 Great Northern Iron Ore Properties (GNI) Investment Valuation

December 20th, 2012 Posted by No Comment yet

Great Northern Iron Ore Properties (GNI) was founded in 1906 and was headquartered in Saint Paul, Minnesota. This investment valuation on Great Northern Iron Ore Properties shows that the company has a very impressive gross margin and net margin.

GNI Value Investing Approach

This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham.

The essence is that any investment should be purchased at a discount, meaning the true value should be more than the market value. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt.

The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.

GNI Investment in Enterprise Value

The whole concept of enterprise value is to calculate how much it would cost for an investor to purchase an entire business. Enterprise Value (EV) is the present value of the entire company. The total debt was zero percent in the last five years and its cash and cash equivalent were averaging 6 percent. As a result, the enterprise value was lesser by 5 percent against the market capitalization. If an investor buys the entire business of GNI, the investor will be paying for 100 percent equity with no debt.

The purchase price of the entire business of Great Northern Iron Ore Properties to date, December 10, 2012, will be \$101 million at \$50.50 per share. The market price to date was \$73.30 per share.

Benjamin Graham’s Stock Test

Net Current Asset Value (NCAV) Method

Benjamin Graham is looking for firms trading with an undervalued price. The reason according to Graham is when a stock trades below the Net Current Asset Value Per Share, they are essentially trading below the company’s liquidation value. So, therefore, the stock is considered a bargain, and it is worth buying. The concept of this method is to identify stocks trading at a discount to the company’s Net Current Asset Value per Share, specifically two-thirds or 66 percent of net current asset value. Explanation

The net current asset value approach of Benjamin Graham tells us that the stock price of GNI was overvalued from 2007 to the trailing twelve months because the market value was greater than the 66 percent ratio. The 66 percent ratio represents only 1.4 percent of the market value, therefore, the price was so expensive.

It shows that the stock of GNI was trading above the liquidation value from 2007 to the trailing twelve months of 2012 which brings us to the conclusion that it did not pass Benjamin Graham’s stock test.

Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

MC/NCAV is another stock test by Graham. The bottom line here is, if the result does not exceed the ratio of 1.2, then the stock passes the test for buying. The MC/NCAV valuation shows that the stock price of Great Northern Iron Ore Properties was overvalued from 2007 up to trailing twelve months 2012 because the ratio exceeded the 1.2 ratios. It shows that the price was expensive and therefore, the stock did not pass the stock test of Benjamin Graham.

Benjamin Graham’s Margin of Safety (MOS)

The margin of safety is used to identify the difference between company value and price. The difference between market value and the true value is called the intrinsic value.

Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. “In my calculation, I used the enterprise value because it takes into account the balance sheet so it is a much more accurate measure of the company’s true market value than market capitalization.

Let’s see what the table below would bring us about GNI’s margin of safety. Explanation

The average margin of safety was 53 percent or \$227 average while the intrinsic value was \$105 average. For 2007 and 2010, there was a zero margin of safety for GNI because the intrinsic value was below zero. The company’s growth during 2007 and 2010 was negative, thus resulted in negative intrinsic value.

The formula for intrinsic value is given below.

Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate) Explanation

The explanation in the calculation of intrinsic value is as follows:

EPS: the company’s last 12-month earnings per share; G: the company’s long-term (five years) sustainable growth estimate; 9: the constant represents the appropriate P-E ratio for a no-growth company(Graham  proposed an 8.5, but we changed it to 9); and 2: the average yield of high-grade corporate bonds.

The earning per share was averaging \$11.98. In addition, the earnings per share (EPS) and the sustainable growth rate (SGR) factor intrinsic value.

Sustainable Growth Rate (SGR)

Sustainable growth rate (SGR) shows how fast a company can grow using internally generated assets without issuing additional debt or equity. In calculating this, you need to know how profitable the company is as measured by its return on equity (ROE). You also need to know what percentage of a company’s earnings per share is paid out in dividends, which is called the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio. The formula: Sustainable growth rate = ROE x (1 – dividend-payout ratio). Explanation

The return on equity was 158 percent average while the payout ratio was 98 percent average. Return on equity (ROE) is an indicator of a company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. Return on Equity formula is: Return on equity shows how many dollars of earnings result from each dollar of equity. There are two approaches in calculating the sustainable growth rate, these are the relative ratio approach and the average ratio approach.

