Valuation of SalMar ASA

Transcription

1 Valuation of SalMar ASA Værdiansættelse af SalMar ASA Master Thesis Author: René Nicholas Kabel Laursen CPR number: xxxxxx-xxxx Date of submission: 15 October 2013 Copenhagen Business School 2013 M.Sc. Accounting, Strategy & Control Supervisor: Edward Vali Department of Accounting and Auditing Number of standard pages: 73,7 Number of characters:

2 Table of Contents Executive Summary Introduction Research Question Structure of the Thesis Methodology and Limitations Introduction to Salmon Farming Salmon Farming Operations VAP Operations SalMar and Peers SalMar Profile Strategy Business Areas and Organizational Structure Executive Management and Board of Directors Ownership Peer Group Lerøy Seafood Group Grieg Seafood Marine Harvest Financial Analysis Growth and Price Development Revenue Growth Salmon Price Accounting Quality Applied Accounting Principles Potential Red Flags Preparing the Income Statement for Analytical Purposes Tax for Analytical Purposes Profitability Analysis Return on Equity Return on Invested Capital Leverage Effect Financial Leverage Interest Margin Liquidity Analysis Short-term Liquidity Long-term Liquidity EBIT/kg Conclusion to the Financial Analysis Strategic Analysis PESTLE Analysis Political Factors

3 Licenses Trade Barriers Economic Factors Exchange Rates GDP Interest Rates Raw Materials Social Factors Health Awareness Media Surveillance Technological Factors Scale Production Feeding Disease prevention Legal Factors Norway Scotland Chile Canada Environmental Factors Sustainability Health Risks Fish Escapes Industry Analysis Substitution treat Suppliers Customers Barriers to entry Rivalry Value Chain Analysis Conclusion of the Strategic Analysis SWOT Analysis Strengths Weaknesses Opportunities Threats Forecast Harvest and Salmon Price Forecast Management s Historical Guidance Harvest Forecast Salmon Price Forecast Supply Demand Regression forecast

4 Testing the model Financial Statements Forecast Period Income Statement Items Balance Sheet Items Valuation WACC Capital Structure Cost of Equity Market Risk Premium Beta Cost of Debt Tax rate DCF Valuation EVA Valuation Peer Valuation Sensitivity Analysis Salmon Price and Growth WACC and Growth Conclusion and Investment Recommendation...82 Bibliography...85 Articles...85 Books...85 Company Reports...85 Financial Data Providers...85 Reports...86 Webpages...86 Appendix...88 Appendix 1: Historical Acquisitions...88 Appendix 2: Geographical Breakdown of Revenues...88 Appendix 3: Leasing Calculations...88 Appendix 4: SalMar Historical Annual Accounts...90 Appendix 5: Analytical Historical Annual Accounts for SALM and Peers...93 Appendix 6: Indexed Annual Accounts for SALM...99 Appendix 7: Common-sized Annual Account for SALM Appendix 8: Management s Historical Guidance vs. Reported Harvest Appendix 9: Regression Model for Forecasted Salmon Price Appendix 10: Assumptions for the Forecasted Financial Statements Appendix 11: CAPM and WACC Calculations Appendix 12: Aquaculture Specific Terms Appendix 13: Subsidiaries and Associated Companies Appendix 14: Major Shareholders

5 Executive Summary This thesis has been written with the intention of finding the intrinsic value of SalMar ASA, by means of mainly using the discounted cash flow and the EVA models, based on assumptions made through a financial and a strategic analysis. A peer valuation is also made to act as a sanity check for the former two models, although the two primary valuation models will be further tested for sensitivity in a separate section. SalMar ASA is a Norwegian salmon farming and processing company. In the recent decade the company, the salmon farming industry as well as the wider aquaculture industry have seen substantial growth rates. This has meant that the focus on the industry from investors interest for the industry has also increased. SalMar has been highly regarded within the industry as the most innovative and cost efficient producer of salmon in the world, however, as the fundamental analysis reveals, in recent years SalMar has lost some of the historical superiority due to biological issues and higher than expected raw material costs. Therefore, the company has now initiated several initiatives to regain its former number one position. Using a WACC of 6,0%, the primary valuation models estimate an intrinsic value of NOK 73,49 on 30 April 2013, indicating 27% premium to the market price of the share. This premium is due to the author s positive view on the company s abilities to cut operating costs in addition to the rising salmon price throughout the forecasting horizon. The peer valuations indicate a valuation range between NOK 44 and NOK 79, leaving the estimate of NOK 73,49 in the higher end of the range. This also verifies the intrinsic value derived by the primary valuation models. 5

