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Weyerhaeuser Equity Valuation and Analysis
As of November 1, 2007
Alissa Glenn
Andrew Davenport
Corey Miller
Doug Bina
James Capps
1
Table of Contents
Executive Summary 3
Business & Industry Analysis 9
Company Overview 9
Industry Overview 13
Five Forces Model 14
Rivalry Among Existing Firms 14
Threat of New Entrants 18
Threat of Substitute Products 20
Bargaining Power of Suppliers 22
Bargaining Power of Customers 25
Value Chain Analysis 27
Firm Competitive Advantage Analysis 33
Cost Leadership 33
Differentiation 36
Accounting Analysis 39
Key Accounting Policies 41
Potential Accounting Flexibility 46
Actual Accounting Strategy 48
Qualitative Analysis of Disclosure 50
Overall Organization 50
Sales Breakdown 51
Quantitative Analysis of Disclosure 53
Sales Manipulation Diagnostics 53
Expense Manipulation Diagnostics 61
Potential “Red Flags” 67
Financial Analysis 69
Liquidity Ratios 69
Profitability Ratios 79
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Capital Structure Ratios 86
Financial Statement Forecasting 91
Income Statement 91
Balance Sheet 94
Cash Flow Statement 100
Cost of Equity 103
Regression Analysis 105
Cost of Debt 106
Weighted Average Cost of Capital 107
Analysis of Valuations 108
Method of Comparables 108
Intrinsic Valuations 114
Discounted Dividends 114
Free Cash Flows 116
Residual Income 118
Long Run ROE RI Perpetuity 120
Abnormal Earnings Growth 122
Conclusion 123
Credit Analysis 124
Altman’s Z Score 125
Analyst Recommendation 126
Appendix 128
References 169
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Recommendation – Overvalued – Sell
Weyerhaeuser - NYSE (11/1/2007) $73.37 Altman's Z-score:
52 Week Range: $59.67 - $87.09 2002 2003 2004 2005 2006
Revenue: $21,896M 1.45 1.42 1.78 1.9 1.93
Market Capitalization: $14.54B
Shares Outstanding: $211.11M Valuation Estimates:
3-month avg. Daily Trading Volume: 2,078,170 Actual Price (11/1/2007): $73.37
Percent Institutional
Ownership: 82.20%
Book Value Per Share: $37.38
ROE: 4.62% Financial Based Valuations:
ROA: 1.69% Trailing P/E: $18.85
Forward P/E: $44.52
P.E.G.: $20.79
Cost of Capital Est. R2 Beta Ke P/B: $47.74
Estimated: P/EBITDA: $53.08
3-month 0.2912 1.0477 11.20% P/FCF: $34.83
1-Year 0.2909 1.0491 11.31% EV/EBITDA: $1.96
2-year 0.2897 1.0458 11.15% D/P $94.99
5-year 0.2886 1.0432 11.37%
7-Year 0.2884 1.0428 11.49% Intrinsic Valuations:
10-Year 0.2885 1.0431 11.70% Discount Dividend: $34.26
Free Cash Flows: $61.70
Published Beta: Residual Income: $35.38
Kd(BT): 5.55% LR ROE: $32.74
WACC(BT): 8.09% WACC(AT):7.02% AEG: $37.53
4
Industry Analysis
In 1900, Weyerhaeuser Company was founded by Frederick Weyerhaeuser who
forever changed the lumber industry. After making the largest initial land
transaction of that time by purchasing 900,000 acres of timberlands,
Weyerhaeuser continues to be a leader in the lumber and wood production
industry manufacturing goods including containerboard, softwood and hardwood
lumber, and softwood market pulp in its six main market segments of
timberlands, wood products, cellulose fiber and white paper, containerboard,
packaging and recycling, corporate and other, and real estate. With company
branches in 18 countries around the world employing over 41,000 people,
Weyerhaeuser strives to maintain a vision “to release the potential in trees to
solve important problems for people and the planet” (www.weyerhaeuser.com).
Weyerhaeuser’s main competitors in the lumber and wood products industry
include Bowater Inc., International Paper, Louisiana-Pacific Corp., and Universal
Forest Products Inc. These firms compete amongst themselves on the basis of
maintaining efficient production, tight cost control, superior product quality and
variety, investment in brand image, and investment in research and
development. With these competitive advantages taken into consideration as well
as the reputation of already long standing firms, it is hard for new entrants into
the industry to achieve a large enough market share to be successful and
become a serious competitive firm in the industry. Therefore, the threat of new
entrants is very low. In addition to possible new entrants in an industry,
substitute products could also play a factor. In the lumber and wood production
industry there are possible product substitutes such as composite lumber and
plastics. These possibilities are not too much of a threat since the basic
traditional wood products manufactured by the leading firms are a commodity in
our economy and cannot ultimately be completely replaced.
5
Although lumber and wood products are commodities and are hard to be
substituted, firms need to use various techniques in order to differentiate
themselves within the industry. Weyerhaeuser chooses to do so by investing in
brand image through building on environmental concerns via pollution reduction
and recycling. Offering a variety of products such as cellulose fibers and white
papers, packaging materials, real estate, and wood products also helps set
Weyerhaeuser apart from its competitors.
Overall key success factors implemented by all the industry’s firms include lower
input costs, product quality and variety, customer service, and investment in
research and development. Firms must keep these competitive points in
consideration in order to retain as well as expand their market share.
Accounting Analysis
In order to effectively value a company, key accounting policies and financial
statements need to be carefully scrutinized in order to assess the firm’s accuracy
and flexibility in its accounting disclosures. Firms are given an amount of
leverage by the GAAP that allows them to strategically benefit their annual
reports while possibly withholding information deemed important to investors.
Observing the amount of accounting information the firm decides to disclose
results in the level of transparency, or the amount of information it chooses to
accurately portray.
Key accounting policies used by a firm should coincide with its success factors in
order to achieve a competitive advantage over the other companies in an
industry. Weyerhaeuser’s accounting policies it discloses information about
include pension and post-retirement benefit plans, goodwill, and depletion;
maintaining high levels of transparency in these accounts help with its success
factors of tight cost control, economies of scale, and investment research and
development.
6
Pension discount rates disclosed by Weyerhaeuser give a high level of
transparency to its investors. While they are declining over a five year period, the
industry as a whole is as well. While this may not be highly profitable or cost
reducing, Weyerhaeuser has a higher rate than most of its competitors and gives
it an advantage in its cost control success factor.
Information on goodwill and acquisition is also disclosed. Acquisitions on other
segment branches support the economies of scale, expanding level of
operations. Weyerhaeuser’s goodwill disclosures help support their tight cost
control success factor, but delayed write-downs bring about questions to the
level of accuracy and possible motive behind these statement choices. Depletion
information is also disclosed to support the investment in research and
development.
Qualitative disclosure is overall very high in Weyerhaeuser’s 10-K reports,
keeping accounts and segments organized and detailed. Quantitative disclosure
was also deemed credible and high.
Potential “red flags” are accounts or certain disclosures that could contain
accounting errors or have intentional manipulations or accounting numbers. Very
few “red flags” were found for Weyerhaeuser. One is the decline in the net
sales/inventory ratio, but it is explained by the decreased demand in the
economy’s housing market. Another potential “red flag” is the goodwill account.
Delayed write-downs and impairments paired with overstated assets bring to
question the amount of leverage the firm is taking advantage of in order to make
financial statements more appealing. Even with the goodwill “red flag” taken into
consideration, the overall disclosure of the firm’s financial statements is fairly
high.
7
Financial Analysis, Forecast Financials and Cost of Capital Estimation
Financial analysis is evaluated through the use of three main ratios: liquidity,
profitability, and capital structure. These ratios are used to compare firms within
an industry and help forecast financial outcomes in the future to predict value
over time. A regression model is also formatted to find an accurate Beta and
determine cost of equity, cost of debt, and weighted average cost of capital.
Analyzing Weyerhaeuser’s liquidity ratios illustrates that it is a very liquid firm.
The company’s current asset ratio, quick asset ratio, receivables turnover, and
inventory turnover all fall within the average for the entire industry.
Weyerhaeuser exceeds the average and leads the industry in working capital
turnover, however. The combination of these five ratios makes it a very liquid
firm. Weyerhaeuser’s profitability has been on the decline the past two years,
however, it excels in asset turnover and operating profit margin, also maintaining
a gross profit margin that is steady with the industry’s average. The firm’s capital
structure ratios show that its times interest earned ratio is favorable and can
cover its interest expense. Also, the ratio of debt to equity is declining over years
which is also good for the company as the amount of equity rises to being more
than cover liabilities. However, Weyerhaeuser is having to receive financing
externally from banks and institutions and unable to rely on internal funds to
accommodate for its projects which is portrayed through its IGR.
Forecasts were made for the next ten years using the results from the liquidity,
profitability, and capital structure ratios. After analyzing each of the past six
years’ annual sales growth, we assumed a 5% sales growth over the next ten
years. The majority of other line items remained consistent year to year over the
past six years, and the average of these was found and used accordingly in the
forecasting process. Interest expense and net income varied in their last two
observed years due to debt financing and economic slumps, respectively. These
8
were adjusted with consideration to those factors and the appropriate forecast
was made.
We found the cost of capital to be reasonable for Weyerhaeuser. To obtain this
number we found the cost of equity and the cost of debt and plugged them into
the WACC formula. WACC (BT) was equal to 8.09%, WACC (AT) was equal to
7.02%.
Valuation
We valued WY using several different models. The first method used was the
comparables method. This method is the least accurate of the models used in
this valuation. The results varied between $1.96 per share and $94.99 per
share. We found this method to be largely unreliable. The next method used
was the dividend discount model. This model has only about 5% explanatory
power. It yielded a estimated price of $34.26 per share. The next model used
was the free cash flows model. This is also an unreliable model, given its 15%
explanatory power. The model gave an estimated share price of $61.70. The
next model used was the residual income model. This model is an accurate
predictor of share price. It yielded an estimated price of $35.38. We then ran
the long run return on equity residual income perpetuity model. This gave us an
estimated share price of $32.74. The final valuation model used was the
abnormal earnings growth model. This is another good predictor of stock price.
It gave us an estimated share price of $37.53. These results show
Weyerhaeuser to be overvalued by a large amount. All valuation models are
discussed in detail in the analysis of valuations section of the report.
9
Business & Industry Analysis
Company Overview
Weyerhaeuser Company (WY) was established in 1900 by Frederick
Weyerhaeuser. It has since grown into one of the largest North American firms
in the Forest Products industry, with a market cap of $14.54 Billion. “As one of
the world’s largest timberland owners, Weyerhaeuser grows and harvests trees
on more than 21.5 million acres in five different countries” (Weyerhaeuser.com).
Roughly 98% of this acreage is located in the United States and Canada. In
2007, Weyerhaeuser was rated number 105 on the Fortune 500 list of America’s
largest corporations (cnnmoney.com)
Weyerhaeuser’s operations are made up of six business segments. These
segments include Timberlands; Wood Products; Cellulose Fiber and White Paper;
Containerboard, Packaging and Recycling; Corporate and Other; and Real Estate.
These diverse segments allow for Weyerhaeuser to make the most of their vast
logging operations. In recent years the Timberlands, Wood Products, and Real
-600-2002006001000
Timberlands
Wood Product s
Cel lu lose Fiber & ...
Cont ainerboard , P...
Real Est at e
Corporat e & Ot her
Contribut ion to Earnings(in Millions o f $)
200420052006
10
Estate segments have made the most significant contributions to earnings.
Business Segments
The Timberlands segment is mainly involved with the growing and harvesting of
trees for commercial use. The lumber produced is either sold to external buyers,
or used in one of Weyerhaeuser’s other business segments. The Timberlands
segment also generates income from oil and gas royalties earned from company
owned land. Weyerhaeuser is committed to generating growth in this segment
through maximizing the potential of each acre of forest. This commitment is
shown by Weyerhaeuser’s 2006 $19 million forest research budget.
The Wood Products segment offers several different products used in residential
and industrial construction. Softwood lumber, engineered lumber, and structural
panels make up the largest portion of sales. They also supply products used for
cabinets and furniture. Products are sold through Weyerhaeuser’s distribution
facilities, as well as through home improvement warehouse channels. This
segment has also introduced Weyerhaeuser’s new iLevel program. iLevel is an
integrated software and product package used by home builders. This program
allows for “ dramatically reduced job site waste and less labor to get the job
done, resulting in a 50% boost in construction site efficiency for builders looking
for integrated solutions” (Weyerhaeuser.com)
The Cellulose Fiber & White Paper segment produces various grades of softwood
pulp, which are used in the production of all kinds of paper products. These
products include newsprint, printing paper, tissue, sanitary disposable products,
as well as liquid packaging material.
The Containerboard, Packaging, & Recycling segment of Weyerhaeuser primarily
produces containerboard and corrugated packaging at over 100 locations in the
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United States and Mexico. The segment also operates 19 recycling facilities in
the United States.
Weyerhaeuser’s Real Estate segment focuses on building single-family homes
and large community development projects. They concentrate this activity in
high growth areas across the United States. Weyerhaeuser Real Estate Company
is ranked among the top 20 home building companies in the US. As shown
above, this segment is one of Weyerhaeuser’s largest earnings contributors.
The Corporate & Other segment is made up of lumber operations outside of
North America, as well as a marine transportation operation. Through this
segment, Weyerhaeuser manages timberland in Australia, New Zealand,
Uruguay, and Brazil. The marine transport operation, dubbed Westwood
Shipping Lines, provides marine transport between North America and Asia.
Positioned in the Forest & Paper Products industry; Weyerhaeuser competes with
International Paper (IP), Louisiana Pacific (LPX), Universal Forest Products
(UFPI), Potlatch Corporation (PCH), Bowater (BOW), and Plum Creek Timber
(PCL). Of these companies, only International Paper exceeds Weyerhaeuser’s
market cap.
Company Performance
As shown below, in recent years Weyerhaeuser’s stock has posted much smaller
returns than some of their competitors. However, in the last five years
Weyerhaeuser has yet to post a negative return in any single year. This seems
to be a result of the firm’s strategy of continually restructuring its business
portfolio to provide a consistent return to investors.
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http://moneycentral.msn.com
Weyerhaeuser’s sales growth increased at a considerable rate from 2002-2004.
However, this growth decreased significantly during 2005-2006. This may be
attributed to the increase in real estate activity over this time span that has since
leveled off. From 2001-2004 the number of new privately owned housing units
started increased by 22%. As of 2006 this number had decreased by
approximately 8% (www.census.gov)
Total Asset Value, Net Sales, & Sales Growth
*in millions
2002 2003 2004 2005 2006
Total Assets $28,317 $28,599 $29,954 $28,229 $26,862
Net Sales $17,533 $18,865 $21,411 $22,046 $21,896
Sales Growth 25.93% 7.60% 13.50% 2.97% -0.68%
13
Industry Overview
The forest products industry is responsible for producing thousands products that
consumers use everyday. These products range from newspaper to housing
construction products. In the United States this industry is separated into two
categories: Paper Manufacturing and Wood Product Manufacturing. “These
industries are often grouped together because both rely on the nation’s vast
forest resources for raw materials. In addition, many companies that produce
pulp and paper also produce lumber and wood products in integrated operations”
(energy.gov).
The amount of products manufactured by this industry is extremely diverse. The
paper related products include newspaper, tissue, paper towels, printer paper,
and paper plates just to name a few. Firms in this industry also produce all kinds
of packaging material. These products include cardboard boxes, milk containers,
and corrugated packaging. Another major sector of the forest products industry
is the construction of wood products. These products are used mainly for
housing construction and do-it-yourself projects. Plywood, i-joints, beams,
cabinets, doors, and lumber are just a few examples. Other products provided
by smaller firms include firewood, wood carvings, and handmade furniture.
In 2001, the industry accounted for over $243 billion in sales. These activities
resulted in 1.2 percent of the U.S. GDP. The industry also employs 1.1 million
Americans in over 16,000 facilities. According to yahoo.finance.com there are
262 publicly traded companies that compete within the forest products industry.
The industry is made up of a few large companies and several smaller ones.
Regardless of size, firms tend to produce similar products. The larger firms,
however, do so on a much bigger scale.
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Five Forces Model
The five forces model is a mechanism to analyze the industry structure and
profitability. The five forces model will first examine the degree of actual and
potential competition within an industry. There are three potential sources of
competition, which included rivalry among existing firms, threat of new entrants,
and threat of substitute products. Then, the five forces examine the
comparative economic power between the buyers and suppliers. The model will
evaluate the bargaining power buyers and bargaining power of suppliers.
Discount Variety Industry Rivalry Among Existing Firms High Threat of New Entrants Low Threat of Substitute Products High Bargaining Power of Customers Low Bargaining Power of Suppliers Low
Rivalry among Existing Firms
The average level of profitability in the lumber and wood industry is influenced
by the rivalry among existing firms. Some firms compete aggressively on quality
and other firms compete aggressively on price. Several factors determine the
competition with other industries. The principle in the lumber and wood industry
is the selling price of the product or service. To maintain suitable margins is a
large part of controlling cost. In this industry, firms are sensitive to other factors
improving design, quality, and service with varying status on the product line.
Firms face intense competition in this industry, and failure to compete effectively
could have a material adverse effect on a firm.
15
Industry Growth
Rapid industry growth lessens the need for firms to take market share from one
another. Industries that are stagnant must fight one another to increase their
market share. In the lumber and wood production industry growth was at a
breakeven point in 2002 and rose about 6% through 2004. Then, through the
next year of 2005 it dropped about 12% and in 2006 decreased to a -3%. In the
next few years in this industry firms are really going to have to acquire market
share from one another. There is little reason for firms to enter the market, and
the firms that already established a name for themselves in the lumber and wood
production industry survive by cost leadership and differentiation in the market.
This gives firms the opportunity to establish new cliental and acquire customers
from other firms.
-5.00%0.00%5.00%
10.00%15.00%20.00%
2002 2003 2004 2005 2006Percentages derived from sales growth of WY, IP, LPX, UFPI, PCH, BOW, & PCL
Forest Product Industy Growth Rate
16
Concentration
The number of firms and their size will decide the concentration level a firm is
in. For example, an industry with a large number of firms will then be in a low
concentration level. Then, when there are one or two dominating firms they
then will be classified as high concentration level. Firms in the lumber and wood
production industry are considered high competition industry, so they will then
be put on a low concentration level. In the chart below you will see that there is
not a firm that is dominating in market shares. With the exception of
Weyerhaeuser and International paper who dominate the industry most firms
having a low level of concentration, they are evenly matched and unconditionally
cooperating with one another to avoid critical price completion. You can see in
this chart that if one or two firms increase or decrease the market share there is
not much movement in the market share percentage. Over the past five years
the market has not had any drastic changes in the market shares, therefore
Weyerhaeuser has caught up with International Paper at 40%.
17
Differentiation and Switching Cost
Switching cost gives firms the ability to do something else with their production
assets. In the lumber and wood production industry, the products and services
are comparable in price; for that reason, customers have a low switching cost.
The lumber and wood production industry competes heavily on competition
selling price. The ability to maintain content limitations will give firms ability to
control the cost. Firms need to have differentiation in their products and
services to be profitable. For firms to achieve this is by easier replenishment of
wood product and packaging of paper products, as opposed to other industries
such as plastic and computer technology.
Economies of Scale
Economies of scale can be enjoyed by any size firm expanding its scale of
operation. In the lumber and wood industry, firms expand scales of economies
by doing business in different counties. Total asset size gives firms the
opportunity to increase revenue and profit as opposed to relying on limited land
use in the United States. Firms also expand economies of scale by the
replenishing of forest land after each harvest.
Conclusion
The lumber and wood production industry is a high competitive and low
concentration industry. Firms must have differentiation and a low switching cost
to be competitive and profitable. This industry has slow industry growth and
strong competition between existing firms. Firms also become profitable and
competitive through expanding their economies of scale internationally.
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Threat of New Entrants
The lumber and wood production industry is in the low concentration level and
consists of many competitive firms. Earning unusual profits will attract new
entrants to the industry. Successful firms in the lumber and wood industry have
been around for years. This makes it difficult for new entrants to enter the
lumber and wood production industry. New entrants will have obstacles to
overcome to become a competitor with your well known firms such as
Weyerhaeuser, Louisiana-Pacific Corporation, and International paper. It is
improbable for new entrants to enter the industry because of the reputation
most of the firms have.
Economies of scale
In the lumber and wood production industry new entrants are going to be
challenged with the choice of investing in a large capacity that might not be
utilized, or they may have to start off with less optimum capacity. This will lead
into a cost disadvantage and struggle with the existing firms. When new
entrants enter the industry they are unable to purchase large amounts of
forestry to supply the firms in need of lumber and wood production. This will
result in lack of customer base, differentiation and switching cost. Other firms
are going to have an advantage against the new entrants because of the
experience and growth they obtained over the years. The existing firms will
always have a competitive advantage verses new entrants.
Total Assets
2002 2003 2004 2005 2006 Weyerhaeuser $26,249.00 $26,595.00 $27,482.00 $25,270.00 $23,238.00 International Paper $33,792.00 $35,525.00 $34,217.00 $28,771.00 $24,034.00
Bowater $5,590.30 $5,615.80 $5,458.90 $5,152.40 $4,645.90 Louisiana pacific $2,780.00 $3,204.40 $3,450.60 $3,598.00 $3,436.40 Universal Forest $634,794 $686,931 $762,360 $876,920 $913,441
19
Products
First mover Advantage
New entrants will avoid existing firms if there are first mover advantages. In the
first mover advantage, new entrants gain if there are learning economies. This
will give new entrants cost advantage over existing firms. When there is a lot of
switching cost between existing firms, it makes it hard of new entrants to be
competitive. The main focus in lumber and wood production industry is
switching cost. This almost makes it impossible for new entrants to survive. We
feel that the first mover advantage does not exist in the lumber and wood
production industry. This is because it is hard for a firm to move to benefit with
the first mover advantage because of the land needed for production.
Conclusion
New entrants will be challenged with many different obstacles. The lumber and
wood industry does not usually have new entrants because there are not
extreme profits being made. This is an industry that switching cost is a main
factor between firms and for new entrants will struggle for many years. Without
large capacity of land, new entrants will struggle with cost advantage. New
entrants have really one advantage coming into the lumber and wood production
industry which results in learning economies in the first move advantage.
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Threat of Substitute Products
Most would assume that within the forestry industry there resides a small
number of large firms, but this is not the case. The market is actually highly
competitive with numerous firms selling very similar products. The average
homeowner might view all lumber products as all very similar, but there is
actually a wide array of differences in cost, quality, and service related to the
production and shipping of the product. Not only is there a threat of other
dimensional lumber suppliers, but there is also the threat of lumber substitutes.
Composite lumber and plastic alternatives are a rising trend in this market, but
many customers are currently wary of its quality and performance. These
products are also significantly more expensive. The overall threat is moderate as
most of the traditional wood products are essential in construction and there is
an inherent need of these products in our economy.
Relative Price and Performance
Most customers want the product they need quickly and at low cost. Customers
of these firms range from homeowners, to retail home improvement stores, to
major construction firms with varying needs of quality and quantity. This broad
spectrum of customers creates a large market to satisfy. Within the retail market
substitutes are always a worry. Both quality and cost must meet at the right
equilibrium to provide a good match for the average homeowner. Most
customers know the price range that a quality product will lie in. Too low of a
price and the product is considered to be of poor quality. Too high of a cost and
the product will be outside the majority of the customers price range. On the
other end of the scale they must also provide the quality and cost to the large
firms but with the added objective of getting the products to them in large
quantities as frequent as needed.
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Customer’s Willingness to Switch
In high priced industries where the product is infrequently purchased, customers
will spend large amounts of time researching all available products to find the
right match of quality and cost. In an industry such as this, customers spend
much less time making these decisions. They want what they need quickly and
with little hassle. If they had a positive experience with the product in the past,
most will continue to use it in the future. As long as the firms can keep prices
low and continue to satisfy the customers’ expectations of quality and
performance, they will retain their business. The willingness to switch is relatively
low in this market.
