See Disclaimer below
Continuing from our earlier post we go to the key part of valuation, the strategy and financial side. https://www.ecointelfinance.org/post/part-1-applus-overvalued-or-undervalued
Strategy Side
Step 1: At Business Level, what strategy is the company following and understand the elements of value it is propagating
Key elements of Applus+ strategy:
Expansion of service offerings: Applus+ has been expanding its service offerings by investing in new technologies, acquiring companies with complementary services, and developing new services to meet the needs of its clients. For example, Applus+ has developed new services in areas such as cybersecurity, data privacy, and renewable energy, and has acquired companies with expertise in these areas.
Geographic expansion: Applus+ has a presence in more than 70 countries and has been expanding its operations in emerging markets such as Latin America and Asia, where there is a high demand for testing, inspection, and certification services. Applus+ has also been expanding its operations in developed markets such as the United States and Europe, where there is a high demand for specialized services.
Focus on digital transformation: Applus+ has been investing in digital technologies to improve its operations and provide better services to its clients. For example, Applus+ has developed a digital platform that allows clients to access testing and inspection results in real-time and has implemented digital technologies such as artificial intelligence, big data analytics, and automation to improve the efficiency and accuracy of its services.
Sustainable growth: Applus+ has been implementing sustainability practices in its operations, such as reducing energy consumption, waste generation, and greenhouse gas emissions. Applus+ has also been developing services that help clients to achieve sustainability goals, such as renewable energy certification and environmental compliance services.
Overall, Applus+ strategy is focused on expanding its service offerings, geographic reach, and digital capabilities, while maintaining a sustainable approach to growth. These elements are expected to support Applus+ in achieving its growth objectives and maintaining its position as a global leader in testing, inspection, and certification services.
As we have seen the demand for in each sector is increasing at a decent pace there is a good opportunity to increase revenue in the regions in which Applus+ provides services and expand into new geographies and customer segments. The same is reflected in Applus+ annual strategy presentation. Here are the excerpts for each business unit:
Applus + Energy & Industry
Key Priorities
Accelerate portfolio evolution towards end markets with higher growth and margins, through organic investments, acquisitions and disposals
Invest in technology and digital tools to generate sustainable revenue streams at higher margins
Grow services related to the Energy Transition and Electrification megatrends especially in power generation and networks, but also in energy efficient buildings and low carbon transport infrastructure
Capture the cyclical upturn in Oil & Gas investment
Increase margins by pricing, cost reductions, efficiencies and disposals
Applus+ Automotive
Key Priorities
Expand use of digital tools and technology to improve efficiencies, reduce costs and maintain high cash flow generation
Maintain our strong renewal track record. Revenue visibility >90% through to 2027
Capture emerging markets growth
Benefit from medium term trend from EV and car sharing
Applus+ Laboratories
Key Priorities
Leverage key global megatrends of Electrification and Connectivity to accelerate growth and returns
Maintain competitive advantage through network, skills and accreditation expansion
Accelerate portfolio evolution via acquisitions of high performing companies and ongoing organic capex to generate revenue and increase its contribution to the Group
Margin expansion through efficiencies, cost synergies, use of technology and more digital services
Applus+ IDIADA
Key Priorities
Maintain leadership position with the traditional OEMs through investing in the global network, people, skills and equipment
Capture the increase in outsourcing of activities, especially amongst new players with less vehicle development knowledge and capabilities
Accelerate transition from traditional engineering activities to higher value and margins AI / advanced simulation services
Finance Side
Step 1: Create basic layout of the valuation model
The basic layout for DCF valuation is based on formula for calculating Free cash flow for the firm. More details can be added to the model like adjustment for Net deferred Taxes and Maintenance costs. But for this model these details are not added as this is an intermediate model.
Formula: Top-Down approach
Table: DCF Summary format
Step 2: Input Historical data in the model - P&L, Balance Sheet, Cash flow statement and Schedules and notes
Historical data can be extracted from the Annual reports available in public domain. When we input historical data remember it should be input in reverse order i.e use latest annual report for data and then go backwards. This is done because adjustments may need to be made for changes in items added by companies to reflect current financial and economic trends and transactions. Further, companies may adopt accounting standards announced by international financial accounting regulatory bodies. There are two main bodies that come out with standards viz. The International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB).