6 1. Introduction The global aquaculture industry has grown by almost 9% annually since 1970, and the UN Food and Agriculture Organization has pointed to aquaculture to become a major employer and revenue generator globally in the future 1. The reason for this growth has among others been the increasing world population and the stagnating global supply of wild fish. With 70% of the earth s surface covered by water, fish farming has been particularly relevant for producing protein for human consumption. Salmon farming is a sub industry that has seen a growth rate of more than 600% since 1980, despite the fact that it is still only plays a marginal role in the overall seafood market 2. With rapid technological innovation, this industry has been able to position itself as a competitive and much sought after protein alternative. As a natural constraint, production of salmon relies on specific sea water temperature conditions, giving countries like Norway, Chile, Canada and Scotland natural advantages within this industry. Especially Norway has been able to grow the industry effectively, setting up a good collaboration between industry players and the government. However, recent year s biological issues in Norway and abroad, a low salmon price in 2012 and increasing media critique all dampen the otherwise positive outlook for the industry. One Norwegian salmon farming company that has been particularly successful is SalMar ASA. SalMar has historically been known as the most efficient salmon producer in the world and has with 15 acquisitions since its IPO in 2007 been a very active player in consolidating the industry. With the establishment of the world s largest and most innovative salmon processing facility, it has positioned itself to partake in the growth going forward Research Question This thesis will analyze SalMar s financial position, the strategic environment as well as the current state of the salmon farming market with the aim of estimating the intrinsic value of the company on the date of its Annual Report Thus, the research question is as follows: What is the intrinsic value of the SalMar share on 30 April 2013? Given this question, a series of sub questions will need to be answered: Which processes go into the production of salmon and how is value created? 1 Encyclopedia of Global Industries: Aquaculture, see link in bibliography. 2 Marine Harvest: Salmon Farming Industry Handbook 2013, p. 6 6

7 How has the financial situation in SalMar developed for the years 2007 to 2012? Which macro- and microeconomic factors will affect SalMar s future growth potential? How is SalMar expected to fare going forward? 1.2. Structure of the Thesis The thesis is structured to give a brief introduction to how the salmon farming industry works, followed by an introduction to SalMar, its Figure 1.1: Thesis structure strategy, business areas, management, ownership and peer group. Next, a financial analysis of SalMar will be conducted in order to gain better insights to the company, which is then applied in the subsequent strategic analysis. The historical period of analysis is six years, from , corresponding to a salmon farming business cycle. Both the financial and the strategic analyses are summarized using the SWOT framework. Upon these findings, a forecast of the salmon price and the expected harvest will be made to forecast revenue, after which a forecast of the financial statements will be made using a value driver setup. The valuation will be performed using a Source: Own research discounted cash flow model and the Economic Value Added (EVA) model. To check if the intrinsic value of the share price is valid another valuation using peer multiples will be made. Finally, the assumptions to the present value models will be tested for sensitivity. The above mentioned structure is illustrated in Figure Methodology and Limitations Empirical data used in the thesis will be secondary data from annual and quarterly reports, quarterly presentations, analyst estimates, news articles, books, financial data providers and correspondence with equity research analysts. Unfortunately, it has not been possible to get the company to give interviews, despite multiple tries and angles. The theoretical framework used for financial analysis will mainly consist of the DuPont model, which tries to decompose and explain causality in the Return on Equity ratio. The DuPont model is often 7

8 criticized for being very extensive, making the financial ratios seem increasingly complex. In extension of the profitability analysis, a liquidity analysis will also be performed. To summarize the financial analysis the Morgan Stanley Model-Ware profitability map is used to gain insights to the historical direction profitability wise. The theoretical frameworks used for the strategic analysis are the PESTLE framework, Porter s Five Forces and the Value Chain analysis. The former describes and analyzes factors in the macroeconomic environment that can affect SalMar. Porter s Five Forces describes and analyses factors and relationships within the salmon farming industry. Lastly, the value chain analysis describes and analyzes SalMar s internal workings. The models will be introduced further in their respective sections. It is important to use the two models in connection with each other as the PESTLE framework has been criticized for its subjective use of inputs by the user 3 and Porter s Five Forces for the assumption that general macroeconomic factors influence all companies within the same industry equally 4. In forecasting the future salmon price a multiple regression using two variables is used to calculate the future salmon price, which limits the validity of the model. However, using more variables would have been too time-consuming and beyond the scope of the thesis. To value SalMar, three valuation models will be used 1) the discounted cash flow model, 2) the Economic Value Added model and 3) a multiple valuation based on peers. The DCF model is often critiqued for being time-consuming to generate inputs to the model, for not producing a value estimate easy to communicate to laymen and for not being able to demonstrate value creation 5. One drawback to the EVA model is the fact that it relies on the clean surplus assumption, i.e. that all revenues and expenses are recognized through the income statement 6. To mitigate this, the pro forma statements will have to live up to this assumption, resulting in an unbiased value estimate from the EVA model. The peer valuation will only be used to support the present value models, as multiples can have different pitfalls to them if not treated properly, e.g. differences in accounting principles, transitory items and similar growth and risk profiles 7. 3 Henry, A.: Understanding Strategic Management, Oxford University Press, 1 st ed. 2008, p Henry, A.: Understanding Strategic Management, Oxford University Press, 1 st ed. 2008, p Petersen, C. & Plenborg, T.: Financial Statement Analysis, Thomson Reuters, 1 st ed. 2010, p Petersen, C. & Plenborg, T.: Financial Statement Analysis, Thomson Reuters, 1 st ed. 2010, p Petersen, C. & Plenborg, T.: Financial Statement Analysis, Thomson Reuters, 1 st ed. 2010, pp