Conclusion
In our world today there is a huge market for lumber and lumber products.
Although there are substitutes in production for these materials, they have made
no real change in the market demand for these goods. As long as houses are
being built there will be a huge market for this industry. To keep their customers,
firms must find a way to put out a high quality product with a low price to entice
consumers. These two factors must meet at a relative balance to ensure that the
item doesn’t appear to be to high-end on price but also that it doesn’t look too
cheap and of low quality. If the firms can continue to balance these factors and
keep up a positive brand image, then they will continue to have repeat business
by their customers.
22
Bargaining Power of Suppliers
The bargaining power of suppliers is important in any industry. Regardless of
whether suppliers have high or low amounts of power, it will affect the way a
company operates. If a supplier has high bargaining power then that means that
they basically have control over the buyer. The supplier can raise the prices and
make the buyer adapt to their needs and preferences. The supplier can gain this
control by there not being many competing companies in their line of business.
They get to set the rules and tell the potential buyer how things are going to
operate dealing with their company. If the supplier has low bargaining power
then that means that the buyer has control over the prices and details of the
transaction. This is usually due to many competing suppliers in a given field or
that supplier's success may be dependent on doing business with that particular
buyer.
In the lumber and wood production industry, the suppliers have low bargaining
power. The companies in the lumber and wood production industry operate on a
very large scale. Each company is covering millions of acres of land and has
many different locations around the world. Due to the large size of these
companies, they can easily choose from many different suppliers giving them
bargaining power over suppliers. Most of these large companies produce many of
the supplies they need to grow their product but still have to purchase supplies
to handle the products and help develop their end product. The supplies that the
companies in this industry tend to buy are chemicals, office equipment, vehicles,
and equipment that is used to manufacture their end product.
23
Price Sensitivity
Price sensitivity is a very important factor in the lumber and wood production
industry. A market is price sensitive when rivaling companies are competing on
the lowest cost. This happens more in markets where products are
undifferentiated and easily substituted for an equal alternative. Since many of
the supplies needed in this industry are very generic, prices are what set
companies apart from its competitors. Companies want to buy quality products
at a cost efficient price. If certain supplies take up big portions of a company’s
costs, then they generally pick suppliers based upon the cheapest price. If the
portion is big enough companies will go to great lengths to find the best
alternatives for their company. Switching costs also play a big role in picking
from potential suppliers. Switching cost is the cost of switching products for a
competitor or substitute. The greater these costs then the more unlikely the
switch will occur. If switching products will cost too much then that means the
supplier has a good amount of bargaining power over that market.
As mentioned above, the firms in the lumber and wood productions industry are
very large, owning millions of acres, and generating billions of dollars in revenue
every year. Many of these firms in this industry operate in a global market. Being
spread out globally allows them to have great amounts of options when it comes
down to picking suppliers. Therefore, since there are vast amounts of suppliers
in this market competing on price, then all of these firms have very low
bargaining power over this industry.
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Relative Bargaining Power
Relative bargaining power is basically what it costs each party to not do business
with the other. Whichever company needs the other more is then put at the
others bargaining will. Relative bargaining power takes in to account many
aspects of the relationship between the supplier and the buyer. For example,
they take into consideration the number of substitute suppliers and buyers
available, whether or not this product is made by another company, and also the
switching costs of changing companies. If a product is highly generic and is
produced by many suppliers then they would have a low relative bargaining
power of the supplier is low. If a product is hard to find and differentiated from
its competitors then that supplier would have a high relative bargaining power
over the buyer. Even if a buyer is trying to get the lowest price, they might not
be able to achieve this if they don't have enough bargaining power over the
supplier.
In the lumber and wood production industry, suppliers to these large companies
have very low relative bargaining power. These companies have suppliers to
choose from all around the world. There is nothing that these firms need to be
able to operate efficiently that they couldn't get from some other supplier. Many
of these suppliers sign long term contracts with these big companies. Seeing
how the firms have high relative bargaining power, these contracts are normally
in favor of what the firm is wanting and not so much the supplier. But in most
cases, it is better to be in business receiving little profit then nothing at all. Most
of the companies in this industry are defined by the types of products they make
and the quality associated with them. We don't feel that the supplies these
companies use to turn their product are reflected in the company’s ability to
produce quality products. In this case, the firms will have the higher relative
bargaining power in most cases.
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Conclusion
Again, bargaining power plays a huge role in any industry. In order to be cost
efficient and get the most bang for your buck, you have to constantly be
worrying the amount bargaining power you possess and figure out how to
maintain it over your competitors. In the lumber and wood production industry,
switching costs for consumers is relatively low. The products produced aren't
very differentiated from one another and usually have about the same price. The
switching cost in this industry depends a lot on the size of the order. Switching
costs for a small amount are very minuet but when purchased on a large scale
the price of switching becomes a much bigger factor. This is also the case in the
switching costs relative to suppliers.
Bargaining Power of Customers
The bargaining power of the firms’ customers varies widely with the broad range
of customers. Your average homeowner buying dimensional lumber for a do-it-
yourself project obviously has little say in the price of the product. However,
large retail home improvement stores like Home Depot and Lowes have a much
larger say in price. The large construction firms and industrial manufacturers
have an even bigger voice. Overall, the average bargaining power of customers
is moderate to low.
Price Sensitivity
Because of the wide span of customers in the market, they all have different
price sensitivities. Very large construction firms are extremely price sensitive
because the lumber products represent such a large part of their costs. They will
expend the resources to shop for a low cost solution. On the other hand, your
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average person going to a home improvement store to make home repairs is the
exact opposite. The wood itself is a much smaller purchase and doesn’t
represent such a large cost to the consumer.
Relative Bargaining Power
Customers that are price sensitive may not have the bargaining power that one
might think. In this industry, the bargaining power tends to move with the
volume per customer. The more a customer orders, and the more frequently
they order, the lower the price of the goods will be. Large construction firms and
home improvement retailers are examples of this. The frequency and volumes
that they order give them the position to shop around to multiple firms. In
contrast, customers that purchase in small quantities hold little bargaining
power. Your average homeowner going to a lumber store is an example of this.
They don’t hold a big enough position to negotiate on price.
Conclusion
In the lumber industry bargaining power of the customers is relatively moderate.
However, this can vary drastically depending on the individual customer and the
quantity of their business with the company. Large firms can bargain for lower
prices because they account for more of the firm’s business. They order mass
quantities at repeated intervals and have multiple firms to choose from. The
smaller firms and individuals have less ability to bargain and are forced to take
price given.
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Value Chain Analysis
Classification of the Industry
Again, the industry that Weyerhaeuser competes in is the lumber and wood
production industry. In this industry, there is very high competition among
existing firms, very few new entrants, a low threat of substitute products, the
buyers have high bargaining power and most of the suppliers have low
bargaining power over the firms. There are many factors that contribute to
companies being successful in this industry. Some of these factors are high
economies of scope, high economies of scale, investments in research and
development, good relationships between customers and suppliers, price
sensitivity, and switching costs. All of these things play a big role in this
particular industry.
There are two basic strategies that firms tend to go by for creating a competitive
advantage in their market. Companies have to choose whether they want to
operate using a cost leadership strategy or a differentiation strategy. When
companies are trying to use a cost leadership strategy, they are basically trying
to compete at low costs but still maintain quality products. When companies are
trying to operate using a differentiation strategy, they are trying to set
themselves apart from their competitors by showing how they are different.
Companies pick which strategy to use by evaluating their product and the
industry in which they operate. Most of the time, companies use a balanced
mixture between these two strategies. Companies generally want to operate at
low cost but also need to set themselves apart from their competitors to be
profitable. In the lumber and wood productions industry, firms use the balanced
approach to operate.
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In this industry, many of the products are very closely related and similar.
Therefore, companies try to find different ways to add value to their product and
set them apart from the rest. Companies try to do this in many different ways.
By evaluating the value chain in this industry, you should be able to pick out
many of the success factors that help firms be successful. You should then be
able to apply these factors to specific companies and evaluate whether or not
they followed these factors and the effects of the choices they made.
Competitive Strategies
If a company wants to be successful in a given industry, they have to find ways
to beat out competition and keep finding new ways to stay on top. You can
never be satisfied in business because that's when you get pushed out. In order
for companies to be successful in the lumber and wood productions industry,
companies have to implement many cost strategies to gain that competitive
advantage. Many of these companies try to lower input costs, maintain efficient
production, and have a tight cost control system. However, companies in this
industry can't be successful without using the differentiation strategies as well.
Companies in this industry may differentiate by providing superior product
quality, superior customer service, and investing time and money into developing
their brand image.
Lower Input Costs
If you are in the lumber and wood productions industry, the first place you need
to look at to maximize your profits is at your input costs. The companies in this
industry are very big and incur huge amounts of cost every year. The firms in
this industry supply their biggest input which is the trees that they produce.
These trees are the base for all the products manufactured in this industry.
Many of the other costs are very generic items purchased in very large amounts.
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The other big input in this industry in the machinery used to grow, harvest, and
transform the wood into finished product. Some of these inputs consist of
seedlings, saws, gas and diesel. The slightest change in inputs could have big
rewards for your company. It is important to maintain quality products at a cost
efficient price. A good thing about this industry is that many of these products
don't spoil in short amounts of time. Products can sit on the shelves for long
periods of time and maintain their value. This is good because then you are not
forced to sell many products at a discounted price and can have the return you
desire for your products. Many of the companies in this industry develop long
term relationships with many of their suppliers. Because of this, companies can
usually get a discount based on continuing business with certain suppliers. This
is a very good way to cut down on input costs but you need to be careful when
selecting which supplies to do this with because you need to be aware that some
can become obsolete.
Maintain Efficient Production
Another way to have cost leadership in the lumber and wood production industry
is to maintain efficient production. This is where good management and
leadership really pays off for a business. If you want to increase your profit,
investigate to make sure you are operating efficiently. Sometimes simplifying a
job, breaking it up into parts, or outsourcing it to another company can really
have an effect on your profit margin. Company’s who are really profitable have
mastered the process for their given industry. Many times you can actually be
losing money by doing a task yourself and not outsourcing it. Many of the
companies in this industry tend to try to produce many different products and
incur more costs by doing this. That's why management is very important in this
industry. Managers in this industry are constantly evaluating processes and jobs
to make sure companies are running as efficiently as possible. A good manager
will always be calling around to other suppliers and making sure they aren’t
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being inefficient. Evaluating operating capacity can really help you measure
efficiency. In this industry, you don’t want to operate at full capacity because
you are going to run down your equipment quicker and making a quality asset
depreciate quicker. 80% is a good operating capacity to be operating at in this
industry.
Tight Cost Control System
In order for any company to develop a cost leadership strategy and gain a
competitive edge over the competition, they have to operate using a tight cost
control system. In the lumber and wood production industry, firms produce
highly generic products. This leads to extreme price competition between firms.
If a firm can manage its cost effectively, it can in turn, pass it’s savings on to the
customer.
It is extremely important for a firm in the lumber and wood production industry
to constantly work towards improving its cost control system. This process
involves managing every aspect of the business to maximize productivity at the
lowest price possible. This is the best way for a firm to increase profits in this
highly price sensitive industry.
Superior Product Quality and Variety
In the lumber industry, differentiating yourself from your competitors is much
more difficult than other industries. To your average consumer, one firm’s
products look nearly identical to another. The only way a firm can set themselves
apart is to somehow make their product or product line stand out from the
others. In other industries, this is done by being a cost leader. Having the lowest
prices gives consumers an incentive to buy your products. However, within the
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lumber industry quality is a necessity. Firms cannot cut corners in production to
make their products cheaper. Their products must be of sound quality to protect
the public’s safety. Successful firms in this industry maintain very high quality
products. This is achieved through many different strategies such as tests for
harmful chemical toxins, durability and “cooperating regularly with the TAPPI
organization in the development, standardization and calibration of testing
methods” (www.weyerhaeuser.com). In addition, these companies also offer a
wide variety of products. Customers in this industry tend to be very brand loyal,
and when they go to purchase a product from their favorite brand, they need to
know that they will be able to find not only what they need, but that it will be of
superior quality while maintaining a decent price.
Investment in Brand Image
As previously stated, customers in this industry tend to be very brand loyal.
When a person buys a car, he or she can spend months researching all the
different brands they are interested in. In this market, customers spend a
relatively minimal amount of time shopping around for various brands. If they
find a product and it works well for them, they will continue to use that product.
It is this reason that firms devote massive amounts of time and capital in
creating and maintaining a positive brand image. Many firms promote
environmentally cautious growing and harvesting techniques and recycling
efforts. Global warming has also become a growing concern among
manufacturers and companies make constructive efforts to reduce the problem
through lower oil usage which decreases the amount of pollutant emissions given
off. Others may talk about their efforts to improve their surrounding communities
through events and charities. All this is done to instill a positive image in
customer’s eyes. Firms want the customer to get a certain feeling about them
each time they hear their names or use their products. This creates a lasting
loyalty that firms spend large amounts of time and money to get and keep.
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Investment in Research and Development
It is very important for firms to retain their customers in this industry. As stated
earlier, this industry is not one in which you can cut corners. Quality is of the
utmost importance. The final product has to meet a certain standard not just for
customer satisfaction but also for consumer safety. Companies in this industry
use research and development to improve the way they do business. For
instance, if a firm develops a more efficient way of growing and harvesting their
forestlands, then they can keep their costs down and lower prices. More recently,
firms have developed new plastic and composite products that are stronger and
have a longer life than traditional wood. With these innovations in mind, each
firm in the industry keeps detailed records of the different segments of their
manufacturing and sales, which in turn leads to a better understanding of
changes or problems within production and income areas. Whether they develop
a more efficient way to grow and harvest lumber, or a new way to make a
previous product better, all this keeps costs low and consumers happy.
Conclusion
In any industry, firms have a challenge to get customers attention. An even
bigger challenge is to retain those customers. Firms use a variety of methods to
differentiate themselves from other companies. They must create new and
innovative products that meet the quality and variety standards of consumers. In
doing this they can create a brand name and a positive image to consumers. A
firm that can balance all these strategies together in one production and
marketing campaign will be the leader in this highly competitive industry.
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Firm Competitive Advantage Analysis
Weyerhaeuser, as stated previously, is one of the largest firms in the lumber and
wood production industry with the highest market cap of $14.54 billion among its
main competitors (Louisiana-Pacific Corp, Potlach Corp, Plum Creek Timber Co,
International Paper Ord, Universal Forest Products Inc, and Bowater Inc). In
order to achieve high revenues in a vastly competitive industry, strategies must
be implemented in order to retain, as well as gain, new customers.
Weyerhaeuser has a mixed competitive advantage including strategies focusing
on both cost leadership and differentiation. The firm’s main strategic points focus
on economies of scale and scope, lower/ tight cost control, maintaining efficient
production, superior product quality and variety, building brand image, and
investing time into research and development.
Cost Leadership
Economies of Scale and Scope
Weyerhaeuser achieves economies of scale by expanding its network of
operations globally. Forests are harvested “on more than 21.5 million acres in
five different countries” including the United States, Canada, Australia, and
Uruguay (www.weyerhaueuser.com). Expanding forest land to other countries
allows the firm to maximize potential revenues and profits as opposed to relying
only on the limited available land in North America. In addition to the locations of
the forests, “Weyerhaeuser will plant over 100 million seedlings to replenish
forests that provide products people use every day” (www.weyerhaeuser.com).
This assures the resource will not become obsolete once removed and will
continuously be available for future cultivations. Constant replenishment is a
major advantage over the possible product substitutions of plastics and computer
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technology that have to be newly manufactured and can easily become
outdated. According to the Weyerhaeuser 2006 10K, new branches to different
segments of the firm have also been added to broaden the scale including
Williamette Industries in 2002 and Maracay Homes in 2006. Weyerhaeuser
exhibits economies of scope by offering a variety of products such as hardwood
and softwood timber, cellulose fibers and paper, packaging materials, and real
estate to fill the variety of demands of the consumers. Product diversity in the
firm adds to customer retention, allowing customers to return to a familiar
producer and also giving the option of finding all wood and lumber needs in one
place.
Maintain Efficient Production
Weyerhaeuser also succeeds in the cost leadership aspect by operating
economically and efficiently within all areas of the firm. In 2006, Weyerhaeuser
merged their Fine Paper business with Domtar, Inc. The branch of the Cellulose
Fiber and White Papers in “combination with Domtar, Inc. will create a leading
producer in fine paper in North America based on the production capacity of the
combined assets” (Weyerhaeuser 2006 10-K). The firm realized a higher revenue
could be accumulated in their paper productions by joining with another asset,
while cutting costs and other competition. In 2006, Weyerhaeuser combined five
of their Residential Wood Products operations into one in order to be more
proficient and organized in serving its customers in the residential construction
market. Furthermore, Weyerhaeuser’s goal is to be a leader in its industry and
forest preservation. In doing so, they use 90 percent of chemicals again in future
productions, and 40 percent of the materials essential in the production of their
paper products are recycled. Recycling its resources not only reduces costs but
also sets Weyerhaeuser apart from competing firms.
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Lower/Tight Cost Control System
Because the lumber and wood productions industry is highly competitive with
cost leadership being a main advantage, Weyerhaeuser strives to keep costs in
control. According to the firm, they abide by a process of “minimum impact
manufacturing” centered around pollution prevention and environmental
preservation, while cutting costs and expenses before they accumulate
(www.weyerhaeuser.com). Weyerhaeuser strives to omit or reduce emissions
and spillages, keep energy levels as low as possible, recycle unused materials
instead of referring to landfills, and maximize all components involved in
production processes to reduce excess waste.
This theory is not only cost effective; it also benefits the environment and
prevents future pollution problems.
2006 2005 2004 2003 2002
Operating Expenses/ Sales .97 .97 .89 .95 .95
The above chart illustrates Weyerhaeuser’s operating expenses as a percentage
of their sales for each given year. While the outcome for 2006 is high, it did not
rise from the previous year. Factors affecting this could include the sale of the
B.C. Coastal operation in 2005 which in turn influenced a drop in timberlands
products sales or other economic conditions such as significant drops U.S.
housing sales, leading to a drop in the demand for lumber. Periodic changes
such as these are common and expected in the economy, but therefore should
not affect the firm over a long-term period. The ratio before Weyerhaeuser’s sale
of the B.C. Coastal operation shows a more favorable relationship between
operating expenses and sales and is likely to be more accurate considering there
were no major changes in as there were in the following year with the sale of
one of its operating branches.
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Differentiation
Product Variety and Quality
Weyerhaeuser prides itself in a large selection of products. Included in the
production items are wood products, timberlands, cellulose fibers and white
papers, packaging materials and containerboard, and real estate. This gives the
company a competitive advantage over its competitors who primarily sell in one
type of product. Louisiana – Pacific Corporation, for example, manufactures and
sells only building material such as sheathing, siding, and moulding for
construction purposes. Having a wide variety builds a much larger client base
filling all of their customers’ wood, packaging, paper, and real estate needs with
one company. This provides convenience to the customer and increases the
probability of returning service in the future, ultimately increasing revenue.
Investing in Brand Image
Weyerhaeuser invests a large amount into the image they project to its
customers as well as society as a whole. The main issue the firm focuses on is
environmental conservation. Not only do they replenish their forests with new
harvests of 120 million trees every year as previously mentioned, they make it a
point to protect the natural wildlife. When cutting down trees in their millions of
acres of forests, Weyerhaeuser leaves some trees and other natural vegetation
specifically zoned for the protection of the inhabiting wildlife. In addition to
guarding animals from the danger, Weyerhaeuser makes extra efforts to
maintain the natural state of its surrounding bodies of water as “culverts, cross-
drains and bridges are built to allow water flow and fish passage and keep silt
out of streams” (www.weyerhaeuser.com). Weyerhaeuser is also aiming to join
the fight to reduce the causes of global warming. According to a 2006 Fortune
article, the company “plans to reduce greenhouse gases by 2020 to 40% below
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their 2000 levels” (www.cnnmoney.com). It plans on switching its energy
resources to biomass instead of natural gas and oil, greatly lowering its level of
pollutant outputs. Weyerhaeuser’s environmental focus helps the firm to stand
out among its competitors who are not as concerned about these problems we
are facing. In 2006 the company accrued $12 million in costs for their
involvement with the cleanup of several hazardous waste sites involving legal
proceedings under the Comprehensive Environmental Response Compensation
and Liability Act (2006 Weyerhaeuser 10-K). Taking the extra steps to help
preserve natural wildlife show customers that they care not only about profiting
from their services and production, but care about their client base as well,
greatly limiting their contribution to the harmful environmental issues affecting
the world today.
Investment in Research and Development
Weyerhaeuser allocates a fair amount of time into research for the company.
The main research method implemented is the analysis of the economic and
market conditions that affect production and sales. Every year in the firm’s
annual 10-K, a summary report is drawn up to examine these issues that extend
beyond the company. These economic results are compared to Weyerhaeuser’s
end of year performance and conclusions are made to explain possible high or
low outcomes for the company.
Net Sales and Revenues by segment (in millions)
(Weyerhaeuser 2006 10-K)
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According to the 2006 Weyerhaeuser 10-K report, the market for pulp producers
was promising for the year and “market pulp prices rose 12 percent due to
higher fiber costs in Europe, closures of market pulp capacity in Canada, and a
strong demand for fluff pulp” (Weyerhaeuser 2006 10-K report). Using this
information, looking at the above table, sales in the cellulose fiber segment rose
in 2006. Taking the economic research then looking at the year’s performance in
that area of the firm, the two can easily be correlated together. In addition,
researchers found that the containerboard industry was operating at a very high
rate for the year due to growth in production of non-durable goods which
dictates the direction of demand for such packaging materials. With this
information in mind, looking once again at the graph above, it is noted that the
containerboard and packaging materials segment of Weyerhaeuser also rose in
revenues for 2006. Researching and forecasting the demands of the economy
and industry allow Weyerhaeuser to gain an upper hand on their firm and plan
for possible growths or declines.
Moving Forward
Weyerhaeuser is focusing its future company strategies around its customer
base. Maintaining current as well as gaining new customers all while building
strong relationships with each is a major concern for the company.
Weyerhaeuser plans to continue researching and brainstorming possible
problems within their company in order to be able to completely meet customers’
needs and expectations when any problem scenario should arise. Also,
Weyerhaeuser will continue to invest in innovative technology in order to meet
supply demands accurately and cost efficiently. Using its competitive advantage
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through its mixture of cost leadership and differentiation and “taking advantage
of [their] size, scale, expertise, and breadth of products that make [them] unique
in serving the structural-frame marketplace”, will aid the success of
Weyerhaeuser in future years (Weyerhaeuser 2006 10-K).
Accounting Analysis
When valuing a company, the second area of concentration to be analyzed is the
accounting aspect. Under accounting analysis, financial statements reported in
the firm’s annual 10-K report are overviewed by investors in order to achieve an
understanding of the company’s overall efficiency and effectiveness in its
industry. While companies are given certain guidelines to follow in the
bookkeeping process, managers are also allowed a degree of flexibility in their
accounting disclosures by the Generally Accepted Accounting Practices (GAAP).
Given this leverage, firms may be tempted to use accounting policies that benefit
the company’s reports in order to boost itself for its own personal gain in its
industry against competitors, while withholding important information from
shareholders and other investors. Furthermore, when potential investors examine
a firm’s financial statements, it can be difficult to know whether all the necessary
information is being presented clearly and not swayed to meet certain biased
outcomes. With this taken into consideration, accounting analysis allows these
distortions to be identified and ultimately corrected.
