Part One – Risk and Return
Steelcase, Inc (SCS)
Steelcase, Inc (SCS) is a 100 year old global, publically traded company that offers workplace products, furnishings
and services. They employ approximately 10,000 people worldwide and had $2.75 billion in revenues for 2012.
What betas did you calculate using the various indices?
A 5 year monthly regression was used to calculate the beta’s (b) for SCS and four indices including the S&P 500,
NYSE Composite, NASDAQ Composite, and the Russell 1000. The results are illustrated in Figure 1.
Figure 1
Steelcase, Inc (SCS) Index Beta’s (b)
Index
SCS Beta (b)
1.28
S&P 500
1.08
NYSE Composite
1.21
NASDAQ Composite
1.07
Russell 1000
Why are they different?
As shown in Figure 1, there is variation in betas between the indices. These differences can be caused by the
structure of the index. As an example, the S&P 500 measures 500 large-cap U.S. stocks and is value weighted which
gives the largest companies the greatest influence. The Nasdaq Composite measures all common stocks listed on the
Nasdaq that includes more than 3200 companies, but has a high concentration of technology stocks so it is more
sensitive to that industry than other sectors. The NYSE Composite measures performance of large, mid and small
cap stocks and is weighted using free-float market capitalization and calculated on both price and a total return basis.
Other factors creating differences in betas across services is that there is more than one way to calculate beta, the
historical time period used, the return intervals used, and the adjustments made to regression betas.
Which index do you feel is most appropriate to use when calculating beta for stocks you are considering?
Although the S&P 500 has a broad range of companies from various sectors and industry groups and is considered
the best representation of the market, it tracks large cap companies of which Steelcase (SCS) is not; therefore, I
believe the NYSE Composite is more appropriate. The NYSE Composite Index covers price movements of common
stock of some 2300 companies listed on the NYSE. Due to its breadth and tracking of small cap companies as well
as mid and large cap, I believe it is a better indicator of market performance and measurement than the S&P. The
Russell 1000 however is a market capitalization index and is considered a leading index for large cap investing so
therefore I do not believe it is an appropriate measure of beta for SCS. Lastly, due to the tech-weighted NASDAQ
Composite, I would not choose it as an appropriate measure.
How do your beta calculations compare with those of the published sources?
The beta calculation with Yahoo Finance is 1.45 compared to the NYSE Composite which is 1.08. This difference is
most likely due to the historical time period (60 months vs. 36 months). Value Line Composite Index reports SCS’s
beta as 1.15. They calculate beta by using the movement of the stock's price each week relative to the movement of
the NYSE Composite. They use five years of weekly data, over 250 data comparisons, to derive beta values. The
difference in betas is due to due to the different return intervals and historical time period.
Comparing your company to the NASDAQ index, which has higher:
(a) total risk?
NASDAQ’s monthly standard deviation is 6.19% vs. SCS’s monthly standard deviation of 13.66%. With
standard deviation being a measure of risk, SCS has higher total risk than NASDAQ due to the lack of
diversification. The market risk for NASDAQ is much higher than that of SCS which is most likely due to
it is heavily weighted in favor of big technology companies.
(b) risk per unit of return?
The coefficient of variation (CV) for the NASDAQ index and SCS are shown in Figure 2. CV is useful as it
measures stand-alone risk for two different investments that have different returns. The values in Figure 2
show that SCS is riskier than the NASDAQ Composite when evaluating for risk per unit of return.
Figure 2
Coefficient of Variation (CV)
NASDAQ Composite
954.12
SCS
1329.03
(c) systematic risk?
Systematic risk aka “un-diversifiable risk” or “market risk” is defined as the risk inherent to the entire
market or entire market segment (www.investopedia.com). A recession or wars are some causes of
systematic risk. With systematic risk, it impacts the market in total and is inescapable through
diversification. The market risk of a stock is quantified by its beta (b). A beta equal to 1.0 is determined to
be as risky as the market. Beta >1, indicates the stock is more risky than the market and a beta <1 is less
risky. In Figure 3, the beta coefficients for SCS and the NASDAQ Composite are displayed along with a
beta coefficient of 1.0 for the NYSE Composite signifying the market. These betas were computed using
the NYSE Composite as representative of the Market Index. As expected, when the NYSE Composite was
regressed on the NYSE Composite, the beta was 1.00.
