.52%
4.76%
21.52%
4.76%
21.52%
4.76%
21.52%
4.71%
21.32%
37.50%
37.50%
37.50%
37.50%
37.50%
37.50%
37.50%
37.50%
37.50%
37.50%
62.00%
62.00%
62.00%
62.00%
62.00%
62.00%
62.00%
62.00%
62.00%
62.00%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Liabilities Total Shareholder's Equity
Total Liabilities and shareholder's equity 18.75%
19.14%
18.75%
18.75%
18.75%
18.75%
18.75%
18.75%
18.75%
18.75%
2.30%
2.80%
11.70%
12.53%
13.78%
14.77%
15.60%
16.21%
16.63%
17.54%
21.05%
21.94%
30.45%
31.28%
32.53%
33.52%
34.35%
34.96%
35.38%
36.29%
94.41%
92.63%
81.97%
80.43%
78.42%
76.72%
75.22%
73.98%
72.97%
71.45%
78.95%
78.06%
69.55%
68.72%
67.47%
66.48%
65.65%
65.04%
64.62%
63.71%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
144 | P a g e Restated Balance Sheet
Due to the capitalization of Weis Market’s operating leases that we performed
during the accounting analysis portion of our valuation, it was necessary to also
forecast the restated balance sheet for the next ten years. Capitalizing the operating
leases caused an increase to long term assets and therefore total assets. It was then
necessary to compute a new asset turnover ratio. The average of the adjusted ratios
was 2.422 compared to the unadjusted average of 2.874. This decrease in the asset
turnover ratio was due to the increase in total assets that created a large denominator
in the ratio. In order to avoid excess decimal places we rounded the average asset
turnover to 2.42. We then forecasted the next ten years of total assets by dividing the
total forecasted sales by the average adjusted asset turnover. Our next step was to
then forecast the non-current assets. It was not necessary to restate our forecasted
current asset because there was no change to them in the actual current assets. This
made it simple to forecast Weis’ non-current assets. The non-current assets were found
by subtracting the current assets from the total assets.
The basic accounting equation of assets=liabilities + stockholder’s equity allows
us to recognize that the restated forecast of total asset will be equal to the restated
forecast of total liabilities and stockholder’s equity. We then determine the restated
forecast stockholders equity by taking the final year of actual stockholders equity
adding in that year’s restated forecasted net income and subtracting that year’s
forecasted dividends then continuing on down the line using the previous year’s
restated forecasted equity instead of the final year of actual equity.
We then need to compute the liabilities. After we have computed the
stockholders equity we can then find the total liabilities by subtracting stockholder’s
equity from total stockholder’s equity and liabilities. Like the current assets, there was
no change in the restated forecasted current liabilities. They were taken from the
forecasted chart. From there the restated forecasted non-current liabilities were
determined by subtracting the current liabilities from the total liabilities.
145 | P a g e Restated Balance Sheet
Actual Financials (in thousands)
2004
2005
2006
2007
58,234
16,212
36,058
165,044
4,970
1,729
285,250
441,074
169,298
69,300
23,210
38,376
179,382
6,076
27,545
38,163
41,885
189,468
3,932
15,731
6,427
632,530
$ 917,780
320,703
446,517
160,310
(16,930)
15,731
5,536
611,164
$ 931,867
300,993
492,543
168,928
(32,961)
15,722
4,804
649,036
$ 950,029
41,187
26,182
48,460
193,732
3,317
8,074
320,952
499,246
158,208
(49,854)
15,722
4,149
627,471
$ 948,423
95,743
20,637
20,172
10,826
100,895
20,079
21,553
12,487
105,859
22,307
22,778
1,435
Forcasted Financials (in thousands)
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Assets
Current
Cash and Cash Equivalents
Marketable Securities
Account Recievables, net
Inventories
Pre‐paid Expenses
Income taxes recoverable
Total Current Assets
Property and Equipment,net
Capitalized leased rights assets
Accrued amortization of lease rights
Goodwill
Intangible and other assets,net
Total Non‐Current Assets
Total Assets
Liabilities
Current:
Accounts payable
Accrued expenses
Accrued self‐insurance
Payable to employee benefit plans
Deferred Revenue, net
Income taxes payable
Deferred income taxes
Total Current Liabilities
Postretirement benefit obligations
Deferred income taxes
Capitalized leased rights liabilities
Total Non‐Current Liabilities
147,378
2,020 865
298
157,034 153,542
12,912
27,596 18,445
160,310 168,928
187,906 200,285
344,940 353,827
59,351
20,128
45,318 45,782.62 $ 49,019.78 51,961 55,079 58,383 62,470 66,843 71,522 76,529 81,886
187,433 209,130 221,052.68 234,979 249,078 264,022 282,504 302,279 323,439 346,080 370,305
5,025
317,255 326,140 345,708.03 405,713 430,056 460,160 492,371 526,837 563,715 603,176 651,430
511,113
152,076
(65,675)
15,722
4,124
617,360 $ 714,374 $ 768,377 $ 775,217 $ 821,731 $ 866,734 $ 927,406 $ 992,324 $ 1,061,787 $ 1,136,112 $ 1,209,607
$ 934,615 $ 1,040,514 $ 1,114,085 $ 1,180,930 $ 1,251,787 $ 1,326,894 $ 1,419,777 $ 1,519,161 $ 1,625,502 $ 1,739,288 $ 1,861,037
111,555 95,128
23,036 28,173
23,442 23,344
1,400
6,920
738
4,134 4,020
163,567 158,323 163,070 172,854 202,857 215,028 230,080 246,185 263,418 281,858 301,588 325,715
14,027 12,454
14,247 16,337
158,208 152,076
186,482 180,867 295,758 371,927 419,918 489,544 559,154 643,774 733,032 826,079 923,183 1,022,705
350,049 339,190 458,828 544,781 622,775 704,572 789,234 889,959 996,450 1,107,937 1,224,771 1,348,420
Total Liabilities
29,404
169,298
198,702
346,080
Shareholders' Equity
Common Stock
Retained earnings
8,199 8,371 8,595 9,830 9,949
702,714 718,935 727,570 729,906 729,798
Accumulated Other Comprehensive Income,net 4,747
Treasury Stock
(143,960)
Total Shareholders' Equity
571,700
Total Liabilities and Equity
$ 917,780
4,296
(144,675)
586,927
$ 931,867
6,084
(146,047)
596,202
$ 950,029
7,339
(148,701)
598,374
$ 948,423
4,560
(148,882)
595,425 581,686 569,304 558,155 547,215 537,660 529,818 522,711 517,565 514,517 512,617
$ 934,615 $ 1,040,514 $ 1,114,085 $ 1,180,930 $ 1,251,787 $ 1,326,894 $ 1,419,777 $ 1,519,161 $ 1,625,502 $ 1,739,288 $ 1,861,037
146 | P a g e Restated Balance Sheet
Actual Financials (in thousands)
2004
2005
2006
2007
58,234
16,212
36,058
165,044
4,970
1,729
285,250
441,074
169,298
69,300
23,210
38,376
179,382
6,076
27,545
38,163
41,885
189,468
3,932
15,731
6,427
632,530
$ 917,780
320,703
446,517
160,310
(16,930)
15,731
5,536
611,164
$ 931,867
300,993
492,543
168,928
(32,961)
15,722
4,804
649,036
$ 950,029
41,187
26,182
48,460
193,732
3,317
8,074
320,952
499,246
158,208
(49,854)
15,722
4,149
627,471
$ 948,423
95,743
20,637
20,172
10,826
100,895
20,079
21,553
12,487
105,859
22,307
22,778
1,435
Forcasted Financials (in thousands)
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Assets
Current
Cash and Cash Equivalents
Marketable Securities
Account Recievables, net
Inventories
Pre‐paid Expenses
Income taxes recoverable
Total Current Assets
Property and Equipment,net
Capitalized leased rights assets
Accrued amortization of lease rights
Goodwill
Intangible and other assets,net
Total Non‐Current Assets
Total Assets
Liabilities
Current:
Accounts payable
Accrued expenses
Accrued self‐insurance
Payable to employee benefit plans
Deferred Revenue, net
Income taxes payable
Deferred income taxes
Total Current Liabilities
Postretirement benefit obligations
Deferred income taxes
Capitalized leased rights liabilities
Total Non‐Current Liabilities
147,378
2,020 865
298
157,034 153,542
12,912
27,596 18,445
160,310 168,928
187,906 200,285
344,940 353,827
59,351
20,128
45,318 45,782.62 $ 49,019.78 51,961 55,079 58,383 62,470 66,843 71,522 76,529 81,886
187,433 209,130 221,052.68 234,979 249,078 264,022 282,504 302,279 323,439 346,080 370,305
5,025
317,255 326,140 345,708.03 405,713 430,056 460,160 492,371 526,837 563,715 603,176 651,430
511,113
152,076
(65,675)
15,722
4,124
617,360 $ 714,374 $ 768,377 $ 775,217 $ 821,731 $ 866,734 $ 927,406 $ 992,324 $ 1,061,787 $ 1,136,112 $ 1,209,607
$ 934,615 $ 1,040,514 $ 1,114,085 $ 1,180,930 $ 1,251,787 $ 1,326,894 $ 1,419,777 $ 1,519,161 $ 1,625,502 $ 1,739,288 $ 1,861,037
111,555 95,128
23,036 28,173
23,442 23,344
1,400
6,920
738
4,134 4,020
163,567 158,323 163,070 172,854 202,857 215,028 230,080 246,185 263,418 281,858 301,588 325,715
14,027 12,454
14,247 16,337
158,208 152,076
186,482 180,867 295,758 371,927 419,918 489,544 559,154 643,774 733,032 826,079 923,183 1,022,705
350,049 339,190 458,828 544,781 622,775 704,572 789,234 889,959 996,450 1,107,937 1,224,771 1,348,420
Total Liabilities
29,404
169,298
198,702
346,080
Shareholders' Equity
Common Stock
Retained earnings
8,199 8,371 8,595 9,830 9,949
702,714 718,935 727,570 729,906 729,798
Accumulated Other Comprehensive Income,net 4,747
Treasury Stock
(143,960)
Total Shareholders' Equity
571,700
Total Liabilities and Equity
$ 917,780
4,296
(144,675)
586,927
$ 931,867
6,084
(146,047)
596,202
$ 950,029
7,339
(148,701)
598,374
$ 948,423
4,560
(148,882)
595,425 581,686 569,304 558,155 547,215 537,660 529,818 522,711 517,565 514,517 512,617
$ 934,615 $ 1,040,514 $ 1,114,085 $ 1,180,930 $ 1,251,787 $ 1,326,894 $ 1,419,777 $ 1,519,161 $ 1,625,502 $ 1,739,288 $ 1,861,037
147 | P a g e Statement of Cash Flows
The statement of cash flows is the last financial document that will be forecasted
for the next ten years. It is predominantly the last item to be forecasted because it is
the most difficult statement to forecast. Although the statement of cash flows is
separated into three different groups, there is not a line item on the statements that
can link statement of cash flows to the balance sheet or income statement making it
harder to effectively forecast. Out of the cash flow from operating activities, cash flow
from investing activities, and cash flow from financing activities, only a few line items
can be forecasted from each.
Cash flow from operating activities is the first section of the statement of cash
flows that will be forecasted. They are the cash flows generated from regular yearly
business operations. Over the past five years, Weis Markets have had a lot of volatility
in cash flow so we used three different ratios to help find a clearer way to forecast
them. CFFO/ Net Income, CFFO/Sales, and CFFO/Operating Income were calculated for
each year for the past five years. Of the three we decided to use CFFO/Sales and used
the ratio of 5% to for forecasting. Next, we took forecasted sales and multiplied by 5%
to get forecasted cash flows.
After calculating forecasting of cash flows from operating activities, cash flow
from investing activates is the next section to forecast. Forecasting the investing
activities is more complex to calculate. With the information provided we decided to use
a growth rate of 6% for 2009 and continue with a growth rate of 7% 2010 to 2018.
This value may contain forecasting errors but it was the best prediction we could find.
The last section of the statement of cash flows to forecast is the cash flow from
financing activities. To best forecast financing activities, we forecasted dividends paid.
We used the past five years to help find a value used for the next ten years. We started
out with $0.30 in dividend paid per share every three months from 2009-2011, and had
an increase of $0.01 every three years. Since dividends are paid quarterly, the total
dividends paid for the year are $1.20 per share from 2009-2011 and increase by $0.04
every three years. Finally we took the total shares outstanding as of 2008 and multiply
148 | P a g e the value by yearly dividends paid to get the total dividends paid. The following
schedule will help show how the dividends were forecasted for the next ten years.