The first step in the accounting process is identifying the principal accounting
policies that support and evaluate the previously discussed success factors and
competitive advantages in the firm. After determining the accounting policies, an
40
evaluation of the accounting flexibility for the firm should be made due to the
fact that different industries are restricted to certain levels of accounting
standards while others are allowed more freedom. Following the assessment of
accounting flexibility for a company, the accounting strategy can then be
scrutinized. Points to be taken into consideration include the overall industry
policies and if the company skews from industry averages, recent estimate or
policy changes to impact possible outcomes, and bias from managers’ choices to
hide negative declines or influence investors and competitors (Business Analysis
& Valuation). Next, the quality of disclosure is evaluated. Under this step, the
level of disclosure, or the amount of financial information the manager chooses
to expose, is analyzed. The more open and clear the information is, the more
transparent and ultimately accurate the financial statements tend to be. After
determining the accounting disclosure, unexplained changes, transactions, and
increases/decreases in the accounting statements should be “red flagged” and
examined. Finally, any distortions found in the previous analytical steps should
be undone as much as possible to prevent confusion in the financial statements
and the relaying of inaccurate information to investors.
Key Accounting Policies
A firm’s key accounting policies should directly coincide with its success factors
and further help the firm to gain a competitive advantage with other companies
in its industry. As previously stated, the main components of Weyerhaeuser’s
success are its tight cost control, economies of scale, and investment in research
and development. The main accounting policies Weyerhaeuser chooses to
disclose to support its key success factors as well as its financial statement
transparency include its Pension and Post-Retirement Benefit Plans, Goodwill,
and Depletion.
Pension and Post-Retirement Benefit Plans
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In the lumber and wood production industry, competition is very high resulting in
the necessity to keep costs low. One area Weyerhaeuser does so is in its pension
and post-retirement benefit plans offered to its employees. Expected rate of
return and the discount rate for the benefit plans play a significant role in
determining the overall cost of the plans and expense to the company. The
expected rate of return on the investments used to fund the pension plans for
2006 was 9.5 percent. Slight changes in this number, however, drastically
change outcomes; “every 0.5 percent decrease in… expected rate of return
would increase expense or reduce credit by approximately $23 million”
(Weyerhaeuser 2006 10-K). The inverse would hold true for 0.5 percent
increases in returns, resulting in the same decrease in expenses. Therefore,
careful research and estimation is made when determining this percentage using
all application and available information. Also, when setting the discount rate,
corporate bond rates with maturity dates similar to the estimated date for the
outflows of the retirement benefits are matched. Discount rates are also very
sensitive to fluctuations with a 0.5 percent decrease resulting in $28 million
expense increase, vice versa.
Pension Discount Rates
2002 2003 2004 2005 2006
Weyerhaeuser 6.75% 6.25% 6.0% 5.9% 5.8%
International Paper 7.25% 6.55% 5.75% 5.5% 5.75%
Bowater 6.5% 6.0% 6.0% 5.3% 5.9%
Louisiana Pacific 6.96% 6.25% 6.06% 5.46% 5.55%
Universal Forest Products N/A N/A N/A N/A N/A
(Percentages from each company’s 10-Ks)
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The table above illustrates the discount rates of Weyerhaeuser and its four
leading competitors in the lumber and wood production industry for the past five
years. When comparing all companies’ rates four years ago in 2002 to the latest
2006 entry, all companies have declined. Weyerhaeuser, however, is the only
firm of the five that has continually dropped from each prior year. This level of
disclosure elevates the transparency of the company allowing investors to see
the lower discount rates although it negatively translates to higher liabilities for
the firm.
Actual return on plan assets
(Weyerhaeuser 2006 10-K)
The discount rate decline does not hurt the return of the benefit plan assets. The
chart above shows that asset returns have significantly increased over the last
year although the discount rate continues to decline. Furthermore, the disclosure
of the conservative pension and post-retirement plans’ discount rates increases
the company statements’ transparency while maintaining its competitive
advantage of cost control by cutting expenses with increasing return on benefit
plan assets.
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Goodwill and Acquisitions
Acquisitions can be instrumental in the growing success of firms. They involve
the “buying, selling and combining of different companies that can aid, finance,
or help a growing company in a given industry grow rapidly”
(www.wikipedia.com).
Weyerhaeuser has “made substantial acquisitions in recent years…[that] make
up a large portion of the net book value of… property and equipment and timber
and timberlands” (Weyerhaeuser 2006 10-K). In 2006, Weyerhaeuser acquired
PSA Composites LLC, a company focused on the technological development of
polymer composites. Also in 2006, Weyerhaeuser’s real estate branch acquired
privately-held homebuilder, Maracay Homes Arizona 1, LLC. Acquisitions like
these strengthen the firm and add to its range of clientele. In turn, this supports
Weyerhaeuser’s key success factor of economies of scale, expanding its sources
of production and income, further becoming more competitive in its industry.
Goodwill is the difference between the purchase price of an asset (usually
acquisitions) and the fair market value of net assets. When an asset is purchased
for a price higher than the reported book value, goodwill must be reported as an
asset to make up for the significant differences in the price and actual value
(www.wikipedia.com).
In 2006, Weyerhaeuser reported a $749 impairment of goodwill to the cellulose
and fine paper segment that was initially overstated. At the end of 2006, the
carrying amount for the business segment was valued at $105 million after the
adjustment. This delayed write-down may have been intentional in order to keep
from reporting impairments on the balance sheet or possibly to avoid recording a
failing or financially unprofitable acquisition in that segment of the firm. If this is
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the case, questions surface on the reliability of this aspect of the accounting
policy and if the firm is purposely overstating assets to pad revenues.
Depletion
Another accounting policy disclosure by Weyerhaeuser is depletion. “Depletion is
a method of expensing the fee timber asset based on the harvest or timber sales
volume” (Weyerhaeuser 2006 10-K).
Five year summary of timberlands production
(Weyerhaeuser 2006 10-K)
The above chart illustrates the depletion of timber harvests over the past five
years. The sale of the company’s B.C. Coastal Operations in 2005 accounts for
the decline from 2004 to 2006 (Weyerhaeuser 2006 10-K). The depletion
expense is recorded on the balance sheet along with the line item of timber and
timberlands at cost, less depletion charged to disposals. Many factors affect the
volume of timber available for harvest, including: “changes in weather patterns,
effect of fertilizer, changes in harvest plans, limits on harvesting certain
timberlands, [and] changes in harvest cycles” (Weyerhaeuser 2006 10-K). This
makes it difficult to accurately predict actual depletion rates and expenses. Also,
Weyerhaeuser’s depletion records do not account for future reforestation costs,
costs associated with existing harvest, and future volume associated with re-
harvesting. These factors should also play a major role in expenses and
45
production as well. With this in mind, it is unclear as to how accurate the
timberlands statistics and recordings are in the financial statements and if they
are possibly being altered to benefit the company’s income to support its cost
control strategy.
Conclusion
A firm’s key accounting policies are important factors that need to be carefully
scrutinized in order to determine the transparency and overall accuracy of its
reported financial statements. After examining Weyerhaeuser’s policies of
pension and post-retirement benefit plans, goodwill, and depletion, there is a
mixed interpretation of the accounting precision due to the possibility that
accounts, such as depletion, may have been altered to fit in line with its key
success factors in which the lumber and wood industry competes. When relating
the firm’s level of disclosure with its competitive advantages over other
companies in the lumber and wood production, the disclosure is fairly high. All
information on pension funds and acquisitions is given supporting
Weyerhaeuser’s expanding economies of scale and maintaining efficient
production advantage theories. Also, the depletion rate displayed in the previous
graph illustrates a drop in number of timber harvests that coincides with the
firm’s investment in research and development efforts in order to keep track of
the segments of the company that are expanding or increasing in sales and
production. Furthermore, Weyerhaeuser’s disclosure regarding its key
competitive advantage points is high although there are questions as to the
accounting accuracy in the numbers given.
46
Potential Accounting Flexibility
A company puts together financial statements for a number of reasons. These
statements are important to managers, owners, government regulators, and
investors. Owners and managers profit from these statements because it allows
them to gauge their success and better understand the market and the position
of their company in it. Government regulators rely on these statements to make
sure that companies are being ethical and following the laws that are emplaced.
Investors rely on these statements to get a better understanding of how the
company is operating and try to determine where they are heading. Often times,
managers are judged by the outcomes of these statements. Within GAAP there is
much flexibility in how outcomes can be skewed. Managers can use flexibility
within GAAP to distort information and portray a different image of the company
that actuality. With this being said, it is important to evaluate the areas where
company’s flexibility becomes a factor.
Pension and post-retirement benefit plans
Pension and post-retirement benefit plans are one of the areas where managers
use flexibility in reporting. These plans are usually a big number line item listed
with your liabilities on your balance sheet. This number has much estimation
implemented into it such as employees ages and expected date of retirement.
Your company will look much more efficient by understating your pension and
post-retirement benefit plans. This will cause an overstatement of assets and an
understatement of expenses and liabilities. Since the company will look more
efficient, more people will want to invest in this company. If a company
overstates these expenses then they would look more inefficient than they
actually are. As stated earlier, the slightest change in the expected rate of return
on investments used to fund pensions can have huge effects on your outcomes.
47
Depending on the manager, these numbers could end up being quite different
from each other and revealing two different things with just the slightest change
in estimation.
Goodwill and Acquisitions
Goodwill and acquisitions are another part of the statements that managers
have flexibility with certain numbers. Goodwill is the difference in the purchase
price and the fair market value of an asset. Weyerhaeuser has goodwill on the
books for 2006 of $2,203,000,000. The previous year goodwill was stated at
$2,982,000,000. Most of the time, these numbers are just estimated and aren’t
realized without the actual sale of the company. However, company’s put them
on the balance sheet as an asset even though it isn’t actualized. There are
constant corrections to these numbers yearly because once again they are just
estimations. Corrections are also due to the fact that different managers have
different ways of valuing a company. Throughout the life of a company, many
different managers will get a chance to value things in their own opinion.
Tampering with goodwill numbers is an easy way for managers to
misconstrue with the value of a company and should be closely
watched. Goodwill is very important when valuing a company. By overstating
goodwill, your assets will be overstated on the balance sheet which in turn will
have great effects on your ratio’s that you will calculate along with many other
pieces of the valuation process. Once again, this can mislead investors down the
wrong path to a bad investment. Impairments are constantly occurring and it
begs the question on whether it was done on purpose to mislead investors or
was it simply a mistake?
48
Acquisitions also display a place where managers have some flexibility. Managers
will buy companies and in doing so they inherit their receivables and many other
things that make the buying company look better. If a company had a bad year
and they know it’s going to show in their statements, they might try to make it
look like an acquisition cost was part of why they look badly that particular year.
Managers might also leave acquisition costs out if they perceive them to make
the statements look badly. This is once again one of those things were it begs
the question mistake or purposely? It is important to identify between those two
before you invest money into a company doing these types of activities on their
financial statements.
Actual Accounting Strategy
Much like discussed above, financial statements are not always a clear
representation of a company. Managers have the ability to take many different
approaches when creating the financial statements and still be following GAAP
accounting principles. Managers can take an aggressive, conservative, or a mixed
approach when it comes to preparing financial statements. Managers who tend
to be conservative have lower net incomes because they didn’t want to
exaggerate their estimations. Aggressive managers do exactly the opposite; they
generally have a higher net income and higher earnings than actuality. Most
companies operate by using a mixture between the two approaches. Since most
managers are judged on their performance off of these statements, there is an
incentive to take the approach that will yield a more efficient company.
This company reports things fairly conservatively. There are no really big
changes from year to year and things seem to be fairly consistent with the prior
year. As stated earlier, there was an adjustment to goodwill but I feel that this
49
was due to a constant decline in that particular department of Weyerhaeuser.
Also, a small change in this industry reflects huge numbers because of the
overall size of this company. The small change can set off the domino effect
throughout the financial statements. The numbers change yearly but not by
huge amounts that would cause any initial concern. This business always has to
deal with changes in the industry as well as changes in prices and costs. One of
the numbers that changed but not a significant amount was the pension discount
rates stated above. The numbers are decreasing over the years and are
consistent with the market. If you look through Weyerhaeuser’s financial
statements you can also observe that they have been cutting back on
employees. This could also be one of the reasons for the rate decreasing like it
is. This number is consistently moving none the less, and is proving to show
that Weyerhaeuser is being fairly conservative with their numbers provided on
their financial statements.
50
Qualitative Analysis of Disclosure
It is extremely important to shareholders of a firm to be knowledgeable about
their investments. One of the few ways that outsiders can gain information on
firms is by analyzing their financial reports. Of those, the annual 10-k is one of
the most common and useful tools to get an inside look into the company’s
operations. The amount of information disclosed and the way in which it is
organized in plays a large role in the decisions investors will make.
Overall Organization
One of Weyerhaeuser’s strongest points is the overall organization of the 10-k in
itself. Everything is broken down into very simple bullets to make it easier on
investors to search for the relevant information they need. While reading it one
gets the feeling that the company is trying to be as transparent as possible. It
gives a feeling of trust to investors and stakeholders that they are not trying to
hide any manipulated numbers or conceal any “red flags.” Every aspect of their
operations is broken to show where their numbers are coming from. Every
segment of their operations is shown separately to display the revenues and
costs associated with each. Graphical representations are given to illustrate to
the reader more easily. They then show all the data combined to give an overall
picture of the company’s progress. All these charts and graphs are followed by
detailed descriptions explaining the reasons for any positive or negative growth
in the company’s operations overall and each sector separately. For example, a
large decrease in net sales is explained in detail as being due to the sudden
decline in housing demand and increase in supply of previously built homes.
51
Sales Breakdown
Another helpful tool in Weyerhaeuser’s annual report is the way in which they
breakdown their sales throughout every aspect of the business. Each sector is
listed separately to show the sales and revenues associated with each. Below is
an excerpt from the Weyerhaeuser 2006 10-k displaying their sale of wood
products for the current year and the previous two years.
They continue this with their timberlands operations, cellulose fiber, packaging
and recycling, and their real estate interests. They then pool all these into one
chart showing the totals from all operations. This is shown below from the 2006
10-k.
In detail they explain the decrease in sales and income due primarily to the
downturn of the housing market. One can obviously see the negative effect this
slowing trend has on all aspects of the company’s operations. These descriptions
and the footnotes associated with them help to ease any worries an investor or
52
potential investor would have in the negative perception these declining numbers
give. They offer optimistic outlooks by saying that they are very confident in their
belief that the housing market will rebound from the obvious problems it has
faced in the current years.
Details of Management
Weyerhaeuser also offers detailed information on executive officers in the
company. This enables readers to know more about who the company is being
steered by. They disclose the positions held by these high ranking managers to
reveal their expertise in the field. Weyerhaeuser wants to let investors know that
those in charge are very knowledgeable in the industry and that because of this
their investments are in excellent hands. This further reiterates the company’s
willingness to hide nothing to investors that they deem is important information
to their decision making process. Obviously they cannot disclose all matters
pertaining to the business as they are obvious security implications with
disclosing valuable trade secrets.
Conclusion
Overall, Weyerhaeuser does an excellent job in disclosing all relevant information
to readers. Their organization of the report is an obvious attempt to help
investors find and understand the detailed information that is needed. They
describe and explain in detail every aspect of the report to further help the
reader understand what they are looking at. Due to more strict regulation in the
past years, some of this is required by law, but we believe that Weyerhaeuser
goes above and beyond what is necessary to get the information across to the
reader.
53
Quantitative Analysis of Disclosure
Managers have significant flexibility when it comes to accounting disclosure. Most
managers use this flexibility to show an accurate picture of their firm. However,
some managers may use this flexibility improperly for personal gain. Quantitative
analysis aids in spotting potential problems in accounting disclosure. It is an
analyst’s job to use these techniques to identify potential “red flags”, and to
investigate these problems more closely.
We have made use of both sales and expense manipulation diagnostics in our
analysis. Both are useful in spotting “red flags” that may signal improper
accounting methods.
Sales Manipulation Diagnostics
Sales manipulation diagnostics involve computing the ratio of net sales compared
to cash from sales, accounts receivable, inventory, warranty liabilities, and
unearned revenues. When evaluating these results, it is important to look for
any large difference from year to year. Managers may try to manipulate sales in
a variety of ways for a variety of reasons. These diagnostics are important tools
to help to detect such manipulation.
“Sales are of good quality if they are unbiased estimates of the cash that the
sales will generate” (Penman). However, the estimate of cash actually received
can be far from the truth.
Net Sales = Cash from Sales + ∆ Net A/R - ∆ Unearned Revenue - ∆ Warranty
liabilities
54
A misrepresentation of any part of the above formula can make sales look better
than they actually are. The sales manipulation diagnostic ratios do a good job of
detecting possible manipulation of these variables.
We have also computed these ratios for Weyerhauser’s four largest competitors.
This helps to see if any large change is industry wide or exclusive to
Weyerhaeuser. The competitors included are International Paper (IP), Bowater
(BOW), Louisiana Pacific (LPX), and Universal Forest Products (UFPI).
55
Net Sales/Cash From Sales
The “net sales/cash from sales” ratio is computed by the following formula.
Net Sales/Sales + Decrease in A/R
Or
Net Sales/Sales – Increase in A/R
This ratio shows the relationship between net sales and the money actually
collected from these sales. The benchmark for this ratio is 1. However, small
deviations regularly occur. A potential red flag may be raised is the ratio reaches
1.05 or higher. This could possibly mean that the firm has undertaken
accounting policies that overstate sales. Firms may do this by understating the
amount accounts receivable that is doubtful to be collected.
Net Sales/Cash From Sales
0.940.950.960.970.980.99
11.011.021.03
2002 2003 2004 2005 2006
Year
WYIPBOWLPXUFPI
56
Weyerhaeuser’s “net sales/cash from sales” ratio remains steadily close to 1 over
the five-year period. Therefore, we find no potential problems with associated to
this ratio.
Net Sales/Net Accounts Receivable
The relationship between net sales and net accounts receivable should remain
fairly constant over time. Any significant change in the “Net Sales/Net Accounts
Receivable” ratio may signal potential manipulation by management. A large
decrease in this ratio may suggest that management has begun overstating
accounts receivable. They may be doing this by understating the amount of
probable bad debt expense. If management is manipulating A/R in this way,
large write offs for bad debt expense are likely to happen in the future.
Weyerhaeuser’s “Net Sales/Net Accounts Receivable” ratio has stayed fairly
constant over the given period. Therefore, we find no issues that need to be
investigated further in regards to this ratio.
Net Sales/Net Accounts Receivable
02468
101214161820
2002 2003 2004 2005 2006
Year
WYIPBOWLPXUFPI
57
Net Sales/Inventory
The relationship between net sales and inventory should remain fairly constant
over time. In addition, a higher ratio is considered better.
The relationship between net sales and inventory can signal a change in demand
for a firms’ product. It can be good or bad news. Inventory can increase in
three separate areas. These areas include finished goods, work in process, and
raw materials. An increase in finished goods inventory tends to be bad news.
The increase could possibly be due to a decrease in demand. In contrast, an
increase in work in process inventory is usually a product of higher expected
demand. An increase in raw materials inventory in relation to net sales will
usually raise the cost of goods sold.
If this ratio changes it is important to see where the change originated from.
Managers know that investors look at such changes and may manipulate the
ratio for personal gain. For example, a manager may boost work in process
inventory to signal a higher expected demand, even if no change in demand is
really expected. This manipulation could temporarily raise the stock price. You
should be suspicious if such a change occurs close to the end of the period,
especially if managers compensation is tied to stock price.
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From 2002 -2005, Weyerhaeuser’s “Net Sales/Inventory” ratio remained fairly
constant. However, in 2006 Weyerhaeuser reported a slight increase in
inventory that was not consistent with net sales growth. After investigating this
issue, it was determined that the change was due to an increase in finished
goods. This increase shows a decrease in demand. This is to be expected with
the current slump in the U.S. housing market.
Net Sales/Unearned Revenue
The relationship between net sales and unearned revenue can be an important
tool for analysts. Unearned revenue can take the form of advanced payments,
gift cards, etc. We have found that firms in the Forest and Paper Products
Industry do not deal with significant amounts of unearned revenue. Therefore,
this ratio is not applicable to this analysis.
Net Sales/Inventory
02
468
1012
1416
2002 2003 2004 2005 2006
Year
WYIPBOWLPXUFPI
59
Net Sales/ Warranty Liabilities
The relationship between net sales and warranty liabilities can show a possible
decline in product quality. We have found that this ratio is not applicable to
Weyerhaeuser. Weyerhaeuser does show a warranty liability line in the notes to
financial statements. However, the amount is less than .001% of net sales. We
find this number to be insignificant and have chosen to exclude it from this
analysis.
Conclusion
After analyzing the sales manipulation diagnostic ratios, we feel that
Weyerhaeuser’s reported sales are credible. The ratios did not raise any red
flags that could signal manipulation. The only suspect finding was the drop in
the Net Sales/Inventory ratio in 2006. Inventory rose at a level that was
inconsistent with sales. After further investigation, we determined that this
increase in inventory was legitimate. It was simply caused by a drop in demand,
not by management manipulation. Therefore, we find Weyerhaeuser’s sales to
be credible.
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Sales Manipulation Diagnostics Weyerhauser 2002 2003 2004 2005 2006 Net Sales/Cash From Sales 1.00 1.00 1.01 1.01 1.00 Net Sales/Net Account Receivables 12.49 12.84 13.76 12.60 12.78 Net Sales/Inventory 7.02 7.54 7.80 7.50 6.48 Net Sales/Unearned Revenues N/A N/A N/A N/A N/A Net Sales/Warranty Liabilities N/A N/A N/A N/A N/A International Paper Net Sales/Cash From Sales 1.00 1.00 1.00 1.00 0.99 Net Sales/Net Account Receivables 8.98 8.70 7.55 8.98 8.13 Net Sales/Inventory 8.67 8.44 8.74 11.23 11.52 Net Sales/Unearned Revenues N/A N/A N/A N/A N/A Net Sales/Warranty Liabilities N/A N/A N/A N/A N/A Bowater Net Sales/Cash From Sales 0.99 1.01 1.01 1.01 1.01 Net Sales/Net Account Receivables 7.82 7.54 8.46 8.50 7.95 Net Sales/Inventory 10.04 9.29 9.73 9.52 10.09 Net Sales/Unearned Revenues N/A N/A N/A N/A N/A Net Sales/Warranty Liabilities N/A N/A N/A N/A N/A Lousiana Pacific Net Sales/Cash From Sales 0.97 1.00 1.02 0.98 1.01 Net Sales/Net Account Receivables 14.97 15.94 14.76 17.80 14.24 Net Sales/Inventory 9.04 11.85 13.45 10.83 9.09 Net Sales/Unearned Revenues N/A N/A N/A N/A N/A Net Sales/Warranty Liabilities N/A N/A N/A N/A N/A Universal Forest Products Net Sales/Cash From Sales 1.01 1.02 1.01 1.01 0.98 Net Sales/Net Account Receivables 15.62 13.76 16.14 14.55 18.00 Net Sales/Inventory 9.88 11.24 11.52 10.59 10.87 Net Sales/Unearned Revenues N/A N/A N/A N/A N/A Net Sales/Warranty Liabilities N/A N/A N/A N/A N/A
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Expense Manipulation Diagnostics
The purpose of expense diagnostic ratio is to review the numbers reported on
the financial statements. It allows analysts to examining the sales performance
and identify any differences from one year to another and examines the
differences from the competitors of the industry. The following section contains
expense manipulation diagnostics for Weyerhaeuser, International Paper,
Bowater, Louisiana Pacific, and Universal Forest Product Incorporated. The
diagnostics shows how a manager can manipulate the firm to make them look
better. The manipulations are perpetrated through the recording of expenses.
We will see in the ratios of the Expense Diagnostics that if the mangers of the
firms altered with the expenses to make the firm look better.
Asset Turnover
The sales divided by assets ratio measures the efficiency of the sales revenue of
the company from the current year to the previous year. Lower expensed meant
62
higher income to sales as net operating assets increase. Lower expenses also
mean lower sales to net operating assets. If there is a change in Asset Turnover
this will designate a manipulation. Weyerhaeuser has overstated sales to make
asset turnover increase from 2002 to 2003 then levels off through 2006.
Weyerhaeuser is doing a lot of sales with fewer assets which also increase the
turnover ratio. Most of the firm’s assets turnovers will stay consistent over time.
