Michael Hill International ($MHI.NZ) is a New Zealand listed jewelry retailer and manufacturer. $MHI.NZ has existing operations in New Zealand, Australia and Canada. $MHI.NZ has recently moved into the US-market. The company’s founder Michael Hill was last week named New Zealand’s 2008 entrepreneur of the year. $MHI.NZ is trading toward the bottom of their 52-week range - $MHI.NZ did a 10:1 stock split in November 2007. How is this in relation to the intrinsic value of the company’s shares?

Valuecruncher valuation model of $MHI.NZ with interactive assumptions

Valuecruncher produces a valuation of NZ$0.88 for $MHI.NZ. This is a current valuation (an estimate of intrinsic value using a discounted cash flow model) not a target price. This valuation is 33.3% above the current share price of NZ$0.66.

Assumptions

• Revenue: Reuters aggregates three analysts covering $MHI.NZ and the mean estimates of 2009 revenues are NZ$412.2 million. For our analysis we have used NZ$410.0 million in 2009, NZ$440.0 million in 2010 and NZ$480.0 million in 2011.
• Profitability: We have used a flat EBITDA margin of 12.0% to 2011. Reuters has $MHI.NZ‘s EBITD margin at 13.5% last year and an average of 12.1% over the last five-years.
• Capital Expenditure: We have assumed capital expenditures of NZ$16.0 million per annum moving forward.
• Discount Rate: 10.0%. The PwC New Zealand cost of capital report has $MHI.NZ at a WACC of 7.8% with the wider NZ market at 9.5%. We believe a discount rate in the 8-10% range is appropriate. We have chosen the top of this range to reflect the more difficult current retail trading environment.
• Terminal Growth Rate: 3.0%.

Our analysis incorporates the cash and debt on the $MHI.NZ balance sheet – Valuecruncher calculates a net debt number.

Play with our assumptions – what does your analysis say?

Disclosure: None

Valuecruncher has placed a mid-point valuation of $9.51 per share on Michael Hill International (MHI) with a sensitivity range of $8.78 to $10.26. This valuation is materially lower than the current market price of $11.44. The current price of $11.44 is at the top end of the 12-month trading range of $6.61 to $11.50. MHI is a very thinly traded stock with over 90% of the shares outstanding held by institutions or insiders. The last significant transaction was a share buyback on 17 August 2007 when the company purchased 246,405 shares at a price of $9.50. The price this buyback occurred at is consistent with the Valuecruncher mid-point valuation.

Michael Hill Operations

Michael Hill International operates 192 jewellery stores in Australia (126), Canada (16) and New Zealand (50) with plans to open another 78 stores over the next three years. The majority of these new stores will be Australia (36) and Canada (36).

MHI grew revenues ($348.8 million) and EBIT (35.1 million) by 13.8% and 44.1% respectively in the 2007 financial year. The significant increase in EBIT reflects a relatively flat operating performance in 2006. 

New Zealand stores exhibit the strongest operating metrics with same store sales growth of 4.6% and EBIT margins of 13.9%.

Australian operations had same store growth of 3.4% and EBIT margins of 9.2%.

Canadian operations are still in their relatively early stages with 4 stores opened in the 2007 FY and revenues increasing 60% to $25 million. Canadian stores experienced same store growth of 2.9% with EBIT margins slightly below break-even.

Valuecruncher Valuation Assumptions

Valuecruncher has assumed annualised revenue growth of 14.1% over the next three years driven by the projected new stores. EBIT margins are forecast to fall slightly to 9.6% by 2010 reflecting the lower operating margins currently being achieved in Australia.

Valuecruncher has used a cost of capital of 11%, this is significantly higher than the 8% used in Valuecruncher’s previous valuation of MHI. The cost of capital of 11% reflects the uncertainty surrounding the planned international growth, particularly in Canada. 

Valuecruncher has assumed a long-term growth rate of 3.5%.

A key factor in MHI’s valuation is the projected EBIT margins. Canadian stores currently represent 7% of the company’s revenues and are at break-even at the EBIT line. Based on management’s projections in 3 years there will be as many stores in Canada as there will be in New Zealand. The operating margins achieved in Canada will have a significant impact on value.   

Valuecruncher Valuation Report - Michael Hill International - 20070924

Valuecruncher places a value of $6.70 for each Michael Hill share with a range between $3.98 and $9.66. This is very close to the current share price of $6.82.

Revenue Growth

Revenue Growth has been fairly unstable in the last few periods with growths of 15.56%, 5.15%, and 12.16% in the 03/04, 04/05, and 05/06 periods. We have forecasted revenue growth at 10%, 8% and 6% for the next three periods.

EBIT Margins

In 2004 and 2005 EBIT margins were 9.16% and 9.48%, respectively. EBIT margins have suffered this year dropping to 7.95%. This can be attributed to high gold (and other metals) prices, with record highs seen during the early-to-mid parts of 2006. It is impossible to predict what will happen to metal prices, so we have forecasted EBIT margins of 8% for the next three years. The wide range of values seen in this valuation is due to the price being extremely sensitive to EBIT margins. A change of EBIT margin by 2% will affect the share price by 30% to 40%.

Terminal Growth

Terminal growth is expected to be lower than the historical long-term growth rate. We expect 2%.

Discount Rate (WACC)

The discount rate used in this analysis is 8%, which is adjusted up from PwC’s estimation of 7.6% (sourced from their cost of capital report).

Michael Hill Valuation