* In thousands
Forecasted Dividends
Dividends/
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
0.30
.3
.3
.31
.31
.31
.32
.32
.32
.33
1.20
1.2
1.2
1.24
1.24
1.24
1.28
1.28
1.28
1.32
27438
27438
27438
27438
27438
27438
27438 27438 27438 27438
32926
32926
32926
34023
34023
34023
35121 35121 35121 36218
Share
Yearly Div/
Share
*Shares
Outstanding
*Dividends
Paid
149 | P a g e Statement of Cash Flows
Actual Financials
2004
Cash Flow from Operating Activities
Net Income
Adj. to reconcile net income to net cash provided by operating activities
Depreciation
Amortization
Loss(gain) on disposition/ impairment of fixed assets
Gain on sale of marketable securities
Changes in operating assets and liabilities
Inventories
Accounts recievable and prepaid expenses
Income taxes recoverable
Accounts payable and other liabilities
Income taxes payable
Deferred Income taxes
Other
2005
2006
Forecasted Financials
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
$ 57,191 $ 63,421 $ 56,010 $ 50,990 $ 46,995 $ 57,942.88 $ 65,235.47 $ 65,104.61 $ 69,010.89 $ 73,151.54 $ 78,272.15 $ 83,751.20 $ 89,613.79 $ 95,886.75 $ 102,598.83
40,614
5,721
1,438
(52)
43,875
6,231
519
(422)
45,000
6,020
974
(431)
47,511
7,331
(8,031)
(6)
47,053
7,978
155
8,508
(2,930)
(1,729)
4,648
(1,955)
6786
6
(14,338)
(3,424)
1,729
(10,086)
(1,365)
2,020
(-2845)
(98)
10,277
(-5762)
-5762
(-201)
(4,264)
(5,960)
(8,074)
8,169
(1,317)
(-1252)
345
6,299
1,434
8,074
(7,441)
738
3946
95
118246
104304
99281
85442 115,326 127,173.95 134,804.39 142,892.65 151,466.21 160,554.18 171,792.98 183,818.49 196,685.78 210,453.79 225,185.55
Cash flow from investing activities
Purchase of PP&E
Proceeds from the sale of PP&E
Purchase of marketable securities
Proceeds from maturities of marketable securities
Proceeds from sale of marketable securities
Increase in intangible and other assets
-82766
9086
-24850
26350
86
-55468
-291
-8248
-99975
2696
-33020
15745
6010
-64233
11374
-66958
324
13780
7
1210
Net cash used in Investing activities
-72094
-62425 -108544
-39072 -65818
Cash flows from financing activities
Proceeds from issuance of commonstock
Dividends paid
Purchase of treasury stock
228
-57438
-4048
172
-30270
-715
224
-31344
-1372
1235
-31309
-2654
119
-31282
-181
Net cash used in financing activities
-61258
-30813 -108544
-32728
-31344
Net increase (decrease) in cash and cash equivalents Cash and Cash equivalents at beginning of year
Cash and cash equivalents at end of year -15106
73340
58234
13642
27545
41187
18164
41187
59351
Net cash provided by operations
1000
-394
(41,136.25) (24,197.79) (14,234.00) (8,372.94) (4,925.26) (2,897.21) (1,704.24) (1,002.50) (589.70) (346.88)
11066
58234
69300
-41755
69300
27545
150 | P a g e Weis Markets: Common Size Statement of Cash Flow
2004
Cash Flow from Operating Activities
Net Income
Adj. to reconcile net income to net cash provided by operating activities
Depreciation
Amortization
Loss(gain) on disposition/ impairment of fixed assets
Gain on sale of marketable securities
Changes in operating assets and liabilities
Inventories
Accounts recievable and prepaid expenses
Income taxes recoverable
Accounts payable and other liabilities
Income taxes payable
Deferred Income taxes
Other
Net cash provided by operations
Cash flow from investing activities
Purchase of PP&E
Proceeds from the sale of PP&E
Purchase of marketable securities
Proceeds from maturities of marketable securities
Proceeds from sale of marketable securities
Increase in intangible and other assets
Net cash used in Investing activities
Cash flows from financing activities
Proceeds from issuance of commonstock
Dividends paid
Purchase of treasury stock
2005
Forecasted Common Size Statement of Cash Flow
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
48.37% 60.80% 56.42% 59.68% 40.75%
53.20%
53.20%
53.20%
53.20%
53.20%
53.20%
53.20%
53.20%
53.20%
53.20%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
34.35% 5.97% 6.06% 8.58%
4.84% 5.97% 6.06% 8.58%
1.22% 0.50% 0.98% ‐9.40%
‐0.04% ‐0.40% ‐0.43% ‐0.01%
7.20%
‐2.48%
‐1.46%
3.93%
‐1.65%
5.74%
0.01%
‐13.75%
‐3.28%
1.66%
0.00%
1.94%
‐2.73%
‐0.09%
‐10.16%
‐1.37%
0.00%
10.35%
‐5.80%
‐5.80%
‐0.20%
100%
100%
100%
6.92%
6.92%
0.13%
0.00%
‐4.99% 5.46%
‐6.98% 1.24%
‐9.45% 7.00%
9.56% ‐6.45%
‐1.54% 0.64%
‐1.47% 3.42%
0.40% 0.08%
100%
100%
114.80% 88.86% 92.11% 164.40% 101.73%
‐12.60% 0.47% ‐2.48% ‐29.11% ‐0.49%
34.47% 13.21% 30.42% 0.00% 0.00%
‐36.55% 0.00% ‐14.51% ‐35.27% ‐1.84%
‐0.12% ‐1.60% ‐5.54% ‐0.02% 0.00%
0.00% 0.00% 0.00% 0.00% 0.60%
100%
100%
100%
100%
100%
‐0.37% ‐0.56% ‐0.21% ‐3.77% ‐0.38%
93.76% 98.24% 28.88% 95.66% 99.80%
6.61% 2.32% 1.26% 8.11% 0.58%
Net cash used in financing activities
100%
100%
100%
100%
100%
151 | P a g e Restated Statement of Cash Flow
The restated of cash flows is very similar to the actual statement of cash flow.
Since net income was the only item that was restated due to capitalizing leases we had
to use the restated net income to help calculate the new statement of cash flow. By
having the restated net income is lower than the actual will lead to a lower cash flow of
operations. To calculate the cash flow from operations, we found the change in each
year’s net income and subtracted the change from the cash flow from operations. The
restated cash flow from operations will not include the decrease in net income for
capitalizing lease obligations. To continue calculating cash flow from operations, we
used the same 5% figure to forecast the next ten years.
152 | P a g e Restated Statement of Cash Flows
2004
Cash Flow from Operating Activities
Net Income
Adj. to reconcile net income to net cash provided by operating activities
Depreciation
Amortization
Loss(gain) on disposition/ impairment of fixed assets
Gain on sale of marketable securities
Changes in operating assets and liabilities
Inventories
Accounts recievable and prepaid expenses
Income taxes recoverable
Accounts payable and other liabilities
Income taxes payable
Deferred Income taxes
Other
Net cash provided by operations
Cash flow from investing activities
Purchase of PP&E
Proceeds from the sale of PP&E
Purchase of marketable securities
Proceeds from maturities of marketable securities
Proceeds from sale of marketable securities
Increase in intangible and other assets
Net cash used in Investing activities
Cash flows from financing activities
Proceeds from issuance of commonstock
Dividends paid
Purchase of treasury stock
$
Restated Statement of Cash Flows
2005
2006
2007
2008
2009
2010
Restated Forecasting of Cash Flows
2011
2012
2013
2014
2015
2016
2017
21 $ 7,667 $ (2,104) $ (5,597) $ (7,685) $ 19,187 $ 20,544 $ 21,777 $ 23,083 $ 24,468 $ 26,181 $ 28,014 $ 29,975 $ 32,073 $ 34,318
40,614
5,721
1,438
(52)
43,875
6,231
519
(422)
45,000
6,020
974
(431)
47,511
7,331
(8,031)
(6)
47,053
7,978
155
8,508
(2,930)
(1,729)
4,648
(1,955)
6786
6
(14,338)
(3,424)
1,729
(10,086)
(1,365)
(4,264)
(5,960)
(8,074)
8,169
(1,317)
(-1252)
345
6,299
1,434
8,074
(7,441)
738
3946
95
2,020
-2845
(98)
$ 57,288 $ 40,914
-82766
9086
-24850
26350
86
-55468
-291
-8248
1000
10,277
(2,845)
(-5762)
(-201)
$41,167 $ 28,855 $ 60,646 $ 63,678 $ 66,862 $ 70,205 $ 73,716 $ 77,401 $ 81,271 $ 85,335 $ 89,602 $ 94,082 $ 98,786
-99975
2696
-33020
15745
6010
-64233
11374
-66958
324
13780
7
1210
-394
$ (72,094) $ (62,425) $ (108,544) $ (39,072) $ (65,818) $ (41,136) $ (24,198) $ (14,234) $ (8,373) $ (4,925) $ (2,897) $ (1,704) $ (1,002) $
228
-57438
-4048
172
-30270
-715
224
-31344
-1372
1235
-31309
-2654
119
-31282
-181
-61258
-30813
-108544
-32728
-31344
(590) $
Net cash used in financing activities
153 | P a g e 2018
(347)
Weis Markets: Restated Common Size Statement of Cash Flow
Cash Flow from Operating Activities
Net Income
Adj. to reconcile net income to net cash provided by operating activities
Depreciation
Amortization
Loss(gain) on disposition/ impairment of fixed assets
Gain on sale of marketable securities
Changes in operating assets and liabilities
Inventories
Accounts recievable and prepaid expenses
Income taxes recoverable
Accounts payable and other liabilities
Income taxes payable
Deferred Income taxes
Other
Net cash provided by operations
Cash flow from investing activities
Purchase of PP&E
Proceeds from the sale of PP&E
Purchase of marketable securities
Proceeds from maturities of marketable securities
Proceeds from sale of marketable securities
Increase in intangible and other assets
Net cash used in Investing activities
Cash flows from financing activities
Proceeds from issuance of commonstock
Dividends paid
Purchase of treasury stock
2004
2005
0.04%
18.74%
2006
Forecasted Restated Common Size Statement of Cash Flow
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
‐5.11% ‐19.40% ‐12.67%
53.20%
53.20%
53.20%
53.20%
53.20%
53.20%
53.20%
53.20%
53.20%
53.20%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
70.89% 107.24% 109.31% 164.65% 77.59%
9.99% 15.23% 14.62% 25.41% 13.16%
2.51%
1.27%
2.37% ‐27.83% 0.26%
‐0.09% ‐1.03% ‐1.05% ‐0.02% 0.00%
14.85% ‐35.04% ‐24.50% ‐14.78% 10.39%
‐5.11% ‐8.37% ‐3.32% ‐20.65% 2.36%
‐3.02%
4.23%
0.00% ‐27.98% 13.31%
8.11%
0.00% 24.96% 28.31% ‐12.27%
‐3.41%
1.94% ‐7.00% ‐1.54% 0.64%
5.74% ‐6.95% ‐14.00% ‐4.30% 3.42%
0.01% ‐0.24% ‐0.49%
1.20% 0.16%
100%
114.80%
‐12.60%
34.47%
‐36.55%
‐0.12%
0.00%
100%
100%
100%
100%
88.86% 92.11% 164.40% 101.73%
0.47% ‐2.48% ‐29.11% ‐0.49%
13.21% 30.42%
0.00% 0.00%
0.00% ‐14.51% ‐35.27% ‐1.84%
‐1.60% ‐5.54% ‐0.02% 0.00%
0.00%
0.00%
0.00% 0.60%
100%
100%
100%
‐0.37%
93.76%
6.61%
‐0.56%
98.24%
2.32%
‐0.21%
28.88%
1.26%
100%
100%
100%
100%
100%
‐3.77% ‐0.38%
95.66% 99.80%
8.11% 0.58%
Net cash used in financing activities
100%
100%
154 | P a g e Cost of Equity
The cost of equity is the minimum required return that stockholders expect to
earn when investing in a company’s stock. The stockholders require this minimum
return in order to compensate them for their wait on their returns and potential risk
they bear. The higher the cost of equity (Ke) or rate of return means that there is
more risk associated with that stock. Although, there may be higher risk the potential
gains are much higher than a lower cost of equity. The capital asset pricing model also
known as the CAPM was used in order to estimate the cost of equity (Ke) of Weis
Markets. The CAPM formula is:
Cost of Equity (Ke) = Risk-Free Rate (Rf) + Beta (β)*Market Risk Premium (MRP)
The cost of equity is estimated using the formula above. The Rf or risk-free rate
is usually derived from the rates on US Treasury Bills. In this case, the risk free rate
was provided from the St. Louis Fed website. The equity’s β or beta, measures the
correlation of the expected return of the asset and the market return, is estimated by
running a linear regression analysis. Finally, the MRP or market risk premium is
calculated by taking the difference of the risk-free rate and the market return.
Since CAPM does not explain the appropriate riskless return, we took 80 months
worth of Weis Markets stock prices and located the 3 month term, 1 year term, 2 year
term, 5 year term, and 10 year term to find five points on the yield curve. Next, we ran
Regressions for five investment points 24, 36, 48, 60, and 72 months to locate each
point on the yield curve and test the steadiness of Beta over time. Using the
information gathered, we looked for the highest Adjusted R squared, which was .25371.
Having a higher Adjusted R Squared would help produce a higher explanatory power for
Beta. Then we concluded that the 2 year yield, at 24 months slice was most relevant
because it contained the highest adjusted r-squared. The analysis gave us a beta (β) of
.72234 with a lower bound beta of .21790 and an upper bound beta of 1.22678. Since
155 | P a g e Beta remained relatively stable over the time frame, we believe this to be accurate, but
having a low R Squared shows low explanatory power. According to Yahoo Finance, the
published Beta they have for Weis Markets is .65, which also helps us believe that the
Beta we calculated is pretty accurate.
rf
mrp
0.034
Months
0.07
Beta
72
60
48
36
24
0.70059
0.70002
0.69825
0.69106
0.72234
B ub
B lb
1.01354
1.03224
1.06209
1.09767
1.22678
0.38764
0.36781
0.33441
0.28444
0.21790
Adj R2
0.21054
0.22154
0.22853
0.23796
0.25371
ke
9.382%
9.380%
9.374%
9.350%
9.456%
Ke low Ke up
6.113%
5.975%
5.741%
5.391%
4.925%
10.495%
10.626%
10.835%
11.084%
11.987%
After gather all of the appropriate information to calculate Beta, we used a riskfree rate of 3.4% (US Treasury Bill) and a market risk premium of 7%. The estimated
cost of equity (Ke) came out to 8.46%. The lower bound Ke is 4.93% and the upper
bound Ke is 11.99%.
Ke
.08456 = .034 + .72234*.07
Lower
.04925 = .034 + .21790*.07
Upper
.11987 = .034 + 1.22678*.07
156 | P a g e Size Adjusted CAPM
The size adjusted CAPM is used in order to get a more precise cost of equity
estimate. In general smaller firms tend to get higher returns compared to larger firms
primarily because their more risky. In order to get a better estimate of cost of equity
we take the CAPM and add a size premium. The following shows the size adjusted
CAPM formula:
Ke = Rf + β*MRP + Size Premium (Palepu Healy)
Since companies like Weis Markets are smaller than the average firm this size
premium will take that into account. It basically takes into account a firm’s size.
Therefore, the size premium is associated with the market capitalization of a company.
The size premium we used was 1.7% since are company has a market cap of 1.5
billion. After adding this size premium to our cost of equity we got a size adjusted cost
of equity of 10.16% with 6.63% and 13.69% lower and upper bound.
Size Adjusted Ke
.10156 = .034 + .72234*.07+.017
Lower Size Adjusted Ke
.06625 = .034 + .21790*.07+.017
Upper Sized Adjusted Ke
.13687= .034 + 1.22678*.07+.017
Alternative cost of equity
An additional way of estimating the cost of equity is using the backdoor method.
This method of estimating the cost of equity should support the current stock price of a
firm. The formula for this method is shown below:
1
157 | P a g e The formula above will calculate the cost of equity (ke) of a firm. The left hand
of the equation is the market to book ratio which equals the return of equity minus Ke
divided by Ke minus the growth rate all added by one. The “g” or the growth rate we
used is the average sales growth of Weis Markets which is 3%.
Backdoor Ke
1.7
1
. 07
.03
» .7
. 07
.03
» .7
.021
.07
»
.
Weis Market’s cost of equity using the backdoor method came out to 5.35%
compared to 8.46% using the CAPM method. Using the CAPM method gives the
stockholders a higher return compared to the backdoor method. Since the CAPM
method has a higher Ke value, we believe the CAPM method provides a more accuarate
value for Ke.
Cost of Debt
The cost of debt (Kd) is calculated by taking the weighted average of a firm’s
current and noncurrent liabilities over their total liabilities. Once the weighted average
of the liabilities is calculated you take each weight and multiply it by the interest rate of
each liability. Then you add all these weights up and you get the cost of debt of a firm.