CFFO/OI
The cash flow operating activities divided by operating income shows how much
cash is made by operating activities from the balance sheet to the operating
income from the income statement. A lower ratio is preferred because more
cash is going to be made from your operating cash flow rather than financing
activities. International Paper and Bowater generate great cash from operating
activities then their competitors. It has been steady for Louisiana Pacific,
Weyerhaeuser and Universal Forest generating cash from operating activities.
Bowater and International paper had a high increase in CFFO with results in a
low operating income.
63
CFFO/NOA
CFFO divided by NOA relates the operating cash flow to fixed assets and
property plant and equipment of a company. This is the cash that usually pays
the company’s bills. The ratio shows how well the firm uses the Property, Plant,
and Equipment in the cash flows. If this ratio increases then the firms are
making use of the Property, Plant, and Equipment. In the graph it shows that
international paper does not use their Property, Plant, and Equipment as well as
their competitors. The steady increase in the CFFO for the firms except
Universal forest products comes from the acquirement of land.
64
Total Accruals
The total accruals divided by change in sales is a ratio that will tell investors if a
company is doing a lot of sales with credit. Investors look at having a increase
in their accounts receivables and accounts payable as not so good. In this ratio
Louisiana Pacific has had a decrease, 2004 to 2006, which, means that the
company is selling more cash sales to their cliental and less credit sales. This is
a good thing because most firms want to have cash sales.
65
Pension Expense/ SG&A
The pension expense to selling, general, and administrative ratio shows the
relationship between the pension expense and operating expense. This shows
the money a firms is spending on retirees and if the firm is spending too much.
The firm is going to want a lower pension expense because it makes up an
irrelevant amount of the firms expenses. A firm should not be spending a large
amount of pension on employees that do not work for the firm anymore. The
firms in the lumber and wood production industry sustain a low pension to
selling, general, and administrative ratio.
66
Weyerhaeuser 2002 2003 2004
2005 2006 CFFO/OI 1.40 1.57 0.90 1.36 0.89 CFFO/NOA 0.09 0.11 0.15 0.12 0.14 Asset Turnover 0.66 0.67 0.71 0.78 0.70 Total Accruals/Change in Sales 0.07 0.08 0.05 0.05 0.06 Pension Expense/SG&A 0.07 0.09 0.11 0.11 0.08
International Paper CFFO/OI 1.92 1.84 6.35 5.28 0.38 CFFO/NOA 0.12 0.11 0.17 0.13 0.13 Asset Turnover 0.71 0.62 0.61 0.75 0.92 Total Accruals/Change in Sales 0.12 0.07 0.12 0.02 0.01 Pension Expense/SG&A 0.00 0.04 0.06 0.09 0.13
Bowater CFFO/OI -0.43 -0.20 4.15 1.71 4.45 CFFO/NOA 0.01 0.01 0.04 0.05 0.06 Asset Turnover 0.46 0.48 0.59 0.68 0.76 Total Accruals/Change in Sales 0.07 0.08 0.07 0.08 0.09 Pension Expense/SG&A n/a n/a n/a n/a n/a
Louisiana Pacific CFFO/OI 1.20 0.90 0.85 0.99 1.67 CFFO/NOA 0.07 0.58 0.71 0.58 0.19 Asset Turnover 0.57 0.68 0.79 0.72 0.65 Total Accruals/Change in Sales 0.95 1.09 0.66 -1.46 0.26 Pension Expense/SG&A 0.01 0.11 0.10 0.10 0.09
Universal Forest Products CFFO/OI 0.03 0.88 0.52 0.60 1.24 CFFO/NOA 0.01 3.29 0.23 0.33 0.61 Asset Turnover 0.26 2.76 3.22 3.07 2.92 Total Accruals/Change in Sales -0.01 0.02 0.00 0.00 0.03 Pension Expense/SG&A N/A N/A N/A N/A N/A
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Potential “Red Flags”
Anyone that is the least bit knowledgeable in financial statements knows that
most of the numbers cannot be completely exact. These are, in fact, people
made numbers and can be incorrect at times. Some of the common ratios that
change over the years are important red flags to note. After looking over multiple
years of financial statements we have found only one of what could be perceived
as red flags. These discrepancies could be caused by a multitude of reasons.
They could be simple changes in the industry, accounting errors, or intentional
manipulations of accounting numbers. Weyerhaeuser reported a $749
impairment of goodwill that was initially overstated. Weyerhaeuser delayed the
write down intentionally to avoid failing or financially unprofitable acquisition in
that segment of the firm. If the case, questions will be asked the firm if they are
purposely overstating assets to pad revenues.
The only red flag found is the net sales/inventory ratio. This ratio has declined in
the past few years, and many could perceive this as an alarming trend. It is
merely caused by an increase in the finished goods inventory caused by a
decrease in demand. This is simply due to the downturn in the housing market.
Weyerhaeuser has continued its operations as normal, but the market for some
of the goods they produce has declined. Fewer houses are being built as of late,
and there is a surplus of previously constructed houses. This problem is
described in detail in the financial reports and the explanation for it is made clear
several times. They also add that they believe the housing market will rebound
soon and that investors should not be worried about a red flag such as this.
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Conclusion
Because of the excellent work Weyerhaeuser does in disclosing its financial
information, few if any red flags could be found. Even after extensive research
into years of reports we were only able to find one. The decline in the net
sales/inventory ratio could alarm some, but its decrease is easily explained by
the happenings of the housing market. In the next year or two this ratio will
quickly rebound as the demand for housing does.
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Financial Ratio Analysis, Forecasting, and Cost of Capital
Financial Ratio Analysis
Financial Analysis is a key component in understanding the overall financial
standing of a firm. Three types of ratios are commonly used to gain this financial
evaluation and understanding of the company’s ultimate profitability. These ratio
groups include liquidity ratios, profitability ratios, and capital structure ratios.
After computing these ratios, it is possible to see positive or negative trends of a
single firm in relation to its competitors in its defined industry.
Liquidity Ratios
Liquidity analysis is the process of determining a firm’s ability to cover its
liabilities and financial obligations. Liquidity ratios are useful because they
illustrate the firm’s level of risk to potential investors and the likelihood of it
being able to cover its liabilities and expenses in a short period of time should
the need arise. The higher the ratio the better because this means that the
company’s assets are more than able to compensate for its outstanding debts.
The ratios included are current ratio, quick asset ratio, inventory turnover,
receivables turnover, working capital turnover, days supply receivables, and days
supply inventory.
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Current Ratio (Current Assets/Current Liabilities)
Current Ratio
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
5.5
6
2002 2003 2004 2005 2006
WYUFPIBOWLPXIP
The current ratio is a firm’s total current assets in relation to its current liabilities.
Cash, marketable securities, accounts receivables, inventory, and other liquid
assets combine to make up the current assets while short-term debts such as
accounts payable, income taxes, compensation and benefits account for current
liabilities. If a company should encounter errors or other unfavorable and
unexpected changes in income or expenses, current assets can be sold to cover
those short-term liabilities that must be satisfied in the near future. Furthermore,
a higher current ratio is desired.
Over the past observed years, Weyerhaeuser has maintained a current ratio
ranging from 1.3 to 1.7 with 2006 ending with a 1.4 ratio. In simpler terms, this
means that for every dollar of current liabilities the firm faces, there is $1.40 in
current assets to cover the debt. This is a fair ratio, however, Weyerhaeuser’s
competitors have slightly higher ratios averaging roughly above 2. Louisiana-
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Pacific has a much higher ratio, peaking at 5.7 in 2006 primarily due to a high
increase in short-term investments in the year. Overall, Weyerhaeuser is in the
lower bracket for the current ratio in its industry, but still maintains an
acceptable average of 1.52 for the previous five years translating to $1.52 of
current assets to cover its outstanding debts resulting in its ability to continue
building revenues should current liabilities need to be immediately paid off.
Quick Asset Ratio (Cash+Securities+A/R / current liabilities)
Quick Asset Ratio
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
2002 2003 2004 2005 2006
WY
UFPI
BOW
LPX
IP
A more refined look at a firm’s financial strength and ability to pay its liabilities is
the quick asset ratio. This ratio consists of the same components as the
previously discussed current ratio but excludes inventory. The reason for this is
the other assets included (marketable securities, accounts receivables, etc) can
easily and quickly be turned into cash while inventory such as raw materials or
finished goods can take more time to be sold and converted.
72
Most of the firms lie in the range of 0.5 and 1.2 for their quick asset ratio. This
means that for every dollar of liabilities, there is $0.50 to $1.20 of quick or liquid
assets to cover that debt. Weyerhaeuser maintains an average quick asset ratio
of 0.72 over the past five observed years. With only $0.72 of coverage for every
dollar of short-term liability could cause a problem for the company if they
encounter a time when they have to quickly pay their debts. However, this is
common for the lumber and wood production industry and Weyerhaeuser
displays average numbers among its competitors.
Receivables Turnover (sales/accounts receivable)
Receivables Turnover
7
9
11
13
15
17
19
2002 2003 2004 2005 2006
WYUFPIBOWLPXIP
The Receivables turnover ratio is the total sales for a company divided by its
accounts receivables. The number calculated shows the rate of return for credit
extended to their buyers; the rate of return is steady between three companies
and fluctuates between 12 to 18 times a year. Bowater and International Paper
fall behind with their receivables turnover between 7 and 9 times. All of the
companies lend out credit to their customers which make the firms have
accounts receivables. A high ratio is preferred because it means a firm is
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operating on a cash to cash basis or account receivables. Weyerhaeuser
maintains a steady turnover rate ranging only between 12.5 and 13 from 2002 to
2006. This lands in the middle of the 5 firms in the industry and a steady rate
with little fluctuation helps the company better predict future accounts
receivables and leaves a smaller chance of error when reporting this account in
its annual financial statements.
Days Supply Receivables (365/accounts receivable turnover)
Days Supply Receivables
20
23
26
29
32
35
38
41
44
47
50
2002 2003 2004 2005 2006
WYUFPIBOWLPXIP
The days supply receivable ratio shows an investor how fast a firm takes to get
paid on credit. Weyerhaeuser and all of the competitors have credit so they will
have accounts receivables which will make each firm have a days’ supply
receivables. This is possible because most of Weyerhaeuser business is done by
credit. A high days supply receivable number tells and analyst that a firm is
strict on its credit policy resulting in a firm taking longer to receive money and
then convert it to cash. A low day’s supply receivables number means that a
company does not necessarily have a tight credit policy so the firm will acquire
the receivables faster. In general, a lower day’s supply receivables is desired
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because the cash flow from these credited accounts is received sooner and can
be recorded and kept track of more efficiently.
Overall, the five firms in the industry varied with their days supply
receivables ratio. Bowater had the highest ratio with an average of 45.5 days
receivables outstanding. International Paper trailed slightly behind, and Louisiana
Pacific and Universal Paper were on the lower end ranging between 20 and 26
days. Weyerhaeuser’s days outstanding over the past five years had averaged
around 28 days. Like the receivables turnover ratio analysis, Weyerhaeuser again
falls in the middle of the five firms in the industry with the most steady and
predictable days supply for receivables. This steady rate with little fluctuation
that Weyerhaeuser illustrates is desirable for the company because it is easier to
predict the income from accounts receivables as well as the amount needed to
be designated to the allowance for bad debt account for clients who fall short on
their payment obligations; past years can be observed and estimates can be
made with more certainty with a trend that remains constant over five years.
Inventory Turnover (cost of goods sold/inventory)
Inventory Turnover
0
1
2
3
4
5
6
7
8
9
10
11
12
2002 2003 2004 2005 2006
WYUFPIBOWLPXIP
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Inventory turnover measures how many times inventory is sold and replaced in
an operating cycle. Inventory turnover is found by dividing the net sales by the
cost of goods sold. You want to have a higher inventory turnover in most cases
or at least above the industry average. Some industries inventory takes longer
before it is sold but it just depends on the type of market they are in. Usually
more expensive things take longer before they are sold because they aren’t sold
at a fast rate. Weyerhaeuser inventory turnover is basically average with firms in
their industry. In 2003 to 2004 there was a boom in the housing production
industry and at first glance the above graph might raise a concern when
observing Weyerhaeuser. It looks like Weyerhaeuser tried to grow with the
market and produce more inventories which kept their inventory turnover down
and after the market fell Weyerhaeuser was left with excess inventory.
Days Supply Inventory (365/inventory turnover)
Days Supply of Inventory
0
20
40
60
80
100
120
2002 2003 2004 2005 2006
WYUFPIBOWLPXIP
Days supply of inventory is another good thing to look at when evaluating a
company. Day supply of inventory should be found by taking the total amount
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of days in a year divided by inventory turnover. This ratio will tell you how long
you have inventory before it becomes finished product and is shipped out. You
want to have a low day supply of inventory because this means that you don’t
have inventory lying around not creating value, and it is being managed
efficiently. Weyerhaeuser is taking about the same amount of days as most of
the firms in their industry. Over time they are gradually getting there day supply
of inventory to go down which is a very good thing because this is showing that
they are getting better processes in place which is creating operating efficiency.
Another important ratio to take into consideration is the cash to cash cycle. This
is the combination of day’s supply of receivables and day’s supply of inventory.
As with the two components individually, a lower number of days for the cash to
cash cycle is also favorable because inventory is used quickly and efficiently and
cash for that processed inventory is received sooner, padding the firms quick
assets. The overall industry average for the past 5 years for the cash to cash
cycle is 79.8 days. This translates to nearly 4.6 times a year inventory is turned
over and cash from accounts receivables is received. Universal Forest has the
lowest number with only 50.7 days, and International Paper has the highest with
105 days. Weyerhaeuser’s average cash to cash cycle is 78.3 days, falling just
below the industry average. This is favorable for the company and helps with its
general liquidity.
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Working Capital Turnover (sales/working capital)
Working Capital Turnover
-140
-120
-100
-80
-60
-40
-20
0
20
40
2002 2003 2004 2005 2006WYUFPIBOWLPXIP
Working capital turnover equals the net sales divided by total working capital.
Subtracting current liabilities from current assets generates working capital. In
simpler terms, working capital is “money which is used to buy stock, pay
expenses and finance credit” (www.wikipedia.com). Therefore working capital
turnover explains the amount of revenue that is generated for every dollar of
working capital invested in the company.
The industry’s working capital turnover varies roughly between 8 and 18.
Louisiana Pacific maintained the lowest five year average (disregarding Bowater’s
irregular negative 2002 result) of only $1.42 of revenue for every dollar of
working capital. Weyerhaeuser had the highest average of 14.3, ending 2006
with $18.90 of revenue for every working capital dollar. This shows investors
that Weyerhaeuser leads the industry among its competitors in efficiently using
its working capital to produce revenue for the firm.
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The days working capital average for the industry from 2002 to 2006 was 81.2
days. Louisiana Pacific’s days working capital was significantly different from the
other four firms with an average of 258.26 days which in turn drastically affected
the industry average. If Louisiana Pacific’s average is removed from the
calculation in order to possibly view what seems to be a more accurate, regular
average, the days working capital calculates to 36.94 days. Weyerhaeuser’s
average is the lowest of the five firms observed in the industry with 27.76 days.
As compared with the cash to cash cycle for Weyerhaeuser, the company is
considered fairly liquid with the lowest days working capital and below average
cash to cash cycle.
Overall Liquidity
Weyerhaeuser proves itself to be a fairly liquid company. It maintains an average
of $1.52 of current assets for every dollar current liabilities for its current ratio.
The firm’s quick asset ratio is a lower $0.72 which can cause a problem if short-
term liabilities need to be immediately covered, however, lower numbers such as
this are normal for the lumber and wood production industry, and Weyerhaeuser
remains safe in the average among its four competitors. It is also very beneficial
for Weyerhaeuser to have the steady days supply of receivables and days supply
of inventory that it displays because future conditions are better forecasted with
little error, greatly benefiting the company should the need arise to liquidate
accounts receivable or inventory. Weyerhaeuser is also the industry leader in
working capital turnover ending 2006 with $18.90 of revenue for every working
capital dollar resulting in the lowest days working capital for the industry. A
combination of all these liquidity ratios proves Weyerhaeuser is a liquid firm.
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Profitability Analysis Gross Profit Margin
Gross Profit Margin
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0.45
2002 2003 2004 2005 2006
WYUFPIBOWLPXIP
Gross profit margin is found by dividing the gross profit of a company by the net
sales for that year. Gross profit is found by taking the net sales minus cost of
goods sold. Gross profit margin helps you find out basic product profitability.
This money is what’s left over to spend on other expenses and to put in savings
accounts. This is important to investors because you want to make sure cost of
goods sold isn’t too major a part of sales and that there is still money left over to
go toward other areas of the company. The higher the results of this ratio are
the better. The higher the number symbolizes a larger amount of money the
company has to pay debt, re-invest in the company, and ability to pay dividends.
Weyerhaeuser’s has had an average gross profit margin of .23 over the last four
years. This is fairly even with the industry average. Many of the companies in
their industry have fluctuated in the last four years but Weyerhaeuser has
remained very steady with no significant changes, which is a very good thing.
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Operating profit Margin
Operating Profit Margin
0
0.05
0.1
0.15
0.2
0.25
0.3
2002 2003 2004 2005 2006
WYUFPIBOWLPXIP
Operating profit margin is found by dividing the operating income of a firm by its
net sales. Essentially, this ratio is giving you how much money is left over after
paying for your variable and operating costs. By finding this out, you can get a
better idea of how much money the firm has to spend on long term debt. A
company is more efficient if this number is increasing around the industry
average. Weyerhaeuser’s average operating profit margin has been about .078.
This number went down slightly in 2004 and 2005 by a small amount but it went
back up in 2006 to the highest it’s been in the last four years. This means that
the company is earning more operating income per every dollar increase in sales.
Operating more efficiently is always a good thing.
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Net Profit Margin
Net Profit Margin
-0.1
-0.05
0
0.05
0.1
0.15
0.2
0.25
2002 2003 2004 2005 2006
WYUFPIBOWLPXIP
Net profit margin is found by dividing the net income of a firm by the sales for
that particular year. This ratio tells you how much you are able to keep in
earnings for every dollar received in sales (Investopedia.com). Companies who
have higher net profit margins are usually more efficient companies and have
better control over their costs and manage them better than their competitors.
Weyerhaeuser has had a fluctuating net profit margin over the last four years.
Weyerhaeuser has maintained a .032 net profit margin average over the last four
years. Its good that are generating earnings but judging by the industry and
their average they aren’t doing a good job of managing their costs. They don’t
have as much fluctuation as some of the other companies but they are
continually getting a small return. They got better in 2004 but then fell off after
that going back to the bad habits they were doing in earlier years.
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Asset Turnover
Asset Turnover
0
0.5
1
1.5
2
2.5
3
3.5
2002 2003 2004 2005 2006
WYUFPIBOWLPXIP
Asset turnover is found by dividing net sales by total assets for that given year.
This ratio will tell you how much in sales you can expect for every dollar you
have invested in your assets. The higher this number is then the better off the
company is because they are going to have higher sales and therefore leading to
higher profitability. Weyerhaeuser has an asset turnover ratio of .75. This is
better than the industry average for most of the companies except for one who
has been leading in all the other phases of these ratios.
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Return on Assets
Return on Assets
-0.1
-0.05
0
0.05
0.1
0.15
0.2
0.25
0.3
2002 2003 2004 2005 2006
WYUFPIBOWLPXIP
Return on Assets is found by taking net income and dividing it by the total assets
from the previous year. You need to use the previous year because you want to
see the earnings that your assets generated from the beginning of the year.
This ratio is important because it basically evaluates manager’s performance.
Since it measures manager’s performance it would be in your best interest to
look at the numbers very carefully so that you are getting an accurate perception
of the return that was generated from these managers and not an inflated
number. This evaluates manager’s performance because you are able to see
how the managers controlled the assets to generate profitability.
Weyerhaeuser’s Return on Assets basically matches their Net Profit margin over
the last four years. This just shows that the managers were being more efficient
for a small amount of time and have started using bad practice. Weyerhaeuser
has a Return on Asset ratio average of .024. This is a little below the average in
the industry and they are basically getting beat on not managing cost efficiently
which is one of their success factors.
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Return on Equity
Return on Equity
-0.2
-0.1
0
0.1
0.2
0.3
0.4
0.5
2002 2003 2004 2005 2006
WYUFPIBOWLPXIP
Return on Equity is found by taking net income and dividing it by the total equity
from the previous year. You use the previous year for the same reason you do
for the Return on Asset ratio, which is to find out the earnings generated from
the beginning of the year balance. Return on equity shows you how much profit
was earned from the money people invested in your company. Weyerhaeuser’s
Return on Equity again resembles many of the other profit ratios. They had a
good management of money and operations for a couple years and have started
sloping downward but still above the initial amounts they started with in 2002.
The industry curves with Weyerhaeuser but Weyerhaeuser’s bottom line is lower
than the industry’s.
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Conclusion
After looking at all of these ratios, you can really start to see the efficiency of
companies in the wood and lumber productions industry. Weyerhaeuser has had
some problems with not getting the full potential out of the dollars the company
has invested in the assets and the firm. Weyerhaeuser followed the trends of
the market which is normal but at the current time they aren’t producing at a
very efficient rate. Managers need to make some changes to how they are
operating and be more efficient with the money they have. Often times when
business is doing really good you can’t see the problems you’re your company
because they are getting covered up by all the money and earnings you are
generating. When business slows up those problems really start to show. Now
that the housing boom has slowed up these operating problems are starting to
show up for Weyerhaeuser. Weyerhaeuser has been on the decline of
profitability in the last two years and needs to figure out what they were doing
when they were more efficient compared to the present operation.
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Capital Structure Analysis
Capital Structure of a company includes the different financing activities that
were undertaken to acquire assets. There are two things to consider with
analyzing capital structure: “the amount of debt relative to the owners’ equity
and the ability to service the principle and the interest requirements on debt”
(Financial Statement Analysis hand-out). The capital structure analysis shows
were the firm stands. The following analysis shows where Weyerhaeuser stands
with the other industry, by using the debt to equity ratio, times interest earned
and Internal and Sustainable growth rate.
Debt To Equity Ratio
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The debt to equity ratio shows the debt of a company to the equity of the
company. The ratio shows how much debt the company has to every dollar of
equity. The total debt relative to equity is an important indicator of the credit
risk to which a company is exposed. The industry is pretty steady between 0.5
and 1.5. Bowater and International paper have a high debt to equity to their
competitors. Weyerhaeuser compared to the wood and lumber production
industry has a favorable record of debt to equity as it gets lower through the
years.
Times Interest Earned Ratio
Times interest earned is a ratio that indicates the adequacy of income from
operations to cover required interest charges. The ratio also tells you for every
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dollar the company has in interest expense, the company has this in the NIBIT to
spend on their interest and taxes. As we look at the companies in the ratio
Bowater is the only company that is unfavorable and did not cover their interest
expense. Weyerhaeuser and the other companies are favorable with this ratio
and can cover their interest expense. Weyerhaeuser has been pretty steady
through the years with this ratio. The higher times interest earned is better for
firms because the income from operations is covering the interest charges. If
operations do not cover interest charges then that is additional debt and the firm
will have to borrow money. The more money the firm will borrow the more
credit risk it has.
IGR/SGR Analysis
Finding a firms growth rates helps to see whether or not the company is going to
be profitable in the future. The growth rate is reliant on the numbers from their
return on assets and equity and the dividend payout ratios.
Internal Growth Rate
The firm’s internal growth rate determines how the company can increase assets
that can be financed in-house and stay constant. This is way the firm can
finance their assets by not using debt. Firms try to finance projects from the
firms operations and not through banks or any financial institutions.
Weyerhaeuser IGR is a rather small with being a negative IGR in 2002 and 2003
and then jumps up to positive IGR 2004 and 2005 and then drops back down to
negative IGR. This shows that Weyerhaeuser is funding more of their projects
with banks and institutions rather than internally generated funding.
Weyerhaeuser IGR is pretty consistent with funding with debt and internal
financing.
