The Valuation of Gloucester Coal: An Expanded Net Present Value Approach

Abstrakt

A well-constructed corporate valuation is an arduous task requiring detailed analysis, cogent assumptions and executed in a clear, synthesised manner. Traditional DCF analysis, whilst used by the majority of the investment community has its weaknesses. The ability for the model to incorporate future flexibility is limited. The valuation of a company is a subjective process that needs to incorporate future expectations in an uncertain environment. The DCF model is presented on the proviso that investment decisions are fixed, naturally assuming that management take a passive role. This however is contradictory to the philosophy of management and the expectations of the investment community. Real option valuation (ROV) allows for flexibility. Building upon the DCF model, ROV recognises that uncertainty isn’t merely represented by downside risk. The ability for corporations to adjust future investments decision when faced with a dynamic environment leads to lower downside risk and the ability to capture increased upside potential. The thesis is presented in three parts. The first section provides a theoretical framework, highlighting the main characteristics of the present value technique and juxtaposing this with ROV. The theory is then implemented in part two of the thesis through a valuation of a case company. Gloucester Coal, an Australian based coal mining company is the focus of this piece. An overview of the coal industry and Gloucester Coal is presented. The valuation is then executed in three parts. Firstly the DCF valuation assuming no flexibility is presented, secondly the terminal value as represented by exploration activities is discussed. A ROV building upon the inherent flexibility in the operating mines is then incorporated. This process involved volatility estimation, Monte Carlo simulation and payoff structure analysis. A binomial lattice model is used to model the option to expand or abandon the production assets. Finally, a comparison to analyst valuations and concluding remarks are provided. The valuation resulted in a fair value of $8.02 AUD per share. The incorporation of a ROV framework resulted in a 14% increase in Enterprise Value assuming no flexibility. The valuation and financial model incorporated throughout the body of this text is presented in the first three parts of the appendix. The thesis demonstrates that there is value in uncertainty and management does have the ability to react to new information. The utilisation of ROV provides the ability for the investment community to recognise the strategic options management carry and assess their performance in execution. Building upon a fully developed DCF valuation of Gloucester Coal, a pragmatic approach is demonstrated with the aim of transcending the academic realm to provide the reader with a palpable valuation tool.