New Lecture 3 Spr 09

Spring 2009

NBA 5060

Lecture 3 – Macroeconomic, Industry, and Strategy Analysis

1. Information Collection 2. Economic, Industry, and Strategy Analysis 3. Application to CBRL

For 01/29/09: Come to class prepared to discuss the accounting analysis questions for CBRL (see today’s handouts). Lecture 2

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Where to find information Company Information: •

SEC website: http://www.sec.gov/edgar.shtml

Guide to Common SEC Filings: Filing Form 10-K

Description This is the annual report filed by most companies. It provides a comprehensive overview of the company’s business. Depending on company size, it must be filed within 60 days of the close of the fiscal year. Form 10-Q This is the quarterly financial report filed by most companies. It includes unaudited financial statements and provides a continuing view of the company’s financial position during the year. Depending on company size, it must be filed within 35 days of the close of the quarter. Form 8-K This is the “current report” that is used to report the occurrence of any material events of corporate changes that are of importance to investors and have not been previously reported. Proxy Statement The proxy statement provides official notification to (form DEF 14A) designated classes of shareholders of matters to be brought to a vote at a shareholders’ meeting. Schedule 13D This filing is required by 5 percent (or more) equity owners within 10 days of the acquisition event. Schedule 13E These are filings required by persons engaging in “going private” transactions in the company’s stock or by companies engaging in tender offers for their own securities. Schedule 13G This is similar to Schedule 13D but is only available in special cases where control of the issuer is not compromised. Schedule 14D These are filings required pursuant to a tender offer. Form 3, Form 4, These are statements of ownership filings required by and Form 5 directors, officers, and 10 percent owners. Form 3 is the initial ownership filing, Form 4 is for changes in ownership, and Form 5 is a special annual filing. Registration These are filings that are used to register securities before Statements(forms they are offered to investors. The most common S-1 and S-3) registration filings are Forms S-1 and S-3. Prospectus (Rule This document is made available to investors in a security 424) offering. It comes in varieties 424A, 424B1, 424B2, 424B3, 424B4, 424B6, and 424B7.

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The Form 10-K Item Cover Page Item 1 – Business Item 2- Properties Item 3 – Legal Proceedings Item 4 – Submission of Matters to Vote Item 5 – Market for Common Stock Item 6 – Selected Financial Data Item 7 – Management’s Discussion and Analysis Item 7A – Disclosures about Market Risk Item 8 – Financial Statements and Supplementary Data Item 9 – Changes in and Disagreements with Accountants Item 9A – Controls and Procedures

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Description Lists company name, fiscal year end, state of incorporation, each class of publically traded securities, and other information. Identifies principal products and services of the company, principal markets and methods of distribution, and other key attributes and risks of the business. Location and character of key properties. Brief description of material pending legal proceedings. Information relating to the convening of a meeting of shareholders, whether annual or special, and the matters voted upon. Principal market in which commons stock is traded: high and low quarterly stock prices for the last two years; number of stockholders; dividends paid during the last two years; future dividend plans. Five-year summary of selected financial data, including net sales and operating revenue, income from continuing operations, total assets, and long-term obligations. Discussion of results of operations, liquidity, capital resources, off-balance-sheet arrangements, and contractual obligations. Discussion should include trends, significant events and uncertainties, causes of material changes, effects of inflation and changing prices, and critical accounting policies. Provides qualitative and quantitative disclosures about market risk (e.g., interest rate, exchange rate, and commodity price risk). Requirements apply to financial instruments and commodity instruments. Two-year audited balance sheets, three-year audited statements of income, three-year audited statements of cash flows, along with supporting notes and schedules. Description of any changes in and disagreements with independent auditors on any matter of accounting principles or practices, financial statement disclosure, or auditing scope of procedure. Opinion of top management and auditors regarding the effectiveness of the company’s internal controls and procedures over financial reporting.

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Where to find information (cont’d) Other sources of company information •

Company website, especially press releases

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Financial press

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Analyst research reports

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Macroeconomic data Data on past economic activity: •

FreeLunch.com

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Economagic

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FedStats

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The White House Economic Statistics Briefing Room

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US Census Bureau

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Bureau of Economic Analysis

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Bureau of Labor Statistics

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Federal Reserve

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Economic calendar of events

Forecasts of future GDP: •

The Conference Board

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Congressional Budget Office

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International GDP forecasts: US Department of Agriculture

Industry data •

S&P Industry Survey

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Polson Enterprises Industry Portals

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Overview of Economic, Industry, and Strategy Analysis Objectives: Macroeconomic Analysis: Understand the general consensus about major macroeconomic factors. Industry Analysis: 1. Understand the sensitivity of the industry to key macroeconomic factors 2. Understand how the industry operates and the key performance metrics for evaluating these operations 3. Understand the competitive structure of the industry Strategy Analysis: Understand the company’s plan for creating and sustaining a competitive advantage. Competitive advantage is what allows a company to earn abnormally high profitability.