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Internal Growth Rate 2002 2003 2004 2005 2006
Weyerhaeuser -0.40% -0.27% 3.02% 0.94% -0.33%
Sustainable Growth Rate
Sustainable growth rate is the maximum rate of growth that a firm can achieve
without adding additional debt. If a firm surpasses the sustainable growth rate
they are going to have to borrow more funds from a bank of financial institution
to keep it at a level growth. SGR is determined on the company’s growth rate,
Weyerhaeuser has the same sustainable growth rate as their competitors.
Weyerhaeuser is constant with their SGR meaning they are increasing their
financial leverage at the same rate every year. Weyerhaeuser had a sustainable
growth rate of -1.7% in 2002 and peaked out at 9.78% in 2004. Weyerhaeuser
sustainable growth rate then decreased to -.98% from 2005 to 2006.
Sustainable Growth Rate
2002 2003 2004 2005 2006
Weyerhaeuser -1.7 -1.09 9.78 2.71 -0.98
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IGR and SGR Analysis
Weyerhaeuser internal and sustainable growth rates determine the amount of
debt that will increase for future projects. The IGR and SGR are significant ratios
because they tell you the profits the firm will have in the future. If the IGR and
SGR are high, then the company will increase profits in the future. If the firms
have more debt for financing then the profits will decrease. Since,
Weyerhaeuser SGR and IGR are smaller than their competitors then the firms will
use more debt than their competitors. Once Weyerhaeuser maintains a steady
growth rate they will have the ability to increase profitability. The internal and
sustainable growth rates show the profits a firm will make in the future.
Forecasting gives a broad picture of what a firm is going to look like in 10 years.
IGR, SGR and forecasting, value the firm for years to come.
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Financial Statement Forecasting
The financial statement forecasts are useful in gaining a picture of what the firm
is likely to look like in the future. This is an important step in valuing the firm.
We looked at the last six years of financial statements for Weyerhaeuser and its
competitors (IP, LPX, UFPI, & BOW) to help determine the appropriate rates to
apply to our forecast. We also applied ratios in our forecast of the statement of
cash flows.
Income Statement Analysis
The first step taken in forecasting the income statement was to determine a
sales growth percentage to apply to net sales. While the average growth was
almost 9%, the average of the last two years was a negative .68%. This is most
likely attributed to the recent housing slump. While this may be a factor for the
next few years, we feel that housing will rebound eventually. Therefore we
assumed that a 5% sales growth rate would be the best estimate to use. This
rate should be somewhere in the middle of the possible highs and lows that the
future may hold. We applied this percentage to our forecast of the years 2007 –
2016.
After forecasting the net sales for the coming years, we simply applied the
appropriate percentages as a part of sales to the rest of the line items. For most
line items the six-year average was fairly close to the average of the last two
years. From this we can conclude that Weyerhaeuser is a stable company, which
sticks to its business strategy through both the good and bad times experienced
in the last six years.
Some line items that showed a fairly significant change between the six-year
average and the average of the last two years, were interest expense and net
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income. The six-year average of interest expense was 3.32% of net sales. The
average for the last two years was 2.75% of net sales. This is a result of
Weyerhaeuser’s focus on paying down their debt. Because of this we chose to
use a rate lower than the six-year average of 3.32%. The 05-06 average of net
income was 2.10%. This is down from the six-year average of 3.02%. This
decrease can be attributed to the housing slump. We chose to use an average
of 3% because we feel that the housing market is likely to rebound in a few
years.
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Weyerhaeuser Income Statement
2001 2002 2003 2004 2005 2006 Average 05-06 Avg.
Ind. Avg Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Net Sales 14545 18521 19873 21411 22046 21896 8.93% -0.68% 6.10% 5.0% 22991 24140 25347 26615 27945 29343 30810 32350 33968 35666
Cost of Goods Sold 10283 14537 15594 16133 17079 17138 76.46% 77.87% 78.00% 76.0% 17473 18347 19264 20227 21239 22300 23416 24586 25816 27106
Gross Profit 4262 3984 4279 5278 4967 4758 23.54% 22.13% 22.00% 23.0% 5288 5552 5830 6121 6427 6749 7086 7441 7813 8203
Selling, Administrative and General Expense 3505 2644 2796 2746 3677 3566 16.37% 16.48% 8.30% 16.0% 3679 3862 4056 4258 4471 4695 4930 5176 5435 5707
Total Operating Expense 13788 17181 18390 18879 20756 20704 92.83% 94.35% 88.10% 93.0% 21381 22451 23573 24752 25989 27289 28653 30086 31590 33170
Operating Income 757 1340 1483 2532 1290 1192 7.17% 5.65% 8.90% 7.0% 1609 1690 1774 1863 1956 2054 2157 2265 2378 2497
Interest Expense 344 771 796 829 680 531 3.32% 2.75% 3.40% 3.0% 690 724 760 798 838 880 924 971 1019 1070
Other Income 43 61 50 55 226 100 0.44% 0.74% 0.4% 92 97 101 106 112 117 123 129 136 143 Equity in income (loss) of affiliates 60 18 14 66 51 65 0.24% 0.26% 0.2% 55 58 61 64 67 70 74 78 82 86 Income (Loss) before Income Taxes 516 648 751 1824 887 826 4.52% 3.90% 7.40% 4.5% 1035 1086 1141 1198 1258 1320 1386 1456 1529 1605
Income Tax Expense -162 -130 -148 -609 -318 -471 -1.50% -1.80% 1.83% 1.5% 345 362 380 399 419 440 462 485 510 535
Net Income (Loss) 354 518 603 1215 569 355 3.02% 2.10% 5.55% 3.0% 690 724 760 798 838 880 924 971 1019 1070
Net Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Cost of Goods Sold 70.70% 78.49% 78.47% 75.35% 77.47% 78.27% 76.46% 77.87%
Gross Profit 29.30% 21.51% 21.53% 24.65% 22.53% 21.73% 23.54% 22.13%
Selling, Administrative and General Expense 24.10% 14.28% 14.07% 12.83% 16.68% 16.29% 16.37% 16.48%
Total Operating Expense 94.80% 92.76% 92.54% 88.17% 94.15% 94.56% 92.83% 94.35%
Operating Income 5.20% 7.24% 7.46% 11.83% 5.85% 5.44% 7.17% 5.65%
Interest Expense 2.37% 4.16% 4.01% 3.87% 3.08% 2.43% 3.32% 2.75%
Other Income 0.30% 0.33% 0.25% 0.26% 1.03% 0.46% 0.44% 0.74% Equity in income (loss) of affiliates 0.41% 0.10% 0.07% 0.31% 0.23% 0.30% 0.24% 0.26% Income (Loss) before Income Taxes 3.55% 3.50% 3.78% 8.52% 4.02% 3.77% 4.52% 3.90%
Income Tax Expense -1.11% -0.70% -0.74% -2.84% -1.44% -2.15% -1.50% -1.80%
Net Income (Loss) 2.43% 2.80% 3.03% 5.67% 2.58% 1.62% 3.02% 2.10%
Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Net Sales 5.0% 22991 24140 25347 26615 27945 29343 30810 32350 33968 35666
Cost of Goods Sold 76.0% 17473 18347 19264 20227 21239 22300 23416 24586 25816 27106
Gross Profit 23.0% 5288 5552 5830 6121 6427 6749 7086 7441 7813 8203
Selling, Administrative and General Expense 16.0% 3679 3862 4056 4258 4471 4695 4930 5176 5435 5707
Total Operating Expense 93.0% 21381 22451 23573 24752 25989 27289 28653 30086 31590 33170
Operating Income 7.0% 1609 1690 1774 1863 1956 2054 2157 2265 2378 2497
Interest Expense 3.0% 690 724 760 798 838 880 924 971 1019 1070
Other Income 0.4% 92 97 101 106 112 117 123 129 136 143 Equity in income (loss) of affiliates 0.2% 55 58 61 64 67 70 74 78 82 86 Income (Loss) before Income Taxes 4.5% 1035 1086 1141 1198 1258 1320 1386 1456 1529 1605
Income Tax Expense 1.5% 345 362 380 399 419 440 462 485 510 535
Net Income (Loss) 3.0% 690 724 760 798 838 880 924 971 1019 1070
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Balance Sheet Analysis
In order to forecast the balance sheet line items, we found growth percentages
for total assets as well as total equity. We then made assumptions based on
previous financial data to allocate percentages of total assets and total equity to
other line items. We then backed into the total liabilities to make the balance
sheet balance. While this may create some error, it is acceptable because we
are doing an equity valuation. This way we preserve the equity portion of the
balance sheet. We would much rather the error be in the liabilities section of the
balance sheet.
To determine the percentage assumptions, we analyzed the six-year average,
the 05-06 average, as well as the industry average for each line item forecasted.
We then made an educated guess to the appropriate percentage to use in our
forecast. Weyerhaeuser has made a point of paying down debt over the last few
years and we expect this trend to continue. They have also been selling off
assets in the Weyerhaeuser segment of the balance sheet. This trend is a result
of the firm ridding itself of unprofitable assets. We expect this trend to continue
into the future. On the other side, the Real Estate and Related Assets segment
has grown substantially over the last few years. This segment has also made a
significant contribution to earnings for the firm. Because of this evidence we
expect this segment to continue growing.
Weyerhaeuser breaks its balance sheet up into two segments. The segments are
Weyerhaeuser and their Real Estate and Related Assets segment. The
Weyerhaeuser segment groups many of the firm’s divisions together. These
divisions include; Timberlands, Wood Products, Cellulose Fiber, Containerboard
and Packaging, and Corporate and Other. The Real Estate and Related Assets
segment contains the various real estate companies held under the
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Weyerhaeuser umbrella. We forecast these two main segments separately and
then added them together to get the total assets and total liabilities forecasts.
96
Weyerhaeuser Balance Sheet 2001 2002 2003 2004 2005 2006 Average 05-06 Avg
Ind. Avg Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Weyerhaeuser
Current Assets:
Cash and cash equivalents 202 115 171 1044 818 223 1.7% 2.1% 7.3% 2.0% 451 439 426 414 402 391 379 369 358 348
Receivables, less allowances 1024 1413 1484 1604 1707 1569 6.1% 6.8% 10.3% 6.1% 1377 1338 1299 1262 1226 1191 1157 1124 1092 1061
Inventories 1428 1941 1911 2045 1885 1929 7.8% 7.9% 7.8% 1752 1701 1653 1606 1560 1515 1472 1430 1389 1349
Prepaid expenses 407 419 455 600 414 400 1.9% 1.7% 1.9% 427 415 403 391 380 369 359 349 339 329
Total Current Assets 3061 3888 4021 5293 4824 4121 17.5% 18.4% 38.6% 20.0% 4515 4386 4260 4138 4020 3905 3794 3685 3580 3477
Property and equipment 8309 12278 12243 11843 10345 10009 45.2% 42.0% 45.2% 10194 9903 9620 9345 9078 8818 8566 8321 8083 7852
Construction in progress 428 687 403 269 527 407 1.9% 1.9% 1.9% 436 423 411 399 388 377 366 356 345 336
Timber and timberlands at cost, less depletion 1789 4402 4287 4212 3705 3682 15.0% 15.3% 15.0% 3375 3279 3185 3094 3006 2920 2836 2755 2676 2600
Investments in and advances to equity affiliates 541 578 546 489 486 499 2.2% 2.0% 2.2% 505 491 477 463 450 437 425 412 401 389
Goodwill 1095 3131 3237 3244 2982 2203 10.7% 10.6% 10.7% 2405 2336 2269 2204 2141 2080 2020 1963 1907 1852
Deferred pension and other assets 1053 1285 1311 1223 1314 1400 5.3% 5.6% 5.3% 1203 1168 1135 1103 1071 1040 1011 982 954 926
Restricted assets held by special purpose entities 547 909 916 917 2.2% 3.8% 2.2% 487 473 459 446 433 421 409 397 386 375
Noncurrent assets of discontinued operations 171 0 0.1% 0.3% 0.1%
Total Non Current Assets 13215 22361 22574 22189 20446 19117 82.5% 81.6% 61.4% 80.0% 18059 17543 17041 16554 16080 15621 15174 14740 14319 13909
Total Assets 16276 26249 26595 27482 25270 23238 -2.9% -8.0% 1.9% -2.9% 22574 21928 21301 20692 20101 19526 18968 18425 17898 17387
Real Estate and Related Assets
Cash and cash equivalents 2 7 31 153 286 20 3.1% 5.2% 3.1%
Receivables less discounts and allowances 71 70 64 43 42 144 2.9% 2.7% 2.9%
Mortgage-related financial instruments 62 1 0.5% 0.0% 0.5%
Real estate in process of development and for sale 689 696 723 861 1055 1449 36.1% 38.1% 36.1%
Land being processed for development 946 962 922 1028 1037 1365 42.8% 36.7% 42.8%
Investments in unconsolidated entities 60 28 38 59 61 72 2.1% 2.0% 2.1%
Other assets 187 206 226 283 296 423 10.7% 10.9% 10.7%
Consolidated assets not owned 0 0 0 45 130 151 1.7% 4.3% 1.7%
Total 2017 1970 2004 2472 2907 3624 13.0% 21.1% 15.0% 4168 4793 5512 6338 7289 8383 9640 11086 12749 14661
Total Current Assets(WY and Real Estate) 3134 3965 4116 5489 5152 4285
Total Non Current Assets(WY and Real Estate) 15159 24254 24483 24465 23025 22577
Total Assets(WY and Real Estate) 18293 28219 28599 29954 28229 26862 26741 26721 26813 27031 27390 27908 28607 29511 30647 32048
Liabilities and Shareholders Interest
Weyerhaeuser
Current Liabilities
Notes Payable and commercail paper 4 2 4 3 3 72 0.1% 0.2% 0.1%
Current maturities of long-term debt 8 786 90 489 381 494 2.0% 2.6% 2.0%
Accounts Payable 809 983 1041 1197 1227 1048 6.3% 6.8% 6.3%
Accrued Liabilities 1042 1223 1390 1460 1622 1515 8.2% 9.4% 8.2%
Current liabilities of discontinued operations 0 0 0 22 0 0.0% 0.1% 0.0%
Total Current Liabilities 1863 2994 2525 3149 3255 3129 16.7% 19.0% 28.7% 20.0% 3131 2975 2826 2685 2550 2423 2302 2187 2077 1973
Long Term Debt 5095 11907 11503 9277 7404 7069 50.0% 43.2% 50.0%
Deferred income taxes 2377 4056 4294 4533 4032 3691 22.4% 23.0% 22.4%
Deferred pension, post-retirement 877 1290 1377 1510 1591 1796 8.3% 10.1% 8.3%
Liabilities (non recourse to WY) 0 0 490 815 764 795 2.7% 4.7% 2.7%
Noncurrent liabilities of disc. Operations 0 0 0 3 0 0.0%
Commitments and contingencies 0 0 0 0 0 0.0%
Total Long Term Liabilites 8349 17253 17664 16135 13794 13351 83.3% 81.0% 71.3% 80.0% 12525 11899 11304 10738 10202 9691 9207 8747 8309 7894
Total 10212 20247 20189 19284 17049 16480 -4.9% -7.5% -5.0% 15656 14873 14130 13423 12752 12114 11509 10933 10387 9867
Real Estate and Related Assets
Notes payable and commercial paper 358 63 1 2 3 0 5.2% 0.1% 5.2%
Long term debt 620 814 893 867 851 606 57.1% 53.7% 57.1%
97
Other liabilities 408 472 407 501 417 606 34.5% 37.9% 34.5%
Consolidated liabilities not owned 0 0 0 45 109 115 3.3% 8.3% 3.3%
Commitments and contingencies 0 0 0 0 0 0 0.0%
Total 1386 1349 1301 1415 1380 1327 -0.8% -3.2% -2.0% 1300 1274 1249 1224 1200 1176 1152 1129 1106 1084
Total current liablities (WY and Real Estate) 2221 3057 2526 3151 3258 3129
Total long term liablities (WY and Real Estate) 9377 18539 18964 17548 15171 14678
Total liabilities(WY and Real Estate) 11598 21596 21490 20699 18429 17777 17473 17235 17073 17084 17196 17425 17876 18484 19277 20367
Shareholder's interest
Common shares: $1.25 par value; 400,000,000 authorized shares
236,020,282 issues; 243,138,423 outsanding 271 274 275 300 304 295 3.6% 3.2% 3.6%
0.0%
Exchangeable shares: no par value; unlimited outstanding 0.0% issued and held by nonaffiliates; 1,987,770 and 2,045,315 shares 224 156 156 144 139 135 2.1% 1.5% 2.1%
0.0%
Other Capital 2693 2875 2940 4075 4227 3812 42.4% 42.5% 42.4%
Retained Earnings 3852 3740 3662 4573 4840 4755 52.8% 50.9% 51.6% 50.0% 4938 5156 5409 5617 5864 6153 6402 6697 7040 7350
Cumulative other comprehensive income -345 -422 76 163 290 88 -0.8% 2.0% -0.8%
Total Shareholders Interest 6695 6623 7109 9255 9800 9085 7.0% -0.7% 9.4% 7.0% 9268 9486 9739 9947 10194 10483 10732 11027 11370 11680
Total Liabilities and Shareholders' interest 18293 28219 28599 29954 28229 26862 26741 26721 26813 27031 27390 27908 28607 29511 30647 32048
98
Common Size Balance Sheet
Weyerhaeuser 2001 2002 2003 2004 2005 2006 Avg. 05-06 Avg.
Current Assets:
Cash and cash equivalents 1.2% 0.4% 0.6% 3.8% 3.2% 1.0% 1.7% 2.1%
Receivables, less allowances 6.3% 5.4% 5.6% 5.8% 6.8% 6.8% 6.1% 6.8%
Inventories 8.8% 7.4% 7.2% 7.4% 7.5% 8.3% 7.8% 7.9%
Prepaid expenses 2.5% 1.6% 1.7% 2.2% 1.6% 1.7% 1.9% 1.7%
Total Current Assets 18.8% 14.8% 15.1% 19.3% 19.1% 17.7% 17.5% 18.4%
Property and equipment 51.1% 46.8% 46.0% 43.1% 40.9% 43.1% 45.2% 42.0%
Construction in progress 2.6% 2.6% 1.5% 1.0% 2.1% 1.8% 1.9% 1.9%
Timber and timberlands at cost, less depletion 11.0% 16.8% 16.1% 15.3% 14.7% 15.8% 15.0% 15.3%
Investments in and advances to equity affiliates 3.3% 2.2% 2.1% 1.8% 1.9% 2.1% 2.2% 2.0%
Goodwill 6.7% 11.9% 12.2% 11.8% 11.8% 9.5% 10.7% 10.6%
Deferred pension and other assets 6.5% 4.9% 4.9% 4.5% 5.2% 6.0% 5.3% 5.6%
Restricted assets held by special purpose entities 0.0% 0.0% 2.1% 3.3% 3.6% 3.9% 2.2% 3.8%
Noncurrent assets of discontinued operations 0.0% 0.0% 0.0% 0.0% 0.7% 0.0% 0.1% 0.3%
Total Non Current Assets 81.2% 85.2% 84.9% 80.7% 80.9% 82.3% 82.5% 81.6%
Total Assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Real Estate and Related Assets
Cash and cash equivalents 0.1% 0.4% 1.5% 6.2% 9.8% 0.6% 3.1% 5.2%
Receivables less discounts and allowances 3.5% 3.6% 3.2% 1.7% 1.4% 4.0% 2.9% 2.7%
Mortgage-related financial instruments 3.1% 0.1% 0.0% 0.0% 0.0% 0.0% 0.5% 0.0%
Real estate in process of development and for sale 34.2% 35.3% 36.1% 34.8% 36.3% 40.0% 36.1% 38.1%
Land being processed for development 46.9% 48.8% 46.0% 41.6% 35.7% 37.7% 42.8% 36.7%
Investments in unconsolidated entities 3.0% 1.4% 1.9% 2.4% 2.1% 2.0% 2.1% 2.0%
Other assets 9.3% 10.5% 11.3% 11.4% 10.2% 11.7% 10.7% 10.9%
Consolidated assets not owned 0.0% 0.0% 0.0% 1.8% 4.5% 4.2% 1.7% 4.3%
Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Liabilities and Shareholders Interest
Weyerhaeuser
Current Liabilities
Notes Payable and commercail paper 0.0% 0.0% 0.0% 0.0% 0.0% 0.4% 0.1% 0.2%
Current maturities of long-term debt 0.1% 3.9% 0.4% 2.5% 2.2% 3.0% 2.0% 2.6%
99
Accounts Payable 7.9% 4.9% 5.2% 6.2% 7.2% 6.4% 6.3% 6.8%
Accrued Liabilities 10.2% 6.0% 6.9% 7.6% 9.5% 9.2% 8.2% 9.4%
Current liabilities of discontinued operations 0.0% 0.0% 0.0% 0.0% 0.1% 0.0% 0.0% 0.1%
Total Current Liabilities 18.2% 14.8% 12.5% 16.3% 19.1% 19.0% 16.7% 19.0%
Long Term Debt 49.9% 58.8% 57.0% 48.1% 43.4% 42.9% 50.0% 43.2%
Deferred income taxes 23.3% 20.0% 21.3% 23.5% 23.6% 22.4% 22.4% 23.0% Deferred pension, post-retirement, and other liabilities 8.6% 6.4% 6.8% 7.8% 9.3% 10.9% 8.3% 10.1%
Liabilities (non recourse to WY) 0.0% 0.0% 2.4% 4.2% 4.5% 4.8% 2.7% 4.7%
Noncurrent liabilities of disc. Operations 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Commitments and contingencies 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Total Long Term Liabilites 81.8% 85.2% 87.5% 83.7% 80.9% 81.0% 83.3% 81.0%
Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Real Estate and Related Assets
Notes payable and commercial paper 25.8% 4.7% 0.1% 0.1% 0.2% 0.0% 5.2% 0.1%
Long term debt 44.7% 60.3% 68.6% 61.3% 61.7% 45.7% 57.1% 53.7%
Other liabilities 29.4% 35.0% 31.3% 35.4% 30.2% 45.7% 34.5% 37.9%
Consolidated liabilities not owned 0.0% 0.0% 0.0% 3.2% 7.9% 8.7% 3.3% 8.3%
Commitments and contingencies 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Shareholder's interest
Common shares: $1.25 par value; 400,000,000 authorized shares
236,020,282 issues; 243,138,423 outsanding 4.0% 4.1% 3.9% 3.2% 3.1% 3.2% 3.6% 3.2%
Exchangeable shares: no par value; unlimited outstanding 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% issued and held by nonaffiliates; 1,987,770 and 2,045,315 shares 3.3% 2.4% 2.2% 1.6% 1.4% 1.5% 2.1% 1.5%
Other Capital 40.2% 43.4% 41.4% 44.0% 43.1% 42.0% 42.4% 42.5%
Retained Earnings 57.5% 56.5% 51.5% 49.4% 49.4% 52.3% 52.8% 50.9%
Cumulative other comprehensive income -5.2% -6.4% 1.1% 1.8% 3.0% 1.0% -0.8% 2.0%
Total Shareholders Interest 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
100
Cash Flow Analysis
We forecast the cash flows from operations as well as the cash flows from
investing. After looking at the CFFO ratios (CFFO/Sales, CFFO/NI, CFFO/OI,
CFFO/Gross Profit), we saw a link between sales and CFFO. Our forecast growth
rate reflects this trend. To forecast CFFI we looked at the firms past
performance and arrived at a justifiable conclusion. The six-year average is
skewed by huge year to year changes. This makes this section difficult to
forecast. We chose to use a 10% rate, which was much lower than the average
of approximately 40%.