The cost of debt is usually lower than the cost of equity for a firm because if a firm
goes into bankruptcy or defaults then the debt holders will be paid first compared to the
equity or stockholders. Therefore, the cost of equity or rate of return for investors is
higher because their more susceptible to risk than debt holders. The cost of debt for
Weis Markets using a portion of their actual balance sheet was 2.36%. After
accounting for capital leases in Weis Markets restated balance sheet the cost of debt
was 4.76%. The following tables show in detail how the cost of debt was calculated for
Weis Markets:
158 | P a g e Actual Financials 2008
Liabilities Current Accounts Payable Short/Current Long Term Debt Other Current Liabilities Non‐Current Long Term Debt Other Liabilities Deferred Long Term Liability Charges $ 151,403 ‐ 6,920 ‐ 12,454 16,337 Total Liabilities $ 187,114 Cost of Debt (Kd) Interest Rate 1.80%
Weight 0.809148434 0 2.40% 0.036982802 0 2.40% 0.066558355 7.50%
0.08731041 1 W*R 0.014565
0
0.000888
0
0
0.001597
0.006548
0.023598
0.02359794 or 2.36% Restated Financials 2008
Liabilities Current Accounts Payable Short/Current Long Term Debt Other Current Liabilities Non‐Current Long Term Debt Other Liabilities Deferred Long Term Liability Charges Total Liabilities Cost of Debt (Kd) $ 95,128 ‐ 63,195 152,076 12,454 16,337 $ 339,190 Interest Rate 1.80%
2.40%
7.50%
2.40%
7.50%
Weight 0.280456381 0 0.186311507 0.448350482 0.036716884 0.048164745 1 W*R 0.005048
0
0.004471
0
0.033626
0.000881
0.003612
0.04764
0.047639538 or 4.76% 159 | P a g e In the tables above the interest rates used to calculate the cost of debt where
derived from various sources. The table below shows why each interest rate was
chosen.
Interest Rate
1.8%
3 Month Commercial Paper Rate which reflects low risk
2.4%
2 yr Corporate Bond Rate which reflects some risk
7.5%
Weis Markets Benefit Plan Rate and Capital Lease Rate
Weighted Average Cost of Capital (WACC)
Each firm finances its assets with debt and equity. Therefore, the Weighted
Average Cost of Capital is the overall rate of return a firm requires. There are two
WACC formulas one for before tax and one after tax. In order to calculate the WACC a
firm must estimate the cost of equity (Ke) and the cost of debt (Kd). The tax rate used
is 30%. The formula in order to calculate WACC before and after tax is shown below:
WACC
Before
Tax
WACC
After Tax
1
In the table above the (VL) stands for the total liabilities of the firm. The (VF)
stands for the value of the firm which is the market cap plus the total liabilities. The
(VE) stands for the value of the equity which in this case is the market cap of the firm.
The tables below show Weis Markets WACC:
160 | P a g e WACC Before Tax Kd Ke WACC Actual 2.36%
8.46%
6.48%
Restated 4.76%
8.46%
6.72%
Backdoor 2.36%
5.35%
4.38%
Size Adj 2.36%
10.16%
7.63%
WACC After Tax (30% tax rate) Kd Ke WACC Actual 2.36%
8.46%
6.25%
Restated 4.76%
8.46%
6.05%
Backdoor 2.36%
5.35%
4.15%
Size Adj 2.36%
10.16%
7.40%
Firm Valuation
There are two stages in prospective analysis. The first stage of prospective
analysis is forecasting which was done in the previous section for Weis Markets. The
final stage of this analysis is firm valuation. This stage of the analysis is just as crucial
as the forecasting because it is reliant on the accuracy of the forecasted statements.
Therefore, Palepu and Healy state “valuation is the process of converting forecasts into
an estimate of the value of firm’s assets or equity.” This becomes useful when firms
need to make important business decisions because any decision will either enhance
the value of a company or hurt the value of the company. We will use several different
valuation models to identify if Weis Markets current stock price represents the
underlying value of the company. By doing so we will come to a conclusion of whether
Weis Markets stock price is overvalued, fairly valued or undervalued.
The first method applied to determine value is the method of comparables which
is widely used by financial analyst. This method takes into account several different
financial ratios that are derived from publicly available information to calculate the value
161 | P a g e of a stock. Even though, this method is widely used among analyst it can be misleading
since it is based on minimal theory.
The second method applied to determine the value of Weis Markets stock is
“intrinsic value.” This method is based on financial theory and involves several different
complex inputs to generate the appropriate stock price for a given firm. There are a
variety of models used to fine the “intrinsic value” of a firm. This method is the most
reliable compared to the method of comparables because it takes into account many
factors that affect the profitability of a firm and is not based on ratios.
When comparing the stock price generated from the models to the current stock
price we used criteria from a 10% analyst viewpoint. A 10% analyst diligently selects
stocks if there undervalued whereas a 5% analyst selects more stocks. Being a 10%
analyst will allow an analyst to be more conservative and be more accurate in the
valuation of firm’s stock. As of November 1st, Weis Markets stock price was $34.98 so
as a 10% analyst if the valuation models show a price between $31.48 and $38.48 then
the stock is fairly valued. If the stock price is greater than $38.48 then the price is
undervalued and therefore should be purchased. Whereas, if Weis Markets stock price
is less than $31.48 then it is overvalued and therefore should be sold. The chart below
shows the criteria that will used throughout the valuation process to determine if Weis
Markets stock price is overvalued or undervalued.
10% Anaylst for WMK
Stock Price
$ 31.48
Overvalued
$ 34.98
Fairly Valued
$ 38.48
Undervalued
162 | P a g e Method of Comparables
The method of comparables is well used among analyst today because it is quick
and simple to implement. In order to apply this method financial data is needed about
a firm and its competitors within the industry. The financial data needed was collected
from http://finance.yahoo.com. The method of comparables has three key steps. The
first one is to gather the financial data of the firm’s competitors in order to compute the
ratios of each company. After these ratios are computed then take an average of the
ratios excluding the target firm in this case Weis Markets. Finally, take the industry
average and apply it to the target firm to get the price per share. The share price then
will be compared to the current price to see if the firm is overvalued, fairly valued or
undervalued based on the 10% analyst criteria. The share price derived from each
comparable will be compared to Weis Markets stock price of $34.98 as of November 1st,
2009. In terms of the criteria, fairly valued price will fall between $31.48 and $38.48.
If the price exceeds $38.48 then it is undervalued and if it is less than $31.48 it is
overvalued. The method of comparables may be a quick and simple approach but there
are pro and cons to this method that will be explained in further detail in each of the
comparables below.
Price to Earnings Ratio (Trailing)
The price to earnings (P/E) trailing ratio is calculated by dividing a firm’s share
price by its earnings per share. This trailing method uses past or historical data and is
more reliable than forecasted data. The first step to compute this ratio for Weis
Markets is to get the P/E ratios of each of its competitor’s then compute the average of
those ratios. If a competitor has a negative ratio it cannot be included in the
calculation of the industry average such as Supervalu. The grocery industry average
came out to 11.5. After the industry average is found then find the earnings per share
of the target firm or in this case Weis Markets and multiply it by the industry average to
get the price per share. Once these two steps are completed then take the industry
average and multiply it be the earnings per share of the target firm. By applying this
163 | P a g e comparable method Weis Markets share price came out to $19.69. After comparing this
price to the stock price of $34.98 it became evident that according to this model the
stock price is overvalued. Therefore, Weis Markets stock should be sold. Overall, this
method is a backwards ratio not a forward ratio so it is not a good indication of stock
price since stock price is a forward looking number. Below is a table of this method:
SWY KR SVU Ind. Avg. P/E (trailing) 11.2 11.8 ‐1.144 11.5 EPS (trailing) WMK 1.712 Stock Price Using This Method P/E (trailing) WMK $ 19.69 Overvalued WMK Stock Price $ 34.98 Price to Earnings Ratio (Forward)
The price to earnings (P/E) forward ratio is calculated by dividing a firm’s share
price by its next year forecasted earnings per share. This method is based on forward
or forecasted data; therefore, it may not be as reliable as the trailing method. Other
than the forecasted element of this comparable the calculation of it is similar to the
trailing method. An industry average of the P/E forward ratio needs to be calculated.
The forward grocery industry average came out to 10.24. Then the forward earnings
per share was calculated for Weis Markets using their forecasted financials which came
out to 2.132. To get the stock price, take the industry average and multiply it by the
earnings per share (forward). Using this method a stock price of $21.83 was computed
which is overvalued using the 10% analyst rule. Since the share price is overvalued
then Weis Markets stock should be sold. The P/E forward looking ratio is a better
indication of stock price since the stock price is forward looking. Although, this
methods earning per share is pointed in the right direction (forward) it does have some
problems. One problem with this method is it assumes a constant rate over the long
term and another problem is it ignores the future. Below is a table of this method:
164 | P a g e SWY KR SVU Ind. Avg. P/E (forward) 11.8 10.8 8.12 10.24 EPS (forward) WMK 2.132 Stock Price Using This Method P/E (forward) WMK $ 21.83 Overvalued WMK Stock Price $ 34.98 Price / Book
The price to book ratio is a widely used method because it compares the price
per share of a firm to the total book value of equity of a firm. First, we collected the
price to book ratio of each of Weis Markets competitors and then took the average of
them to get a industry average. Next, we calculated Weis Markets book value per
share and then took that number and multiplied it by the industry average to get a
stock price of $41.43. This share price is more than 10% greater than Weis Markets
share price of $34.98; therefore, it is undervalued and should be bought. According, to
this method Weis Markets is undervalued compared to the previous two models. The
results from these methods of comparables can vary significantly; therefore, it is hard
to determine which model is correct. This is primarily due to the fact that there is no
“theory” to suggest which method or model is “best” in determining the appropriate
value of a stock. Below is a table of this method:
SWY KR SVU Ind. Avg. P/B 1.3 2.6 1.25 1.72 BPS WMK 24.09 Stock Price Using This Method P/B WMK $ 41.43 Undervalued WMK Stock Price $ 34.98 Dividends / Price
The dividends to price ratio is computed by dividing the annual dividend per
share by the price per share. Since all Weis Markets competitors issued annual
dividends this method was useful in valuing the stock price. In order to use this method
165 | P a g e the dividends to price ratio was collected for each of Weis Markets competitors. Then
an average was taken of these ratios to get an industry average of .025. Once the
industry average was computed then we calculated the annual dividend per share of
Weis Markets which was 1.15. Lastly, Weis Markets dividends per share were divided by
the industry average to get a stock price of $46.00. This price is well over the 10%
threshold of $38.48; therefore, this method suggests Weis Markets stock price is
undervalued and should be bought. This method produced similar results as the price to
book ratio. But once again it is hard to determine which method is best. Below is a
table of this method:
SWY KR SVU Ind. Avg. D/P WMK DPS WMK Stock Price 1.15 $ 34.98 0.016 Stock Price Using This Method 0.016 D/P 0.043 WMK $ 46.00 0.025 Undervalued Price / EBITDA
The price/EBITDA ratio, calculated by dividing earnings before tax, depreciation
and amortization into the firm’s market capitalization, tells us the correlation between a
firm’s profits, discounting taxes, and a firm’s market valuation. The lower the
price/EBITDA ratio the stronger the correlation between the firm’s market valuation of
the assets and value generated by earnings. Weis’s price/EBITDA ratio of $3.99 is
significantly lower than its observed stock price of $34.98 meaning that under the
price/EBITDA assumption, Weis is overvalued.
Price/EBITDA
Firm
WMK
KR
SWY
SVU
Mkt. Cap (Mil)
943.41
13,100.14
3,357.01
273.29
Comparables
EBITDA (Mil)
P/EBITDA Industry Avg.
WMK PPS
70.10 13.46 $ 1.53 $ 3.99
3,990 3.28 WMK Stock Price
$ 34.98
2,790 1.20
2,340 0.12
166 | P a g e Price / Free Cash Flows
By dividing free cash flows into the firm’s market capitalization we can determine
the price/free cash flow ratio. Free cash flow is calculated by adding or subtracting cash
flow from investments from cash flow from operations. According to Weis’s price to free
cash flow model Weis turned out a price per share of $12.12, significantly lower than
their $34.98 stock price, making Weis overvalued.
/
Price/Free Cash Flow
Firm
Comparables
Mkt. Cap (Mil) FCF (Mil) P/FCF
Industry Avg.
WMK PPS
WMK
943.41
84
11.23
$ 3.89
$ 12.12
KR
13,100.14
1,656
7.91
WMK Stock Price
$ 34.98
SWY
3,357.01
520
6.46
SVU
273.29
2,127
0.13
Enterprise Value / EBITDA
To calculate the enterprise value to EBITDA ratio, we divide the firm’s enterprise
value by the firm’s earnings before tax, depreciation, and amortization. The enterprise
value of the firm can be found by adding the firm’s market value and book value of
liabilities and subtracting out the cash and investments. One weakness with this model
is that like the price to EBITDA ratio the enterprise value to EBITDA ration does not
account for taxes and debt, which lessens the accuracy of the model. When comparing
Weis’s enterprise to EBITDA ratio of 36.48 to the observed stock price of 34.98 we can
conclude based on this model that Weis is fairly valued.
167 | P a g e Enterprise Value/EBITDA
Firm
EV (Mil)
Comparables
EBITDA (Mil) EV/EBITDA Industry Avg.
WMK PPS
WMK
1,033.81
70.10
14.75
$ 1.93
$ 36.23
KR
4,789.29
3,990
1.20 WMK Stock Price
$ 34.98
SWY
12,772.74
2,790
4.58
SVU
61.01
2,340
0.03
Enterprise Value / Free Cash Flow
The enterprise value to free cash flow ratio can be found by dividing a firm’s free
cash flow into the enterprise value of the firm. By taking the industry average and
multiplying it by Weis’s free cash flow we can solve for the price per share from the
enterprise value formula explained in the enterprise value to free cash flow ratio above.
Weis’s price per share under this model is $24.99, which is below the 10 percent cut off
of $31.48; therefore Weis is assumed overvalued under the enterprise value to free
cash flow model.
Enterprise Value/Free Cash Flows
Firm
EV (Mil)
FCF (Mil) EV/FCF
Comparables
Industry Avg.
WMK PPS
WMK
1,033.81
84.00
12.31
$ 3.36
$ 24.99
KR
4,789.29
2,127
2.25 WMK Stock Price
$ 34.98
SWY
12,772.74
1,656
7.71
SVU
61.01
520
0.12
Conclusion
Overall, the method of comparables has a wide range of values which makes the
ratios less accurate and therefore it is more difficult to depend on these values. The
ratios within the method of comparables are strictly based on financial numbers and not
on analyst insight. Whereas, the other method the, “intrinsic valuation,” depends on
financial numbers and on analyst insight and assumptions. After computing several
methods of comparable ratios it became evident that this method produces conflicting
168 | P a g e results. Some of the methods suggested that Weis Markets was undervalued and some
suggested their overvalued, It is difficult to separate which ones are accurate and which
ones are not. The first two valuations showed Weis Markets to be overvalued while the
next two shoed Weis to be undervalued. The other four suggested Weis to be
significantly overvalued with the exception of only one, the enterprise to EBITDA ratio,
which suggested Weis to be fairly valued.