Outcomes: Accounting Analysis:

Financial Analysis:

Prospective Analysis:

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Macroeconomic Analysis Some examples of potentially useful economic Indicators • • • • • •

Growth in GDP (long run sustainable growth rates) Consumer confidence Interest rates / yield curve Inflation / CPI / PPI Key Commodity prices (e.g. oil prices) Foreign Exchange rates

Sensitivity of Industry Profitability to Key Macroeconomic Factors: Macroeconomic Factor Sector GDP Interest Rate Oil Price Basic materials ++ –– –– Energy + – ++ Conglomerates + – – Consumer goods ++ –– – Financial + –– – Health care + – – Industrial goods ++ –– –– Services + – – Technology ++ –– – Utilities + – –– Key: + + = strong positive relation; + = positive relation; – = negative relation; – – = strong negative relation.

Understanding current profitability:

Forecasting future profitability:

Note: This is a qualitative assessment. If you are analyzing a firm in the consumer goods industry and overall GDP growth is “high” this tells you to expect “high” profitability for your firm and the other firms in the industry, but it does not tell you how high. Lecture 2

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Industry Analysis Porter’s Five Forces (from Palepu and Healy 2007) 1. Rivalry among existing firms – is there price pressure from existing firms? Over-capacity? 2. Threat of New Entrants – Cost of entry barriers; abnormal profitability? 3. Threat of substitutes – based on existence and relative price/performance of competing products. 4. Buyer Power (relative to the firm) – price sensitivity; relative cost of not doing business with the other party 5. Supplier Power (relative to the firm) – mirror image of buyer power. Includes relative cost of not doing business with the other party.

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Cost Threat Price Threat Supplier Buyer of of Invest of Input Rivalry of Out Subst Power Ent sment put rant itsut s es Suppliers Production Product Switching Relative Scale economies or price costs of service technology labor and and supplied (assets) materials required to First Excess Differentiation performance customers mover capacity to support advantage operations Buyer Distribution Exit Importance barriers willingness access of to Relationships switch for costs product and quality Industry growth Number of buyers suppliersLegal Concentration barriers Volume per buyer supplier Differentiation

Basic idea is to use the five forces analysis to guide your deeper strategic analysis and further research on the company. E.g. if the threat of entry is the most important factor, you should gather additional info on factors such as the costs of entering the market, firms most likely to enter, overall market growth, effect of competition on margins, etc.

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This type of analysis also forces you to learn and understand the industry better. So even without a definite conclusion, the analysis is useful because it provides you with a structured approach.

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Company Strategy Analysis: Evaluating a firm’s operating strategy to evaluate how it intends to position itself within the industry and obtain future economic rents (i.e. profits). Basically to determine if the business model makes sense and will ultimately lead to profitability. Highlights strengths and weakness and potential red flags of which you should be aware.

Applying strategy analysis: Is the strategy based on low-cost leadership or product differentiation? A simple but powerful characterization of firm strategies that can be examined in the financial ratios such as expected turnover and profit margins of the firm.

Degree of geographical diversification. Is the firm targeting only the domestic market or international markets as well? Degree of line of business diversification (i.e. horizontal diversification). This can have an impact on value through risk, management focus, cash drain, etc. Also, there is an empirical regularity known as the diversification discount. Sustainability ofcompetitive advantage. For example, differentiation in retail-apparel is often very difficult to sustain over extended time period.

Note: These are very broad-scope analyses. An analyst or manager should be intimately familiar with the operating environment of the firm, including product lines, key value drivers, growth/expansion opportunities, key risk factors, and potential indicators that the company is executing its strategy competently. One good source of strategy information is from management’s discussion and analysis of results. Tangible plans are useful, while vacuous platitudes are not (e.g.” we plan to expand into the Northeast with 50 new stores by 2007” versus, “our goal is to be the leading supplier of HVAC circulators and pumps”)

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Application of Economic, Industry and Strategy analysis to CBRL Would you describe the overall performance of the economy over the fiscal years 2006, 2007, and 2008 as strong or weak? What does this imply about profitability for the restaurant industry over this time?

How will the economy likely evolve over the next 5 to 10 years, and what does this mean for firms in the industry?

What are the key ratios and statistics that capture financial health of firms in the industry?

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What are the main characteristics shaping competition (and profitability) in the industry? Porter’s Five Forces Rivalry among firms: Threat of new entrants: Treat of Substitutes: Supplier Power: Buyer Power:

What are the main elements of the company’s strategy?

Does CBRL follow a product differentiation strategy or are they a cost leader? What does this imply about profit margin and asset turnovers for CBRL, relative to its competitors?

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