101
Statement of Cash Flows 2001 2002 2003 2004 2005 2006 Average 05-06 Avg Assume 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Cash flows from operations:
Net earnings 354 518 603 1215 569 355 32.95% 27.27% 690 724 760 798 838 880 924 971 1019 1070
Noncash charges (credits) to income: 0.00% 0.00%
Depreciation, depletion and amortization 876 1225 1318 1322 1337 1283 70.80% 78.03%
Deferred income taxes, net 58 57 18 136 -424 -174 -3.27% -17.51%
Pension and other postretirement benefits -194 -28 140 185 172 132 2.16% 9.01%
Share-based compensation expense 0 0 0 0 -1 28 0.28% 0.84%
Equity in (income) loss of affiliates -60 -18 -14 -66 -51 -65 -2.85% -3.48%
Litigation charges (reduction in reserves) 43 0 109 45 63 -118 1.22% -1.87%
Charges for impairment of goodwill 0 0 0 0 0 749 7.76% 23.28%
Charges for impairment of assets 62 64 103 34 660 123 10.15% 22.66%
Loss on early extinguishment of debt 0 35 0 73 35 0 1.19% 1.00%
Donation of technology 0 0 0 23 0 0 0.17% 0.00%
Gain of disposition of assets and operations 0 0 0 -332 -293 -68 -5.93% -10.47%
Charge for acquisition 0 0 0 0 0 9 0.09% 0.28%
Foreign exchange transation gains 12 -33 -108 -27 -16 -28 -1.59% -1.33% Effect to capitalize interest on excess qualifying assets 0 0 0 0 -43 0 -0.41% -1.23%
Decrease (increase) in working capital: 0.00% 0.00%
Receivables 234 31 -9 -150 -181 29 1.35% -4.26%
Inventories, real estate and land 32 17 199 -227 -225 -315 -4.88% -16.21%
Prepaid expenses 9 18 7 -62 54 -1 0.41% 1.51%
Mortgage-related financial instruments 2 29 1 0.30% 0.00%
Accounts payable and accrued liabilities -265 -88 129 168 107 -240 -4.18% -4.40%
Deposits on land positions 0 -117 -205 -92 -91 -98 -5.21% -5.64%
Intercompany advances 0 0 0 0.00% 0.00%
Other -97 117 -138 -45 -84 -90 -3.58% -5.19%
Net cash from operations 1066 1827 2153 2268 1752 1609 11.30% -8.16% 9.0% 1754 1912 2084 2271 2476 2698 2941 3206 3495 3809
Cash from investing activites -73 -26 -124 -401 451 -899 -38.33% -43.43% 10.0% -
988.9 -
1088 -
1197 -
1316 -
1448 -
1593 -
1752 -
1927 -
2120 -
2332
102
Conclusion
After completing the forecasting section, we feel that Weyerhaeuser is a firm
that will be around for a long time. It appears that the company is decreasing
assets in line with its strategy of sliming the business. However, the firm is still
extremely large. We consider this strategy simply trimming dead weight and a
good move for the company. Another item that was apparent is Weyerhaeuser’s
dedication to paying down debt. This is a sound strategy and a mark of a good
business.
103
Cost of Equity
A firms cost of equity is its estimation of the return they expect from their equity.
In calculating Weyerhaeuser’s cost of equity (Ke) we made use of the CAPM
model. One important limitation of CAPM is that it only explains about 20% of
the firm’s risk. Other factors not included in the model can have an impact on
the firm’s performance. It is just one method for estimation.
We ran regressions based on six points on the yield curve. These points were
three months, one year, two years, five years, seven years, and ten years. This
shows us how stable beta is across the yield curve. It also shows which
investment horizon investors are likely to have. For each point we ran
regressions containing observations for 72 months, 60 months, 48 months, 36
months, and 24 months of data. We did this to gauge the stability of beta. This
included monthly quotes from WY, the S&P 500, and monthly treasury rates. We
were looking for the regression yielding the highest R2 adjusted. This is because
the higher the R2 adjusted, the higher the explanatory power of the regression.
After running the regressions we determined that the three month yield gave us
the highest R2 adjusted (.29116) at the 72 month horizon. This indicates that a
short investment horizon is ideal for WY. However, the R2 adjusted did not very
by much at all points in the yield curve. I feel that the Weyerhaeuser is a
company that should be held for the long term. This regression also gave us a
beta of 1.048. The published Beta for WY was 1.35 (finance.yahoo.com). This
difference is a result of the multiple methods for calculating Beta. We chose to
use the Beta of 1.048 because we calculated it ourselves, and therefore know
how we arrived at that conclusion. This Beta indicates that Weyerhaeuser’s
performance changes at approximately the same rate as the economy as a
whole. In other words, Weyerhaeuser is only 4.8% more volatile than the
market.
104
“The Beta risk of a stock reflects the sensitivity of its cash flows and earnings
(and hence stock price) to economy-wide market movements. A firm whose
performance increases or decreases at the same rate as changes in the economy
as whole will have a beta of one. Firms whose performance is highly sensitive to
economy-wide changes will have beta risks higher than one. Firms that are less
sensitive to economic changes will have a beta less than one.” (Business
Analysis and Valuation)
We found Beta to be stable at all points of the yield curve. However, it varied as
much as .4 when the number of entries in the regression was varied (72, 60, 48,
36, and 24 months).
We used the risk free rate of 4% for the three month treasury yield (St. Louis
Fed). The average market risk premium from 1926 to 2005 was 6.8%. The
market risk premium is the excess return investors require for bearing risk. We
felt that this long run average of MRP was most appropriate estimate, because it
covers such a long history of market returns. The last number needed to use
CAPM is the size premium. Size premium takes the size of the firm into
consideration. Historically small firms have generated larger returns.
Weyerhaeuser is a large firm, so its size premium was a relatively small .07%.
The next step was to plug the numbers into the CAPM model.
Cost of Equity = Risk Free Rate + Beta * (Market Risk Premium + Size Premium)
Ke = Rf + Beta (MRP + Size Premium)
Ke = .04 + 1.048 ( .068 + .007)
Ke = 11.20%
105
Regression Analysis
3 Month Rate 72 month
60 month 48 month 36 month
24 month
Risk Free 4.00% 4.00% 4.00% 4.00% 4.00% R-Square Adj. 0.29116145 0.250008 0.227223779 0.194366179 0.1518683
Beta 1.04773442 1.2235454 1.445191091 1.369455534 1.4041436
Ke 11.20% 12.41% 13.93% 13.41% 13.65%
1 Year Rate 72 month 60 month 48 month 36 month
24 month
Risk Free 4.10% 4.10% 4.10% 4.10% 4.10% R-Square Adj. 0.29093278 0.2502659 0.226845263 0.194372089 0.1518502
Beta 1.04911554 1.2220912 1.441624992 1.366867893 1.4009755
Ke 11.31% 12.50% 14.00% 13.49% 13.72%
2 Year Rate 72 month 60 month 48 month 36 month
24 month
Risk Free 3.97% 3.97% 3.97% 3.97% 3.97% R-Square Adj. 0.28968049 0.2499317 0.226668783 0.194204396 0.1518576
Beta 1.04579964 1.2214625 1.440299373 1.365113883 1.3996079
Ke 11.15% 12.36% 13.86% 13.35% 13.59%
5 Year Rate 72 month 60 month 48 month 36 month
24 month
Risk Free 4.20% 4.20% 4.20% 4.20% 4.20% R-Square Adj. 0.28859939 0.2494117 0.22694882 0.194678826 0.1529103
Beta 1.04323684 1.2220963 1.441013552 1.366295088 1.4022909
Ke 11.37% 12.60% 14.10% 13.59% 13.83%
7 Year Rate 72 month 60 month 48 month 36 month
24 month
Risk Free 4.33% 4.33% 4.33% 4.33% 4.33% R-Square Adj. 0.28841559 0.2490154 0.22701702 0.194821016 0.1532634
Beta 1.0428153 1.2219552 1.441364165 1.36711309 1.403584
Ke 11.49% 12.72% 14.23% 13.72% 13.97% 10 Year Rate 72 month
60 month 48 month 36 month
24 month
Risk Free 4.53% 4.53% 4.53% 4.53% 4.53% R-Square Adj. 0.28849819 0.2489732 0.227256061 0.195222988 0.1538259
Beta 1.04310776 1.2226735 1.442204257 1.368804288 1.40574
Ke 11.70% 12.93% 14.44% 13.93% 14.19%
106
Cost of Debt
We calculated Weyerhaeuser’s before tax cost of debt (Kdbt) to be 5.55%. The
after tax cost of debt (Kdat ) was then calculated to be 3.61% by using the
following formula, (Kdbt * (1 – tax rate)). Weyerhaeuser’s tax rate was found to
be 35%. This rate was found on WY’s 10-K.
To get the before tax cost of debt we used a weighted average calculation. We
first took all line items related to liabilities and divided them by total liabilities to
get a weight for each item. We then obtained the appropriate interest rate for
each item and multiplied the weight by the rate to get a value weighted rate.
Finally, we added the value weighted rates together to get the Kdbt . We used
the 3 month non-financial commercial paper rate of 4.63% (St. Louis Fed) for
commercial paper, accrued liabilities, and accounts payable. We used the 6%
rate provided on the WY 10-K for pension and post-retirement benefits. We also
used the 2 year treasury rate of 3.97% for deferred income tax (St. Louis Fed).
Finally, we used a 6.54% rate for long term debt. This was obtained by the
weighting the portion of long term financing provided by banks as well as bond
financing multiplied by their weights and rates.
Current Liabilites Value Weight Rate Value Rated Weight
Current Portion of LT Debt 494 0.0290 0.0654 0.0019Accounts Payable 1048 0.0616 0.0463 0.0029Other Liabilities 2236 0.1314 0.0463 0.0061Commercial Paper 72 0.0042 0.0463 0.0002 Long Term Liabilities Long Term Debt 7675 0.4512 0.0654 0.0295Deffered Income Tax 3691 0.2170 0.0397 0.0086Deffered Pension 1796 0.1056 0.06 0.0063
1Before Tax 5.55%
After Tax 3.61%
107
Weighted Average Cost of Capital
We then used the cost of equity and cost of debt from above to help calculate
the WACC. The before tax WACC was 8.09%, and the after tax WACC was
7.02%. We used the market cap of the firm for the value of equity, and total
liabilities for value of debt.
108
Analysis of Valuations
We used several different valuation models to help value Weyerhaeuser. The
models included method of comparables, dividend discount model, discounted
cash flows, residual income, long run return on equity residual income
perpetuity, and the abnormal earnings growth model. Each of these models
takes a different approach to valuing the company. It is important to remember
that each model has a different degree of reliability. We have taken this fact into
consideration of our final recommendation.
Method of Comparables
Using method of comparables to value a company is a quick and easy method.
However, the results are not all that accurate. The amount of work put into the
valuation shows itself in the reliability of the results. We do not put much value
into the results given from this method. However, if enough people use method
it can become a “self fulfilling prophecy”.
We first gathered the appropriate numbers for these ratios for Weyerhaeuser
and its competitors. Then we computed the ratios and calculated the industry
average excluding Weyerhaeuser. We then set the industry average equal to
Weyerhaeuser’s ratios to drive out a value.
Price P/E Trailing $ 18.85
P/E Forward $ 44.52
D/P $ 94.99 Undervalued > $88.04 P.E.G $ 20.79 Fairly Valued
P/EBITDA $ 53.08 Overvalued < $58.70 P/FCF $ 34.83 EV/EBITDA $ 1.96 P/B $ 47.74
Trailing Price/Earnings
The trailing price to earnings ratio takes the most stock price divided by the most
recent earnings per share. We calculated this ratio for all of the competitors to
109
derive a industry average. We then took this average and set it equal to P/(WY
EPS). The value derived by solving for P gives us our estimated value for
Weyerhaeuser.
WY Earnings Per Share Industry Average P/E Valuation Price
$1.84 10.24 $18.85
This gives us a much lower estimated price than the observed price on Nov, 1,
2007 of $73.37. This leads us to believe that Weyerhaeuser is overvalued. It is
important to remember that the trailing P/E ratio does not agree with financial
theory. Therefore, it should not be considered to be very accurate.
Forward Price/Earnings
The forward P/E ratio is computed in the same way as trailing P/E, but with one
exception. Forward P/E look at earnings forecasted one year into the future
divided by the current price. We took obtained the competitor’s forward P/E
from yahoo.finance.com. to calculate the industry average. We then took
Weyerhauser’s forecasted net income for 2007 and divided it by the number of
shares outstanding. Once we calculated these numbers we set the industry
average equal to P/ (WY EPS) and solved for P to get the value
WY Forward EPS Industry Avg. Forward
P/E
Valuation Price
$3.27 13.62 $44.52
The valuation derived from this method ($44.52) shows Weyerhaeuser to be
overvalued. The forward P/E ratio is a better indicator than trailing P/E, but it
still should not be relied upon too heavily.
110
Dividend/Price Ratio
The dividend/price ratio, also called dividend yield, is computed by dividing
yearly dividends paid by the current price. To derive a value from this method
we calculated the industry average dividend yield from the list of competitors.
We then took Weyerhaeuser’s dividends per share and divided it by the industry
average. This calculation gave us a valuation price.
WY DPS Industry Avg. D/P Valuation Price
$2.20 .0232 $94.99
This method shows Weyerhaeuser to be overvalued. Once, again these methods
are not very reliable. I would not recommend trading on the information
provided by this model.
P.E.G. Ratio
The P.E.G. ratio is computed by dividing a firms P/E by its expected earnings
growth rate. This ratio is driven by earnings and growth. A firm is commonly
considered overvalued if it’s P.E.G. is greater than one. We found WY’s P.E.G to
be 7.98. This would suggest that the firm is overvalued.
We first calculated the industry average by taking the average of the competitors
P.E.G. ratios. We found this number to be 2.26. We then multiplied the average
by WY’s expected earnings growth rate of 5%. Next, we multiplied the answer
by WY’s EPS. This method gave us a share price of $20.79, leading us to believe
that WY is overvalued.
WY EPS Growth Rate Ind. Avg. P.E.G. Valuation Price
$1.83 .05 2.26 $20.79
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Price/Book Ratio
The price to book ratio is computed by taking the price per share divided by the
book value of equity per share. If a firm has a P/B > 1, it means that investors
are paying a premium over the book value of equity. In order to drive out a
valuation price from this method we completed the following steps. First, we
calculated the average of the competitors P/B ratios. We found this number to
be 1.28. We multiplied this number by Weyerhaeuser’s book per share price of
$37.38 to give us an estimated price of $47.74. This price shows WY to be
overvalued as well.
WY BPS Ind. Avg. P/B Valuation Price
$37.38 1.28 $47.74
Price/EBITDA Ratio
The price/EBITDA ratio shows the relationship between price and earnings
before interest, taxes, depreciation, and amortization. This is similar to a cash
flow measure. To drive an estimated price out of this method we took the
industry average of the competitors P/EBITDA ratios. The competitor’s ratios
were found on yahoo.finance.com. The next step was to multiply
Weyerhaeuser’s EBITDA per share ($10.14) by the industry average P/EBITDA.
This gave us an estimated share price of $53.08.
WY EBITDA per share Ind. Avg. P/EBITDA Valuation Price
$10.14 5.24 $53.08
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Price/Free Cash Flows per share
To find the P/FCF ratio you must first find the free cash flows for a firm. Free
cash flows are the cash from operating activities +/- cash from investing
activities. We then divided this number by the number of share outstanding to
get a per share measure.
The industry average P/FCF ratio was found to be 10.37. We then set this equal
to P/ (WY FCF) which was $3.36. Solving for P gave yielded an estimated price
of $34.83.
WY FCF per share Ind. Avg. P/FCF Valuation Price
$3.36 10.37 $34.83
Enterprise Value/EBITDA
Enterprise value is a measure of a firm’s current core underlying assets. It is
computed by the following formula.
EV = MVE + BVL – (Cash + All Investments)
We gathered all of the competitors EV/EBITDA ratios from yahoo.finance.com.
We averaged all of them together and got an average of 7.96. We then used
the following formula to drive out an estimated price for WY. All values in
billions.
Ind. Average = (P * # of shares +(Cash +all investments))/EBITDA
7.96 = (P * .211 + (16.62))/ 2.14
17.03 = P * .211 + 16.62
.4144 = P * .211
P = $1.96
This estimated price of $1.96 per share shows Weyerhaeuser to be extremely
overvalued. Obviously this valuation method does not work well for
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Weyerhaeuser. The estimated price is far below any reasonable estimated price
for WY.
Conclusion
Based on these valuations, we find Weyerhaeuser to be overvalued. However,
these methods are not a very accurate way to value a firm. They assume
uniformity of firms that in reality doesn’t exist. These methods also fail to
consider the forecasted picture of the firm. Intrinsic valuation models do a much
better job of this.
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Intrinsic Valuations
There are many different ways to value a company and some are better than
others. Intrinsic valuations help you to assign a more accurate value to a
company than that of the method of comparables. There are five basic types of
intrinsic valuations which is the dividend discount model, the free cash flows
model, the residual income model, the Abnormal Earnings Growth model, and
the long run ROE residual income model. These five models evaluate different
factors inside the company which affect the value of the company. The more
factors a model has taken into consideration will generate a more accurate
company value. In the rest of this section we will discuss the basic principles of
each model and take a look at how our findings relate to the actual pricing at
this current time.
Dividend Discount Model
The dividend discount model is a way to value a company by looking at the
money the company holds to give back to investors. Shareholders can evaluate
the money that they are given in dividends and derive a value to that particular
company. This may sound nice but there are several problems with this model
that will be discussed below.
The dividend discount model is one of the least reliable of the five intrinsic
models. It only has an explanatory power of about 5%. The reason why the
dividend discount model is not as accurate as the others is mainly due to the
assumptions that the model entails. This model assumes that a company’s
dividends increase at a constant rate over time. In reality dividends usually
increase in lumps and then remain constant until the next increase. This makes
dividends hard to forecast in the long run. The model also assumes that
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dividends are related to share value. This is not exactly correct. Any money
received in dividends is taken out of the share price. For if a company pays a $2
dividend, stock price should decrease by $2 as well. This ends up creating no
value for shareholders. When dividend policies are set up like this you can’t
really judge the performance of that company. Some companies have actually
been known to take out loans to pay for their dividends. This model only works
well when the company has a fixed dividend yield. This ties dividends directly to
earnings. WY does not have a fixed dividend yield. Therefore, this model is not
a great predictor for this firm.
The model takes the present value of future dividend payments which we
forecasted and adds them to the present value of the terminal value perpetuity
of dividends to be paid. This gave us a value for the firm at the end of 2006.
We then applied the following formula to get a time consistent price at Nov, 1,
2007.
Time consistent Price = P * (1+Ke)10/12
growth 0 0.03 0.05 0.07 0.09
0.17 18.66 19.69 20.66 22.03 24.07 Undervalued > $88.04
0.15 21.48 23.1 24.72 27.15 31.2 Fairly Valued
0.13 25.23 27.91 30.8 35.63 45.29 Overvalued < $58.70
Ke 0.112 29.81 34.26 39.61 50.06 79.5 0.09 38.01 47.24 61.09 102.6 n/a 0.07 50.11 71.53 121.5 n/a n/a 0.05 72.15 144.6 n/a n/a n/a
The above sensitivity analysis shows Weyerhaeuser to be mostly overvalued. It
would take a growth rate of 3% and a cost of equity of 7% to make the
company fairly valued at a price of $71.53, which is still below the observed price
at $73.37. The 7% cost of equity is unlikely to occur in real life and is much
below the current cost of equity of 11.2%.
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Discounted Free Cash Flow Model
The discounted free cash flow model does a better job of valuing a firm than the
dividend discount model. Cash flow valuation is rooted in basic finance theory of
present value. However, the model still has some problems when applied to
valuing a firm. First, the model has room for manipulation. A firm may increase
cash flows by simply cutting back on investments. In the long run this strategy is
likely to decrease future earnings. Secondly, the model treats investments as a
loss of value. In reality investments should increase value in the long run.
Finally, stock prices are forward looking while cash flows are backwards looking.
Because of its limitations discounted free cash flow only has an explanatory
power of about 15%. The model takes before tax WACC, cash from operations,
cash from investments, book value of debt, and the growth rate of the terminal
value perpetuity into consideration.
We first looked at our forecasted statement of cash flows. To get the free cash
flows we subtracted cash from operations from cash from investments year by
year. We then multiplied each year by the PV factor for that year to get a total.
We then added the present value of the terminal value perpetuity to it to get the
value of the firm. We then subtracted the book value of liabilities to get the
estimated market value of equity. This was then divided by the number of
shares outstanding to get a per share figure. We then converted this to a time
consistent price for Nov 1, 2007.
Growth
0.03 0.04 0.05 0.06 0.07
0.11 n/a n/a n/a n/a 9.78
0.1 n/a n/a 2.52 17.85 43.39 Undervalued > $88.04
WACCbt 0.09 n/a 9.93 26.59 54.36 109.9 Fairly Valued
0.0809 15.94 33.22 61.7 117.42 275.38 Overvalued < $58.70
0.07 46.42 79.33 145.14 342.58 n/a
0.06 93.53 165.26 380.45 n/a n/a
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The sensitivity analysis performed above shows Weyerhaeuser to be either
undervalued or overvalued depending on which WACC and growth rate is
applied. It is important to note that the estimated share price changes
significantly when either WACC or the growth rate are varied. This is a
weakness of this model. In reality a small change in either of these variables
should not have such a drastic effect on share price. It is also important to note
that the PV of cash flows was equal to 23% of the value of the firm. The PV of
the terminal value perpetuity was equal to 77% of the value of the firm. This
lessens the potential accuracy of this model for WY. Forecasts are less accurate
the farther you go into the future. Having 77% of the firms value resting on
cash flows that are far into the future leaves a lot of room for error.
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Residual Income Model
The Residual income model is by far the best model to value a firm. The model
has at least 50% explanatory power. This gives you a much more accurate
picture of the firm that the previous models have. This model is based on
accrual accounting data. Accrual accounting is forward looking. Stock prices are
forward looking. Cash flows are backward looking. So, this model should give
you a better picture than the FCF model.
We first found the book value of equity for the years forecasted. This was found
by adding retained earnings to the initial book value of equity each year.
Retained earnings is equal to net income minus dividends paid. Residual income
can be defined as actual earnings minus normal earnings. Normal earnings are
the previous year’s shareholders equity multiplied by the cost of equity. This is
based on the theory that in equilibrium a firms earnings should grow at its cost
of equity. For WY we found negative residual income each year of the forecast.
This shows that the firm is destroying shareholder value each year.
After finding our forecasted residual income we multiplied them by the yearly
present value factor to get the total PV of annual residual income. We then
found the continuing terminal value perpetuity and took the present value of it.
It is important to note that the growth rate for the perpetuity is a negative
number. This relies on the theory that firms earnings should move towards
equilibrium. Equilibrium, in this case, is that a firm’s earnings should be equal to
its cost of equity. This would make its residual income equal to zero. A negative
growth rate allows for this to happen. We then took the initial book value of plus
or minus the PV of annual residual income and the PV of the continuing terminal
value perpetuity. This total was then divided by the number of shares
outstanding to get a per share price. We then found the time consistent price
per share for Nov 1, 2007.
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growth 0 -0.1 -0.2 -0.3 -0.4 -0.5 0.17 26.24 26.73 26.95 27.08 27.17 27.23 0.15 29.04 29.74 30.04 30.21 30.32 30.39 Undervalued > $88.04 Ke 0.13 32.21 33.24 33.65 33.87 34 34.1 Fairly Valued 0.112 35.38 36.89 37.43 37.71 37.88 37.99 Overvalued < $58.70 0.09 39.57 42.08 42.86 43.24 43.47 43.61 0.07 43.34 47.63 48.74 49.25 49.54 49.73
The above sensitivity analysis shows Weyerhaeuser to be overvalued at all points
in the analysis. We are fully aware that our forecasts are likely to have some
amount of error in them that could bias these results. However, it would take a
growth rate of -50% and a cost of equity of 1.5% to bring the valuation up to
the observed market price of $73.37. These are extremely unrealistic rates that
are likely to never occur in reality. For this reason I feel comfortable with the
overvalued recommendation provided by this model.
