# VSE Corporation (VSEC) Investment Valuation

December 3rd, 2012 Posted by No Comment yet

VSE Corporation (VSEC) since 1959, provided engineering and technical services to the owners and operators of transportation and equipment assets and large, mission-critical fleets, including ships, vehicles, and aircraft.

## Value Investing Approach on VSE

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.

## VSE Investment in Enterprise Value

The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value EV) is the present value of the entire company.  Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash.

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

#### Explanation

After analyzing VSE Corporation, market capitalization was decreasing at a rate of nine percent average. The total debt represents 24 percent and the cash and cash equivalent were 1 percent of the enterprise value. Thus, the enterprise value was greater by 23 percent against market value. If you would buy the entire business of VSEC, you would be paying 87 percent equity and 23 percent of its total debt.

Buying the entire business of VSEC to date, November 10, 2012, would cost \$260.5 at \$52.10 per share.  The market price to date was \$21.81 per share.

## Benjamin Graham’s Stock Test

### Net Current Asset Value (NCAV) Approach

The Net Current Asset Value (NCAV) is a method from Benjamin Graham to identify whether the stock is trading below the company’s net current asset value per share, specifically two-thirds or 66 percent of net current asset value. Meaning they are essentially trading below the company’s liquidation value and therefore, the stocks are trading in a bargain, and it is worth buying.

### Net Current Asset Value (NCAV) Method

#### Explanation

The net current asset value approach of Benjamin Graham tells us that the stock of VSEC was trading at an overvalued price from 2007 to ttm6 2012 because the market value per share was greater than the 66 percent of the NCAVPS. The 66 percent ratio was only 18 percent of the market value per share.

It tells us that the stock of VSEC has not passed the stock test by Benjamin Graham because the price was expensive.

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

Another stock test by Graham is by using market capitalization and dividing it to net current asset value (NCAV).  The idea is, if the result does not exceed the ratio of 1.2, then the stock passes the test for buying. So, let us see if the stock of VSEC passed the test.

MC/NCAV valuation shows that  VSEC stocks were trading at an overvalued price because the ratio exceeded the 1.2 ratios of 2007 to ttm 2012. What does this mean? It indicates that the price was expensive and therefore, it did not pass the stock test of Benjamin Graham.

### Benjamin Graham’s Margin of Safety (MOS)

According to Graham, the investor should invest only if the market price is trading at a discount to its intrinsic value. Value investing is buying with a sufficient margin of safety. Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. The enterprise value is used because I think it is a much more accurate measure of the company’s true market value than market capitalization.

#### Explanation

Benjamin Graham’s margin of safety valuation shows that there was a margin of safety for VSEC from 2007 to ttm 2012 at an average of 76 percent.  In ttm 2012, the margin of safety resulted in 71 percent.

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

#### Explanation

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

Looking closely in the above table, there was an average of \$12 for the intrinsic value, while SGR was 22 and EPS was 4 percent.

#### 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. To calculate the sustainable growth rate for a company, you need to know its return on equity (ROE). You also need to know 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.  Formula: Sustainable growth rate = ROE x (1 – dividend-payout ratio)

#### Explanation

VSE Corporation’s Return on Equity got a  23 on average, while the payout ratio was 5.25 average.  There was a payout ratio from 2007 to ttm6 2012 because VSEC was paying cash dividends to its shareholders.

There are two approaches to calculating the sustainable growth rate. The first one is by using the relative ratio and the other one is by using the average return on equity.

As we can see, a higher result was produced using the average ratio. The margin of safety was higher also by 1 percent using the same ratio.

The space between the intrinsic value line and the enterprise value line is the margin of safety. Converting it to figures we got 76 percent, this is measured by the difference between the two lines as shown in the table of the margin of safety.

## VSE Relative Valuation Methods

The relative valuation methods for valuing a stock is to compare the 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)

How to do this is by simply 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. From there we can determine the status of the stock price.

The P/E*EPS valuation shows that in 2007 and 2009, the stock of VSEC was fair valued while from 2008 to 2010 going forward, the price was overvalued. Because the enterprise value was greater than the P/E*EPS ratio.

The enterprise value per share was over by 34 percent against the P/E*EPS ratio, therefore, the price was overvalued.

Using the average price to earnings ratio in calculating this valuation, produced a higher ratio than by using the relative price to earnings ratio. The result was higher by 7 percent.

### Enterprise Value (EV)/Earning Per Share (EPS) or (EV/EPS)

The use of this ratio is to separate price and earnings in the enterprise value. The process of this is dividing the enterprise value of projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).

#### Explanation

The EV/EPS valuation tells us that price (P/E) was 25 percent. On the other hand, the earnings (EPS) was  75 percent average out of the enterprise value per share. This indicates that the price was undervalued using the enterprise value. The discretion on this valuation depends on the analysts whether the ratio was appropriate or not.

### Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)

This metric is used in estimating business valuation. It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries. It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.

The EV/EBITDA valuation indicates that it will take 6 years to cover the costs of buying the entire business. In other words, it will take 6 times the cash earnings of the company to cover the purchase price. It will be a long period of waiting. VSEC has the free cash flow for 2008 to ttm6 2012.

Conclusion:

The market value of VSE Corporation was decreasing at a rate of nine percent average.  Total debt was 24 percent and the cash and cash equivalent was 1 percent of the enterprise value. Buying the entire business would be paying 87 percent of its equity and 23 percent of its total debt. Buying the entire business of VSEC to date, November 10, 2012, would cost \$260.5 at \$52.10 per share.  The market price to date was \$21.81 per share.

On the other hand, the net current asset value approach shows that the stock has traded at overvalued prices. For the reason, the stock was trading above the liquidation value of the company. While the MC/NCAV valuation shows that the ratio exceeded 1.2. Therefore the stock of the company did not pass the stock test.

#### The Margin of Safety

Further, the margin of safety indicates a 76 percent average margin of safety. The intrinsic value was \$212 average. The sustainable growth rate was 22 percent, and the annual growth rate was 53 percent. While the return on equity was 23 percent.

Furthermore, the relative valuation method tells us that the stock price was fairly valued in 2007 and 2009. While in 2008, 2010 onwards, the price was overvalued. The price to earnings using the relative ratio was 9 percent. While the average price to earnings ratio was 10 percent. Using the average ratio, the P/E*EPS ratio was 85 percent against the relative ratio of 78 percent.

#### Relative Valuation

EV/EPS valuation indicates a price (P/E) of 25 percent and earnings (EPS) of 75 percent. This might indicate that the price was cheap. While EV/EBITDA shows 6 years or 6 times for the earnings of VSE to cover the costs of buying VSE

Overall, the stock price was expensive. A HOLD position is recommended in the stock of VSE Corporation.

Researched and written by Criselda