Intrinsic Valuation Models
The intrinsic valuation models are used to estimate the value of a firm’s stock
price. By computing this value using several different intrinsic models a firm’s stock
price can be categorized as undervalued, fairly valued or overvalued. Unlike, the
method of comparables model this model is a theory based model. Several different
factors go into the computation of each mode; therefore, this model is more closely
linked to the stock price of a company. This model tends to produce significantly more
reliable numbers than the method of comparables model. The intrinsic valuation model
includes a discounted dividends model, residual income models, abnormal earnings
growth model and discounted free cash flows model. Each of these models will use
numbers derived from Weis Markets forecasted financials to create assumptions. In
addition to computing the stock price using each model a sensitivity analysis will be
done for each model. The sensitivity analysis will use a variety of growth rates and cost
of equity of the firm to find the value of the firm or stock price. All of these models will
use a combination of the forecasted financials such as the balance sheet, income
statement or statement of cash flows. By assessing these models we will come to a
conclusion of whether Weis Markets is undervalued, overvalued or fairly valued based
on the 10% analyst rule. In addition, one advantage of this model is it requires
substantial judgment and estimates on the part of the analyst and it utilizes present
values. By doing an in depth analysis of each of these intrinsic valuation models they
will give an analyst a better understanding of the value of a firm or in this case the
value of Weis Markets.
169 | P a g e Discounted Dividends Model
The discounted dividends model is the easiest model to compute the value of the
stock because it simply takes the present value of all future dividends. Although, it may
be the simplest model it is not very reliable primarily because stocks are generally
volatile while dividends are not. Also, this model ignores capital gains and usually
overvalues the stock price. Therefore, this intrinsic model has the lowest explanatory
power. In order to compute the value of the stock price using this model first the
forecasted dividends from 2009 through 2019 needed to be calculated. Then simply
take the present value of the dividends per share and then adjust it for the time
consistent price. Weis Markets cost of equity is .0846. At this rate of equity the model
shows that about $16.02 out of the $34.98 is explained through dividends. Overall, the
chart below shows Weis Markets to be overvalued.
The sensitivity analysis was computed by creating a chart with a variety of
growth rates and Weis Markets range of cost of equity. These are the two factors used
in determining the value of the Weis Markets stock. The chart below lists the growth
rates starting with zero to 12% growth and cost of equity ranging from 4.93% to
11.99%. The chart below shows that in order for Weis Markets to be undervalued the
firm would have to have a lower cost of equity and higher growth. Overall, the chart
below shows Weis Markets to be overvalued and only accounts for about 50% of the
stock price. Also, since the model is sensitive to growth rates that puts a significant
limitation to this model. In addition, the chart below has N/A values which mean the
stock price came out to a negative number which is not probable. This occurs when the
growth rate exceeds the cost of equity. The cost of equity should always be greater
than a given growth rate.
170 | P a g e Growth Rates
0
Cost of Equity (Ke)
0.02
0.04
0.06
0.08
0.1
0.12
0.0493 $ 26.99
$ 38.57
$ 99.95
N/A
N/A
N/A
N/A
0.065 $ 20.63
$ 25.62
$ 38.60
$ 155.38
N/A
N/A
N/A
0.07 $ 19.21
$ 23.20
$ 32.53
$
79.14
N/A
N/A
N/A
0.0846 $ 16.02
$ 18.28
$ 22.56
$
33.82
$ 142.96
N/A
N/A
0.09 $ 15.10
$ 16.97
$ 20.34
$
28.21
$
67.54
N/A
N/A
0.1 $ 13.66
$ 15.02
$ 17.28
$
21.80
$
35.37
N/A
N/A
0.1199 $ 11.52
$ 12.29
$ 13.44
$
15.37
$
19.22
$ 30.81
N/A
10% Analyst Range
< $31.48
$
34.98
> $38.48
Residual Income Model
The residual income model is one of the most accurate of the intrinsic valuation
models with an explanatory power equal to the average industry basis of 75 percent to
80 percent accuracy rate. One key advantage to the residual income model is that it is
not sensitive to increases in growth rates which will lessen the likelihood of volatile
stock price changes. The model’s explanatory power comes from the fact that it takes
into account different parts of the business including net income, which is easier to
forecast than dividends or cash flows.
Residual income is a product of the firm’s net income less the normal income.
The normal income of a firm, or its benchmark, is simply deduced by multiplying the
book value of equity to the cost of equity factor. Effectively the goal of the residual
income model is to determine the net income required to meet shareholders’ expected
return. This model is also a measure of how much value the firm is creating or
destroying.
The as stated residual income model sensitivity analysis for Weis Markets
demonstrates that Weis is overvalued compared to their observed stock price of $34.98.
As assumed the prices were not volatile due to the fact that the model is not sensitive
to increases in growth rates.
171 | P a g e Cost of Equity (Ke)
0.0493
0.065
0.07
0.0846
0.09
0.1
0.1199
$
$
$
$
$
$
$
-0.1
44.93
36.92
34.79
29.48
27.80
25.04
20.62
$
$
$
$
$
$
$
-0.2
41.34
35.08
33.35
28.91
27.47
25.05
21.04
Growth Rates
-0.3
-0.4
-0.5
$ 39.80 $ 38.95 $ 38.41
$ 34.25 $ 33.78 $ 33.47
$ 32.69 $ 32.32 $ 32.07
$ 28.64 $ 28.49 $ 28.38
$ 27.31 $ 27.22 $ 27.16
$ 25.06 $ 25.06 $ 25.06
$ 21.26 $ 21.39 $ 21.49
10% Analyst Range
<$31.48 $ 34.98 $ 38.48
$
$
$
$
$
$
$
-0.6
38.03
33.26
31.90
28.31
27.11
25.06
21.55
$
$
$
$
$
$
$
-0.7
37.76
33.10
31.77
28.25
27.08
25.07
21.60
Growth Rates
Cost of Equity(Ke)
0.015
0.02
0.0493
0.065
0.07
$
$
$
$
$
-0.1
35.95
33.59
23.58
20.01
19.06
0.0846
0.09
0.1
0.1199
$
$
$
$
16.65
15.88
14.61
12.54
$
$
$
$
$
-0.2
32.23
30.58
22.96
19.97
19.13
$
$
$
$
$
$
$
$
$
16.98
16.28
15.09
13.09
$
$
$
$
-0.3
30.86
29.45
22.70
19.95
19.17
$
$
$
$
$
-0.4
30.16
28.85
22.55
19.94
19.19
$
$
$
$
$
-0.5
29.73
28.49
22.46
19.93
19.21
17.14 $
17.23 $
17.29
16.47 $
16.58 $
16.66
15.32 $
15.47 $
15.56
13.38 $
13.55 $
13.67
10% Analyst Range
<$31.48
$34.98 > $38.48
$
$
$
$
$
-0.6
29.44
28.24
22.39
19.92
19.21
$
$
$
$
$
-0.7
29.23
28.06
22.35
19.92
19.22
$
$
$
$
17.34
16.71
15.63
13.76
$
$
$
$
17.37
16.75
15.68
13.83
The restated residual income as shown above shows that Weis Markets is
significantly overvalued compared to its observed stock price of $34.98. This is due to
the decrease in net income in the restated income statement.
Discounted Free Cash Flows Model
The discounted free cash flow model is known as an error prone model with an
estimated 20 percent explanatory power. It is calculate by taking the cash flow from
operations and subtracting or adding the cash flow from investing activities to find the
free cash flow for a firm. The next step is computing the market value of equity by
finding the present value of the year-by-year free cash flows and adding the present
value of the year-by-year free cash flow perpetuity and subtracting out the book value
of liabilities. This model also takes into account the weighted average cost of capital
172 | P a g e (before tax) and an initial perpetuity growth rate of zero. In order to find the time
consistent price, take your market value of equity and divide by the shares outstanding.
The as stated sensitivity table below shows Weis Markets is predominantly
undervalued at the initial time consistent price of $120.10 compared to the observed
stock price of $34.98. The significant disparity between the stock price in the
discounted free cash flow model is due to cash flows being more volatile than
dividends. In addition, this model is really sensitive to weighted average cost of capital
and growth rates more than the dividends model.
0
WACC (BT)
0.02
0.03
0.04
0.0648
0.08
0.09
0.1
0.12
0.1771
0.18
0.19
0.2075
0.22
0.25
Growth Rates
0.04
0.06
0.02
420.13 N/A
0.08
0.1
0.12
N/A
N/A
N/A
N/A
N/A
274.93
719.66 N/A
N/A
N/A
N/A
N/A
202.59
355.22 N/A
N/A
N/A
N/A
N/A
120.1
154
242.55
1069.04 N/A
N/A
N/A
95.11
113.11
149.11
257.1 N/A
N/A
N/A
83.35
95.95
118.64
171.57
436.23 N/A
N/A
74
83.13
98.34
128.77
60.09
65.25
72.99
85.89
111.68
220.05 N/A
38.11
39.52
41.34
43.78
47.23
37.37
38.71
40.42
42.7
35.03
36.13
37.52
39.34
31.48
32.28
33.27
34.53
29.31
29.95
30.74
25.00
25.40
25.87
N/A
189.06 N/A
52.48
61.39
45.9
50.7
58.69
41.82
45.41
51.05
36.18
38.45
41.75
31.72
32.98
34.66
37.02
26.43
27.13
28.02
29.18
10% Analyst Range
<$31.48
$34.98
>$38.48
Due to restated net income, free cash flows will be adjusted for the change in
net income. Below is the restated discounted dividend cash flow, which indicated that
after adjustments to free cash flows Weis markets is fairly undervalued in comparison
to its observed price of $34.98 which is fairly similar to the as stated results.
173 | P a g e Growth Rates
0
WACC (BT)
0.02
0.03
0.04
0.0648
0.08
0.09
0.1
$ 177.65
$ 116.95
$ 86.62
$ 51.82
$ 41.16
$ 36.11
$ 32.07
0.02
N/A
$ 302.26
$ 150.22
$ 65.94
$ 48.66
$ 41.36
$ 35.87
0.04
N/A
N/A
N/A
$ 102.84
$ 63.66
$ 50.82
$ 42.21
0.06
N/A
N/A
N/A
$ 447.21
$ 108.66
$ 72.87
$ 54.89
0.08
N/A
N/A
N/A
N/A
N/A
$ 183.15
$ 92.92
0.1
N/A
N/A
N/A
N/A
N/A
N/A
N/A
10% Analyst Range
<$31.48
$
34.98
> $38.48
Abnormal Earnings Growth
The abnormal earnings growth rate is found by first computing the dividends
reinvestment or DRIP, which is equal to the lagged year’s total dividend payment
multiplied by the cost of equity factor. After finding the DRIP take the net income for
the year plus the DRIP to find cumulative dividends and subtract normal income
(benchmark) to get the abnormal earnings growth rate. The cumulative dividend
income is calculated by taking the core net income adding total present value of
abnormal earnings growth and adding to that the present value of the terminal value.
Essentially, the abnormal earnings growth rate can also be found by measuring the
change in residual income of the firm’s raw cash flows.
The explanatory power of the abnormal earnings growth rate model is typically
the most accurate of all the “intrinsic valuation” models, because it based on earnings
and dividends that can be taken straight out of the firm’s forecasted financial
statements. In addition, the AEG model is a forward earnings perpetuity. Below is the
AEG sensitivity analysis for Weis Markets, which suggests that overall Weis is fairly
valued compared to its observed stock price of $34.98. This model indicates a initial
stock price of $32.76, very close to the observed price.
174 | P a g e Growth Rates
0.0493 $
0.065 $
0.07 $
Cost of Equity (Ke)
Cost of Equity (Ke)
0.0846
0.09
0.1
0.1199
$
$
$
$
-0.1
42.01 $
37.22 $
35.95 $
32.76
31.76
30.11
27.29
10%
<$31.48
0.0493
0.065
0.07
0.0846
0.09
0.1
0.1199
-0.2
39.39 $
35.76 $
34.75 $
-0.3
38.26 $
35.09 $
34.20 $
$
32.17 $ 31.89
$
31.34 $ 31.13
$
29.93 $ 29.84
$
27.62 $ 27.69
Analyst Range
$
34.98 > $38.48
$
$
$
$
-0.4
37.64 $
34.72 $
33.89 $
-0.5
37.25 $
34.47 $
33.68 $
-0.6
36.97
34.30
33.54
31.72
31.01
29.79
27.74
31.61
30.92
29.75
27.77
31.53
30.87
29.73
27.79
$
$
$
$
Growth Rates
-0.1
-0.2
-0.3
-0.4
$ 19.52 $ 17.84 $
17.12 $ 16.72
$ 18.93 $ 17.63 $
17.05 $ 16.71
$ 18.77 $ 17.58 $
17.03 $ 16.72
$ 18.41 $ 17.46 $
17.01 $ 16.74
$ 18.31 $ 17.43 $
17.00 $ 16.75
$ 18.14 $ 17.38 $
17.01 $ 16.78
$ 17.91 $ 17.34 $
17.04 $ 16.86
10% Analyst Range
$ 34.98 > $38.48
<$31.48
$
$
$
$
$
$
$
$
$
$
$
-0.5
16.47
16.50
16.51
16.56
16.58
16.63
16.73
Above is the restated EAG sensitivity analysis, which suggests that Weis is very
overvalued. The significant disparity between as stated and restated is due in large part
to the changes in net income from capitalized lease obligations, which decreased net
income and in turn decreased the normal income as well.
175 | P a g e $
$
$
$
$
$
$
-0.6
16.29
16.35
16.37
16.44
16.47
16.52
16.64
Long Run Residual Income
The long run residual income is similar to the the residual income model in that
they both equate a firm’s market value of equity. Although similar the long run residual
model utilizes a different approach than the residual income model. The long run
residual income model factor in the firm’s ROE; therefore the model is accounting for
the return on equity to measure the firm’s market value of equity without using the
terminal value of a perpetuity or annual residual income.
MV (Equity) = Be(t0) * [1+(Roe-Ke)/(Ke-g)]
The first step to finding the firm’s long run residual income is finding its return
on equity (ROE) for the forecasted 10 years. We can do this by taking Weis’s net
income and dividing it by the last year’s book value of equity. Below is Weis’s as-stated
and restated return on equity figures from our forecasted financials through 2018.
ROE
ROE
Restated
2009
8.8%
2009
3.2%
2010
9.6%
2010
3.5%
2011
9.1%
2011
3.8%
2012
9.3%
2013
9.4%
2012
4.1%
2014
9.5%
2013
4.5%
2015
9.7%
2014
4.9%
2016
9.8%
2015
5.3%
2017
9.9%
2016
5.7%
2018
10.0%
2017
6.2%
In order to start our sensitivity analysis we must first choose constant figures for
our return on equity, growth rate, and cost of equity. By taking the average of our asstated and restated return on equity figures we can assess a constant return of 0.095
for our as-stated data and a restated return on equity of 0.048. Our constant growth
rate was determined by taking the average from the percent change in return on
equity. For are as-stated data we assumed a constant growth rate of 0.014 and a
restated growth rate of .084. Lastly we had already solved for Weis’s cost of equity and
176 | P a g e 2018
6.7%
therefore could use the calculated .0846 for our constant cost of equity value in both
as-stated and restated analysis. By utilizing our ROE, growth rate, and cost of equity
variables we can find our firm’s market value of equity, by simply plugging in the
variables. By using our book value of equity of $661.10 we can solve for our market
value of equity:
MV (Equity) = $661.10 * [1+ (.095-.0846/(.0846-.014)] = $758.49
Because we still need to value our company we must use our computed market
value of equity of $758.49 and divide by our constant shares outstanding of 27.438 to
get our estimated price per share of $27.64. This price was then adjusted to get a time
consistent price of $29.58 by using the following formula:
Stock Price = $27.64*(1+ .0846)^(10/12) = $29.58
In comparison to our observed stock price of $34.98 Weis is overvalued
according to the long run residual income model. Once we have calculated for out time
consistent price we can analyze the change in stock price due to the change in growth
rate, return on equity, and cost of equity. By keeping one variable constant we can
better analyze the sensitivity of the stock price when the two remaining variable
change.