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Long Run Return on Equity Residual Income Perpetuity Model
The long run return on equity residual income perpetuity model is another
credible way to value a company. It is driven by three key factors. The three
factors are long run return on equity, cost of equity, and long run growth in
equity. We used the cost of equity as found previously of 11.2%. To calculate
the long run return on equity we made use of our forecasted financials. We
divided net income by the previous year’s book value of equity to get the return
on equity. These figures helped us to gauge Weyerhaeuser’s probable long run
return on equity. We estimated this number to be 9%.
Weyerhaeuser’s Return on Equity
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
7.59% 7.81% 8.02% 8.2% 8.64% 8.63% 8.81% 9.04% 9.24% 9.41%
To get the growth rate on equity we simply calculated the yearly change in book
value of equity. By doing this we were able to make a more accurate estimate of
the firm’s long run growth in equity rate. We estimated this number to be 2%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
2.01% 2.35% 2.68% 2.13% 2.49% 2.84% 2.37% 2.75% 3.11% 2.73%
Once these assumptions were made we could then compute the long run return
on equity residual income perpetuity. The formula for this perpetuity is shown
below.
MVE = BVE * (1+(ROE-Ke)/(Ke-g)))
We then divided the result of this formula by the number of shares outstanding
to give us an estimated share price. We then converted this to a time consistent
share price for Nov 1, 2007. The following sensitivity analysis shows our
findings.
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ROE = 9% growth 0.02 0.03 0.04 0.05 0.06 0.17 20.08 18.44 16.55 14.34 11.74 0.15 23.17 21.52 19.56 17.21 14.34 Undervalued > $88.04
Ke 0.13 27.39 25.82 23.91 21.52 18.44 Fairly Valued 0.11 32.74 31.49 29.89 27.76 24.83 Overvalued < $58.70 0.09 43.03 43.03 43.03 43.03 43.03 0.07 60.25 64.55 71.72 86.07 129.1
Growth = 4% ROE
0.077 0.09 0.11 0.13 0.15 0.17 12.25 16.55 23.17 29.97 36.41 0.15 14.48 19.56 27.39 35.21 43.03
Ke 0.13 17.69 23.91 33.47 43.03 52.6 Undervalued > $88.04 0.11 22.11 29.89 41.84 53.79 65.75 Fairly Valued 0.09 31.85 43.03 60.25 77.46 94.68 Overvalued < $58.70 0.07 53.08 71.72 100.41 129.1 157.79
Ke = 11.20% ROE
0.077 0.09 0.11 0.13 0.15 0.02 26.66 32.74 42.1 51.45 60.81 0.03 24.67 31.49 41.98 52.48 62.98
Growth 0.04 22.11 29.89 41.84 53.79 65.75 Undervalued > $88.04 0.05 18.74 27.76 41.65 55.53 69.41 Fairly Valued 0.06 14.07 24.83 41.38 57.93 74.48 Overvalued < $58.70 0.07 7.17 20.49 40.99 61.48 81.97
The above sensitivity analysis shows Weyerhaeuser to be overvalued once again.
Although not so much as the previous residual income model did. The analysis
shows that it would take an unreasonable combination of ROE, g, and Ke to
bring the price up to the observed price of $73.37. For this reason, I feel that
the overvalued estimate given by this model is likely to be correct.
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Abnormal Earnings Growth Model
The abnormal earnings growth model is another credible method for valuing a
firm. It is a modified version of the P/E forward ratio. One important point to
mention is that the AEG model discounts back to year one (the other models go
back to year zero). The model is also very similar to the residual income model.
Abnormal earnings are earnings about the normal earnings that create value for
the firm. Our sensitivity analysis is presented below. It is important to note that
a negative growth rate is used. This is a function of the theory that abnormal
earnings should return to equilibrium of zero. This is another similarity of the
residual income model.
growth 0 -0.1 -0.2 -0.3 -0.4 -0.5 0.17 21.83 21.84 21.85 21.83 21.86 21.86 0.15 25.51 25.4 25.35 25.46 25.31 25.29 Ke 0.13 30.7 30.29 30.12 30.52 29.98 29.94 Undervalued > $88.04 0.112 37.53 36.49 36.12 37.06 35.81 35.74 Fairly Valued 0.09 51.08 48.13 47.21 49.68 46.5 46.33 Overvalued < $58.70 0.07 74.24 66.23 64.15 70.15 62.65 62.29
The first step is to compute the DRIP income. DRIP is a dividend reinvestment
program. To compute DRIP we multiplied the dividends paid by the cost of
equity. We then added DRIP year 0 to net income year 1 to get the Cumulative
Dividend Earnings for year 1. We then subtracted normal earnings from this
number to get the annual AEG. This number provides a valuable check figure.
Annual AEG should be equal to the annual change in residual income from the
residual income model. In WY’s case, the numbers matched up.
2008 2009 2010 2011 2012 2013 2014 2015 2016 Annual AEG 14 12 10 17 14 12 18 15 12 Annual Change in RI 14 12 10 17 14 12 18 15 12
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This check figure helps to prove that the calculations we made within these
models are correct.
We then found the present value of the annual AEG by multiplying the year by
year AEG by the yearly PV factor and adding them up. The next step was to find
the PV of the perpetuity. We then added this number to PV of annual AEG to get
total PV of AEG. This was then added to the core earnings (2007 NI). We then
divided by the number of shares outstanding to get a per share figure. We then
divided this number by the cost of equity to get an estimated share price. We
then converted this into a time consistent price for Nov, 1, 2007.
The sensitivity analysis above shows Weyerhaeuser to be overvalued. It would
take an cost of equity of 7% to make the firm fairly valued. In reality this would
be close to the lowest possible cost of equity. I feel that this is a condition that
is highly unlikely to be found in reality. Therefore, I am confident in the
overvalued indication presented from the AEG model.
Conclusion
The only model that showed WY to be fairly valued was the discounted cash
flows model. This model is somewhat inaccurate because cash flows are
backwards looking, while stock prices are forward looking. The last three
models, residual income, long run return on equity residual income perpetuity,
and abnormal earnings growth, all show WY to be overvalued. These three
models are good predictors of stock price. Therefore, we feel confident in the
overvalued estimation shown by them.
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Credit Analysis
When thinking of investing in a company, you need to make sure that the
company is not struggling and heading for bankruptcy. One good indicator to
look at if you want to check for company’s which are heading for this type of
disaster is by computing its Altman z score. This score is calculated by looking at
five different ratios and applying a weight to each of those numbers, some being
more significant than others. This system isn’t perfect and it can only be as
accurate as the information you put into it so it is important to realize that it isn’t
immune to accounting distortions. Another flaw to this system is how it
evaluates start-up companies. Newer companies are always going to yield a
lower score because of their earnings and lack of financial history. This model is
also just a snapshot for the present time. It should be calculated fairly often and
you should be aware of how write offs can affect your score and make it not as
accurate. This model is fairly accurate and predicted 72% of corporate
bankruptcies two years prior (www.investopedia.com). A lower score indicates a
higher likely hood that a company will go bankrupt. When the score is above
three this will indicate that the company is healthy. If the score is between 1.8
and 3 then they are in the grey area and should be further investigated before
investing. If the score falls below 1.8 then the company is said to be heading for
bankruptcy.
The formula shown below is the correct way to calculate the Altman Z-score:
Z-Score=1.2(working capital/total assets) +1.4(retained earnings/total assets)
+3.3(EBIT/total assets) +.6(Market value of equity/total liabilities) +1(sales/total
assets)
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Weyerhaeuser’s Altman Z Scores
2002 2003 2004 2005 2006
1.45 1.42 1.78 1.90 1.93
The current Altman Z-score for Weyerhaeuser is 1.93. This is very close to being
a red flag but if look at the history they have been steadily improving over the
years. We feel that a big reason Weyerhaeuser is experiencing lower numbers is
because of all of the debt. They have steadily been dropping their debt for the
past five years. Companies in this industry all have lots of debt because to be a
big competitor you have to own lots of land and have a big scale operation which
costs lots of money. We have all heard the phrase “you have to spend money to
make money.” They were supposed to go bankrupt starting in 2002 but it looks
like they buckled down and really started managing better. This just goes to
show you that just because you fall below 1.8 you can still battle back and
salvage your company.
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Analyst Recommendation
After much research, we have come to the conclusion that the Weyerhaeuser
Company is significantly overvalued and you should sell if you own stock. We
came to this conclusion by analyzing the industry, analyzing the accounting
policies, evaluating annual financial reports, comparing them with competitors,
forecasting the company’s results for the next ten years, and running their
information through many different valuation models.
All the numbers and assumptions used to evaluate this company were taken
from annual reports found online. We developed industry averages by
comparing Weyerhaeuser with four of its biggest competitors. The four
competitors that we chose to use in these calculations were International paper,
Louisiana Pacific, Bowater, and Universal Forrest Products. In the lumber and
wood productions industry, it is very competitive with many big firms. The firms
in this industry compete on tight cost control systems in order to succeed. It is
important to manage jobs and money very well in this industry. Bad
management decisions which cause companies to not run efficiently can really
hurt a company in this industry.
When we ran the ratio analysis, we found that Weyerhaeuser was among one of
the better companies in the industry. They were constantly being a little better
than the industry average. We could also tell that Weyerhaeuser had better
potential than how they were actually performing. We feel that some of this was
due to bad decisions by management. They later corrected these mistakes and
started producing at a more efficient level. They had ample amounts of
information available to view online and were constantly providing more
information than what was actually required by law. They were fairly consistent
with their numbers and there wasn’t many big corrections made to their previous
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year’s statements. That is a good indicator that the accounting was done
properly and numbers hadn’t been misconstrued. We feel that the numbers
used to get our results for valuation are accurate enough to get a good
valuation.
We forecasted the next ten years by looking back on the yearly financial
statements for the last five years. We also looked at the same types of
statements for that of their competitors as well. We used a 5% growth rate,
which is a normal growth rate for firms in this industry. All the numbers were
kept relatively conservative to keep as much error out of our valuation as
possible and help make sure that the numbers are as accurate as possible.
We didn’t find any big problems in the forecasts we constructed. Weyerhaeuser
is one of the biggest companies in this industry capturing a big part of the
market. They have had management problems at times but have constantly
battled back and corrected mistakes that had been made and it really shows in
their Altman Z-score. All the intrinsic models showed that the company was
overvalued except the free cash flows model which showed that the company
was fairly valued. However, this model is one of the least accurate ones used in
this valuation.
After much research and analyzing, we feel that Weyerhaeuser is extremely
overvalued. We recommend that you should be set to sell if you own stock.
One explanation for the high price the stock is trading at is the commodity
market which it competes in is also experiencing high prices. When commodities
start to go down, Weyerhaeuser will move closer to the actual value of the
company.
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Appendix
Weyerhaeuser Trend Analysis 2002 2003 2004 2005 2006 LIQUIDITY Current Ratio 1.3 1.6 1.7 1.6 1.4 Quick Asset Ratio 0.5 0.7 0.9 0.9 0.6 A/R Turnover 12.5 12.8 13.0 12.6 12.8 A/R Days 29.2 28.4 28.1 29.0 28.6 Inventory Turnover 6.8 7.4 7.0 8.0 7.7 Inventory Days 53.6 49.5 51.9 45.5 47.6 Working Capital Turnover 19.1 12.5 9.2 11.6 18.9 PROFITABILITY Gross Profit Margin 21.51% 21.53% 24.65% 22.53% 21.73% Operating Expense Ratio 7.75% 7.94% 7.64% 7.34% 8.16% Net Profit Margin 1.30% 1.39% 5.99% 3.32% 2.07% Asset Turnover 0.66 0.69 0.71 0.78 0.82 Return on Assets 0.85% 0.97% 4.28% 2.60% 1.69% Return on Equity 3.60% 4.18% 18.05% 7.92% 4.62% CAPITAL STRUCTURE Debt to equity ratio 3.3 3.0 2.2 1.9 2.0 Times interest earned 1.7 1.9 3.1 1.9 2.2 Debt service margin 228.4 2.7 25.2 3.6 4.2 IGR -0.40% -0.27% 3.02% 0.94% -0.33% SGR -1.70% -1.09% 9.78% 2.71% -0.98%
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LOUISIANA-PACIFIC Financial Statement Ratio Analysis
2002 2003 2004 2005 2006
Liquidity Analysis Current Ratio 1.844 4.576 3.646 5.179 5.678Quick-asset ratio 0.888 3.667 3.042 4.252 4.606Accounts Receivable Turnover 16.114 16.901 14.721 17.704 14.200
Days supply of receivables 22.651 21.597 24.795 20.617 25.704Inventory Turnover 7.850 8.364 7.577 7.421 7.423
Days supply of inventory 46.496 43.637 48.174 49.184 49.172Working Capital turnover 2.112 1.424 1.336 1.215 1.264
Profitability Analysis
Gross profit margin 0.198 0.335 0.402 0.314 0.183Operating profit margin 0.047 0.248 0.273 0.201 0.049Net profit margin -0.039 0.118 0.154 0.175 0.055
Asset turnover 0.576 0.718 0.791 0.722 0.650
Return on assets -0.022 0.085 0.122 0.127 0.036
Return on equity 0.062 0.208 0.238 0.223 0.060 Capital Structure Analysis
Debt to Equity Ratio 1.335 1.000 0.601 0.529 0.440
Times interest earned 0.789 6.444 11.415 9.553 2.231Debt service margin 0.419 2.027 2.406 2.113 0.763
igr -2.23% 8.50% 11.24% 11.21% 1.75% sgr -5.21% 17.00% 17.99% 17.14% 2.53%
igr 5.77% 5.84% 6.38% 7.68% 7.68% sgr 13.93% 13.15% 13.62% 15.60% 13.62%
avg igr 1.77% 7.17% 8.81% 9.45% 4.72% avg sgr 4.36% 15.08% 15.81% 16.37% 8.07%
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International Paper Ratios 2002 2003 2004 2005 2006 Liquidity Current ratio 1.7 1.4 1.7 2.4 1.9 Quick asset ratio 0.8 0.8 0.7 0.8 0.9 A/R turnover 9.0 8.7 8.7 9.0 8.1 A/R days 40.6 42.0 41.8 40.6 44.9 Inventory Turnover 6.3 6.3 3.2 8.5 8.5 Inventory days 57.6 57.9 113.5 43.2 42.9 Working capital turnover 7.9 8.0 6.6 6.9 7.0 Profitability Gross profit margin 0.3 0.3 0.3 0.2 0.3 Operating expense ratio 0.1 0.1 0.1 0.1 0.1 Net profit margin 0.1 0.1 0.1 0.1 0.2 Asset turnover 0.7 0.7 0.6 0.8 0.9 Return on assets 0.1 0.0 0.0 0.0 0.1 Return on equity 0.2 0.2 0.2 0.1 0.4 Capital Structure Debt to equity ratio 3.6 3.6 3.6 3.6 3.6 Times interest earned 3.6 3.3 3.1 3.5 4.8 Debt service margin 0.4 0.4 0.4 0.4 0.4
131
UFPI Trend Analysis 2002 2003 2004 2005 2006 LIQUIDITY Current Ratio 2.70 2.33 2.21 2.46 2.47 Quick Acid Ratio 1.09 1.08 0.96 1.13 1.04 A/R Turnover 15.59 13.79 16.16 14.54 17.97 A/R Days 23.42 26.46 22.59 25.10 20.31 Inventory Turnover 8.49 9.68 10.13 9.19 9.31 Inventory Days 42.99 37.72 36.03 39.71 39.19 Working Capital Turnover 8.85 9.97 11.02 9.03 9.42 PROFITABILITY Gross Profit Margin 14.05% 13.59% 12.08% 13.35% 14.32% Operating Expense Ratio 9.65% 9.36% 8.21% 8.76% 9.70% Net Profit Margin 2.23% 2.11% 1.98% 2.50% 2.63% Asset Turnover 2.58 2.76 3.22 3.07 2.92 Return on Assets 5.77% 5.84% 6.38% 7.68% 7.68% Return on Equity 13.93% 13.15% 13.62% 15.60% 13.62% CAPITAL STRUCTURE Debt to equity ratio 1.41 1.25 1.14 1.03 0.77 Times interest earned 6.34 5.49 6.46 8.15 8.76
132
3 Month Regression SUMMARY OUTPUT 72 month
Regression Statistics Beta R2-adj Multiple R 0.548766882 72 month 1.047734421 0.29116145 R Square 0.301145091 Adjusted R Square 0.291161449 Standard Error 0.05593908 Observations 72 ANOVA
df SS MS F Significance
F Regression 1 0.094388143 0.094388143 30.1638524 6.0111E-07 Residual 70 0.219042646 0.003129181 Total 71 0.313430789
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0%
Upper 95.0%
Intercept 0.005101714 0.006624074 0.770177698 0.443786012 -0.00810958 0.01831301 -
0.00810958 0.01831301 X Variable 1 1.047734421 0.190769002 5.492162816 6.01112E-07 0.66725765 1.42821119 0.66725765 1.42821119
133
3 Month Regression SUMMARY OUTPUT 60 month
Regression Statistics Multiple R 0.512561941 R Square 0.262719744 Adjusted R Square 0.250008015 Standard Error 0.054355099 Observations 60 ANOVA
df SS MS F Significance
F Regression 1 0.061061672 0.06106167 20.6675074 2.82841E-05 Residual 58 0.171359656 0.00295448 Total 59 0.232421327
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0%
Upper 95.0%
Intercept 0.002752272 0.00726438 0.37887223 0.70616617 -
0.011788964 0.01729351 -
0.01178896 0.01729351 X Variable 1 1.223545379 0.269138626 4.54615303 2.8284E-05 0.684805891 1.76228487 0.68480589 1.76228487
134
3 Month Regression SUMMARY OUTPUT 48 month
Regression Statistics Multiple R 0.493625188 R Square 0.243665826 Adjusted R Square 0.227223779 Standard Error 0.055316823 Observations 48 ANOVA
df SS MS F Significance F Regression 1 0.045347483 0.045347483 14.8196768 0.000363533 Residual 46 0.140757741 0.003059951 Total 47 0.186105224
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0%
Upper 95.0%
Intercept -
0.000445181 0.008218261 -
0.054169717 0.95703453 -0.016987682 0.01609732 -
0.01698768 0.01609732 X Variable 1 1.445191091 0.375410063 3.849633335 0.00036353 0.68952984 2.20085234 0.68952984 2.20085234
135
3 Month Regression SUMMARY OUTPUT 36 month
Regression Statistics Multiple R 0.46624488 R Square 0.217384288 Adjusted R Square 0.194366179 Standard Error 0.057440885 Observations 36 ANOVA
df SS MS F Significance
F Regression 1 0.031160237 0.03116024 9.44405497 0.004155201 Residual 34 0.112181479 0.00329946 Total 35 0.143341716
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0%
Upper 95.0%
Intercept -1.65876E-
05 0.009841432 -
0.00168549 0.99866503 -
0.020016783 0.01998361 -
0.020016783 0.019983608 X Variable 1 1.369455534 0.445624113 3.07311812 0.0041552 0.463838384 2.27507269 0.463838384 2.275072685
136
3 Month Regression SUMMARY OUTPUT 24 month
Regression Statistics Multiple R 0.434446261 R Square 0.188743553 Adjusted R Square 0.15186826 Standard Error 0.061735753 Observations 24 ANOVA
df SS MS F Significance
F Regression 1 0.019507883 0.01950788 5.11842857 0.033890648 Residual 22 0.083848671 0.0038113 Total 23 0.103356555
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0%
Upper 95.0%
Intercept -0.000239391 0.01312569 -
0.01823838 0.98561308 -0.027460407 0.02698162 -
0.027460407 0.026981624 X Variable 1 1.404143551 0.620644893 2.26239443 0.03389065 0.117004829 2.69128227 0.117004829 2.691282273
137
1 Year Regression SUMMARY OUTPUT 72 Month
Regression Statistics Multiple R 0.548561428 R Square 0.30091964 Adjusted R Square 0.290932778 Standard Error 0.056109504 Observations 72 ANOVA
df SS MS F Significance
F Regression 1 0.094862449 0.094862 30.13155 6.08146E-07 Residual 70 0.220379351 0.003148 Total 71 0.3152418
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.005806953 0.006638825 0.874696 0.384731 -
0.007433766 0.0190477 -0.00743377 0.019047672 X Variable 1 1.049115537 0.191122837 5.489221 6.08E-07 0.667933064 1.430298 0.667933064 1.430298011
138
1 Year Regression SUMMARY OUTPUT 60 Month
Regression Statistics Multiple R 0.512809151 R Square 0.262973226 Adjusted R Square 0.250265867 Standard Error 0.054345755 Observations 60 ANOVA
df SS MS F Significance
F Regression 1 0.061120586 0.061121 20.69456309 2.79914E-05 Residual 58 0.171300741 0.002953 Total 59 0.232421327
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.003127013 0.007242038 0.431786 0.667497609 -
0.011369501 0.017624 -0.01137 0.017624
139
X Variable 1 1.222091248 0.268642984 4.549128 2.79914E-05 0.684343894 1.759839 0.684344 1.759839
1 Year Regression SUMMARY OUTPUT 48 Month
Regression Statistics Multiple R 0.493249798 R Square 0.243295363 Adjusted R Square 0.226845263 Standard Error 0.055330369 Observations 48 ANOVA
df SS MS F Significance
F Regression 1 0.045278538 0.045279 14.78990107 0.000367893 Residual 46 0.140826686 0.003061 Total 47 0.186105224
140
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 6.48682E-05 0.008190195 0.00792 0.993714886 -
0.016421139 0.01655088 -
0.01642114 0.016550875 X Variable 1 1.441624992 0.37486049 3.845764 0.000367893 0.687069974 2.19618001 0.68706997 2.19618001
1 Year Regression SUMMARY OUTPUT 36 Month
Regression Statistics Multiple R 0.466251037 R Square 0.21739003 Adjusted R Square 0.194372089 Standard Error 0.057440674 Observations 36 ANOVA
df SS MS F Significance F Regression 1 0.03116106 0.03116106 9.444373691 0.004154638 Residual 34 0.112180656 0.003299431 Total 35 0.143341716
141
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0%
Upp95.