Relative and Average Approaches Results given in the table above shows that the margin of safety was greater by one percent in the average approach.

During 2007 and 2010, there was no margin of safety because the intrinsic value line was below the enterprise value line. There was a margin of safety because the IV line was on top of the EV line. The difference between the two lines is the margin of safety.

GNI Relative Valuation Methods

Relative valuation methods’ core concept for valuing a stock, is to compare market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

Price to Earnings/Earning Per Share (P/E*EPS)

This valuation will help us determine whether the stocks are undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share. This will answer our question as to “What’s the status of the stock price?” The P/E*EPS valuation shows that the stock price of GNI was undervalued. The enterprise value represents 67 percent of the P/E*EPS ratio. Thus, the price was cheap as a result of this valuation.

Relative and Average Approaches

Another way of calculating this valuation is by using the average approach.  The table below will show us the difference between using the two approaches. By using the average approach, the price to earnings ratio was greater by \$1 and the percentage of P/E*EPS ratio was greater by 27 percent.

The Enterprise value (EV)/Earning Per Share (EPS) or (EV/EPS)

The use of EV/EPS ratio is to separate price and earnings in the enterprise value by dividing the enterprise value of projected earnings (EPS). The result represents the price (P/E) and the difference represents the earnings (EPS). The EV/EPS valuation, tells us that the price (P/E) was 9 percent and the earnings (EPS) was a 91 percent average. This might indicate that the price was cheap because it represents only nearly one-tenth of the enterprise value per share.

GNI EV/EPS Graph The price was high than the earnings from 2007 to the trailing twelve months of 2012.

Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA) The result of EV/EBITDA valuations tells us that it will take 8 years to cover the costs of buying the entire business.  In other words,  it will take 8 times of GNI’s cash earnings to cover the purchase price. Eight years is a long period of waiting. EBITDA represents only 13 percent of the enterprise value.

The company’s gross margin was 98.98 percent average while its net margin was 83.68 percent average. A very impressive ratio.

In conclusion,

The market capitalization of Great Northern Iron Ore Properties was stable. The company has a zero debt and its cash and cash equivalent were a 5 percent average. Thus, the enterprise value was lesser of 5 percent of the market capitalization. The cost of buying the entire business to date, December 10, 2012, was \$ 101 million at \$50.50 per share.  The market price to date was \$73.30 per share.

Net Current Asset Value

The net current asset value approach tells us that the stock price was overvalued from 2007 to 2012. It indicates that the stock was trading above the liquidation value of the company. Therefore, it did not pass the stock test of Benjamin Graham. On the other hand, the MC/NCAV valuation shows that the price was overvalued because the ratio exceeded the 1.2 ratios. Therefore the stock did not pass the stock test as well.

Further, the margin of safety by Benjamin Graham shows a 53 percent average margin of safety. The intrinsic value was averaging \$105 in the last five years. While the earning per share was \$11.98 and the return on equity was 158 percent average. And the payout ratio was 98 percent.

Relative Valuation

The price was undervalued and the enterprise value represents 67 percent of the P/E*EPS ratio. Therefore, the price was cheap. On the other hand, the price (P/E) was 9 percent and the earnings (EPS) was a 91 percent average.

EV/EBITDA

The EV/EBITDA indicates that it will take 8 years to cover the cost of buying the entire business. The gross margin of the company was a 98.98 percent average. While its net margins were 83.68 percent average, a very impressive ratio.

The margin of safety was averaging 53 percent therefore, the price was cheap. In addition, the gross margin and the net margin of GNI was very impressive. Therefore, I recommend a BUY on the stock of Great Northern Iron Ore Properties (GNI).

Research and written by Cris

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