1. CFA Institute Research Challenge
Hosted by
CFA Society of Chicago
Blue Team/University of Illinois at Chicago
2. Investment Summary
• We currently issue a HOLD recommendation on MJN, despite their mixed 4th
Quarter and 2015 earnings
• Our intrinsic value estimate has changed to $76.02 per share, which is 4.8%
above the current market price
• In spite of low earnings we still have
confidence in MJN’s management,
leading to our high price target
• Their push into the Toddler section of
the child nutrition market is
promising because of their large
amount of free cash
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
Market Profile Column1
Closing Price (2/3/2016)
52-Week High / Low
Average Volume
Diluted Shares Outstanding
Market Cap
Dividend Yield
Beta
EV / Revenue
EV / EBITDA
P / FFO Share
Instituational Holdings
Insider Holdings
3. Business Description
• MJN is a worldwide leader in the pediatric nutrition market with 2015 annual
sales of approximately $4.1 billion
• MJN offers over 70 products in 50 countries, while 76% of their annual sales
are outside of the US, mainly concentrated in Asia
• Infant products account for over half of MJN’s 2014 net sales
Asia
52%
Latin America
20%
North
America/Europe
28%
2014 NET SALES Routine Infant Formula 38%
Solutions Products 11%
Specialty Products 8%
Total Infant 57%
Children's Nutrition Products 41%
Total Children's 41%
Other 2%
Total Other 2%
Product % of 2014 Net Sales
4. Industry Overview & Competitive Position
Pediatric nutritional products: Demand for these products arise from parents need to properly feed their
children with required nutrients in the form of infant formula, products targeting specialized nutritional
deficiencies, and children nutritional supplements.
Source: Statista & Team Figures
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
Source: Statista & Team Figures
5. Demand Drivers
China
2-Child policy:
1.5 – 2 Mil more
births/year
E-Commerce:
32% growth rate
Input
Costs
Dairy: Main
production cost
USDA: Expects
Dairy costs to
decrease thru
2018
Currency
Exchange
Dollar vs. Yuan:
Expected to
strengthen
Euro vs. Yuan:
Expected to
Strengthen
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
6. Porter’s Five Forces Analysis
• Bargaining Power of Customers (Low)
• Intensity of Competition (High)
• Bargaining Power of Suppliers
(Insignificant)
• Threat of Substitutes (Moderate)
• Barriers to Entry (Significant)
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
0
1
2
3
4
5
Bargaining
Power of
Customers
Intensity of
Competitive
Rivalry
Baragining
Power of
Suppliers
Threat of
Substitutes
Barriers to Entry
Porter's Five Forces
0 = No threat to MJN
1 = Insignificant threat to MJN
2 = Low threat to MJN
3 = Moderate threat to MJN
4 = Significant threat to MJN
5 = High threat to MJN
7. Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
Consumer Brand Preference
• I buy whatever brand I want, regardless
off price41%
• I have a limited set of baby food brands I
am willing to buy, and I choose the least
expensive out of that set
46%
• I always seek out baby food with the
lowest price, regardless of what the
brand is
13%
Source: Nielsen Global Baby Care Survey
9. Investment Risks
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
Regulatory
Government and
International Agencies:
Pricing, Sanctions, Health
No Material Litigation
pending at this time.
Market
Foreign Currency
Exchange: 76% of
sales outside of
US.
Input Prices: Dairy
costs declining thru
2018
Economic
Middle Class in
Emerging Markets
Birth Rates: Directly
related to economic
condition.
Operational
R & D: No
guarantee of ROI
Significant
exposure to
China as a
portion of sales
10. Derivatives / Hedges
(in millions)
Hedge
Designation
Sept. 30, 2015
Dec.
31,
2014
Foreign exhange contracts Cash Flow 13.3 13.0
Interest rate forward swaps Fair Value 13.7 0.0
Commodity contracts Cash Flow 0.7 0.0
Foreign exhange contracts Cash Flow 0.0 (0.2)
Commodity contracts Cash Flow (0.3) (0.8)
Interest rate forward swaps Fair Value 0.0 (0.9)
Net asset/(liability) of
derivatives designated as
hedging items
27.4 11.1
Earnings Before Interest and Income Taxes (EBIT)
Nine Months Ended September
30,
2015 % of Sales 2014 % of Sales %
(in millions) Change
Asia 542.1 35% 623.4 36% -13%
Latin America 141 24% 152.6 23% -8%
North America/Europe 264.9 28% 200.9 22% 32%
Corporate and Other -207.6 -198.2 -5%
EBIT as reported 740.4 24% 778.7 23% -5%
Specified Items 20.8 20.9
Impact of F/X 42.4
EBIT as adjusted 803.6 799.6 1%
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
11. Profitability Ratios
• MJN is more efficiently deploying
its assets to generate its revenue
• With higher ROA, MJN is earning
more money on less investment
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
12. Profitability Ratios
• Low Profit Margin due to
low sales and realized
interest on additional
debt
• Gross Profit Margin
rose from 61% to 64%
• Operating Profit Margin
rose from 22% to 23%
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
13. Liquidity Ratios
• Considering interest on debt is paid by cash, Quick and Current ratio remained
same from 2014 to 2015.