Figure 3
SCS
1.08
Beta Coefficients (b)
NYSE Composite
NASDAQ Composite
1.00
1.21
These beta coefficients indicate that both the NASDAQ Composite and SCS are more risky than the market;
however, SCS is not as systematically risky as NASDAQ and is more aligned with the market or the NYSE
Composite.
Does your company have a higher expected return than the overall stock market? Why?
Historical data of averages from the last 60 months are displayed in Figure 4 for SCS, NYSE Composite, NASDAQ
Composite, and the S&P 500.
Figure 4
Expected Returns
SCS
NYSE Composite
NASDAQ Composite
S&P 500
1.03
.14
.65
.29
In comparing these values, SCS has a higher expected return. This is most likely due to SCS’s lack of diversification
in comparison to the indices that are comprised of numerous stocks. With variegation, the indices are able to
experience volatility without realizing a large loss or gain as individual stock losses or gains do not affect their
aggregate returns. Also, expected returns for SCS are higher due to a greater degree of risk.
An alternate method of determining higher expected return would be to examine the systematic risk/beta of SCS
versus the market. If markets are efficient, then securities with betas greater than one have higher expected/required
returns when compared to the market portfolio. Since SCS has a beta of 1.08, then the SCS expected return is
higher than the market portfolio.
Part Two – Financial Analysis
A 3 year trend analysis was created utilizing data from the SCS balance sheet and income statement and is shown
below. In reviewing the balance sheet, there was a change in net working capital in that both current assets and
current liabilities increased in Y10 and decreased in Y11. The current ratios reflect this movement also in that they
decreased in Y10 and increased in Y11. In that total liabilities also decreased in Y11, this may suggest that SCS paid
off some short term debt as long term debt remained stable.
SCS TREND ANALYSIS
($ Millions)
Balance Sheet
Current Assets
Current Liabilities
Current Ratio
Other Assets
Total Liabilities
Long Term Debt
Shareholder Equity
Y11
Y10
Y09
1 yr %
Chg
2 yr %
Chg
702.100
1,012.300
643.600
-30.6%
9.1%
461.900
736.800
433.700
-37.3%
6.5%
1.52
1.37
1.48
35.7%
10.9%
998.900
984.200
1,033.600
1.5%
-3.4%
992.400
1,278.100
979.600
-22.4%
1.3%
288.900
291.300
293.400
-0.8%
-1.5%
708.600
718.400
697.600
-1.4%
1.6%
2,749.500
2,437.100
2,291.700
12.8%
20.0%
1,857.900
1,629.400
1,545.700
14.0%
20.2%
56.700
20.400
(13.600)
177.9%
516.9%
0.66
0.33
0.07
100.0%
842.9%
Income Statement
Sales
Cost of
Goods/Operations
Net Income
EPS Basic from
Operations
The income statement reflects steady and substantial increases in sales, COGS, net income and EPS for the three
years. In particular, net income and EPS 2 year increases were 516.9% and 842.9% respectively. Perhaps this is due
to an economic recovery following the financial meltdown in 2007-2009.
The line graph below was constructed to highlight Leverage Ratios for SCS during Y7 to Y11. The debt-to-equity
ratios for SCS were consistently below industry averages with the exception of Y10 when it rose 55% above the
industry average and was also reflected earlier in the change in net working capital. In Y10, SCS had $0.76 of debt
for every dollar of equity whereas the industry average was .49. In Y11 they were able to reduce debt to $0.41 for
every dollar of equity. Their debt ratio also decreased in Y11 from .76 to .50 indicating 50% of SCS’s financing was
in the form of liabilities. While creditors favor low debt management ratios, stockholders prefer more leverage as it
increases their returns.
Leverage Ratios
10
8
Debt to Equity SCS
6
Debt to Equity Industry
4
Times Interest
Earned - SCS
2
Times Interest
Earned - Industry
0
Y11
Y10
Y9
Y8
Y7
The times interest earned (TIE) ratio measures how far operating income can decline before SCS is unable to meet
its annual interest costs. In the last 5 years, SCS’s TIE has steadily declined and they are below the industry average.
