Part 2: Estimate Valuation Models

1. Valuation Analysis with the CAPM Estimation

To provide an accurate forecast in the value of NCM’s stock price, we must first examine the
relationship between risk and expected returns of this particular security. Utilising historical data to
determine the value of the CAPM equation’s individual variables.

This model suggests that investors should be compensated for the level of risk their asset/portfolio is
invested into and the level of return should be dependent on the extent above the risk-free rate the
asset’s risk is.

CAPM Equation
E(Ri) = RFR + βi [E(Rm) – RFR]

Whereby,
E(Ri) = Required Return on Equity
RFR = Risk Free Rate
βi = Risk Free Rate
E(Rm) = Market Return

Risk-Free Rate (RFR)

The starting point for the analysis requires a risk-free rate to be determined which, in theoretical
terms, is an investment which has zero risk. Generally, treasury bonds have a very low risk due to the
probability of the Government defaulting is quite low. This is why the 10 Year Australian Government
Bond rates has been chosen.

This particular security provides a successful proxy for the risk free rate of return, as all three of the
dominating credit agencies (S&P, Moody’s and Fitch) have rated the long term credit rating of
Australia as AAA, Aaa and AAA respectively, which essentially are the highest ratings possible and only
under extreme circumstances would there ever be a default. Add Reference to S&P/Moody/Fitch

The current yield of the Australian Government 10-year Bond is at 2.86% on the 18 September 2015.

Insert: http://www.bloomberg.com/markets/rates-bonds/government-bonds/australia

Market Portfolio Selection

The Market Portfolio is needed to be chosen, from which the market returns variable in the CAPM
equation would be determined.. Careful selection is required to determine one with similar
performance and a strong positive correlation otherwise it may lead to incorrect evaluation of the
portfolio. The ASX/S&P 200 (XJO) share price index has been chosen as the proxy for share price
index. XJO is selected as it is an exchange based in Australia, this indices includes New Crest Mining
within and accounts for 72% of the Australian Equity Market which presents a highly suitable
benchmark for the NCM stock mark. Add Reference to: http://www.marketindex.com.au/asx200
Beta
Systematic Risks are separated from Unsystematic Risk when conducting the CAPM modelling as
Systematic Risk, represented by Beta, are those risks which are unable to be mitigated through
diversification. Beta represents a measurement of the relative risk exhibited by the company in the
market. The regression analysis calculates beta by showing price changes of a relevant broad market
index i.e. ASX/S&P200 against the price changes of NCM shares.

The analysis will determine the movement of the security against the market, whereby a beta of less
than 1 indicates that the NCM shares are less volatile than the market. A beta of 1 indicates NCM
shares moves with the market however a beta greater than 1, suggests NCM is more volatile than the
market.

Raw Beta
The raw beta is determined by analysing the percentage change in XJO share price index against the
NCM closing share price through a regression. The period between each data point generally causes
deviations from the correct Beta, and thus to avoid non-trading errors which may arise from shorter
return intervals, the monthly returns have been chosen over a five year period. The beta derived is
0.68901, suggesting that NCM share price moves are less volatile than the market.

Insert: Returns Regression Table / Chart.excel

Adjusted Beta
Raw Beta relies completely on historical data and as such requires adjustment to account for the beta
instability problem when forecasting. This arises over time, as the true betas below 1 may revert
towards the market average of one whilst betas above 1 may eventually decline over time. This
adjustment estimates the security’s future Beta and accounts for the instability problem through the
formula:

Adjusted Beta = (Raw Beta x 0.67) + 0.33 x 1.00

= 0.68901 x 0.67 + 0.33 x 1
= 0.79164

Expected Market Returns & Risk Premium

The Expected Market Returns reflects the overall theoretical returns from a portfolio containing a
diverse range of assets. When this figure is subtracted from the risk free rate, the remaining figure
represents the Market Risk Premium.