There are financial and accounting regulatory bodies in each country. But most of the authorities have adopted IFRS and IAS standards. IFRS Standards are required in 167 jurisdictions and permitted in many parts of the world, including Afghanistan, South Korea, Brazil, the European Union, India, Hong Kong, Australia, Malaysia, Pakistan, GCC countries, Russia, Chile, Philippines, Kenya, South Africa, Singapore, Israel and Turkey.
However, each jurisdiction is allowed to make changes to base regulation based on economy and business environment prevalent in respective countries.
Further, in October 2004 at a joint meeting between IASB and US FASB it was decided to add to their respective agendas a joint project to develop a common conceptual framework, based on and built on both the existing IASB Framework and the FASB Conceptual Framework, that both Boards would use as a basis for their accounting standards.
The two boards reached the following tentative decisions about the approach to the project:
1. The project should initially focus on concepts applicable to business entities in the private sector. Later, the boards should consider the applicability of those concepts to other sectors, beginning with not-for-profit organizations in the private sector.
2. The project should be divided into phases, with the initial focus being on achieving the convergence of the frameworks and improving particular aspects of the frameworks dealing with objectives, qualitative characteristics, elements, recognition, and measurement. Furthermore, as the frameworks converge and are improved, priority should be given to addressing issues that are likely to yield benefits to the boards in the short term, that is, cross-cutting issues that affect a number of their projects for new or revised standards.
The converged framework should be in the form of a single document. It should include a summary and a basis for conclusions.
Current status of the project
During late 2010, the IASB effectively deferred further work on the joint project until after other more urgent convergence projects were finalized. As a result of the IASB's Agenda consultation 2011, the IASB decided in December 2012 to reactivate the Conceptual Framework project as an IASB-only comprehensive project.
Step 3: Understanding the accounting standards and accounting policies company follows to create financial numbers
In 2019 Applus+ SA adopted the new lease standards IFRS 16 as per their annual report 2021. As mentioned in the section above, when we input historical data we start from current annual report for Applus and go backwards we see the numbers for 2018 for leases is different from what was recognized in 2019. Before 2019 IAS 17 standards was used.
The scope of IFRS 16 is generally similar to IAS 17, the key difference between IAS 17 and IFRS 16 is that according to the old standard (IAS 17) operating leases are not capitalized whereas they are considered as capitalized assets and recorded in the balance sheet under IFRS 16.
Further, there were two types of leases defined in IAS 17 viz Financial Lease and Operating lease however, with IFRS 16 all leases are considered financial lease.
The other key change in accounting standards adopted by Applus+ is the IFRS 15 Revenue from contracts with customers. According to annual report 2021 the following policy is adopted.
“Revenue recognition- In general, the Group recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Group expects to be entitled in exchange for those goods or services.
Certain contracts such as non-destructive testing or engineering and consultancy contracts are performed as projects that envisage the use of labour and/or materials to provide one or more services requested by the customer and give rise to one or more performance obligations.
To the extent that these performance obligations can be distinguished in accordance with the criteria defined in IFRS 15, revenue is recognised when (or as) each performance obligation is satisfied on the basis of the costs incurred relative to total costs (input method) through the recognition of "projects in progress to be billed" (contract assets) to the extent that there is an enforceable right to payment for performance completed to date. Also, these contracts may include billings for milestones based on the satisfaction of the performance obligations, although no significant differences were identified between the price determined for each milestone and its fair value.”
Additionally, revenue relating to supplier inspections, vehicle roadworthiness testing services and certifications, inter alia, is identified as arising from services provided for which there is a single performance obligation that is satisfied at a specific point in time, the price of which is determined in the contracts with customers.
In general, therefore, the recognition of revenue from these activities is not complex and occurs when the performance obligation is satisfied. No costs incurred in winning contracts with customers were capitalized in 2021 and 2020 as the related amounts were not material.”