9 2. Introduction to Salmon Farming This section provides a brief introduction to salmon farming; focus will be on the salmon farming operations in general and on VAP operations. In appendix 12 there is a list of aquaculture specific terms with explanations Salmon Farming Operations Salmon farming typically starts with salmon eggs also called roe in an incubator tray. These are either internally produced or bought from a supplier. Roe are kept in fresh water for about 60 days before they hatch. Upon hatching they will turn into alevins/yolk sac fry after which they turn into fry about four to six weeks after, from there the fry has used up all of its yolk and can begin to eat feed, this is also called the juvenile stage. After months in large fresh water tanks the salmon go through the process of smoltification which allows them to migrate from fresh water to saltwater. Around this time they weigh no more than grams and are moved to net pens at sea. After having undergone smoltification, the salmon will stay at the sea for another months until they weigh 4-6 kg 8. Then the salmon will be harvested and go through the primary processing of slaughtering and gutting, up to this point in the value chain is where the normal salmon price index relate to 9. Figure 2.1: Salmon growth cycle Source: Marine Harvest: Salmon Farming Industry Handbook 2013, p. 37 Figure 2.1 shows the three different ways salmon can be bred. S0 s are light manipulated, meaning that the farmer has speeded up the juvenile growth phase by up to six months. S1 are normally grown juveniles while S1½ s are bred much slower, which is also the most uncommon 10. The fourth quarter of the year is the quarter with the highest harvesting numbers as the S0 s and S1 s are typically harvested here. 8 Norwegian Seafood Federation: Aquaculture in Norway, Marine Harvest: Salmon Farming Industry Handbook 2013, F. Asche & T. Bjørndal, The Economics of Salmon Aquaculture, 2011, Wiley-Blackwell 2 nd edition. 9 Marine Harvest: Salmon Farming Industry Handbook 2013, p Marine Harvest: Salmon Farming Industry Handbook 2013, p. 37 9

10 Salmon eggs are either sourced internally or bought from suppliers who specialize in breeding salmon. They will choose the fish with the best characteristics with relation to resistance to disease, speed of growth and fillet color. The fish used for this purpose are called broodstock 11. Generally, the biggest cost driver in salmon farming is feed as can be seen in Figure 2.2. Variations in the cost of feed across regions are due to different use of raw materials in the feed (more on raw materials later). Figure 2.2 gives a good indication of the different inputs to the production of salmon farming. Figure 2.2: Production costs 2% 1% 11% 5% 3% 3% 6% 9% 10% 50% Feed Primary processing Smolt Salary Maintenance Well boat Depreciation Sales and marketing Mortality Other Source: Marine Harvest, Salmon Farming Handbook 2013, p. 42 Further, the salmon price is important when dealing with the salmon farming industry not only because it sets the price of the product sold, but also because it can fluctuate a lot causing salmon farmers to forecast both salmon price and volume, making it difficult to guide for future revenue. In Norway, the salmon price is denominated in NOK, though other big markets such as Chile and Canada also have their own reference price. Salmon produced in different countries, but competing on the same markets will have a similar price development. However, in the case where the Chilean price of salmon might not develop similarly to the Norwegian, is when they are not in direct competition on the same markets 12. This means that the development of the Chilean and Canadian salmon prices need not converge. Lastly, it is important to mention the high biological risks associated with salmon farming. As with other types of animal husbandry, good performance comes from well managed day-to-day processes and care. The main factors are disease and escapes, which will be further developed in later sections and 12 F. Asche and T. Bjørndal, The Economics of Salmon Aquaculture, 2011, Wiley-Blackwell, pp

11 2.2. VAP Operations In addition to farming, some salmon farmers have integrated value added products (VAP) operations or secondary processing. VAP typically relates to filleting, fillet trimming, portioning, choplets, smoking, ready meals or packing with modified atmosphere 13. VAP operations work countercyclical to selling salmon head on gutted (HOG), because the salmon price represents an input cost for VAP, i.e. a low salmon price will mean high VAP margins. This way salmon farmers can alter volume depending on the market price for salmon. VAP operations also help increase profitability as non-superior fish with ethical flaws would trade at a lower price if sold as HOG, but through secondary processing can be sold as fillets, which realize a higher margin. 3. SalMar and Peers This section provides insights into SalMar (SALM 14 ) and its peer group. I have chosen Lerøy Seafood Group (LSG), Grieg Seafood (GSF) and Marine Harvest (MHG) as SALM s peers. Further, I have chosen not to include Cermaq due to the fact that the main focus is on the production of fish feed and fish oil. This makes it incompatible in terms of its operations, risk profile and gives it different growth assumptions, as fish feed and fish oil are used for other than the salmon farming industry as well SalMar Profile Headquartered on the island of Frøya in the region of Central Norway, SALM is one of the world s leading producers of Atlantic salmon, and is known to be one of the largest and most efficient producers of farmed salmon 15. SALM operates farms in both Central and Northern Norway. In extension of this, SALM also has VAP its own operations in Norway and sales and marketing activities in Europe, Japan and South Korea. SALM was created in 1991 as part of the restructuring and industrialization the salmon farming industry faced at the time. In the beginning, the main business was to process frozen salmon. While SALM only owned one license and a packing and processing facility to begin with, the company acquired further licenses through time and also expanded into the hatchery business. In 2001, SALM expanded internationally for the first time in a 50/50 partnership with Lerøy Seafood Group in Scotland. The two companies established Norskott Havbruk AS, which fully owns Scottish Sea Farms Ltd., the second largest producer of farmed salmon in the UK. In 2005, SALM divested its herring activities to concentrate on its core business: farming, harvesting and processing of salmon Marine Harvest: Salmon Farming Industry Handbook 2013, p The ticker symbols for the peer group will be used from here on out. 15 This section is based on information from 11