Expected Market Returns Risk-Free Rate Market Risk Premium

9.96% 2.86% 7.1%

Adjusted Expected Market Returns

The Market Portfolio proxy has been selected as the ASX/S&P 200 suitability to NCM is ideal. A model
was developed that produces an expected market returns which challenges the Bloomberg calculated
at 9.96%. GET LINDA TO HELP ON THIS, the question is “do you think this 9.96% return is the correct
prediction for Australian market: provide justification”

Required Rate of Return NCM

E(Ri) = RFR + βi [E(Rm) – RFR]
= 0.0286 + 0.79164 [0.0996 - 0.0286]
= 0.08481

The required rate of return for Newcrest Mining stock is 8.4

Part 2b: Dividend Discount Model (DDM)
Dividend Discount Model (DDM)
The intrinsic value of a company’s stock, through this model, is assumed to be calculated through
summing the present value of all expected future dividends. (Reilly & Brown 2012). Through summing
the net present value of future inflows, this model estimates the intrinsic value. It makes two
assumptions; that there are constant dividend growth and the required return on equity is greater
than the growth rate.

Estimated Growth Rate

In determining the estimated growth rate of dividends, the projected return on equity calculated
through the DuPont analysis is multiplied by the retention rate. This identifies the individual growth
rate for each year. For NCM the average of these rates over the last five years is -14.36%.

Year Return on Equity (ROE) Retention Rate (RR) Growth Rate (G)
2015 6.18% 100% 6.18%
2014 -29.93% 100% -29.93%
2013 -58.18% 100% -58.18%
2012 7.78% 76% 5.92%
2011 6.96% 60% 4.20%
Average Growth Rate = -14.36%

The average growth rate table represents the historical growth rate over the last 5 years for NCM
between the years of 2011-2015. The negative value of growth was driven largely through the 2013
financial results which saw the ROE with a -58.18% and subsequent year also negative at -29.93%.

Dividend Discount Model

There are two models to estimate the intrinsic value of a stock. Constant Growth Rate model which
assumes future dividends grow at a constant rate for an infinite period. However it is our prediction
there will be two dominating rates which suggests the multi stage dividend discount model to be
implemented with two distinct stages of growth rates.

To forecast the growth rate of dividends for, the economic outlook the NCM is to be determined.
Recent operations and financial strategies have allowed their ROE to become positive.

As the current economic environment of this industry results in a volatile and minimal consistency
growth, it is difficult to accurately compute a growth rate. Thus an industry average growth rate
according to IBIS World Australia will be assumed of 2.7% between the years 2016/17 to 2020/21.

Forecasted Growth
Stage 1 Stage 2
2016-2020 2021 Onwards
Stable Growth Rate at 2.7% Stable Growth Rate at 6.23%
- Improved US economic conditions - Using the average growth of previous
(resulting in higher AUD Gold Prices) 7 years growth omitting negative
- Improved outlook on Golpu mine growth years

Newcrest Mining announced a 50% chance of dividends for 2016 as well as a very likely chance of
paying dividends in the 2017 year. http://www.smh.com.au/business/mining-and-
resources/newcrest-dividend-drought-continues-despite-improved-profit-20150816-gj0fcr.html From
this, we will assume dividends will be paid in the 2016 and 2017. Where the 2016 year dividends were
based on the previous years average and subsequent years were computed as the prior year total
multiplied by the expected growth of the respective year.
For the periods from 2021 onwards, a constant growth rate of 6.23% will be assumed, which is an
average of the previous 7 years of growth whilst omitting the negative growth which would skew the
data. The years omitting the negative growth were chosen as they present a period when there was
normal stable growth.

Share Price Analysis – Computation of Growth

Dividend Growth Rate Required Discount Factor

N Year Present Value
Forecasted (g) Return (k) 1/(1+k)^t

0 2015/16 0 - 0

1 2016/17 $0.27 2.70% 8.48% 0.92183 0.25

2 2017/18 $0.28 2.70% 8.48% 0.84977 0.24

3 2018/19 $0.28 2.70% 8.48% 0.78334 0.22

4 2019/20 $0.29 2.70% 8.48% 0.72211 0.21

5 2020/21 $0.30 2.70% 8.48% 0.66566 0.20

6 2021/22 $0.31 6.23% 8.48% 0.61362 9.13

Intrinsic Share Price: $10.24

Sensitivity Analysis
Considering that the Discount Dividend Model was based on a two-stage of growth model, we have
established a sensitivity analysis to enable investors to see potential deviations in these two factors.
Especially considering there can be no absolute accuracy in predicting dividend value, if any are even
distributed, it is useful to provide a breakdown of how different values of both growth stages can
affect the valuation of the company’s equity.