The new standards and amendments to standards adopted by the company are as follows:
Source: Applus+ Annual Report 2021-22
Source: Applus+ Annual Report 2021-22
Implication of accounting policies and standards on valuation forecasts
When we forecast numbers we need to see how these are accounted for in forecasts. Take for example dividends and costs related to issuance of new shares. Again according to accounting policies related to equity the annual report 2021 says:
Source: Applus+ Annual Report 2021-22
So, when we forecast dividends we do not but the expenses in the profit and loss account but directly adjust these in equity accounts. The impact on financial statements are as follows:
Step 4: Create Assumption sheet for forecasting financial statements and schedules
Assumptions have to made for each category of incomes, expenses, assets, liabilities, tax dividends, working capital, Capex, leases, debt and equity.
1. Revenue
Revenue assumptions are based on industry analysis to which Applus+ provides services. The key sectors to which company caters to are oil and gas, automotive, Pharma & Fine Chemicals, Electrical & Electronics, Wind power and the countries in which it operates. Based on these assumptions we create scenarios for accessing the growth rates. We have used three scenarios: Base line, Bull and Bear.
Figure Revenue assumptions
Figure: Business Unit Growth Assumptions
Figure: Revenue Scenarios
1. Expenses assumptions
To forecast Expenses we have used percentage of sales as driver. Sales in this industry is based expenses on mainly trained technical engineers, inspectors and project management and equipment used for testing and inspection.
Figure : Operating and Non-operating assumptions
2. Expenses assumptions assumptions: Assets for which we need to make assumptions about are future capex, useful life of existing asset. Depreciation, Current assets – operating current assets which include inventory, accounts receivables. Current liabilities – Trade Payables.
Figure: Useful Life of Assets
Figure: Working Capital
Figure: Future Capex
DCF valuation
Revenue - Market Size
The ITC industry is highly competitive, with many companies operating in the market, ranging from large multinational corporations to smaller, specialized firms. Companies in the industry compete on factors such as price, quality of service, geographic coverage, technical expertise, and customer service. The industry's future growth is expected to be driven by increasing regulations and standards, globalization of trade, and growing demand for product safety and quality.
According to The TIC council report the market for TIC services was estimated at US$ 200 billion in 2020 and is slated to grow at a CAGR of 5.5% by 2026. The Asia-Pacific region is the largest and fastest-growing market for TIC services, driven by increasing demand from emerging economies such as China, India, and Southeast Asia. The region accounted for around 41% of the global TIC market in 2020 and is expected to grow at a CAGR of 7.1% during the forecast period.
Figure: Size of TIC in areas of application globally, 2020
Note: The figure shows Bureau Veritas’s estimates based on end-user expenditure. Source: Bureau Veritas (2020). “Other” includes Public authorities, Marine, Health, Banking & insurance, and Process (which may include TIC services applied to the conformity assessment of end-users’ internal processes).
The industry growth in the industries mentioned above are as follows:
As can we seen the demand for in each sector is increasing at a decent pace there is a good opportunity to increase revenue in the regions in which Applus+ provides services.
Table: Applus+ Industry-wise revenue distribution
Table Region-wise distribution of Applus+ revenues
Valuation output
Based on analysis of market, consumer behavior, Porter 5- forces, competitor and strategy analysis as presented in annual reports and investor presentations we have formulated the valuation of Applus+. The output for the same is presented below:
Disclaimer
"This valuation report has been prepared solely for education purposes. The valuation is based on publically available information and is subject to assumptions and limiting conditions. The information has not independently verified and assumes no responsibility for its accuracy or completeness.
This report is not intended for use in any legal proceeding or for any other purpose. The valuator does not provide any opinion or assurance as to the future financial performance of the subject business, nor does this report consider any potential changes in economic, legal, or regulatory factors that could impact the valuation.
The valuator accepts no responsibility or liability for any damages arising out of or in connection with the use of this report or the conclusions drawn from it. This report is not a recommendation to buy, sell, or hold any securities, nor does it constitute an offer or solicitation of an offer to buy or sell any securities. The valuator disclaims any and all express or implied warranties, including warranties of fitness for a particular purpose, merchantability, or non-infringement of intellectual property rights."
Comments