12 In order to finance the expansion in capacity and partake in the general industry consolidation, the Board of Directors decided to list SALM on the Oslo Stock Exchange in From this point, SALM has invested in and acquired various smaller players, thus gradually becoming larger. In 2011, construction of the InnovaMar facility was completed, featuring square meters with a capacity of approximately tons of salmon. Through InnovaMar, it is SALM s vision to become the most cost effective supplier of salmon and salmon products, while maintaining high standards with respect to biology, ethical production and quality 16. Since SALM s IPO on 8 March 2007, the share price has been closely correlated with the salmon price as Figure 3.1 shows. The figure depicts the weekly share price development as well as the salmon price, both indexed as of the IPO date. The following will describe eight kinks in the share price development based on corporate events. Figure 3.1: SalMar indexed share price development since IPO with salmon price 175% 150% E 175% 125% 100% 75% 50% 25% A B C D F 150% G 125% 100% Jan/13 Feb/13 Mar/13 Apr/13 H 0% May/07 Oct/07 Mar/08 Aug/08 Jan/09 Jun/09 Nov/09 Apr/10 Sep/10 Feb/11 Jul/11 Dec/11 May/12 Oct/12 Mar/13 SALM Salmon Price Source: Factset, Fish Pool, Dow Jones Newswires, company reports, ABG Sundal Collier, own research A. Delivered in-line Q1'08 results, but reported rising feed costs. Subsidiary Senja Sjøfarm AS acquired Straumen Havbruk AS and Fjordsmolt AS. Q2 08 reported slower growth, higher feed costs and higher production costs due to disease issues. Negative. B. Reported strong Q4'08 and Q1'09 results with small beats to consensus and avoiding disease infected Chile. Positive. C. Reported good Q2'09 results, where the market had expected higher costs due to a PD outbreak, SALM still delivered superior EBIT/kg margins and had been able to increase its VAP activity. There was a positive outlook for the salmon price. Acquired the remaining 66% of Volstad Seafood AS. Positive

13 D. Acquired 75,54% of the shares in Rauma Gruppen in May 2010, a strategically important move enabling SalMar to produce its own broodstock. Reported very strong Q3'10 due to high salmon prices, good operational efficiency and continued satisfactory biological development in the biomass. Secured a new financing agreement with a banking syndicate. Also acquired a 21,8% minority stake in Bakkafrost P/F. Positive. E. Reported a mixed Q4'10 showing good biological development, but very low harvested volumes due to a fire at the InnovaMar facility and low sea water temperatures. CEO Leif Inge Nordhammer stepped down by own request, and was replaced by Yngve Myhre. Acquired 53,4% of Bringsvor Laks AS. Mixed, mostly negative. F. Reported weak Q4'11 and Q1'12 due to low harvest volumes and biological challenges in Central Norway. In February '12, SALM entered into a harvesting and processing agreement with LSG, improving capacity utilization at InnovaMar. Positive outlook for the salmon price, low salmon prices affect in-store consumer prices spurring more demand. Increased the stake in Bakkafrost P/F to 25,21% and acquired 10 licenses in Finnmark from Villa Arctic AS. Mixed, mostly positive. G. Acquired the remaining part of SalMar Rauma AS. Positive. H. Reported a good AR'12, in-line with consensus, showed continued cost improvement and beat consensus in EBIT/kg due to higher salmon prices. Weak salmon price outlook in the near term. Positive Strategy Since SALM s main competence lies within efficient processing of salmon, the company focuses on increased biological control in order to enable further industrialization through increased smolt survival rates, reduced levels of lice infestation and prevention of escaping fish 17. The company also wishes to increase the output volume by improving exploitation of its existing licenses, increasing the level of processing and become self-sufficient in high-quality smolt. Another important focus area is the continuous development of the group s corporate culture and operating model through the SalMar Standard, which sets out that all employees must operate in accordance with the same principles and objectives Business Areas and Organizational Structure Being a leading producer of farmed salmon, SALM has integrated its business vertically in order to have as much control as possible, throughout the value chain. The better able a salmon producer is to control all business processes, the more industrialized the production becomes, resulting in large 17 SalMar Annual Report 2012, p SalMar Annual Report 2012, p