177 | P a g e ROE
Ke =0.0846
0.088
0.016
0.015
0.014
-0.1
-0.2
Growth rate
$
$
$
$
$
27.06
27.04
27.02
26.26
26.09
0.091
0.095
$
$
$
$
$
28.91
$ 29.69
$
28.15
$ 29.63
$
28.12
$ 29.58
$
26.68
$ 27.23
$
26.36
$ 26.72
$
10% Analyst Range
< $31.48
$34.98
>
0.097
30.44
30.37
30.31
27.51
26.90
0.099
$
$
$
$
$
31.19
31.12
31.04
27.79
27.09
$38.48
ROE
g=0.014
0.088
Cost of Equity (Ke)
0.0493
0.065
0.07
0.0846
0.09
0.1
0.1199
$
$
$
$
$
$
$
52.58
36.84
33.69
27.02
25.21
22.45
18.50
0.091
0.095
0.097
$
$
$
$
$
$
$
54.71
$ 57.55
$ 58.97
38.34
$ 40.33
$ 41.33
35.05
$ 36.87
$ 37.78
28.12
$ 29.58
$ 30.31
26.23
$ 27.59
$ 28.27
23.36
$ 24.57
$ 25.18
19.25
$ 20.25
$ 20.75
10% Analyst Range
< $31.48
$34.98
> $38.48
0.099
$
$
$
$
$
$
$
60.39
42.32
38.69
31.04
28.95
25.78
21.25
Growth Rates
ROE= 0.095
Cost of Equity (Ke)
-0.2
-0.1
0.0493
0.065
0.07
$
$
$
29.68
28.27
27.85
$
$
$
0.0846
0.09
0.1
0.1199
$
$
$
$
26.72
26.33
25.65
24.42
$
$
$
$
32.76
30.01
29.24
0.014
$
$
$
57.55
40.33
36.87
0.015
$
$
$
27.23
$ 29.58
$
26.57
$ 27.59
$
25.43
$ 24.57
$
23.48
$ 20.25
$
10% Analyst Range
< $31.48
$34.98
>
0.016
58.50
40.63
37.08
$
$
$
59.50
40.94
37.29
29.63
27.61
24.55
20.19
$
$
$
$
29.69
27.64
24.53
20.13
$38.48
178 | P a g e By solving for two of the factors and holding the third constant we are able to
come up with three scenarios that can help determine Weis’s stock price value in
relation to the long run residual income. Above are the three as stated long run residual
income sensitivity tables which propose that overall Weis is an overvalued firm. Of all
the three tables, when we hold a constant growth rate and adjust for changing ROE
and cost of equity we can get a more diverse picture of Weis’s stock price sensitivity.
Although we calculated restated variables for Weis Markets using this model we
found that Weis had a negative time consistent stock price; therefore, we were unable
to use this model on a restated basis because stock prices cannot be negative or fall
below zero. Because we had a growth rate bigger than our return on equity and almost
equal to our cost of equity our market value of equity was negative; thus, our stock
price would have to be negative.
Conclusion
After extensive analysis of our intrinsic valuation models, it became evident that
Weis Market’s stock price is predominantly overvalued when compared to the observed
stock price of $34.98. We found that the intrinsic valuation models relayed more
accurate results than the method of comparables. Because we were able to account for
different parts of the forecasted financial statements, and input different variables such
as weighted average cost of capital (before tax), cost of equity, growth rates and return
on equity.; whereas, the method of comparables is based on a wide array of ratios that
do not account for these important variables.
179 | P a g e Analyst Recommendation
After reviewing our broad research and valuations we have concluded that Weis
Markets is overvalued. We were able to come up with our conclusion by reviewing the
data we collected on the grocery retail industry as well as Weis Markets and its
competitor’s key accounting policies and financial statements. Our industry analysis
helped in understanding the factors that allows for companies within the grocery retail
industry to succeed. By analyzing Weis Markets competitor’s financial statements and
significant accounting policies; we were able to determine an accurate financial picture
of Weis Markets and their competitors within their industry. After determining the
accuracy of Weis Markets financial statements we performed a ten year forecast from
2009 through 2018 that allowed for us to build a better picture of how Weis could
perform in the future. We used these forecasted financials to develop valuation models
that allowed for further insight into the value of Weis Markets.
It is important to understand the grocery retail industry so we can determine
what factors allow for success. Since Weis Markets does not capitalize operating leases
it was imperative to restate Weis’ financials by doing so our restated balance sheet and
income statement provide a more accurate picture of Weis Markets. Our forecast
analysis was important to understand so we can gain a better idea of what Weis will
look like in the future. We were able to forecast the financials as stated and restated
over the next ten years. The current recession was one of the leading factors that came
into mind when determining our most important forecastable line item, sales growth.
Our sales growth percentage represented a base for almost all other forecastable line
items. This line item is the most forecastable number to forecast. Weis Markets growth
from 2004 through 2008 was very minimal and stable. Every year Weis Markets sales
seem to grow by a percent or two. This is typical in the grocery retail industry. Even
though we are in the midst of a recession the grocery retail industry is not as affected
as other industries. We believe our as-stated and restated forecasted financials provide
an in depth look into Weis Markets foreseeable financial performance in the future.
180 | P a g e When determining whether Weis Markets is overvalued, fairy valued or
undervalued we took into account the results for the intrinsic valuation models. Thus,
the intrinsic valuation models provide the most accurate display of Weis’ value. The first
model is the discounted dividends model which showed Weis Markets to be mostly
overvalued. The next model, the discounted free cash flows model showed Weis to be
fairly undervalued. These two valuation models came into consideration when
determining our final conclusion but due to their low explanatory power we believe our
other valuation models such as the abnormal earnings growth model provide a better
overall picture of Weis’ value. The abnormal earnings growth model has the highest
explanatory power and showed that Weis was fairly valued. This model is the most
accurate because it takes into account several different assumptions that coincide with
determining the appropriate stock price. The restated abnormal earnings growth model
suggested Weis Markets to be overvalued. The residual income model using our
restated financials showed Weis to be overvalued. This model is also very accurate
because it is closely related to the abnormal earnings growth model. The long run
residual income models as stated came out to be overvalued, and we did not have a
restated due to it producing a negative stock price.
Weis Markets observed share price on November 1, 2009 was $34.98; which
served as our benchmark in determining the value of the firm. We conducted each
valuation model using a 10% analyst approach; which means Weis Markets is fairly
valued anywhere between $31.48 and $38.48. Any value above $38.48 would be
undervalued whereas any value below $31.48 would be overvalued. As a result of our
valuations, we believe Weis Markets is overvalued. Since Weis Markets is a small
grocery retail firm and has little growth you can expect Weis’ stock to have minimal
change over the next ten years. Thus, we recommend investors to hold onto Weis
Markets’ stock.
181 | P a g e Appendix
Works Cited
Weis Markets Inc. Form 10-K, <http://www.weismarkets.com/financial_info.php>
SuperValu Inc. Form 10-K, <http://investor.supervalu.com/phoenix.zhtml?c=93272&p=irolsec>
The Kroger Co. Form 10-K,
<http://www.thekrogerco.com/finance/financialinfo_reportsandstatements.htm>
Safeway Inc. Form 10-K. < http://www.safeway.com/IFL/Grocery/Investors#iframetop>
Safeway Inc. <http://www.safeway.com/>
“First Research” <http://www.firstresearch.com/>
Andrejczak, Matt. “Gorcery-Store prices hikes most since 1980.” <www.wsj.com>
Blalik, Carl. “Justice—Wait for it—on the checkout line” <www.wsj.com>
Brat, Ilan. Byron, Ellen. Zimmerman, Ann. “Retailers cut back on Variety, Once the Spice of
Marketing.” <www.wsj.com>
Cordeiro, Anjali. “Heinz, Hormel Buoyed by Frugal Consumers.” <www.wsj.com>
Martin, Timothy. “Frugal Shoppers Drive groceries Back to Basics.” <www.wsj.com>
Martin, Timothy. “Choice Advise from Meat Cutters” <www.wsj.com>
Food Marketing Institute <http://www.fmi.org>
182 | P a g e LIQUIDITY RATIOS
Current Ratio
SVU
KR
WMK
2004
2005
2006
2007
2008
WMK
2004
2005
2006
2007
2008
WMK
2004
2005
2006
2007
2008
SWY
1.94
1.09
1.01
0.95
2.04
1.30
1.01
0.87
1.96
1.44
0.96
0.77
1.96
0.95
0.89
0.78
2.00
0.90
0.82
0.88
Quick Asset Ratio
SVU
KR
SWY
0.75
0.40
0.15
0.16
0.83
0.57
0.13
0.17
0.70
0.75
0.13
0.15
0.71
0.26
0.13
0.17
0.79
0.26
0.12
0.20
Inventory Turnover
SVU
KR
SWY
9.38
16.11
9.51
9.12
16.16
8.91
9.87
8.69
17.79
9.33
10.82
8.86
10.65
9.91
10.77
9.58
12.23
11.08
12.19
Days Supply of Inventory WMK
SVU
KR
2004
2005
2006
2007
2008
22.66
38.39
39.65
40.02
22.58
40.96
36.98
41.98
20.51
39.14
33.72
41.20
34.28
36.85
33.89
38.10
29.85
32.95
29.94
SWY
58.18
45.12
79.81
105.67
57.92
41.71
85.38
109.57
53.59
45.23
89.05
87.13
47.84
39.09
85.53
73.17
53.45
46.32
89.36
85.62
Days Sales Outstanding
WMK
SVU
KR
2004
2005
2006
2007
2008
WMK
2004
2005
2006
2007
2008
SWY
6.27
8.09
4.57
3.45
6.30
8.75
4.28
3.33
6.81
8.07
4.10
4.19
7.63
9.34
4.27
4.99
6.83
7.88
4.08
4.26
Cash to Cash Cycle
SVU
KR
SWY
45.18
30.74
42.96
43.11
46.32
31.33
45.24
40.31
48.79
28.58
43.24
37.91
48.83
43.62
41.11
38.88
44.93
37.73
37.04
34.21
Working Capital Turnover
WMK
SVU
KR
2004
2005
2006
2007
2008
SWY
38.91
Receivables Turnover
WMK
SVU
KR
2004
2005
2006
2007
2008
9.20
SWY
15.21
122.41
1630.03
13.58
39.49
627.04
-184.27
-68.42
15.22
30.04
-243.18
-38.80
14.73
-152.68
-80.04
-37.46
15.24
-95.76
-44.59
-84.33
183 | P a g e PROFITABILITY RATIOS
WMK
2004
2005
2006
2007
2008
Gross Profit Margin
SVU
KR
SWY
0.26
0.14
0.26
0.30
0.26
0.15
0.25
0.29
0.27
0.15
0.25
0.29
0.26
0.22
0.24
0.29
0.26
0.23
0.23
0.28
Operating Expense Ratio
WMK
SVU
KR
2004
2005
2006
2007
2008
0.11
0.19
0.26
0.23
0.11
0.19
0.26
0.23
0.12
0.18
0.25
0.23
0.18
0.18
0.25
0.23
0.19
0.17
0.24
Operating Profit Margin
WMK
SVU
KR
2004
2005
2006
2007
2008
WMK
2004
2005
2006
2007
2008
WMK
2004
2005
2006
2007
2008
WMK
2004
2005
2006
2007
2008
SWY
0.04
0.03
0.03
0.03
0.04
0.04
0.02
0.03
0.04
0.02
0.03
0.04
0.03
0.03
0.04
0.04
0.03
0.04
0.03
0.04
Net Profit Margin
SVU
KR
SWY
0.03
0.01
0.01
0.02
0.03
0.02
0.00
0.01
0.02
0.01
0.02
0.02
0.02
0.01
0.02
0.02
0.02
0.01
0.02
0.02
Asset Turnover
SVU
KR
WMK
2004
2005
2006
2007
2008
SWY
0.23
SWY
2.82
3.43
2.68
2.37
2.97
3.18
2.80
2.50
2.85
3.16
2.96
2.55
2.85
6.19
3.23
2.60
2.88
2.03
3.31
2.50
Return on Assets
SVU
KR
SWY
0.08
0.05
0.02
0.04
0.08
0.06
0.00
0.04
0.07
0.03
0.05
0.06
0.06
0.07
0.05
0.05
0.06
0.03
0.06
0.05
Return on Equity
SVU
KR
SWY
0.10
0.14
0.08
0.15
0.11
0.17
-0.02
0.13
0.09
0.08
0.27
0.18
0.08
0.17
0.25
0.16
0.07
0.11
0.24
0.14
184 | P a g e CAPITAL STRUCTURE RATIOS
Debt to Equity
WMK Adj SVU
WMK
2004
2005
2006
2007
2008
N/A
1.78
4.03
2.57
0.31
N/A
1.50
4.79
2.20
0.29
N/A
1.31
3.67
1.87
0.30
N/A
3.09
3.31
1.63
0.28
N/A
2.54
3.54
1.58
Times Interest Earned
WMK Adj SVU
KR
N/A
4.11
2.27
3.10
0.00
N/A
6.23
1.52
3.32
0.00
N/A
4.11
3.99
4.45
0.00
N/A
2.34
2.54
4.81
N/A
2.38
4.85
5.32
Debt Service Margin
WMK Adj SVU
KR
WMK
4.29
7.49
6.29
3.18
0.00
3.77
2.89
9.40
3.15
0.00
3.48
10.48
30.87
3.05
0.00
2.96
10.72
4.24
2.77
4.03
7.66
2.85
2.36
0.00
Internal Growth Rate WMK Adj SVU
KR
SWY
-0.0003
-0.14
0.034
0.016
0.037
0.044
-0.236
0.050
-0.005
0.034
0.031
1.11
0.019
0.047
0.049
0.022
0.40
0.056
0.048
0.048
0.019
0.30
0.021
0.046
0.047
WMK
2004
2005
2006
2007
2008
SWY
0.00
WMK
2004
2005
2006
2007
2008
SWY
0.00
0.00
2004
2005
2006
2007
2008
SWY
0.31
WMK
2004
2005
2006
2007
2008
KR
Sustainable Growth Rate WMK Adj SVU
KR
SWY
-0.0004
-0.22
0.096
0.079
0.132
0.058
-0.534
0.124
-0.029
0.108
0.040
2.11
0.044
0.218
0.141
0.029
0.64
0.230
0.205
0.126
0.024
0.47
0.074
0.209
0.122
185 | P a g e Sales Manipulation Diagnostic Overview (Raw)
WMK
SVU
KR
SWY
2004
2005
2006
2007
2008
Net Sales/Cash from Sales
1.002
1
1.002
1.006
.995
Net Sales/Receivables
58.2
57.9
53.6
47.8
53.5
Net Sales/Inventory
12.7
12.4
11.8
11.9
12.9
Net Sales/Unearned Revenue
N/A
N/A
N/A
N/A
N/A
Net Sales/Warranty Liability
