Common Industry Risks P-‐03 • General Economic Situation (Customer Demand) : All Companies• US or Non-US Government Budget & Policies:Defense (Raytheon & Boeing), Infra (CAT)• Foreign Exchange Fluctuation : All companies• Products & services Less-Diversification:Raytheon (Military), Boeing (Aircraft),CAT (Construction), Except 3M• Other Common Risks:Commodity Price Fluctuation, International Law Environment,Credit Rating, Product Innovation, Competition, Taxation, etc.
Common Industry Risks P-‐04 RTN1) Deep Relation with Defense Budget(73% of US)2) Fixed Price OF Contracts3) Some Financial Ratio ProblemsBA1) Dependency on U.S. Gov. Sales(Defense Budget)2) Commercial Aircraft IndustryCompetition3) Reputation (787 Engine Issue) 3M1) High % of International sales (2/3)2) Acceptance of New Products3) Dependency on Other IndustriesCAT1) CAT Financial Subsidiary Risks2) Component Price (ex, Steel)3) Dependency on Energy & Mining
Risk Management Strategies P-‐05 Raytheon (RTN) Domestic & International Sales• Department of Defense (DoD) Priorities• Over 15,000 Contracts• Diverse Portfolio of Programs• International customers continue to adopt Defense Modernization• Leverage on Knowledge• Innovative supply chain solutions• Deliver innovative supply chain solutionsFixed price Contract• Wide Standard Disciplined Quarterly• Estimate at Completion (EAC) Process• Management Reviews Progress & Performance of Contracts• Key Contract Matters• Progress to Completion• Risks & Opportunities• Estimate Revenues & Cost• Quarterly Adjustment to Net Sales
Risk Management Strategies P-‐06 Boeing (BA) Commercial Airline Industries• International Competitors• Airbus, Russia, China, Japan• Improve Process & Cost Reduction• Customer Support Services Network• Aviation Support• Spares• Training• Maintenance Document• Resulted Customer Satisfaction & Pricing Strategies787 Program• Newest Boeing program• Battery Failure• Production continues & increase production rate• Improving production system• Coordinate with suppliers• Increase production rate in final assembly
Risk Management Strategies P-‐07 3M (MMM) Market Risks:• Foreign Exchange Rates• Interest Rates• Commodity prices• Value at RiskForeign Exchange Rate• Forward & Option Contracts to Hedge Exchange Rates• Cross Currency Swaps & Forwards to Hedge Net Foreign InvestmentsInterest Rates• Fixed & Floating Rate Debt for Interest Expenses• Interest Rate Swaps to Manage Borrowing CostsCommodity Prices• Negotiated Supply Contracts• Price Protection Agreements• Forward Physical ContractsValue at Risk• Monte Carlo Simulation
OpAmal Capital Structure P-‐09 All Companies Keep Similar Capital Structure With Their Optimal Capital Structure Assumptions• Calculate Corporate Values by Indirect Method• Downgrade One S&P Rating with each 10% Increase of D/ A Ratio• Increase Yield Spreads with each 10% Increase of D/A RatioYield Spreads Over 10- Y Treasury Bonds by Bond Ratings (Basis Points) AAA AA A BAA BA B CAAYield Spread 58 71 92 147 410 610 955Source: Graham R & Smart (2011). Introduction to Corporate Finance. Cengage LearningTable 4-3. The Relationship Between Bond Ratings and Spreads at 10 year Maturity in Basis Points on page 138 Raytheon Boeing 3M Caterpillar(Billions) Current Optimal Current Optimal Current Optimal Current OptimalDebt: Equity 20.2:79.8 30:70 16:84 20:80 9.8:90.2 0:100 39.4:60.6 40:60Corporate Value 23.4 23.4 67.3 68.3 70.3 72.3 96.8 96.9WACC 9.1% 9.1% 9.2% 9.1% 8.2% 8.0% 10.0% 9.9%
OpAmal Capital Structure P-‐10 In Spite of Large-‐ Scale Businesses, RTN & BA Keep Low D/A RaAos However, Future Uncertainty may Aﬀect Capital Structures Raytheon• Long- Term & Large Scale Production• Slightly Higher D/A Ratio than Boeingbecause of Lowest Beta• Uncertainty of Gov. Policy May CausesCapital Structure Reorganization Raytheon Boeing (Billions) Current Optimal Current OptimalDebt: Equity 20.2:79.8 30:70 16:84 20:80Corporate value 23.44 23.45 67.4 68.3Debt Value 4.7 7.0 10.8 13.7Equity Value (Mkt) 18.7 16.5 56.6 54.6WACC 9.1% 9.1% 9.2% 9.1%Cost of Debt After- Tax 4.7% 5.1% 4.8% 4.8%Cost of Capital 10.2% 10.7% 10.1% 10.2%Levered Beta 1.13 1.25 1.11 1.13Boeing• Long- Term & Large Scale Production• Low D/A Ratio Due to AdvanceReceived• 787 Problems May Change CurrentCapital Structure
OpAmal Capital Structure P-‐11 Diﬀerent Cost of Debt & Capital Cause Diﬀerent Capital Structures 3M & CAT Could Change Their Capital Structures Gradually 3M• High Cost of Debt: Low Liquidity & LowEffective Tax Rate• Low Cost of Capital: Low Beta Due toDiversified Business(Using More Equity Maximize Value)• Could Change Capital Structure Slowly 3M Catapiller (Billions) Current Optimal Current OptimalDebt: Equity 9.8:90.2 0:100 39.4:60.6 40:60Corporate Value 70.3 72.3 96.8 96.9Debt Value 6.9 0 38.1 38.8Equity Value (Mkt) 63.4 72.3 58.7 58.1WACC 8.2% 8.0% 10.0% 9.9%Cost of Debt After- Tax 5.3% 0.0% 3.8% 3.8%Cost of Capital 8.6% 8.0% 13.9% 14.0%Levered Beta 1.07 0.96 2.15 2.17Catapiller• Low Cost of Debt• High Cost of Capital: High Beta Due toLess-Diversified Business(Using More Debts Maximize Value)• Could Change Capital Structure Slowly(e.g. Project/ Capex Financing)