14 scale production advantages, cost efficiencies, etc., which fit very well with SALM s vision of becoming the most cost effective supplier of salmon. Smolt: This area is part of SALM s hatchery production, i.e. that which pertains to fry and smolt. This is a key strategic input as it makes SALM self-sufficient in providing its own smolt for the production, while ensuring the desired level of quality. To make optimal use of the production potential, it is important that the company be able to spread the transfer of smolt throughout the year, effectively achieving non-seasonal smolt production. Therefore, SALM has researched extensively within this area. Farming: This is the actual fish farming, similar to that of more traditional animal husbandry. In accordance with the company s vision, the focus here is on cost effective operations and high ethical standards. Consequently, SALM has set up a system of sub-objectives, which must be met, and has made up a set of best practices to realize greater efficiency and full traceability of the salmon. These include achieving the fastest possible growth with the lowest possible feed factor, installment of larger net-pens and increased smolt transfers. Processing: Closely linked with the farming operations as access to processing facilities capable of handling large harvest volumes ensure proper economies of scale and optimal utilization of the entire salmon. The new InnovaMar facility, based at the headquarters in Frøya in Central Norway, comprises two departments capable of harvesting and secondary processing. It symbolizes the technological development and innovative view on salmon farming SALM stands for, by challenging conventional approaches to processing, in order to ensure a more cost effective facility. It is considered to be the most innovative and cost effective facility in the industry, in fact, in the Annual Report 2012 the company states that it wishes to maintain a target rate to harvest 110 fish per minute per year 19. Sales & Distribution: Represented either by an in-house sales force or through partners. Focus is on proximity to the markets and the customers. SALM is organized into two main production units: Central Norway and Northern Norway. Central Norway is the main production sites where it all started, where the headquarters are located and where the InnovaMar facility is also located. Under Central Norway, the Rauma Segment is currently reporting separately due to the fact that it is not wholly owned. Figure 3.2: Business areas and subsidiaries 19 SalMar Annual Report 2012, p

15 Source: SALM consists of a lot of subsidiaries as a result of the consolidation the industry has been through the past decade. In appendix 13 is shown a list of all the subsidiaries and associated companies under SALM. Figure 3.2 shows the major subsidiaries under the two main production units, sorted by their place in the value chain, and showing the non-norwegian activities of SALM. For later analytical purposes, it is important to briefly describe the primary operations of the associated companies, which will be done below: Norskott Havbruk: Is a 50/50 joint venture with LSG and constitutes SALM s activities in the UK by being the sole owner of Scottish Sea Farms Ltd. Scottish Sea Farms is the UK s second largest producer of farmed salmon. Nordskag Næringspark: Is the real estate company that leases the InnovaMar facility to SALM 20. Nordskag Næringspark invested in the building and SALM invested in all the machinery. Ownership in Nordskag Næringspark is as follows: Kverva 42.5%, Salmar 42.5% and Abra Norge 15%. Marinetech: Is a salvage, underwater cleaning and inspection company, as well as underwater installation of quays and wharfs 21. Bakkafrost P/F: Is a Faroese, vertically integrated fish farming company (salmon and trout) that manages a total chain of production from fishmeal, fish oil and feed, to hatchery, farming and processing, and to marketing and distribution of the finished product 22. Trøndersk Kystkompetanse: Is a network for the development of goods and services for the benefit of companies and the greater society in and around mid-norway Note 1, SalMar 2012 Annual Report

16 Executive Management and Board of Directors For the purpose of later analysis, this subsection will describe the qualifications, education and careers of the Executive Management and the Board of Directors. The Executive Management is comprised by six company managers: President and CEO: Yngve Myhre (44), comes from a position as CEO in Aker Seafoods. Also serves as a board member at Norway Royal Salmon AS. Mr. Myhre holds an MSc. in Business. Mr. Myhre owns shares and has been granted options. CFO: Ulrik Steinvik (39). Prior to being appointed CFO, Mr. Steinvik was Head of Finance and Accounting at SALM. Before that, Mr. Steinvik worked as an auditor, and is thus a Norwegian state authorized public accountant. Mr. Steinvik owns shares and has been granted options. Manager Farming: Bjørn Larsen (51), has been with SALM since Mr. Larsen owns shares and has been granted options. Business Development / Manager Processing: Gustav Witzøe (60), co-founder of SALM. Mr. Witzøe holds a degree in engineering and has extensive experience in fish farming and processing. In addition, Mr. Witzøe is chairman of Egersund Fisk AS and also serves as a member of the board in SALM and other seafood companies. Mr. Witzøe owns 91,8% of the shares in Kverva AS, which owns 53,4% of the shares in SALM, but holds no options. Manager Logistics, Sales and Marketing: Dag Nikolai Ryste (46), has been with SALM since 2009 when Volstad Seafood was acquired by SALM. At Volstad Seafood Mr. Ryste was the CEO, and holds a Magister degree in agriculture. Mr. Ryste owns no shares in SALM, but has been granted options. Head of Quality Management: Eva Haugen, has worked in SALM since 2005 and holds a degree in Ecotoxicology and Physiology in salmonids. Mrs. Haugen owns 800 shares and has been granted options. The Board of Directors is comprised by 4 independent directors, one executive director and two employee representatives: Chairman: Bjørn Flåtgård, currently functions as a board member in several Norwegian companies and as investor. Previously, Mr. Flåtgård worked as CEO at Elopak ASA and Nycomed Pharma. He holds an MSc. in Chemical Engineering and a degree in Economics and Business Administration. Through his company GloMar AS, Mr. Flåtgård owns 2.38% of the shares in Kverva AS, which owns 53.4% of the shares in SalMar. Executive Director: Gustav Witzøe, see above. Independent Director: Nina Udnes Tronstad, currently functions as the Senior Vice President of Procurement at Kvaerner ASA. Mrs. Tronstad holds a degree in Chemical Engineering. 16