N/A
N/A
N/A
N/A
N/A
Net Sales/Cash from Sales
.999
1.011
.999
1.014
.999
Net Sales/Receivables
45.1
41.7
45.2
39.1
46.3
Net Sales/Inventory
18.7
18.9
20.8
13.6
15.9
Net Sales/Unearned Revenue
N/A
N/A
N/A
N/A
N/A
Net Sales/Warranty Liability
N/A
N/A
N/A
N/A
N/A
Net Sales/Cash from Sales
.999
.999
1
1.001
1
Net Sales/Receivables
79.8
85.4
89
85.5
89.4
Net Sales/Inventory
12.9
11.9
12.4
13.1
14.5
Net Sales/Unearned Revenue
N/A
N/A
N/A
N/A
N/A
Net Sales/Warranty Liability
N/A
N/A
N/A
N/A
N/A
Net Sales/Cash from Sales
.999
1
1.003
1.003
.999
Net Sales/Receivables
105.7
109.6
87.1
73.2
85.6
Net Sales/Inventory
13.1
13.9
15.2
15.1
17.0
Net Sales/Unearned Revenue
N/A
N/A
N/A
N/A
N/A
Net Sales/Warranty Liability
N/A
N/A
N/A
N/A
N/A
186 | P a g e Expense Manipulation Diagnostic Overview (Raw)
WMK
SVU
KR
SWY
2004
2005
2006
2007
2008
Asset Turnover
2.82
2.97
2.85
2.85
2.88
CFFO/OI
1.64
1.31
1.22
1.14
1.71
CFFO/NOA
0.27
0.23
0.20
0.17
0.23
Accrual/Sales
-.029
-.018
-.019
-.015
-.028
Pension/SG&A
1.360
1.152
1.245
1.414
1.231
Asset Turnover
3.43
3.18
3.16
6.19
2.03
CFFO/OI
1.38
1.11
1.55
0.61
1.03
CFFO/NOA
0.34
0.36
0.34
0.10
0.23
Accrual/Sales
-.027
-.021
-.024
-.009
-.026
Pension/SG&A
0.024
0.026
0.025
0.019
0.018
Asset Turnover
2.68
2.80
2.96
3.23
3.31
CFFO/OI
1.61
2.75
1.08
0.81
1.12
CFFO/NOA
0.20
0.20
0.19
0.20
0.21
Accrual/Sales
-.035
-.043
-.020
-.019
-.020
Pension/SG&A
0.021
0.022
0.024
0.016
0.017
Asset Turnover
2.37
2.50
2.55
2.60
2.50
CFFO/OI
1.91
1.55
1.36
1.24
1.21
CFFO/NOA
0.26
0.21
0.22
0.21
0.21
Accrual/Sales
-.047
-.034
-.034
-.031
-.029
Pension/SG&A
0.023
0.024
0.023
0.021
0.019
187 | P a g e Regression Analysis 3 Month rf
mrp
0.034 Months
0.07
72
60
48
36
24
Beta
0.701033
0.703714
0.701781
0.690866
0.71443
B ub
1.014153
1.036734
1.066844
1.097900
1.215094
B lb
0.387913
0.370693
0.336718
0.283833
0.213767
Adj R2
ke
Ke low
Ke up
0.210573 0.083072 0.061154 0.104991
0.222578 0.08326 0.059949 0.106571
0.229167 0.083125 0.05757 0.108679
0.237442 0.082361 0.053868 0.110853
0.252221 0.08401 0.048964 0.119057
1 Year
rf
mrp
0.034 Months
0.07
72
60
48
36
24
Beta
0.699464
0.701805
0.699805
0.689056
0.71272
B ub
1.012421
1.034659
1.064632
1.095835
1.213338
B lb
0.386506
0.368951
0.334977
0.282276
0.212102
Adj R2
0.209971
0.221767
0.228345
0.236652
0.25124
ke
0.082962
0.083126
0.082986
0.082234
0.08389
Ke low
0.061055
0.059827
0.057448
0.053759
0.048847
Ke up
0.104869
0.106426
0.108524
0.110708
0.118934
Beta
B ub
B lb
Adj R2
ke
0.700589 1.01354 0.387639 0.210541 0.083041
0.700024 1.032235 0.367813 0.221545 0.083002
0.698247 1.062089 0.334406 0.228526 0.082877
0.691058 1.097674 0.284441 0.237957 0.082374
0.722342 1.22678 0.217904 0.253715 0.084564
Ke low
0.061135
0.059747
0.057408
0.053911
0.049253
Ke up
0.104948
0.106256
0.108346
0.110837
0.119875
2 Year
rf
mrp
0.034 Months
0.07
72
60
48
36
24
5 Year
rf
mrp
0.034 Months
0.07
72
60
48
36
24
Beta
0.698641
0.698823
0.696814
0.689664
0.720131
B ub
1.011294
1.030874
1.060641
1.096111
1.223882
B lb
0.385987
0.366772
0.332987
0.283217
0.21638
Adj R2
0.209899
0.221093
0.227765
0.237324
0.252988
ke
0.082905
0.082918
0.082777
0.082277
0.084409
Ke low
0.061019
0.059674
0.057309
0.053825
0.049147
Ke up
0.104791
0.106161
0.108245
0.110728
0.119672
Adj R2
0.210752
0.222065
0.228957
0.237639
0.252536
ke
0.083046
0.083085
0.08296
0.082283
0.084114
Ke low
0.061151
0.059824
0.057477
0.053851
0.049021
Ke up
0.104942
0.106347
0.108443
0.110716
0.119207
10 Year
rf
mrp
0.034 Months
0.07
72
60
48
36
24
Beta
0.700663
0.701221
0.699426
0.689763
0.715908
B ub
1.013457
1.033527
1.063467
1.095944
1.217236
B lb
0.387868
0.368915
0.335385
0.283582
0.21458
188 | P a g e 3 Month Treasury SUMMARY OUTPUT
6 yr‐72mo
Regression Statistics
Multiple R
0.470841741
R Square
0.221691945
Adjusted R Square
0.210573258
Standard Error
0.057263259
Observations
72
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
70
71
SS
MS
F
Significance F
0.065380547 0.065380547 19.93868111
2.99333E‐05
0.229535657 0.003279081
0.294916204
Coefficients Standard Error
t Stat
P‐value
0.004361371
0.006748816 0.646242306 0.520235601
0.701032969
0.156996594 4.465275032 2.99333E‐05
Lower 95%
Upper 95%
Lower 95.0% Upper 95.0%
‐0.009098719
0.01782146 ‐0.009098719
0.01782146
0.387913141 1.014152798 0.387913141 1.014152798
SUMMARY OUTPUT
5 yr‐60m
Regression Statistics
Multiple R
0.485545956
R Square
0.235754875
Adjusted R Square
0.222578235
Standard Error
0.058710489
Observations
60
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
58
59
SS
MS
F
Significance F
0.06167191
0.06167191 17.89188094
8.41172E‐05
0.199921451 0.003446922
0.261593362
Coefficients Standard Error
t Stat
P‐value
0.005363114
0.00758852 0.706740452 0.482557535
0.703713618
0.166367295 4.229879542 8.41172E‐05
Lower 95%
Upper 95%
Lower 95.0% Upper 95.0%
‐0.009826959 0.020553187 ‐0.009826959 0.020553187
0.370693297 1.036733939 0.370693297 1.036733939
SUMMARY OUTPUT
4 yr ‐48mo
Regression Statistics
Multiple R
0.49554811
R Square
0.245567929
Adjusted R Square
0.229167232
Standard Error
0.062145254
Observations
48
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
46
47
SS
MS
F
Significance F
0.057826283 0.057826283 14.97301767
0.000341923
0.177653502 0.003862033
0.235479785
Coefficients Standard Error
t Stat
P‐value
0.003267893
0.009003915
0.36294128 0.718311219
0.701780809
0.181362218 3.869498375 0.000341923
Lower 95%
Upper 95%
Lower 95.0% Upper 95.0%
‐0.014856049 0.021391834 ‐0.014856049 0.021391834
0.336717604 1.066844014 0.336717604 1.066844014
SUMMARY OUTPUT
3yr‐36mo
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.509145795
0.259229441
0.237442071
0.067203974
36
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
34
35
SS
MS
F
Significance F
0.053736507 0.053736507 11.89815236
0.001517685
0.153556718 0.004516374
0.207293225
Coefficients Standard Error
t Stat
P‐value
0.004068795
0.011284671 0.360559485 0.720659269
0.690866452
0.200287729
3.44936985 0.001517685
Upper 95%
Lower 95.0% Upper 95.0%
Lower 95%
‐0.018864416 0.027002007 ‐0.018864416 0.027002007
0.283832818 1.097900087 0.283832818 1.097900087
SUMMARY OUTPUT
2 yr‐24mo
Regression Statistics
Multiple R
0.533603552
R Square
0.28473275
Adjusted R Square
0.252220603
Standard Error
0.077305276
Observations
24
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
22
23
SS
MS
F
Significance F
0.052337146 0.052337146 8.757734277
0.007244839
0.131474327 0.005976106
0.183811473
Coefficients Standard Error
t Stat
P‐value
0.004478526
0.016137578 0.277521541 0.783970853
0.714430154
0.241414802 2.959346934 0.007244839
Lower 95%
Upper 95%
Lower 95.0% Upper 95.0%
‐0.028988763 0.037945815 ‐0.028988763 0.037945815
0.2137665 1.215093808
0.2137665 1.215093808
189 | P a g e 1 Year Treasury SUMMARY OUTPUT
6 yr‐72mo
Regression Statistics
Multiple R
0.470210931
R Square
0.22109832
Adjusted R Square
0.209971153
Standard Error
0.057285092
Observations
72
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
70
71
SS
MS
F
Significance F
0.065205477 0.065205477 19.87013608
3.07798E‐05
0.229710727 0.003281582
0.294916204
Coefficients Standard Error
t Stat
P‐value
0.004535626
0.006751858 0.671759692 0.503947749
0.699463742
0.156915118 4.457593082 3.07798E‐05
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.00893053 0.018001781 ‐0.00893053 0.018001781
0.386506413 1.012421072 0.386506413 1.012421072
SUMMARY OUTPUT
5 yr‐60m
Regression Statistics
Multiple R
0.484723681
R Square
0.234957047
Adjusted R Square
0.221766652
Standard Error
0.058741127
Observations
60
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
58
59
SS
MS
F
Significance F
0.061463204 0.061463204 17.81273678
8.68316E‐05
0.200130158
0.00345052
0.261593362
Coefficients Standard Error
t Stat
P‐value
0.005513656
0.007594336 0.726022107 0.470744918
0.701805219
0.166284308 4.220513805 8.68316E‐05
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.00968806 0.020715372 ‐0.00968806 0.020715372
0.368951014 1.034659423 0.368951014 1.034659423
SUMMARY OUTPUT
4 yr ‐48mo
Regression Statistics
Multiple R
0.494735862
R Square
0.244763573
Adjusted R Square
0.22834539
Standard Error
0.062178374
Observations
48
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
46
47
SS
MS
F
Significance F
0.057636874 0.057636874 14.90807905
0.000350905
0.177842911
0.00386615
0.235479785
Coefficients Standard Error
t Stat
P‐value
0.003391435
0.009011665 0.376338357 0.708395653
0.699804527
0.181244946 3.861098166 0.000350905
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.014748106 0.021530977 ‐0.014748106 0.021530977
0.33497738 1.064631675
0.33497738 1.064631675
SUMMARY OUTPUT
3yr‐36mo
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.508391763
0.258462184
0.236652249
0.067238768
36
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
34
35
SS
MS
F
Significance F
0.05357746
0.05357746 11.85066234
0.001546554
0.153715765 0.004521052
0.207293225
Coefficients Standard Error
t Stat
P‐value
0.004193543
0.01129524 0.371266358 0.712742695
0.689055657
0.200162626 3.442479098 0.001546554
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.018761146 0.027148231 ‐0.018761146 0.027148231
0.282276261 1.095835052 0.282276261 1.095835052
SUMMARY OUTPUT
2 yr‐24mo
Regression Statistics
Multiple R
0.532723887
R Square
0.283794739
Adjusted R Square
0.251239955
Standard Error
0.077355949
Observations
24
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
22
23
SS
MS
0.052164729 0.052164729
0.131646744 0.005983943
0.183811473
F
Significance F
8.717451
0.007359672
Coefficients Standard Error
t Stat
P‐value
0.004666672
0.01616281 0.288728971 0.775491829
0.71271986
0.241392684
2.95253298 0.007359672
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.028852945 0.038186288 ‐0.028852945 0.038186288
0.212102077 1.213337643 0.212102077 1.213337643
190 | P a g e 2 Year Treasury SUMMARY OUTPUT
6 yr‐72mo
Regression Statistics
Multiple R
0.470807844
R Square
0.221660026
Adjusted R Square
0.210540883
Standard Error
0.057264433
Observations
72
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
SS
MS
0.065371133 0.065371133
70
0.229545071 0.003279215
71
0.294916204
F
Significance F
19.9349928
2.99783E‐05
Coefficients Standard Error
t Stat
P‐value
0.004764766
0.006750377 0.705851861 0.482622829
0.700589069
0.156911696 4.464862013 2.99783E‐05
Lower 95%
Upper 95%
Lower 95.0% Upper 95.0%
‐0.008698436 0.018227969 ‐0.008698436 0.018227969
0.387638564 1.013539574 0.387638564 1.013539574
SUMMARY OUTPUT
5 yr‐60m
Regression Statistics
Multiple R
0.484498555
R Square
0.23473885
Adjusted R Square
0.221544692
Standard Error
0.058749503
Observations
60
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
58
59
SS
MS
F
Significance F
0.061406125 0.061406125 17.79112044
8.75887E‐05
0.200187237 0.003451504
0.261593362
Coefficients Standard Error
t Stat
P‐value
0.005461272
0.007594774 0.719082849 0.474977189
0.700024078
0.16596302 4.217952161 8.75887E‐05
Lower 95%
Upper 95%
Lower 95.0% Upper 95.0%
‐0.009741321 0.020663864 ‐0.009741321 0.020663864
0.367813002 1.032235153 0.367813002 1.032235153
SUMMARY OUTPUT
4 yr ‐48mo
Regression Statistics
Multiple R
0.494914383
R Square
0.244940247
Adjusted R Square
0.228525904
Standard Error
0.062171101
Observations
48
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
46
47
SS
MS
F
Significance F
0.057678477 0.057678477 14.92233073
0.000348913
0.177801308 0.003865246
0.235479785
Coefficients Standard Error
t Stat
P‐value
0.003342242
0.009009441 0.370971029 0.712362157
0.698247355
0.18075527 3.862943273 0.000348913
Lower 95%
Upper 95%
Lower 95.0% Upper 95.0%
‐0.014792823 0.021477306 ‐0.014792823 0.021477306
0.334405873 1.062088837 0.334405873 1.062088837
SUMMARY OUTPUT
3yr‐36mo
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.509637007
0.259729878
0.237957228
0.067181269
36
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
34
35
SS
MS
F
Significance F
0.053840244 0.053840244 11.92918046
0.001499135
0.153452981 0.004513323
0.207293225
Coefficients Standard Error
t Stat
P‐value
0.004720695
0.011305216
0.41756789 0.678888322
0.691057902
0.200082513 3.453864568 0.001499135
Lower 95.0% Upper 95.0%
Lower 95%
Upper 95%
‐0.018254268 0.027695659 ‐0.018254268 0.027695659