Intercept 0.000398807 0.009810944 0.040649199 0.967813328 -0.01953943 0.020337044 -0.01953943 0.0203X Variable 1 1.366867893 0.444774583 3.073169974 0.004154638 0.462977194 2.270758591 0.462977194 2.2707
1 Year Regression SUMMARY OUTPUT 24 Month
Regression Statistics Multiple R 0.434426342 R Square 0.188726247 Adjusted R Square 0.151850167 Standard Error 0.061736412 Observations 24 ANOVA
df SS MS F Significance
F Regression 1 0.019506095 0.019506095 5.117850057 0.033899749 Residual 22 0.08385046 0.003811385
142
Total 23 0.103356555
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95% Lower 95.0%
Upper 95.0%
Intercept 2.74388E-05 0.013093374 0.002095628 0.998346819 -
0.027126556 0.027181434 -0.02713 0.027181 X Variable 1 1.40097548 0.619279574 2.262266575 0.033899749 0.116668257 2.685282704 0.116668 2.685283
143
2 Year Regression SUMMARY OUTPUT 72 month
Regression Statistics Multiple R 0.54743492 R Square 0.29968499 Adjusted R Square 0.28968049 Standard Error 0.05615903 Observations 72 ANOVA
df SS MS F Significance
F Regression 1 0.094473235 0.094473 29.95502 6.48E-07 Residual 70 0.220768565 0.003154 Total 71 0.3152418
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.00605503 0.006640911 0.911778 0.365015 -0.00719 0.0193 -0.00719 0.0193 X Variable 1 1.04579964 0.191079323 5.473118 6.48E-07 0.664704 1.426895 0.664704 1.426895
144
2 Year Regression SUMMARY OUTPUT 60 month
Regression Statistics Multiple R 0.512488793 R Square 0.262644763 Adjusted R Square 0.249931742 Standard Error 0.054357863 Observations 60 ANOVA
df SS MS F Significance
F Regression 1 0.061044 0.061044 20.65951 2.84E-05 Residual 58 0.171377 0.002955 Total 59 0.232421
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.003323935 0.007233 0.459532 0.64757 -0.01116 0.017803 -0.01116 0.017803 X Variable 1 1.221462517 0.268732 4.545273 2.84E-05 0.683536 1.759389 0.683536 1.759389
145
2 Year Regression SUMMARY OUTPUT 48 month
Regression Statistics Multiple R 0.493074679 R Square 0.243122639 Adjusted R Square 0.226668783 Standard Error 0.055336683 Observations 48 ANOVA
df SS MS F Significance
F Regression 1 0.045246 0.045246 14.77603 0.00037 Residual 46 0.140859 0.003062 Total 47 0.186105
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.000241827 0.008181 0.029559 0.976547 -0.01623 0.01671 -0.01623 0.01671 X Variable 1 1.440299373 0.374692 3.84396 0.00037 0.686084 2.194514 0.686084 2.194514
146
2 Year Regression SUMMARY OUTPUT 36 month
Regression Statistics Multiple R 0.466076311 R Square 0.217227128 Adjusted R Square 0.194204396 Standard Error 0.057446652 Observations 36 ANOVA
df SS MS F Significance
F Regression 1 0.031137709 0.031138 9.435333 0.004171 Residual 34 0.112204006 0.0033 Total 35 0.143341716
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.000419908 0.00981064 0.042801 0.96611 -0.01952 0.020358 -0.01952 0.020358 X Variable 1 1.365113883 0.444416606 3.071699 0.004171 0.461951 2.268277 0.461951 2.268277
147
2 Year Regression SUMMARY OUTPUT 24 month
Regression Statistics Multiple R 0.43443456 R Square 0.188733387 Adjusted R Square 0.151857632 Standard Error 0.06173614 Observations 24 ANOVA
df SS MS F Significance
F Regression 1 0.019507 0.019507 5.118089 0.033896 Residual 22 0.08385 0.003811 Total 23 0.103357
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept -0.00010759 0.01311 -0.00821 0.993526 -0.0273 0.02708 -0.0273 0.02708 X Variable 1 1.399607912 0.618661 2.262319 0.033896 0.116584 2.682632 0.116584 2.682632
148
5 Year Regression SUMMARY OUTPUT 72 month
Regression Statistics Multiple R 0.546460537 R Square 0.298619118 Adjusted R Square 0.288599391 Standard Error 0.05620175 Observations 72 ANOVA
df SS MS F Significance
F Regression 1 0.094137 0.094137 29.80312 6.85E-07 Residual 70 0.221105 0.003159 Total 71 0.315242
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.006624911 0.006638 0.99799 0.321722 -0.00661 0.019864 -0.00661 0.019864 X Variable 1 1.043236836 0.191096 5.459223 6.85E-07 0.662107 1.424366 0.662107 1.424366
149
5 Year Regression SUMMARY OUTPUT 60 month
Regression Statistics Multiple R 0.511989764 R Square 0.262133518 Adjusted R Square 0.249411683 Standard Error 0.054376704 Observations 60 ANOVA
df SS MS F Significance
F Regression 1 0.060925 0.060925 20.60501 2.9E-05 Residual 58 0.171496 0.002957 Total 59 0.232421
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.003868045 0.007208 0.536626 0.593578 -0.01056 0.018297 -0.01056 0.018297 X Variable 1 1.222096315 0.269227 4.539274 2.9E-05 0.683179 1.761013 0.683179 1.761013
150
5 Year Regression SUMMARY OUTPUT 48 month
Regression Statistics Multiple R 0.493352528 R Square 0.243396717 Adjusted R Square 0.22694882 Standard Error 0.055326663 Observations 48 ANOVA
df SS MS F Significance
F Regression 1 0.045297 0.045297 14.79804 0.000367 Residual 46 0.140808 0.003061 Total 47 0.186105
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.000661749 0.008157 0.081131 0.93569 -0.01576 0.01708 -0.01576 0.01708 X Variable 1 1.441013552 0.374598 3.846823 0.000367 0.686986 2.195041 0.686986 2.195041
151
5 Year Regression SUMMARY OUTPUT 36 month
Regression Statistics Multiple R 0.466570468 R Square 0.217688002 Adjusted R Square 0.194678826 Standard Error 0.057429738 Observations 36 ANOVA
df SS MS F Significance
F Regression 1 0.031204 0.031204 9.460921 0.004126 Residual 34 0.112138 0.003298 Total 35 0.143342
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.000505308 0.009801 0.051555 0.959185 -0.01941 0.020424 -0.01941 0.020424 X Variable 1 1.366295088 0.444199 3.075861 0.004126 0.463574 2.269017 0.463574 2.269017
152
5 Year Regression SUMMARY OUTPUT 24 month
Regression Statistics Multiple R 0.435591848 R Square 0.189740258 Adjusted R Square 0.15291027 Standard Error 0.061697818 Observations 24 ANOVA
df SS MS F Significance
F Regression 1 0.019611 0.019611 5.151787 0.03337 Residual 22 0.083746 0.003807 Total 23 0.103357
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept -0.000157831 0.013105 -0.01204 0.990499 -0.02734 0.02702 -0.02734 0.02702 X Variable 1 1.402290905 0.617816 2.269755 0.03337 0.121019 2.683563 0.121019 2.683563
153
7 Year Regression SUMMARY OUTPUT 72 month
Regression Statistics Multiple R 0.546294704 R Square 0.298437904 Adjusted R Square 0.288415588 Standard Error 0.05620901 Observations 72 ANOVA
df SS MS F Significance
F Regression 1 0.09408 0.09408 29.77734 6.91E-07 Residual 70 0.221162 0.003159 Total 71 0.315242
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.006874523 0.006636 1.035909 0.30381 -0.00636 0.02011 -0.00636 0.02011 X Variable 1 1.042815302 0.191102 5.456862 6.91E-07 0.661675 1.423956 0.661675 1.423956
154
7 Year Regression SUMMARY OUTPUT 60 month
Regression Statistics Multiple R 0.511609156 R Square 0.261743929 Adjusted R Square 0.249015376 Standard Error 0.054391058 Observations 60 ANOVA
df SS MS F Significance
F Regression 1 0.060835 0.060835 20.56353 2.94E-05 Residual 58 0.171586 0.002958 Total 59 0.232421
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.004123477 0.007198 0.57289 0.568934 -0.01028 0.018531 -0.01028 0.018531 X Variable 1 1.221955206 0.269468 4.534702 2.94E-05 0.682557 1.761353 0.682557 1.761353
155
7 Year Regression SUMMARY OUTPUT 48 month
Regression Statistics Multiple R 0.493420172 R Square 0.243463466 Adjusted R Square 0.22701702 Standard Error 0.055324222 Observations 48 ANOVA
df SS MS F Significance
F Regression 1 0.04531 0.04531 14.80341 0.000366 Residual 46 0.140795 0.003061 Total 47 0.186105
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.000865388 0.008146 0.106241 0.915853 -0.01553 0.017262 -0.01553 0.017262 X Variable 1 1.441364165 0.374622 3.84752 0.000366 0.68729 2.195438 0.68729 2.195438
156
7 Year Regression SUMMARY OUTPUT 36 month
Regression Statistics Multiple R 0.466718469 R Square 0.217826129 Adjusted R Square 0.194821016 Standard Error 0.057424668 Observations 36 ANOVA
df SS MS F Significance
F Regression 1 0.031224 0.031224 9.468596 0.004112 Residual 34 0.112118 0.003298 Total 35 0.143342
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.000582754 0.009795 0.059496 0.952905 -0.01932 0.020488 -0.01932 0.020488 X Variable 1 1.36711309 0.444285 3.077108 0.004112 0.464217 2.270009 0.464217 2.270009
157
7 Year Regression SUMMARY OUTPUT 24 month
Regression Statistics Multiple R 0.435979431 R Square 0.190078064 Adjusted R Square 0.153263431 Standard Error 0.061684955 Observations 24 ANOVA
df SS MS F Significance
F Regression 1 0.019646 0.019646 5.163112 0.033196 Residual 22 0.083711 0.003805 Total 23 0.103357
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept -0.000132762 0.013098 -0.01014 0.992004 -0.0273 0.027031 -0.0273 0.027031 X Variable 1 1.403583996 0.617707 2.272248 0.033196 0.122538 2.68463 0.122538 2.68463
158
10 Year Regression SUMMARY OUTPUT 72 month
Regression Statistics Multiple R 0.546369237 R Square 0.298519344 Adjusted R Square 0.288498191 Standard Error 0.056205748 Observations 72 ANOVA
df SS MS F Significance
F Regression 1 0.094106 0.094106 29.78892 6.88E-07 Residual 70 0.221136 0.003159 Total 71 0.315242
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.00708978 0.006634 1.06877 0.288845 -0.00614 0.02032 -0.00614 0.02032 X Variable 1 1.043107761 0.191118 5.457923 6.88E-07 0.661935 1.424281 0.661935 1.424281
159
10 Year Regression SUMMARY OUTPUT 60 month
Regression Statistics Multiple R 0.511568637 R Square 0.26170247 Adjusted R Square 0.248973203 Standard Error 0.054392585 Observations 60 ANOVA
df SS MS F Significance
F Regression 1 0.060825 0.060825 20.55911 2.95E-05 Residual 58 0.171596 0.002959 Total 59 0.232421
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.004366344 0.007186 0.60759 0.545831 -0.01002 0.018751 -0.01002 0.018751 X Variable 1 1.222673535 0.269655 4.534216 2.95E-05 0.682901 1.762446 0.682901 1.762446
160
10 Year Regression SUMMARY OUTPUT 48 month
Regression Statistics Multiple R 0.49365719 R Square 0.243697421 Adjusted R Square 0.227256061 Standard Error 0.055315667 Observations 48 ANOVA
df SS MS F Significance
F Regression 1 0.045353 0.045353 14.82222 0.000363 Residual 46 0.140752 0.00306 Total 47 0.186105
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.001082121 0.008133 0.133049 0.894735 -0.01529 0.017453 -0.01529 0.017453 X Variable 1 1.442204257 0.374602 3.849963 0.000363 0.688169 2.196239 0.688169 2.196239
161
10 Year Regression SUMMARY OUTPUT 36 month
Regression Statistics Multiple R 0.467136615 R Square 0.218216617 Adjusted R Square 0.195222988 Standard Error 0.057410332 Observations 36 ANOVA
df SS MS F Significance
F Regression 1 0.03128 0.03128 9.490308 0.004074 Residual 34 0.112062 0.003296 Total 35 0.143342
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.000687941 0.009785 0.070307 0.944361 -0.0192 0.020573 -0.0192 0.020573 X Variable 1 1.368804288 0.444325 3.080634 0.004074 0.465826 2.271782 0.465826 2.271782
162
10 Year Regression SUMMARY OUTPUT 24 month
Regression Statistics Multiple R 0.43659597 R Square 0.190616041 Adjusted R Square 0.153825861 Standard Error 0.061664465 Observations 24 ANOVA
df SS MS F Significance
F Regression 1 0.019701 0.019701 5.181166 0.03292 Residual 22 0.083655 0.003803 Total 23 0.103357
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept -7.60462E-05 0.013086 -0.00581 0.995416 -0.02721 0.027062 -0.02721 0.027062 X Variable 1 1.405739977 0.617577 2.276218 0.03292 0.124963 2.686517 0.124963 2.686517
163
Method of Comparables EPS BPS DPS PPS EPS
Forward EBITDA per
share FCF per share
Weyerhaeuser 1.84 37.38 2.2 73.37 3.27 10.14 3.36
Intl. Paper 6.27 18.56 1 33.77
LA Pacific -1.47 18.23 0.6 16.46
Bowater -2.41 14.5 0.8 19.05
UFPI 2.13 28.99 0.11 32.16
average (excluding WY) 1.13 20.07 0.6275 25.36
P/E
(trailing) P/B D/P P.E.G P/E
(forward) P/EBITDA P/FCF EV/EBITDA
Weyerhaeuser 39.88 1.96 0.0300 7.98 22.44 6.97 21.84 14.54
Intl. Paper 5.39 1.82 0.0296 3.10 12.31 5.43 5.80 7.34
LA Pacific -11.20 0.90 0.0365 n/a n/a n/a n/a n/a
Bowater -7.90 1.31 0.0420 n/a n/a 26.46 n/a n/a
UFPI 15.10 1.11 0.0034 1.42 14.92 5.04 14.93 8.57
average (excluding WY) 10.24 1.28 0.0232 2.26 13.62 5.24 10.37 7.96
Weyerhaeuser valuations 18.85 47.74 94.99 20.79 44.52 53.08 34.83 1.96
Undervalued > $88.04
Fairly Valued
Overvalued < $58.70
164
Discounted Dividends Model WACC(BT) 0.0809 Kd 0.056 Ke 0.11
Perp
0 1 2 3 4 5 6 7 8 9 10 11
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
EPS (Earnings Per Share) 1.84
DPS (Dividends Per Share) 2.4 2.40 2.40 2.40 2.80 2.80 2.80 3.20 3.20 3.20 3.60 3.60
BPS (Book Value Equity per Share) 37.38
Cash From Operations 1754 1912 2084 2271 2476 2698 2941 3206 3495 3809
Cash Investments -989 -1088 -1197 -1316 -1448 -1593 -
1752 -1927 -2120 -2332
PV Factor 0.8993 0.8087 0.7273 0.6540 0.5881 0.5289 #### 0.4277 0.3846 0.3459
PV Dividends Year by Year 2.16 1.94 1.75 1.83 1.65 1.48 1.52 1.37 1.23 1.25
Total PV of Annual Dividends 16.17
Continuing (Terminal) Value Perpetuity 43.90
PV of Terminal Value Perpetuity 15.19
Estimated Price per Share (end of 2006) 31.36
Implied Nov, 1 2007 Price $34.26
Observed Share Price(11/1/07) $73.37
Initial Cost of Equity (You Derive) 0.112
Perpetuity Growth Rate (g) 0.03
growth
0 0.03 0.05 0.07 0.09
0.17 18.66 19.69 20.66 22.03 24.07 Undervalued > $88.04
0.15 21.48 23.1 24.72 27.15 31.2 Fairly Valued
0.13 25.23 27.91 30.8 35.63 45.29 Overvalued < $58.70
Ke 0.112 29.81 34.26 39.61 50.06 79.5
0.09 38.01 47.24 61.09 102.62 n/a
0.07 50.11 71.53 121.5 n/a n/a
0.05 72.15 144.58 n/a n/a n/a
165
Discounted Free Cash Flows Model WACC(BT) 0.0809 Kd 0.056 Ke 0.11 Perp 0 1 2 3 4 5 6 7 8 9 10 11 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 EPS (Earnings Per Share) DPS (Dividends Per Share) 2.4 2.40 2.40 2.40 2.80 2.80 2.80 3.20 3.20 3.20 3.60 BPS (Book Value Equity per Share) 37.38 Cash From Operations 1754 1912 2084 2271 2476 2698 2941 3206 3495 3809 Cash Investments -989 -1088 -1197 -1316 -1448 -1593 -1752 -1927 -2120 -2332 Book Value of Debt and Preferred Stock $17,777 Annual Free Cash Flow 765 824 887 955 1028 1106 1189 1279 1375 1477 1550 PV Factor 0.9252 0.8559 0.7919 0.7326 0.6778 0.6270 0.5801 0.5367 0.4965 0.4594 PV of Free Cash Flows 707.66 705.15 702.48 699.63 696.59 693.38 689.98 686.39 682.60 678.61 Total PV of Annual Free Cash Flows 6942.5 Continuing (Terminal) Value Perpetuity 50161.8 PV of Terminal Value Perpetuity 23041.9 Value of Firm 29984.3 Growth
Book Value of Liabilities $17,777 0.03 0.04 0.05 0.06 0.07
Estimated Market Value of Equity $12,207 0.11 n/a n/a n/a n/a 9.78
Number of Shares 211.11 0.1 n/a n/a 2.52 17.85 43.39 Undervalued > $88.04
Estimated Price per Share (end of 2007) 57.82 WACCbt 0.09 n/a 9.93 26.59 54.36 109.9 Fairly Valued
Time Consistent Implied Price, 11/1/07 $61.70 0.081 15.94 33.22 61.7 117.42 275.4 Overvalued < $58.70
Observed Share Price, 11/1/07 $73.37 0.07 46.42 79.33 145.14 342.58 n/a
Initial WACC 0.0809 0.06 93.53 165.26 380.45 n/a n/a
Perpetuity Growth Rate (g) 0.05
166
Residual Income Valuation
WACC(BT) 0.0809 Kd 0.056 Ke 0.112
Annual Change in Residual Income 14 12 10 17 14 12 18 15 12 perp
0 1 2 3 4 5 6 7 8 9 10 11
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Net Income 690 724 760 798 838 880 924 971 1019 1070
Dividends Paid 507 507 507 507 591 591 591 676 676 676 760
Sharholders Equity 9085 9268 9486 9739 9947 10194 10483 10732 11027 11370 11680
Cash From Operations 1754 1912 2084 2271 2476 2698 2941 3206 3495 3809
Cash Investments -989 -1088 -1197 -1316 -1448 -1593 -1752 -1927 -2120 -2332
Actual Net Income 690 724 760 798 838 880 924 971 1019 1070
"Normal" (Benchmark) Earnings 1018 1038 1062 1091 1114 1142 1174 1202 1235 1273
Residual Income (Annual) -328 -314 -302 -292 -276 -261 -250 -231 -216 -203 -200
PV Factor 0.8993 0.8087 0.7273 0.6540 0.5881 0.5289 0.4756 0.4277 0.3846 0.3459
PV of Annual Residual Income -295 -254 -220 -191 -162 -138 -119 -99 -83 -70
Total PV of Annual Residual Income -1631
Continuing (Terminal) Value Perpetuity -
1785.714 -1786
PV of Terminal Value Perpetuity -618
Initial Book Value of Equity 9085 growth
Total 6836 0 -0.1 -0.2 -0.3 -0.4 -0.5
Estimated Price per Share (end of 2007) 32.38 0.17 26.24 26.73 26.95 27.08 27.17 27.23
Time Consistent Price 11/1/07 $35.38 0.15 29.04 29.74 30.04 30.21 30.32 30.39 Undervalued > $88.04
Observed Share Price 11/1/07 $73.37 Ke 0.13 32.21 33.24 33.65 33.87 34 34.1 Fairly Valued
Initial Cost of Equity (You Derive) 0.112 0.112 35.38 36.89 37.43 37.71 37.88 37.99 Overvalued < $58.70
Perpetuity Growth Rate (g) 0 0.09 39.57 42.08 42.86 43.24 43.47 43.61
0.07 43.34 47.63 48.74 49.25 49.54 49.73
167
Long Run Return on Equity Risidual Income Perpetuity growth Book Value of Equity $43.03 0.02 0 0 0.05 0.06 Long Run Return on Equity 9.00% 0.17 20.08 18 17 14.34 11.74 Long Run Growth Rate in Equity 2.00% 0.15 23.17 22 20 17.21 14.34 Undervalued > $88.04 Cost of Equity 11.20% Ke 0.13 27.39 26 24 21.52 18.44 Fairly Valued 0.112 32.74 31 30 27.76 24.83 Overvalued < $58.70 Estimated Price per Share (end of 2007) 32.74 0.09 43.03 43 43 43.03 43.03 0.07 60.25 65 72 86.07 129.1 Observed Share Price $73.37 ROE 0.077 0.09 0.11 0.13 0.15 0.02 26.66 32.74 42.1 51.45 60.81 0.03 24.67 31.49 41.98 52.48 62.98
Growth 0.04 22.11 29.89 41.84 53.79 65.75 Undervalued > $88.04
0.05 18.74 27.76 41.65 55.53 69.41 Fairly Valued
0.06 14.07 24.83 41.38 57.93 74.48 Overvalued < $58.70
0.07 7.17 20.49 40.99 61.48 81.97 ROE 0.077 0.09 0.11 0.13 0.15 0.17 12.25 16.55 23.17 29.97 36.41 0.15 14.48 19.56 27.39 35.21 43.03
Ke 0.13 17.69 23.91 33.47 43.03 52.6 Undervalued > $88.04
0.112 22.11 29.89 41.84 53.79 65.75 Fairly Valued
0.09 31.85 43.03 60.25 77.46 94.68 Overvalued < $58.70
0.07 53.08 71.72 100.4 129.1 157.8
168
WACC(BT) 0.09 Kd 0.056 Ke 0.11 0 1 2 3 4 5 6 7 8 9 Perp 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Net Income 690 724 760 798 838 880 924 971 1019 1070 Dividends Paid 507 507 507 507 591 591 591 676 676 676 760 Book Value Of Equity 9085 9268 9486 9739 9947 10194 10483 10732 11027 11370 11680 Cash From Operations Cash Investments Annual Income 690 724 760 798 838 880 924 971 1019 1070 Drip Income 56.7 56.7 56.7 66.2 66.2 66.2 75.7 75.7 75.7 85.1 Cumulative Dividend Income 781 817 855 905 946 991 1046 1095 1146 "Normal" Annual Income (Benchmark) 767 805 846 888 932 979 1028 1079 1133 Annual AEG 14 12 10 17 14 12 18 15 12 14 PV Factor 0.8993 0.8087 0.7273 0.6540 0.5881 0.5289 0.4756 0.4277 0.3846 PV AEG (Annual) 12.58 9.58 6.98 10.92 8.37 6.15 8.73 6.63 4.80 RI Check Figure 14 12 10 17 14 12 18 15 12 Core Earnings 690 PV of AEG 74.7 Continuing (Terminal Value) 123.3 PV of Terminal Value 47.4 Total PV of AEG 122.2 Total Average Income Perp(t+1) 812.2 Total Average EPS Perp(t+1) 3.8 Capitalization Rate (Ke) 0.112 Estimated Price per Share (end of 2007) $34.35 Time Consistent Implied Price $37.53 Observed Share Price $73.37 Perpetuity Growth Rate (g) 0
growth 0 -0.1 -0.2 -0.3 -0.4 -0.5
0.17 21.83 21.84 21.85 21.83 21.86 21.86 0.15 25.51 25.4 25.35 25.46 25.31 25.29 Ke 0.13 30.7 30.29 30.12 30.52 29.98 29.94 Undervalued > $88.04 0.112 37.53 36.49 36.12 37.06 35.81 35.74 Fairly Valued 0.09 51.08 48.13 47.21 49.68 46.5 46.33 Overvalued < $58.70 0.07 74.24 66.23 64.15 70.15 62.65 62.29
169
Altman's Z Score 2002 2003 2004 2005 2006 Z Score = 1.2 * working capital 894 1496 2144 1569 992 total assets 26249 26595 27482 25270 23238 + 1.4 * retained earnings 3740 3662 4573 4840 4755 total assets 26249 26595 27482 25270 23238 + 3.3 * EBIT 648 751 1824 887 826 total assets 26249 26595 27482 25270 23238 + .6 * MV Equity 14426 10735 14752 16289 14540 BV Liabilites 20247 20189 19284 17049 16480 + 1* Sales 18521 19873 21411 22046 21896 total assets 26249 26595 27482 25270 23238 Z Score 1.4549 1.419742 1.783684 1.904156 1.926615
170
References
1. Weyerhaeuser website: www.weyerhaeuser.com
2002-2007 10-K
2. U.S. Census: www.census.gov
3. MSN Money: www.moneycentral.msn.com
4. CNN Money: www.cnnmoney.com
5. Department of Energy: www.energy.gov
6. Investopedia: www.investopedia.com
7. St. Louis Fed Data: www.stlouisfed.org
8. Financial Statement Analysis Handout:
9. Business Analysis and Valuation:
10. Bowater 10-K:
11. International Paper 10-K:
12. Louisiana Pacific 10-K:
13. UFPI 10-K:
14. Yahoo Finance: www.finance.yahoo.com
15. Financial Statement Analysis
And Security Valuation (Penman):
16. Wikipedia: www.wikipedia.com