17 Independent Director: Kjell Storeide, is currently chairman of several Norwegian industrial companies and was previously co-founder and CEO of Stokke Gruppen AS. Mr. Storeide holds a degree in Economics and Business Administration. Independent Director: Tove Nedreberg, currently the CEO of Adresseavisen Gruppen AS, also holds other board positions. Employee Representative: Alf Skjærvik, is currently Quality Manager of Biological Production. Mr. Skjærvik has worked within aquaculture since 1986, and serves on the boards of the Mid-Norwegian Seafood Federation, FHL s Industry Group for Aquaculture and the FHL Prevent Escape Committee. Employee Representative: Monicha Seternes, is currently a Key Account Manager in SalMar Sales and has been with the company since Ownership Looking into the ownership structure of SALM, it follows the Pareto Principle wherein the top 19 institutional investors and SalMar itself, hold 81% of the shares in SALM. As mentioned, Kverva AS owned by founder Gustav Witzøe, owns the majority of the shares in SALM (53,4%). See appendix 14 for a specification of the major shareholders Peer Group The following section, will briefly survey peer activities. For each peer, a list of management and the board of directors qualifications has been made like that of SALM. This will, however, not be included in the subsequent sections Lerøy Seafood Group LSG is the second largest producer of Atlantic salmon in the world, in addition to which LSG also produces trout, whitefish and shellfish. Like SALM, it too, is a wholly integrated producer and distributor of farmed salmon. Headquartered in Bergen, LSG has been listed on the Oslo Stock Exchange since LSG s vision is to become the leading and most profitable global supplier of quality seafood. Founded on principles of sustainability, LSG plans to achieve this by supplying highquality products, with which it will develop profitable relationships with its clients 24. It has a market share of 11%, measured by harvest in 2012 in Norway Grieg Seafood Headquartered in Bergen, GSF is a leading fish farming company specializing in salmon and trout. GSF has been listed on the Oslo Stock Exchange since The company is vertically integrated from the production and farming of salmon, to harvesting, processing and distribution. Besides from 24 This section is based on information from 17

18 Norway, GSF generates roughly an equal amount of revenue from the UK and Canada. It is GSF s vision to be a leading aquaculture company 25. It has a market share of 3,7% Marine Harvest MHG is the largest seafood company in the world measured by market cap. The company is headquartered in Bergen and was listed in its current form on the Oslo Stock Exchange in MHG has about one fifth of the global production of farmed salmon, and while salmon is the main product, MHG also farms white halibut and offers processed seafood. Like the rest of the peer group, MHG is vertically integrated in the production and farming of salmon, it is however, in the process of trying to set up a fish feed business, by offering to buy Cermaq due to its EWOS division which produces feed and nutrition for the aquaculture industry. Being the largest salmon producer in the world, MHG has farms all around the world, especially in Canada, Chile, Scotland and the US 26. Below, is provided an overview of peer group s main data, to give a more nuanced picture of the current competitive situation. It has a market share of 24%. Table 3.1: Peer group operating data for 2012 Harvest 2012 Tonnes gutted weight SALM MHG* LSG GSF Total 116, , ,100 70,000 Northern Norway 22, ,306 20,000 20,100 Central Norway 80,200 61,900 0 Southern Norway ,200 Western Norway 0 71,600 0 Internationally 13, ,000 13,600 30,700 *MHG does not split its domestic harvest geographically. Licenses 2012 SALM MHG LSG GSF Total Northern Norway Central Norway Southern Norway 0 n/a 20 Western Norway Internationally n/a n/a 60 *2012 n/a *2012 *2012 Summary of peer group SALM MHG LSG GSF Market cap, million NOK (30/4/2013) 6,571 22,490 9,824 1, This section is based on information from 26 This section is based on information from 18

19 Number of employees, ,389 1, Year established 1991 *1965/ Year listed 2007 **1997/ * Marine Harvest N.V. founded in ** Pan Fish ASA acquired Fjord Seafood and Marine Harvest in 2006 and changed the name of the group to Marine Harvest. Pan Fish was listed in the Oslo Stock Exchange in Business areas: SALM MHG LSG GSF Smolt x x x x Farming x x x x Processing x x x x Sales & Distribution x x x x Source: Company reports, Factset 4. Financial Analysis In order to properly understand SALM s business, it is important to review the historical accounts and key financial ratios to see the level and trend of the financial performance, and from here, create a solid foundation for forecasting in section 7. The time frame of the financial analysis will be from 2007 to 2012, thus allowing for six years of historical data, which is also the typical length of a business cycle in the salmon farming industry. In order to give further perspective on the level and trend of the accounts and key financial ratios, comparisons to peers will be made in this section. The section will be concluded with a profitability map. Before diving into the accounts, it is important to study the salmon price as it has tremendous influence on the P&L Growth and Price Development It is important to analyze the company s historical growth rate properly as this, among others, feeds into the assumptions regarding the future growth of the company. Equally important is understanding how the salmon price has behaved historically to be able to create a good basis for modeling a future salmon price Revenue Growth In this subsection the development of the revenue in SALM will be compared to that of the peer group. The forecast will primarily be dependent on the expected future revenue, as value drivers will be set up based on this, which is why precision of the expected future revenue is important so as to avoid an incorrect valuation. During the analyzed period, SALM has averaged a double-digit year-over-year revenue growth of 23.5%, in all but 2008, as can be seen in Table 4.1. According to the annual accounts for 2008, this 19