The sensitivity analysis assumes that the company will be paying dividends on a yearly basis as of the
2016/17 year and continuously. A second sensitivity analysis is added to analyse the relationship of
volatile market factors such as the growth rate and required return on equity.

Sensitivity Analysis – Growth Variation

Growth/Growth 2.1% 2.3% 2.5% 2.7% 2.9% 3.1% 3.3%

5.43% 7.65 7.72 7.78 7.85 7.91 7.98 8.05
5.63% 8.11 8.18 8.25 8.32 8.39 8.46 8.53
5.83% 8.64 8.71 8.79 8.86 8.94 9.02 9.09
6.03% 9.25 9.33 9.42 9.50 9.58 9.66 9.74
6.23% 9.98 10.07 10.15 10.24 10.33 10.42 10.51
6.43% 10.84 10.94 11.03 11.13 11.23 11.33 11.43
6.63% 11.89 12.00 12.11 12.21 12.32 12.43 12.54
6.83% 13.20 13.32 13.44 13.56 13.68 13.80 13.93
7.03% 14.87 15.00 15.14 15.28 15.41 15.55 15.69
7.23% 17.07 17.22 17.38 17.54 17.70 17.86 18.03

Sensitivity Analysis – Growth vs Required Return on Equity

Growth/Required
Return on Equity 2.1% 2.3% 2.5% 2.7% 2.9% 3.1% 3.3%
7.68% 15.41 15.55 15.69 15.83 15.98 16.12 16.27
7.88% 13.56 13.68 13.80 13.93 14.05 14.18 14.31
8.08% 12.11 12.21 12.32 12.43 12.54 12.66 12.77
8.28% 10.94 11.04 11.13 11.23 11.33 11.43 11.53
8.48% 9.98 10.07 10.15 10.24 10.33 10.42 10.51
8.68% 9.17 9.25 9.33 9.41 9.49 9.58 9.66
8.88% 8.49 8.56 8.64 8.71 8.79 8.86 8.94
9.08% 7.90 7.97 8.04 8.11 8.18 8.24 8.31
9.28% 7.39 7.46 7.52 7.58 7.64 7.71 7.77
9.48% 6.95 7.00 7.06 7.12 7.18 7.24 7.30
Part 2b: Free Cash flow to Equity (FCFE)
Free Cash Flow to Equity Model (FCFE)
This tool, in the approach to company valuation, allows us to identify how much free cash-flow is
available for a firm to return to its equity holders. It identifies the net income and offsets this with the
net capital expenditures, then the net working capital and also includes the debt repayments and new
issuance. This model looks at the company’s value without factoring dividends. This is useful for when
the firm does not distribute dividends on an annual basis. Utilisation of both DDM and FCFE allows a
clearer understanding of growth model through factoring in different scenarios.

The graphical representation of the ‘FCFE per share’, shows the variation in available funds to be paid
out to shareholders. It can be clearly noted throughout the analysed years, the FCFE per share has
remained negative. This has occurred largely due to the significant level of capital expenditure
occurring whereby in some years this figure is significantly greater than the net income. Suggesting
that the dividends were paid out of retained earnings. There was a visible upward trend between the
years 2009-2012 however the pattern disappeared with the gold prices falling during 2013-2014.

Due to the nature of the stock and to allow for comparison with DDM, a two stage growth model will
be utilised assuming there’s one constant growth period between 2016-2021 and then a different
constant growth from 2021 onwards.

In reality growth used in this model should differ to the growth of dividends, as the free cash flow is
assumed to be paid out to shareholders which would ultimately affect the ability of the firm to make
reinvestments and stimulate growth.

Since the poor performance year of 2013, NCM have attempted to lower their capital expenditure
from $2,564million to $693million the following year. Although the most recent year was at
$2,270million to accommodate for this NCM have increased their net debt / borrowings to
$3,761million to accommodate for these funding requirements which has also boosted the FCFE in
the most recent period.

To present a fairer valuation of the company through it’s performance, not just basing the company
on it’s most recent years performance, an average of the FCFE between 2010-2015 will be used
however with the 2013 year value omitted as it presents an outlier which will be assumed to not
reoccur with the operational and financial changes. The average FCFE resulted in $0.87 per share.