In Y10 and Y11 however they have trended upwards but are still below the industry average. In Y11 for example,
SCS’s TIE was 3.1 (industry average 4.8) which is a low margin of safety for them to be able to meet their interest
charges.
The Liquidity Ratio graph below highlights SCS’s current ratios and cash flow per share along with the industry
averages. Liquidity ratios measure a company’s ability to pay their short term debt obligations.
Liquidity Ratios
5
Current Ratio - SCS
4
Current Ratio Industry
3
2
Cash Flow Per Share
($) - SCS
1
0
Y11
Y10
Y9
Y8
Y7
Cash Flow Per Share
($) - Industry
Beginning with the current ratio aka liquidity ratio, which is a measure of short term solvency, SCS’s current ratio
has consistently been above the industry average but not to a substantial degree; and further, it does not show wide
fluctuations. This indicates that SCS’s assets could be converted to cash quickly to cover the claims of short term
creditors if needed and that they are in relatively good short term standing. While creditors favor high current ratios,
shareholders prefer lower ones.
The cash flow per share is a measure of a company’s profitability and is calculated by: Cash Flow Per Share =
(Operating Cash Flow – Preferred Dividends) / Common Shares Outstanding. This ratio is considered a better
measure of financial strength than EPS because cash is difficult to manipulate where EPS can be easily altered to
appear positive. In 2007, SCS’s cash flow per share was above the industry average and through Y8 to Y11 it has
been well below the average; however, since Y10 it is trending upwards.
Activity Ratios
80
Fixed Asset
Turnover - SCS
60
40
Fixed Asset
Turnover - Industry
20
Operating Cycle
(Days) - SCS
0
Operating Cycle
(Days) - Indusry
Y11
Y10
Y9
Y8
Y7
The Activity Ratio graph above illustrates the Fixed Asset Turnover ratio and the Operating Cycle for SCS and the
industry norms. The Fixed Asset Turnover ratio reflects how effectively a firm generates sales from fixed asset
investments, e.g., property, plant and equipment. The ratio is calculated by dividing sales into total assets. SCS has
been consistent with industry averages for Y7 through Y11. The Operating Cycle is the length of time between the
purchase of inventory and the collection of cash from accounts receivable. A short Operating Cycle indicates the
company is collecting receivables efficiently, has good payment terms with businesses that it owes money and is
moving inventory with the average production ability and customer demand. As illustrated in the graph, SCS’s cycle
is comparable to industry norms.
Statement of Cash Flows for SCS indicates a steady decline in operating activities from Y7 to Y9 with a shortfall
from operations in Y9 where Net Income before extraordinary items went from 133.2MM in Y8 to -11.7 in Y9. In
Y10 and Y11, net cash flow from operating activities has been trending upwards. Investing activities from Y11 to
Y12 went from -254.300MM to 203.200MM with sale of investments. Long term debt was issued in Y11 of
247.400MM and in Y12, financing activities resulted in a decrease in cash flow of -334.300MM.
Part Three – Stock Valuation
To determine the value of SCS stock, I will apply two models. I will apply the constant growth Model and the nonconstant growth model. To apply this model, one requires three types of inputs, estimated dividends, growht rates,
and required rates of return.
To compute the required rate of return, I am using my beta as computed using the NYSE Composite index. This
was the beta that I determined to the be the best estimate of beta for SCS.
Determine the discount rates using the CAPM model.
rRF = 3%, RPm = 6.5%, beta (b) = 1.08
rs = rRF + RPm*beta = 3% + 6.5%*1.08 = 10.02%
Next, I must determine the long run growth rates for my company. To do this I used analyst’s earnings forecasts
from a reputable source to determine expected growth rates for earnings. My first choice was finance.yahoo.com.
In this situation, the forecasted 5 year growth estimates, past and next, figures are either NA or larger than the
expected return (10.02%). The constant growht model requires that the long-run growth rate be less than the
required return. As the yahoo long-run numbers were too high, I also checked Zacks.com and thestreet.com. In all
cases, the constant growth model was not applicable as the growth rates exceeded the required return. At this point,
I was left with two choices, I could increase the required rate of return or I could find a lower long-run growth rate.
I believe that that required returns were reasonably accurate, but that the long run growth rate were too high. For this
reason, I chose the Next 5 Years grwoth rate for the S&P 500 as my long-run growth rate.