20 blip is partly attributable to lower exports to the Far East, difficulties with the Russian banking system 27 and an outbreak of the ISA virus on three of SALM s farms 28. The CAGR reveals that SALM has grown by more than 22% since 2006, and that GSF is the only peer to outgrow SALM. Table 4.1: Revenue Growth, y-o-y, average and CAGR Avg. '07-'12 CAGR '07-'12 SALM 34% 2% 39% 44% 12% 10% 23.5% 20.2% Harvest, SALM 45% 2% 18% 3% 32% 12% 18.6% 17.55% LSG 12% -4% 23% 19% 3% -1% 8.8% 7.7% GSF 97% 39% 9% 51% -16% 1% 30.2% 14.2% MHG 176% -4% 1% -12% 8% 15% 30.7% 1.9% Source: Annual reports , own research Indexing the revenue from 2006, shows growth of 237% until 2012 (see appendix 6), and shows an otherwise steady rise throughout. The simple average, the CAGR and the indexed numbers show a quality to SALM s growth. Growth has been demand driven, and since salmon farmers are only allowed to hold a certain amount of biomass per license, the consolidation the industry has seen in recent years, could be one of the drivers of growth 29. Looking into the geographical split of revenue, gives a clear indication of SALM s main export markets, which are Asia, Russia, USA/Canada and Europe incl. Norway. Figure 4.1: Revenue, geographical split with percentage of total NOK % 68% 60% 64% 53% 48% 7% 4% 7% 7% 5% 2% 0% 0% 2% 27% 26% 13% 26% 26% 24% 20% 26% 21% Asia Russia USA/Canada Europe, incl. Norway Source: Annual reports , own research Looking into the growth for per region, figure 4.1 shows each region as a percentage of the total revenue per year. Each year, sales to Europe make up a larger part of total revenue, the same goes 27 SalMar Annual Report 2008, p SalMar Q2 and Q See appendix 1 for a list of historical acquisitions. 20

21 more or less for Asia, while Russia and USA/Canada make up an increasingly smaller part of total revenue. From the average y-o-y growth for Europe was 30%, 27% for Asia, -12% for Russia and 109% for USA/Canada (including a decline of 39% for the past two years and only from ) 30. All in all, revenue growth has been solid throughout the period, only indicating low single digit growth in 2008 due to issues with the Far East and Russia and a small outbreak of ISA, otherwise, being having the financial strength to grow through acquisitions is also seems to be an important factor Salmon Price The level of the salmon price when the salmon is sold has tremendous importance to revenue, as a higher realized salmon price per kilo of salmon sold, all else equal, will lead to higher revenue. For that reason, salmon farmers and investors follow the development of the salmon price closely. In Figure 4.2, the weekly development of the spot price for Norwegian HOG salmon is shown over time. It shows the minimum and maximum price levels from , as well as the average for that period. It also shows the weekly development for 2010, 2011 and Interestingly, 85% of the historical ( ) maximum prices were achieved in most of 2010 and Q1 of 2011, after which prices collapsed reaching historical lows in week 43 of 2011, followed by a return to the historical average. Going back to Table 4.1 shows that a rise in harvest does not necessarily mean an increase in revenues, exactly due to the level of the salmon price. Figure 4.2: Spot price for Norwegian salmon NOK/kg Weeks Min-Max Average Source: Fish Pool, own research As the events in Figure 4.2 show, the salmon price can fluctuate greatly in a matter of weeks. Therefore, it is not unimportant when salmon farmers harvest their fish. Having Figure 2.1 in mind, 30 See appendix 2 21

