Risk Identification
Dairy Farm International Holdings identifies the risks facing the company through an audit committee. The committee is charged with assessing areas of risk and uncertainty and the effectiveness of the firm’s internal control processes. This occurs on a regular basis but the reporting of the committee’s findings to management is done semi-annually. In order to be more effective, the committee works closely with the internal and external auditors of the company. Once the committee has identified the risk areas, it makes recommendations to management on how to deal with the risks. Management then implements the recommendation and this implementation is subject to review by both the audit committee and the internal audit units.
Risk Management
The audit committee of the company is charged with ensuring that the internal control systems of the firm are working properly and also working closely with employees so that they can raise any issues of concern regarding the company’s operations. The committee also reviews the work of the internal audit department as well as the recommendations of the external auditors of the company. If it finds such recommendations to be significant, it passes them on to management for implementation which is subject to periodic review by the committee.
Risks Facing the Company
The ultimate responsibility for risk identification and management lies with the company’s management (Crawford 2010). The following are the major risks facing the company:
Economic Risk
Economic risk refers to the risk that a company faces as a result of new developments in the global and financial markets (Fortune 2011). This form of a company’s exposure arises because of the linkages that a company has with other companies and financial institutions in the world (Scott 2007). The main forms of economic risks that the company faces are the risks of recession, inflation, foreign exchange risks, and fluctuation in the prices of raw materials (Jones & Wilson 2010).
Business Risk
Business risk refers to the risk faced by a company owing to competition (Wilson 2009). Because of competitors, it becomes important for a company to produce high-quality products or services and to price its products properly so that it avoids being driven out of the market. Business risk also means that a company’s earnings are subject to fluctuations a matter which is very important especially to shareholders in determining the value of a company’s shares (Siegel 2008). Dairy Farm International operates in a highly volatile environment and it is therefore exposed to significant business risk.
Political and Regulatory Risk
Dairy Farm International is a multinational company which means that it experiences different regulatory environments. This situation increases the regulatory risk of the company. The fact that the company is a multinational also makes it subject to the risk of expropriation of its assets by foreign governments (Ellis 2010).
Cost of Equity and Growth Rate
Balance sheet
The Diary Farm company’s total assets, excluding cash and bank balances, of US$2,809 million were US$233 million higher than 2010, mainly reflecting the investment in new and refurbished stores and the associated increase in the level of stock. Net operating assets were US$930 million at the end of 2011, a 27% increase over the previous year.
Results
The Diary Farm company Sales, excluding those of associates, were US$9,134 million, a 15% increase over 2010. Operating profit before interest and tax (‘PBIT’) was US$535 million, an increase of US$66 million over the previous year, maintaining the PBIT to sales ratio at 5.9%.
The current interest rate on AAA corporate bonds is 6.45%. The risk premium for stocks over the risk-free rate of return is 27 / 5.9 = 4.6 percentage points. The firm’s beta is estimated to be 0.59.
Cost of equity (COE) =.0625 + 0.59 (.046) = 0.0271
Firm’s growth rate:
g; 0.12=0.088(1+g)4
g=0.08
Kos=Kgr +β [Km –Kgr]
Kos= 0.12 + 0.59[18%-0.12%] =0.107
Vo=Do(1+g)/ Kos-g =0.19(1+0.08)/0.107-0.08 =$7.6
(Yahoo Finance 2012)
Divident
The Diary Farm company’s board is recommending a final dividend of US¢15.00 per share. This will bring the total dividend in respect of 2011 to US¢21.00 per share, an increase of 17% over 2010 and a payout of approximately 60% of the year’s underlying profit.
Recommendation
In any investment the goals are firstly to get the timing right, the interesting part is that an investment can be profitable even if the firm is wrong about the strategy used and valuation. Secondly, if the firm strategy and timing are wrong and the valuation used is right – the investment may still end up being profitable. Lastly, the firm’s timing and valuation may fail but the investment profit is guaranteed if the strategy used is right (Good and positive numerical results expectations combined with perfect risk management). A good investment is all about the three things above i.e. strategy, timing, and risk management. These cannot be achieved without hard work and commitment.
With the Diary Farm company, the share is not a good investment because it is currently valued above its intrinsic value of $7.6. This falls in the first scenario i.e. wrong valuation. The strategy used of increasing the shares by 17% was not that good, the increment would have been gradual in respect the current intrinsic value.
References
Crawford, M 2010, Planning Assumptions: Will the Real Long-term Return Please Stand Up? AAII Journal 19(10), 10-12.
Ellis, D 2010, Investment Policy, Homewood: Dow Jones-Irwin.
Fortune, P 2011, An Assessment of Financial Market Volatility: Bills, Bonds, and Stocks, Economic Review 44(5), 13-18.
Jones, P & Wilson, W 2010, Stocks for the Long-run: A Guide to Selecting Markets for Long-term Growth, Homewood, IL: Irwin.
Scott, W 2007, Why Does Stock Volatility Change over Time? Journal of Finance 44(5), 1115-1153.
Siegel, B 2008, The World Bond Market: Market Values, Yields, and Returns, Journal of Fixed Income 1(1), 90-99.
Wilson, W 2009, A comparison of Annual Stock Returns, Journal of Business 60(2), 239-258.
Yahoo Finance 2012, Web.