►Yahoo
Growth Est
SCS
Industry
Sector
S&P 500
Current Qtr.
0.00%
-40.40%
77.80%
10.40%
Next Qtr.
8.00%
133.60%
26.90%
16.20%
This Year
-10.70%
70.00%
46.90%
8.20%
Next Year
26.10%
55.90%
-11.00%
12.90%
Past 5 Years
15.05%
N/A
N/A
N/A
(per annum)
Next
5 Years
20.00%
13.27%
13.40%
8.98%
(per annum)
Price/Earnings
14.99
15.36
18.06
18.97
(avg. for
PEG Ratio (avg.
0.75
2.27
-1.80
1.94
comparison
for comparison
categories)
categories)
►ZACKS
EARNINGS GROWTH ESTIMATES
Current Qtr (05/2013)
Next Qtr (08/2013)
Current Year (02/2013)
Next Year (02/2014)
Past 5 Years
SCS
0.00
8.00
21.10
20.20
1.00
IND
NA
NA
5.20
18.50
-2.00
S&P
NA
NA
5.80
5.70
3.20
Next 5 Years
NA
7.50
NA
PE
PEG Ratio
14.40
NA
17.60
2.35
15.60
NA
►The Street.com
Use Constant growth model to determine stock valuation:
►Dividend for SCS from Yahoo
Dividends & Splits
Forward Annual Dividend Rate4:
0.40
Forward Annual Dividend Yield4:
3.10%
Trailing Annual Dividend Yield3:
0.37
Trailing Annual Dividend Yield3:
2.70%
5 Year Average Dividend Yield4:
3.50%
Payout Ratio4:
120.00%
Dividend Date3:
Apr 14, 2013
Ex-Dividend Date4:
Apr 4, 2013
Last Split Factor (new per old)2:
N/A
Last Split Date3:
N/A
The third input was the dividend. I chose the most recent 12 months of dividends as my D0. Thus D0 was $.40.
Applying the constant growth model yield a valuation of:
P0 = (D0 (1+g))/(rs – g) =(.40(1+8.98%)) / (10.02% - 8.98%) = $41.91
As of the market close on 4/12/2013, the stock price was $13.65, so according to this valuation method, the stock is
very undervalued.
Supernormal growth model:
Growth Est
SCS
Industry
Sector
S&P 500
Current Qtr.
0.00%
-40.40%
77.80%
10.40%
Next Qtr.
8.00%
133.60%
26.90%
16.20%
This Year
-10.70%
70.00%
46.90%
8.20%
Next Year
26.10%
55.90%
-11.00%
12.90%
Past 5 Years
15.05%
N/A
N/A
N/A
(per annum)
Next
5 Years
20.00%
13.27%
13.40%
8.98%
(per annum)
Price/Earnings
14.99
15.36
18.06
18.97
(avg. for
0.75
2.27
-1.80
PEG Ratio (avg.
For supernormalforcomparison
growth,
I used the following inputs. Dividend at time 0 remained
comparison
categories)
rate from year 0 to
1 was -10.70%, years 1 to 2 is 26.10%, and the long run growth
categories)
1.94
$.40.4%. My expected growth
rate remained 8.98%.
Based on the initial dividen of $0.40, D1 = 0.40*(1+ -10.70%) = $0.357, D2 = $0.357*(1+26.10%) = $0.450, D3 =
$0.53*(1 +8.98%) = $0.491. Calculating the price of the stock at time 2 based on D3. P2 = D3 / (rs – g ) = $0.491 /
(10.02% - 8.98%) = $47.21. Calculate PV of D1, D2, and P2 and sum:
PV(D1) = $0.357 / 1.1002 = $0.3244
PV(D2) = $0.450 / (1.1002)2 = $0.3717
PV(P2) = $47.21 / (1.1002)2 = $39.0023
The present values are added together to find a valuation of $39.70 which indicates again that SCS is undervalued
according to this valuation.
It is difficult to judge whether these models should be used based on these calculations as the earnings growth rate
was not based on SCS earnings or growth history. I believe that stock markets are generally efficient, so one would
not expect that there would be a large difference between the true value ($41.91 or $39.70) and the current value
($13.65).