22 the fact that most of the harvest is in Q4, this explains why the 2010 revenue grew 44% while the 2011 revenue only grew 12%, despite record high prices for the first four months of The above discussion of the historical salmon price refers to the price in Norwegian kroner. However, as mentioned in section 2.1, the salmon price is also typically denominated in USD/kg from Chilean salmon and in USD/lb from Canadian salmon. These three price denominations for salmon are the most common as Norway, Chile and Canada are the largest producers of salmon. The strategic analysis will look further into what factors influence the salmon price Accounting Quality This section will look into the accounting quality of SALM to make sure that the accounts present a fair picture of the company s financial position and whether there are any red flags Applied Accounting Principles SALM s consolidated accounts have been prepared in accordance with IFRS, while the parent company, SalMar ASA, reports it financial accounts in accordance with Norwegian GAAP. For the purpose of this thesis, only the consolidated accounts will be used for analysis and investment decision. The same is true for the peer group. In 2012, there was one change in accounting principles related to the way the statement of cash flow is prepared. Since the statement of cash flow will not be used for analytical purposes, the change has no effect on the valuation and will not be looked into further Potential Red Flags From 2007 to 2008, SALM changed its independent auditor from SystemRevisjon to PwC, which is not mentioned in neither of the annual reports from 2007 and SALM has kept PwC as its auditor since then, and has received a clean audit report throughout the entire period. According to the company s corporate governance, the auditor is appointed each year at the AGM and independently of SALM assessed for its independence and objectivity 31. Interestingly, the responsible auditor from SystemsRevisjon, Trond Tuvstein started at PwC the same year SALM changed to PwC and also became the auditor responsible for SALM here, signing off on all the auditor reports until 2011 where he then became SALM s Head of Investor Relations. Looking to Marine Harvest, the world s largest salmon farmer, using the same auditor seems to be standard procedure as it has had the same auditor responsible from Ernst & Young from There should be no red flags here, although it is of the author s opinion that the same auditing company should not be used for more than five years in a row in order to maintain the auditor s independence. 31 SalMar Annual Report 2012, Corporate Governance, 15. Auditor, p

23 SALM classifies leasing agreements in accordance with IAS 17 and recognizes leases which transfer the bulk of the financial risk and control, on the balance sheet 32. Based on that, SALM has itself brought some of its leases onto the balance sheet, though it still holds some operating leases in the form of the fish landing facility at InnovaMar (15 years), the Kjørsvik Settefisk hatchery and water rights (expires 1 January 2014) and Vikenco s harvesting plant (10 years) 33. Since all three leases relate to SALM s primary production activities, they will be capitalized for analytical purposes. There are, however, a couple of obstacles as SALM does not report how much each lease is worth or report lease expenses. Because of the unique nature of SALM s leased equipment, finding comparable leases on the market is difficult. As of 2012, SALM reports the value of financial leases and the interest paid on these 34. The implied interest expense will be calculated using this interest rate. The depreciation expense will make up the residual which makes the lease obligation zero upon expiry assuming straight line depreciation. Since SALM does not report lease expense, the implied interest and depreciation expenses will make up an imputed lease expense, which will be deducted other operating expenses 35. The adjustment for the income statement looks as follows: Table 4.2: Operating lease adjustments to income statement Other operating expenses Less "imputed" lease expense Other operating expenses, adjusted Depreciation Plus implied depreciation Depreciation, adjusted Interest expenses Plus implied interest expense Interest expenses, adjusted Source: Company reports, own research The above calculations have no effect on profit for the year. The corresponding adjustment to the statement of financial position will contain each year s book value of the leased equipment and the resulting lease obligation. For 2012, the lease obligation constitutes 4,7% of the resulting net interest-bearing debt, i.e. not a significant portion, but still a potential red flag as this has historically been higher. 32 SalMar Annual Report 2012, Note 1 Accounting Principles, p SalMar Annual Report 2012, Note 22 Other Off Balance Sheet Liabilities, p See the full calculation in appendix 3 35 For the actual calculations, please see appendix 3 23

24 It is interesting why SALM does not provide enough information for analysts to perform these calculations more precisely taking into consideration that it already capitalizes some leases. One reason could be due to the potential breach of debt covenants. This will be looked into in the financial analysis. In the follow sections, the accounting quality will be further assessed as relating to permanent or transitory items. Only permanent items from SALM and peers will be used when formulating the analytical financial statements Preparing the Income Statement for Analytical Purposes In order to properly account for the sources of value creation in SALM and the peer group, the income statements have been reformulated to better reflect this through an analytical income statement. The basic idea of the analytical income statement is to classify the items from the income statement as either belonging to operations or financing 36. Then, Net Operating Profit After Tax (NOPAT) is calculated to denote the value creation from operations and Net Financial Expenses After Tax (NFEAT) is calculated to denote financing related value creation. Before moving on to the analytical considerations, a few notes on the standard reporting procedures in salmon farming. In order to get EBITDA, depreciation and amortization has been excluded from Total Operating Expenses, otherwise SALM reports its income statement by nature of expense. It is normal industry procedure to report Operational EBIT before regular EBIT in the income statement, to show the operational performance for the period. Operational EBIT is based on realized costs of harvested salmon and excludes Fair Value Adjustments on Biomass, which is part of EBIT 37. In the following, critical items from the income statement will briefly be highlighted to explain how they have been treated for analytical purposes. Other operating revenues: As opposed to Sales Revenues, it must be assumed that this item does not generate revenue from SALM s primary area of operations, but as there is no note to shed light on what activity has generated this revenue, it will be treated as part of operations. Exceptional Biological Items: This line item is part of operations and will be considered so in the analytical income statement due to its definition in Note 24 of the 2011 Annual Report where it is defined as destruction of salmon required by authority due to outbreak of Pancreas Disease and single event of escaped fish with a significant number of salmon. With this definition in mind, the item has to be included for analytical purposes, because being able to prevent for diseases and 36 Petersen, C. & Plenborg, T.: Financial Statement Analysis, Thomson Reuters, first ed. 2010, p Marine Harvest: Salmon Farming Industry Handbook 2012, p