0.284441316 1.097674488 0.284441316 1.097674488
SUMMARY OUTPUT
2 yr‐24mo
Regression Statistics
Multiple R
0.53494111
R Square
0.286161991
Adjusted R Square
0.253714808
Standard Error
0.077228003
Observations
24
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
22
23
SS
MS
F
Significance F
0.052599857 0.052599857 8.819317145
0.007073095
0.131211616 0.005964164
0.183811473
Coefficients Standard Error
t Stat
P‐value
0.00648717
0.016274411 0.398611648 0.694021809
0.722342254
0.243234705 2.969733514 0.007073095
Lower 95%
Upper 95%
Lower 95.0% Upper 95.0%
‐0.027263892 0.040238232 ‐0.027263892 0.040238232
0.217904353 1.226780155 0.217904353 1.226780155
191 | P a g e 5 Year Treasury SUMMARY OUTPUT
6 yr‐72mo
Regression Statistics
Multiple R
0.470135231
R Square
0.221027136
Adjusted R Square
0.209898952
Standard Error
0.05728771
Observations
72
ANOVA
df
Regression
1
Residual
70
Total
71
Intercept
X Variable 1
SS
MS
F
Significance F
0.065184484 0.065184484 19.86192358
3.08829E‐05
0.22973172 0.003281882
0.294916204
Coefficients Standard Error
t Stat
P‐value
0.005210614
0.006756114 0.771244286 0.443157794
0.698640767
0.156762893 4.456671805 3.08829E‐05
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.00826403 0.018685259 ‐0.00826403 0.018685259
0.385987039 1.011294496 0.385987039 1.011294496
SUMMARY OUTPUT
5 yr‐60m
Regression Statistics
Multiple R
0.484040569
R Square
0.234295272
Adjusted R Square
0.221093466
Standard Error
0.058766527
Observations
60
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
58
59
SS
MS
F
Significance F
0.061290088 0.061290088 17.74721414
8.91476E‐05
0.200303274 0.003453505
0.261593362
Coefficients Standard Error
t Stat
P‐value
0.006012429
0.007604917 0.790597619 0.432399701
0.698823011
0.165883084 4.212744253 8.91476E‐05
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.009210466 0.021235324 ‐0.009210466 0.021235324
0.366771943 1.030874078 0.366771943 1.030874078
SUMMARY OUTPUT
4 yr ‐48mo
Regression Statistics
Multiple R
0.494161202
R Square
0.244195294
Adjusted R Square
0.227764757
Standard Error
0.062201763
Observations
48
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
46
47
SS
MS
F
Significance F
0.057503055 0.057503055 14.86228309
0.000357388
0.17797673 0.003869059
0.235479785
Coefficients Standard Error
t Stat
P‐value
0.003937848
0.009029088 0.436129066 0.664783158
0.696814039
0.180748261 3.855163173 0.000357388
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.014236764 0.022112459 ‐0.014236764 0.022112459
0.332986666 1.060641412 0.332986666 1.060641412
SUMMARY OUTPUT
3yr‐36mo
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.509032895
0.259114488
0.237323737
0.067209188
36
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
34
35
SS
MS
F
Significance F
0.053712678 0.053712678 11.89103098
0.001521977
0.153580547 0.004517075
0.207293225
Coefficients Standard Error
t Stat
P‐value
0.005275441
0.011333534 0.465471829 0.644561495
0.68966433
0.199999085 3.448337423 0.001521977
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.017757072 0.028307954 ‐0.017757072 0.028307954
0.28321729 1.096111371
0.28321729 1.096111371
SUMMARY OUTPUT
2 yr‐24mo
Regression Statistics
Multiple R
0.534290926
R Square
0.285466793
Adjusted R Square
0.252988011
Standard Error
0.077265599
Observations
24
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
22
23
SS
MS
F
Significance F
0.052472072 0.052472072 8.789331818
0.00715615
0.131339402 0.005969973
0.183811473
Coefficients Standard Error
t Stat
P‐value
0.00689124
0.016317993 0.422309265 0.676897974
0.720130945
0.242903372 2.964680728
0.00715615
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.026950207 0.040732686 ‐0.026950207 0.040732686
0.216380187 1.223881704 0.216380187 1.223881704
192 | P a g e 10 Year Treasury SUMMARY OUTPUT
6yr‐72mo
Regression Statistics
Multiple R
0.471029081
R Square
0.221868395
Adjusted R Square
0.210752229
Standard Error
0.057256767
Observations
72
ANOVA
df
Regression
1
SS
MS
F
Significance F
0.065432585 0.065432585 19.95907577
2.96861E‐05
Residual
70
0.229483619 0.003278337
Total
71
0.294916204
Intercept
X Variable 1
Coefficients Standard Error
t Stat
P‐value
0.005278414
0.006753029 0.781636484 0.437064041
0.700662752
0.156833494 4.467558144 2.96861E‐05
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.008190077 0.018746904 ‐0.00819008 0.018746904
0.387868216 1.013457288 0.387868216 1.013457288
SUMMARY OUTPUT
5yr‐60mo
Regression Statistics
Multiple R
0.485026258
R Square
0.235250471
Adjusted R Square
0.222065134
Standard Error
0.058729861
Observations
60
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
58
59
SS
MS
F
Significance F
0.061539961 0.061539961 17.84182502
8.58235E‐05
0.2000534 0.003449197
0.261593362
Coefficients Standard Error
t Stat
P‐value
0.006086936
0.007601336 0.800771918 0.426531832
0.70122077
0.166010338 4.223958454 8.58235E‐05
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.00912879 0.021302662 ‐0.00912879 0.021302662
0.368914977 1.033526563 0.368914977 1.033526563
SUMMARY OUTPUT
4yr‐48mo
Regression Statistics
Multiple R
0.495340212
R Square
0.245361926
Adjusted R Square
0.22895675
Standard Error
0.062153738
Observations
48
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
46
47
SS
MS
0.057777774 0.057777774
0.177702011 0.003863087
0.235479785
F
Significance F
14.9563731
0.000344202
Coefficients Standard Error
t Stat
P‐value
0.003953645
0.009022309 0.438207701 0.663286773
0.699426211
0.180854266 3.867347036 0.000344202
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.01420732
0.02211461 ‐0.01420732
0.02211461
0.33538546 1.063466962
0.33538546 1.063466962
SUMMARY OUTPUT
3yr‐36mo
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.509333599
0.259420715
0.237638971
0.067195297
36
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
34
35
SS
MS
F
Significance F
0.053776157 0.053776157 11.91000678
0.001510569
0.153517068 0.004515208
0.207293225
Coefficients Standard Error
t Stat
P‐value
0.00494019
0.01131667 0.436540987 0.665204043
0.68976276
0.199868217 3.451087768 0.001510569
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.01805805
0.02793843 ‐0.01805805
0.02793843
0.283581675 1.095943845 0.283581675 1.095943845
SUMMARY OUTPUT
2yr‐24mo
Regression Statistics
Multiple R
0.533885816
R Square
0.285034064
Adjusted R Square
0.252535612
Standard Error
0.077288992
Observations
24
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
1
22
23
SS
MS
F
Significance F
0.052392531 0.052392531 8.770696746
0.007208309
0.131418942 0.005973588
0.183811473
Coefficients Standard Error
t Stat
P‐value
0.00590915
0.01624177 0.363824277 0.719462321
0.715907955
0.241735337 2.961536214 0.007208309
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
‐0.027774219
0.03959252 ‐0.02777422
0.03959252
0.214579552 1.217236358 0.214579552 1.217236358
193 | P a g e Discounted Dividends Approach
Relevant Valuation Item
0
1
2
3
4
5
6
7
8
9
10
11
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
DPS (Dividends Per Share)
$ 1.20 $ 1.20 $ 1.20 $ 1.24 $ 1.24 $ 1.24 $ 1.28 $ 1.28 $ 1.28 $ 1.32 $ 1.30
PV Factor
0.9220
0.8501
0.7838
0.7226
0.6663
0.6143
0.5664
0.5222 0.4815
0.4439
$ 1.11 $ 1.02 $ 0.94 $ 0.90 $ 0.83 $ 0.76 $ 0.72 $ 0.67 $ 0.62 $ 0.59
Year by Year PV annual dividend
Total PV of YBY dividends
$ 8.15
PV TV Perp
6.821
$ 14.97
$ 16.02
0
Model Value (12/31/08)
Time Consistent Price
Observed Share Price (11/2/09)
Initial Cost of Equity (You Derive)
Perpetuity Growth Rate (g)
$ 34.98
0.0846
0
0.02
0.04
0.06
0.08
0.1
0.12
0.0493 $
26.99
$ 38.57
$
99.95
N/A
N/A
N/A
N/A
0.065 $
20.63
$ 25.62
$
38.60
$ 155.38
N/A
N/A
N/A
0.07 $
19.21
$ 23.20
$
32.53
$
79.14
N/A
N/A
N/A
0.0846 $
16.02
$ 18.28
$
22.56
$
33.82
$ 142.96
N/A
N/A
0.09 $
15.10
$ 16.97
$
20.34
$
28.21
$
67.54
N/A
N/A
0.1 $
13.66
$ 15.02
$
17.28
$
21.80
$
35.37
N/A
N/A
0.1199 $
11.52
$ 12.29
$
13.44
$
15.37
$
19.22
$ 30.81
N/A
15.37
Red = Overvalued
White = Fairly Valued
Green = Undervalued
Assum e WACC=.0648 and Cost of Debt= .0236. Assum e Cost of Equity= .0846. There are 27.438 m illion shares outstanding.
Assum e from 2019 forw ard that Dividends w ill be $1.30 per share w ith no grow th.
Overvalued according to a 10% Analyst.
Discounted Free Cash Flow
0
2008
Cash Flow From Operations
Cash Flow From Investing FCF Firm's Assets
PV Factor
PV YBY Free Cash Flows
Total PV YBY FCF
FCF Perp
Market Value of Assets(12/31/08) 1,337,785.30
1,976,768.50
3,314,553.80
Book Value of Debt and Preferred Stock
187,114.00
Market Value of Equity
3,127,439.80
PPS at 12/31/08
113.98
Time Consistent Price 11/2/09
120.10
Observed Share Price 11/2/09
$ 34.98
WACC (BT) Perp Growth Rate
1
2
2009
2010
127,173.95 134,804.39
72078.75
42399.26
‐0.110658716
199,252.70 177,203.65
0.939143501 0.881990516
187,126.88 156,291.94
0.0648
0
*Assumed cash flows at t=11 is $240,000 with 27438 shares outstanding
3
2011
142,892.65
24940.74
‐0.052878466
167,833.40
0.828315661
139,019.03
4
5
6
7
8
9
10
11
2012
2013
2014
2015
2016
2017
2018
2019
151,466.21 160,554.18 171,792.98 183,818.49 196,685.78 210,453.79
225185.55
14671.03
8630.02
5076.48
2986.16
1756.57
1033.27
607.81
‐0.010106206 0.018340031 0.045425384 0.056172465 0.062298754 0.065735526
0.067646214
166,137.24 169,184.20 176,869.46 186,804.65 198,442.35 211,487.06 225,793.36 240,000.00
0.77790727 0.730566557 0.686106834 0.644352774 0.60513972 0.568313036
0.533727494
129,239.37 123,600.32 121,351.34 120,368.09 120,085.35 120,190.85 120,512.12
3,703,703.70
0
0.02
0.03
0.04
0.0648
0.08
0.09
0.1
0.12
0.1771
0.18
0.19
0.2075
0.22
0.25
0.02
420.13 N/A
0.04
0.06
0.08
0.1
0.12
N/A
N/A
N/A
N/A
N/A
274.93
719.66 N/A
N/A
N/A
N/A
N/A
202.59
355.22 N/A
N/A
N/A
N/A
N/A
1069.04 N/A
N/A
N/A
120.1
154
242.55
95.11
113.11
149.11
N/A
N/A
83.35
95.95
118.64
171.57
436.23 N/A
N/A
220.05 N/A
257.1 N/A
74
83.13
98.34
128.77
60.09
65.25
72.99
85.89
111.68
N/A
38.11
39.52
41.34
43.78
47.23
52.48
37.37
38.71
40.42
42.7
45.9
50.7
58.69
35.03
36.13
37.52
39.34
41.82
45.41
51.05
31.48
32.28
33.27
34.53
36.18
38.45
41.75
29.31
29.95
30.74
31.72
32.98
34.66
37.02
25.00
25.40
25.87
26.43
27.13
28.02
29.18
189.06 N/A
61.39
Red = Overvalued (sell) White = Fairly Valued Green = Undervalued (buy) 194 | P a g e 0
2008
Net Income (Millions)
Total Dividends (Millions)
Book Value Equity (Millions)
$
661.10
Annual Normal Income (Benchmark)
Annual Residual Income
pv factor
YBY PV RI
WMK-Residual Income
2
3
4
5
2010
2011
2012
2013
1
2009
6
2014
7
2015
8
2016
9
2017
10
2018
$
58.50
$ 65.86
$ 65.73
$
69.67
$ 73.85
$ 79.02
$ 84.56
$ 90.48
$
96.81
$
103.59
$
32.93
$ 32.93
$ 32.93
$
34.02
$ 34.02
$ 34.02
$ 35.12
$ 35.12
$
35.12
$
36.22
$ 686.67
$ 719.61
$ 752.42
$ 788.07
$ 827.90
$ 872.90
$ 922.34
$ 977.69
$ 1,039.38
$ 1,106.75
$ 58.09
$ 60.88
$
63.65
$ 66.67
$ 70.04
$ 73.85
$ 78.03
$
82.71
$
87.93
$
$
$
6.02
$
$
$ 10.71
$ 12.45
$
14.10
$
15.65
$
55.93
$
2.57
7.77
0.922
0.850
2.370
Change in ROE
0.723
3.802
(2.919)
8.8%
ROE
0.784
6.605
5.199
4.85
8.98
0.666
4.350
1.169
7.18
0.614
4.787
1.164
0.566
5.519
1.800
1.725
6.065
1.737
0.522
6.499
1.650
0.481
6.787
1.557
$
661.10
$
53.73
7%
41.03
5%
755.87
100%
$
6.949
1.409
9.6%
9.1%
9.3%
9.4%
9.5%
9.7%
9.8%
9.9%
10.0%
8.4%
-4.8%
1.4%
1.2%
1.9%
1.5%
1.3%
0.9%
0.6%
1.09
87%
-0.1
-0.2
0.0493 $ 44.93
$ 41.34
-0.3
-0.4
$ 39.80
$ 38.95
-0.5
$ 38.41
-0.6
$ 38.03
-0.7
$ 37.76
0.065 $ 36.92
$ 35.08
$ 34.25
$ 33.78
$ 33.47
$ 33.26
$ 33.10
0.07 $ 34.79
$ 33.35
$ 32.69
$ 32.32
$ 32.07
$ 31.90
$ 31.77
27.55
0.0846 $ 29.48
$ 28.91
$ 28.64
$ 28.49
$ 28.38
$ 28.31
$ 28.25
29.48
0.09 $ 27.80
$ 27.47
$ 27.31
$ 27.22
$ 27.16
$ 27.11
$ 27.08
0.1 $ 25.04
$ 25.05
$ 25.06
$ 25.06
$ 25.06
$ 25.06
$ 25.07
0.1199 $ 20.62
$ 21.04
$ 21.26
$ 21.39
$ 21.49
$ 21.55
$ 21.60
27.438
$
$34.98
Observed Share Price (11/1/2009
Initial Cost of Equity (You Derive)
Perpetuity Growth Rate (g)
$ 17.06
0.444
Value%
Book Value Equity (Millions)
Total PV of YBY RI
Terminal Value Perpetuity
MVE 12/31/08
divide by shares
Model Price on 12/31/08
time consistent Price
Perp
2019
92.43
0.0846
-0.1
Red = Overvalued
Assume a WACC = 0.0648 and a Cost of Debt = 0.0236
Cost of Equity =.0846 Assume 27.438 million shares outstanding.