FCFE Expected Required Discount Factor =8.48%

N Year Perpetuity Value
($) Growth Return (k) (1+k)^t
0 2015/16 $0.31 - 0
1 2016/17 $0.32 2.70% 8.48% 1.08481 0.29
2 2017/18 $0.33 2.70% 8.48% 1.17681 0.28
3 2018/19 $0.34 2.70% 8.48% 1.27661 0.26
4 2019/20 $0.34 2.70% 8.48% 1.38487 0.25
5 2020/21 $0.35 2.70% 8.48% 1.50232 0.24
6 2021/22 $0.38 $17.76 6.23% 8.48% 11.13
Total Present Value = $12.45
Given that the most recent market price $12.63 it is clear that the industry is undervalued where it’s
two-stage growth

Sensitivity Analysis
Sensitivity Analysis can be utilised to further demonstrate the effects of changes in growth of a
company and the adjusted beta coefficient on the share price.
Part 3: Estimate Valuation Models
The intrinsic value of the stock was estimated through the discount dividend model
and the free cash flow to equity model. The results were

Model Computed Value

Two-Stage Growth DDM $10.24
Two-Stage Growth FCFE $12.45
Current Share Price $12.63

DDM NCM
The intrinsic value estimated through the Discount Dividend Model suggests a value of $10.24. This is
a value lower than what it is currently trading on the 18 September at $12.63. Assuming that the
dividend discount model is accurate, this suggests that NCM stocks are presently undervalued. The
deviation of the intrinsic value opposed to the current share price may have arisen due to the
numerous assumptions made under DDM.

Although New Crest Mining has announced it may be paying dividends out for the 2015/16 year and a
50% chance of paying dividends out in 2016/17 year. It is clear from these announcements that no
there is no certainty of payment in the upcoming years. An assumption is made that in both years and
continuously, dividends will be paid. Considering the Discount Dividend Model is purely based on the
present value of all dividends, when dividends are not actually paid but forecasted this would
challenge the reliability of the intrinsic value calculated. However the assumption was made largely
due to NCM’s results which have improved significantly. Due to their operational and financial
strategies, there is a strong chance that their profitability and balance sheet strength and
reinvestments will result in a dividend payment.

Companies whom have also paid dividends previously has higher accuracy in their DDM model’s
intrinsic value. Considering the last three financial years there has been no amounts paid out, it
presents inherent dividend forecasting errors as a figure will have to be estimated, which was done so
through an average of previous amounts paid. This estimate has resulted in an additional cause of
deviation from the current share price.

This model also relies on assuming growth rates based on patterns and historical data. As the growth
rate is inconsistent and sporadic, it proves a difficult model to rely on such assumptions. Growth rates
for New Crest Mining range from -58.18% to 6.18% over the last three years. This does not allow for a
accurate forecast.

FCFE NCM
The Free Cash Flow to Equity model resulted in a value of $12.45 per share. This figure is less than the
current trading value of $12.63 by 1.58%. Overall this suggests that the value of the company was at
$9,543,061,588.95.

FCFE largely depends on financial data and their ratios to compute an accurate FCFE per share value.

There are clear and distinct differences in valuations with DDM accounting for a lower valuation
whilst FCFE at a higher value at $12.45. The result is largely due to the greater FCFE value over
dividends and the direction of excess cash being invested into other projects. FCFE’s calculation are
based on all earnings that could be paid out to shareholders whilst DDM only uses what is actually
paid to shareholders.

Dividends which are not paid out are reinvested into the earnings under the implicit assumptions of
DDM, however NCM in particular has certain periods of no dividends thus there is are reliable base
and an assumption has been made for this value. Where assumptions are made, there is the risk of
inaccuracies.

Further to this, considering whether to distribute dividends or not are affected by varying factors such
as the drive to ensure stability for the company, tax factors and payout doing so may affect future
investment needs. Although these factors have been taken into consideration when determining the
DDM growth, there are factors outside of their control which may result in no dividends being paid.

Exterior to analysing assumptions and calculations to determine the most appropriate model, there
are other factors which may influence this which can be identified in the financial reports. Firms
which exert stability through stable leverage rate which is the case for NCM with a Leverage of 1.7 in
2015, 1.76 in 2014 and 1.70 in 2013.

Through this as dividends have not been paid in recent years and due to the numerous assumptions
required to develop the DDM model, the most appropriate model determined is the FCFE.