Green = Undervalued
White = Fairly Valued
Abnornal Earnings Growth Model
0
1
2
3
4
5
6
7
8
9
Perp
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
(All Item s in Millions of Dollars)
2008
Net Income (millions)
Total Dividends (millions)
Dividends Reinvested at 8.46% (Drip)
Cum-Dividend Earnings
Normal Earnings
Abnormal Earning Growth (AEG)
$
$
58.50
32.93
$
65.86
$
32.93
$
2.79
$ 68.65
$ 63.45
$
5.20
$
$
$
$
$
$
0.9220
PV Factor
PV of AEG
Residual Incom e Check Figure
Mkt Cap
Core Net Income
Total PV of AEG
Continuing (Terminal) Value
PV of Terminal Value
Total PV of AEG
Total Average Net Income Perp (t+1)
Number of shares Outstanding
Divide by shares to Get Average EPS Perp
Capitalization Rate (perpetuity)
Intrinsic Value Per Share (12/31/2008)
$
$
$
58.50
8.92
$
3.65
$
$
71.08
27.438
2.59
0.0846
65.73
32.93
2.79
68.52
71.43
(2.92)
$
$
$
$
$
$
0.8501
69.67
34.02
2.79
72.46
71.29
1.17
$
$
$
$
$
$
73.85
34.02
2.88
76.73
75.57
1.16
0.7838
$
$
$
$
$
$
0.7226
79.02
34.02
2.88
81.90
80.10
1.80
$
$
$
$
$
$
0.6663
84.56
35.12
2.88
87.43
85.71
1.72
$
$
$
$
$
$
0.6143
90.48
35.12
2.97
93.45
91.71
1.74
0.5664
$
$
$
$
$
$
96.81
35.12
2.97
99.78
98.13
1.65
0.5222
$
$
$
$
$
$
103.59
36.22
2.97
106.56
105.00
1.56
(2.4810)
0.9159
0.8414
1.1993
1.0594
0.9836
0.8618
0.7499
5.20
(2.92)
1.17
1.16
1.80
1.72
1.74
1.65
1.56
0.0493
0.065
0.07
0.0846
0.09
0.1
0.1199
$
$
$
$
$
$
$
30.62
-0.1
42.01
37.22
35.95
32.76
31.76
30.11
27.29
$
$
$
$
$
$
$
-0.2
39.39
35.76
34.75
32.17
31.34
29.93
27.62
$
$
$
$
$
$
$
-0.3
38.26
35.09
34.20
31.89
31.13
29.84
27.69
$
$
$
$
$
$
$
-0.4
37.64
34.72
33.89
31.72
31.01
29.79
27.74
$
$
$
$
$
$
$
-0.5
37.25
34.47
33.68
31.61
30.92
29.75
27.77
$
$
$
$
$
$
$
-0.6
36.97
34.30
33.54
31.53
30.87
29.73
27.79
$
1.40
0.4815
4.7936
7.58
Red = Overvalued
time consistent implied price 11/1/2009 $ 32.76
Nov 1, 2009 observed price
$ 34.98
Ke
0.0846
g
-0.1
Green = Undervalued
White = Fairly Valued
LR ROE RI
Book Value of Equity
Return on Equity (RI Model)
Percent Change in ROE
Cost of Equity (ke)
Market Value of Equity
Divide by Shares
$
$
Estimated Price per Share
$
Time Consistent Price
Observed Share Price
$
$
661.10
0.095
0.014
0.0846
758.49
27.438
27.64
29.58
34.98
195 | P a g e Restated Discounted Free Cash Flow
0
2008
Cash Flow From Operations
Cash Flow From Investing FCF Firm's Assets
PV Factor
PV YBY Free Cash Flows
Total PV YBY FCF
FCF Perp
Market Value of Assets(12/31/08) 614,328.77
385,543.29
999,872.06
Book Value of Debt and Preferred Stock
187,114.00
Market Value of Equity
812,758.06
PPS at 12/31/08
29.62
3
2011
70,205.33
24940.74
‐0.129189263
95,146.07
0.751314801
71,484.65
4
5
6
7
8
9
10
2012
2013
2014
2015
2016
2017
2018
73,715.59 77,401.37 81,271.44 85,335.01 89,601.76 94,081.85 98,785.94
14671.03
8630.02
5076.48
2986.16
1756.57
1033.27
607.81
‐0.07104289 ‐0.026646919 0.003679272 0.022852397 0.034387602 0.041121545
0.044983659
88,386.62 86,031.39 86,347.92 88,321.18 91,358.33 95,115.13 99,393.75
0.683013455 0.620921323
0.56447393 0.513158118 0.46650738 0.424097618
0.385543289
60,369.25 53,418.72 48,741.15 45,322.73 42,619.34 40,338.10 38,320.59
100,000
Growth Rates
0
0.02
0.03
0.04
0.0648
0.08
0.09
0.1
WACC (BT)
Time Consistent Price 11/2/09
32.07
Observed Share Price 11/2/09
$ 34.98
WACC (BT) Perp Growth Rate
1
2
2009
2010
63,678.30 66,862.22
72078.75
42399.26
‐0.195169019
135,757.05 109,261.48
0.909090909 0.826446281
123,415.50 90,298.74
0.02
$ 177.65 N/A
0.04
N/A
0.06
N/A
0.08
N/A
0.1 1,000,000.00
N/A
$ 116.95 $ 302.26 N/A
N/A
N/A
N/A
$ 86.62 $ 150.22 N/A
N/A
N/A
N/A
$ 51.82 $ 65.94 $ 102.84 $ 447.21 N/A
N/A
$ 41.16 $ 48.66 $ 63.66 $ 108.66 N/A
N/A
$ 36.11 $ 41.36 $ 50.82 $ 72.87 $ 183.15 N/A
$ 32.07 $ 35.87 $ 42.21 $ 54.89 $ 92.92 N/A
0.1
0
*Assumed cash flows at t=11 is $240,000 with 27438 shares outstanding
Restated Residual Income Model
All Items in Millions of Dollars
0
2008
Net Income (Millions)
Total Dividends (Millions)
Book Value Equity (Millions)
$
595.43
1
2009
3
2011
6
2014
7
2015
8
2016
9
2017
$
20.54
$
21.78
$
23.08
$
24.47
$
26.18
$
28.01
$
29.97
$
32.07
$
34.32
32.93
$
32.93
$
32.93
$
34.02
$
34.02
$
34.02
$
35.12
$
35.12
$
35.12
$
36.22
$
581.69
$
569.30
$
558.16
$
547.22
$
537.66
$
529.82
$
522.71
$
517.57
$
514.52
50.37
$
49.21
$
48.16
$
47.22
$
46.29
$
45.49
$
44.82
$
44.22
$
$
43.79
(24.14) $
(21.83) $
(19.30) $
(16.81) $
(14.25) $
(11.71) $
0.922
0.850
0.784
0.723
0.666
0.614
0.566
0.522
0.481
0.444
-28.753
-24.369
-20.681
-17.442
-14.542
-11.859
-9.520
-7.440
-5.639
-4.088
2.519
2.280
2.250
2.311
2.521
2.496
2.562
2.534
2.503
(0.829)
3.8%
4.1%
4.5%
4.9%
5.3%
5.7%
6.2%
6.7%
9.6%
8.3%
8.1%
8.1%
8.9%
8.6%
8.5%
8.1%
7.6%
-0.1
-0.2
-0.3
-0.4
-0.5
-0.6
-0.7
139%
$
(144.33)
-34%
0.02 $
33.59
$
30.58
$
29.45
$
28.85
$
28.49
$
28.24
$
28.06
(24.14)
-6%
0.0493 $
23.58
$
22.96
$
22.70
$
22.55
$
22.46
$
22.39
$
22.35
426.95
100%
0.065 $
20.01
$
19.97
$
19.95
$
19.94
$
19.93
$
19.92
$
19.92
0.07 $
19.06
$
19.13
$
19.17
$
19.19
$
19.21
$
19.21
$
19.22
15.56
0.0846 $
16.65
$
16.98
$
17.14
$
17.23
$
17.29
$
17.34
$
17.37
16.65
0.09 $
15.88
$
16.28
$
16.47
$
16.58
$
16.66
$
16.71
$
16.75
0.1 $
14.61
$
15.09
$
15.32
$
15.47
$
15.56
$
15.63
$
15.68
0.1199 $
12.54
$
13.09
$
13.38
$
13.55
$
13.67
$
13.76
$
13.83
27.438
$
$34.98
0.015 $
35.95
$
32.23
$
30.86
$
30.16
$
29.73
$
29.44
$
35
(9.21) $ (10.04)
3.5%
Value%
$
43.53
(26.39) $
595.43
$
$
(28.67) $
$
2019
$ 512.62
(31.19) $
Change in ROE
Perp
10
2018
19.19
3.2%
Observed Share Price (11/1/2009)
Initial Cost of Equity (You Derive)
Perpetuity Growth Rate (g)
5
2013
$
ROE
Book Value Equity (Millions)
Total PV of YBY RI
Terminal Value Perpetuity
MVE 12/31/08
divide by shares
Model Price on 12/31/08
time consistent Price
4
2012
$
$
Annual Normal Income (Benchmark)
Annual Residual Income
pv factor
YBY PV RI
2
2010
4.8%
8.4%
1.09
29.23
-54.38
0.0846
-0.1
Red = Overvalued
Assume a WACC = 0.0648 and a Cost of Debt = 0.0236
Cost of Equity =.0846 Assume 27.438 million shares outstanding.
Green = Undervalued
White = Fairly Valued
31.38
38.48
196 | P a g e Restated Abnornal Earnings Growth Model
(All Items in Millions of Dollars)
2008
$
$
Net Income (millions)
Total Dividends (millions)
Dividends Reinvested at 8.46% (Drip)
Cum-Dividend Earnings
Normal Earnings
Abnormal Earning Growth (AEG)
0
1
2
3
4
5
6
7
8
9
Perp
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
19.19 $
32.93 $
$
$
$
$
20.54 $
32.93 $
2.79 $
23.33 $
20.81 $
2.52 $
0.9220
PV Factor
PV of AEG
Residual Income Check Figure
Mkt Cap
Core Net Income
Total PV of AEG
Continuing (Terminal) Value
PV of Terminal Value
Total PV of AEG
Total Average Net Income Perp (t+1)
Number of shares Outstanding
Divide by shares to Get Average EPS Perp
Capitalization Rate (perpetuity)
$
$
$
$
$
Intrinsic Value Per Share (12/31/2008)
$
time consistent implied price 11/1/2009
Nov 1, 2009 observed price
Ke
g
$ 18.41
0.8501
39.95
27.438
1.46
0.0846
23.08 $
34.02 $
2.79 $
25.87 $
23.62 $
2.25 $
0.7838
24.47 $
34.02 $
2.88 $
27.35 $
25.04 $
2.31 $
0.7226
26.18 $
34.02 $
2.88 $
29.06 $
26.54 $
2.52 $
0.6663
28.01 $
35.12 $
2.88 $
30.89 $
28.40 $
2.50 $
0.6143
29.97 $
35.12 $
2.97 $
32.95 $
30.38 $
2.56 $
0.5664
32.07 $
35.12 $
2.97 $
35.04 $
32.51 $
2.53 $
0.5222
34.32
36.22
2.97
37.29
34.79
2.50
1.9383
1.7633
1.6697
1.6798
1.5334
1.4512
1.3231
1.2051
2.52
2.28
2.25
2.31
2.52
2.50
2.56
2.53
2.50
0.0493
0.065
0.07
0.0846
0.09
0.1
0.1199
17.21
$
$
$
$
$
$
$
-0.1
19.52
18.93
18.77
18.41
18.31
18.14
17.91
$
$
$
$
$
$
$
-0.2
17.84
17.63
17.58
17.46
17.43
17.38
17.34
$
$
$
$
$
$
$
-0.3
17.12
17.05
17.03
17.01
17.00
17.01
17.04
$
$
$
$
$
$
$
-0.4
16.72
16.71
16.72
16.74
16.75
16.78
16.86
$
$
$
$
$
$
$
-0.5
16.47
16.50
16.51
16.56
16.58
16.63
16.73
$
$
$
$
$
$
$
-0.6
16.29
16.35
16.37
16.44
16.47
16.52
16.64
$
2.25
0.4815
2.3225
19.19
14.89
5.87
21.78 $
32.93 $
2.79 $
24.56 $
22.28 $
2.28 $
12.19
Red = Overvalued
Green = Undervalued
White = Fairly Valued
$ 34.98
0.0846
-0.1
Restated LR ROE RI
Book Value of Equity
Return on Equity (RI Model)
Percent Change in ROE
Cost of Equity (ke)
Market Value of Equity
Divide by Shares
$
Estimated Price per Share
$
Time Consistent Price
Observed Share Price
$
595.43
0.048
0.084
0.0846
(35,725.50)
27.438
(1,302.04)
$ (1,393.21)
$
34.98
*Cannot use thie model since the price is negative.
197 | P a g e