• MJN can more easily pay its short term debt by quick cash.
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
14. Liquidity Ratios:
• Days in Payable dropped from 170 days
to 124 days
• MJN’s Cash-to-Cash Cycle dropped
significantly from -20 days to 39 days
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
15. Solvency Ratios
• Times Interest Earned dropped from 16
to 6 due to interest on additional debt
• MJN is more sufficient in paying its short term debt
• DSCR dropped from 12 to 6, due to increase in
interest on debt
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
19. Intrinsic Valuation
Discounted Cash Flow to Firm WACC: 9.5%
Free Cash Flow to Firm
2016E 2017E 2018E 2019E 2020E
EBIT 991.5 1,093.5 1,219.1 1,358.4 1,459.9
Tax Rate 23.8% 23.8% 23.8% 23.8% 23.8%
NOPAT 755.5 833.2 929.0 1,035.1 1,112.5
Depreciation & Amortization 52.9 52.3 47.6 48.8 52.4
Stock-Based Compensation 27.4 27.7 28.3 28.8 31.0
Working Capital 3.3 25.1 32.5 35.3 38.3
Cash from Operations 839.1 938.3 1,037.4 1,148.1 1,234.2
Capital Expenditures (173.3) (183.7) (197.1) (211.6) (227.5)
Free Cash Flow to Firm 665.8 754.7 840.3 936.4 1,006.8
% Growth - 13.4% 11.3% 11.4% 7.5%
PV of FCFF 612.3 634.0 644.9 656.5 644.8
Total 3,192.6
WACC w/ Taxes Assumptions
Cost of Debt 5.0%
Tax Rate 23.8%
Debt and Equivalents 1,282.6
Debt as % of Total Capital 18.6%
Risk Free Rate 2.1%
Beta 1.44
Market Risk Premium 6.0%
Cost of Equity 10.8%
Equity as % of Total Capital Structure 81.4%
Cost of Capital (WACC) 9.5%
Sources: Yahoo! Finance, Federal Reserve
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
20. Terminal Value
Growth in Perpetuity: 4% EBITDA Exit Multiple: 14.3
Perpetuity Approach Strong Case Assumptions
Unlevered FCF in last forecast period (2020) 1,006.8
FCFF (2021) 1,047.1
Long-Term Growth Rate 4.0%
Terminal Value 19,143.9
PV of Terminal Value 12,260.6
PV of Stage 1 Cash Flows 3,192.6
Enterprise Value 15,453.3
Less: Net Debt 1,282.6
Equity Value 14,170.7
Shares Outstanding 186.4
Equity Value Per Share $76.02
EBITDA Exit Multiple Approach
Terminal Year EBITDA 1,543.4
Terminal Value EBITDA Multiple 14.3x
Terminal Value 22,070.2
PV of Terminal Value 14,134.8
PV of Stage 1Cash Flows 3,192.6
Enterprise Value 17,327.4
Less: Net Debt 1,282.6
Equity Value 16,044.8
Shares Outstanding 186.4
Equity Value Per Share $86.08
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
21. Scenario Analysis
Strong Case Revenue Growth
• Estimate: $94.16
Weak Case Revenue Growth
• Estimate: $64.21
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
22. Relative Valuation
• Peer Group: Abbott Laboratories, Mondelez International, Hain
Celestial Group
Multiples
MJN 13.8 20.4 14.4
ABT 54.8 17.1 14.2
MDLZ 66.0 23.3 13.4
HAIN 3.6 18.1 15.2
Mean: 19.7 14.3
Implied Price: $67.87 $81.48
Market
Cap ($B)
P/E
Multiple
EV/EBITDA MJN Historical P/E Multiples
High Low
33.8 19.8
Implied Price: $116.13 $68.04
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
24. Investment Summary
• Recommendation: HOLD
• Investment Risks:
• Continued Currency Headwinds
• Input Costs
• Target Price: $76.02
• Investment Opportunities:
• High-Margin Products
• Toddler Product Line
Investment Summary &
Business Description
Industry Overview &
Investment Risks
Financial Analysis Valuation Conclusion
25. Appendix: S.W.O.T Analysis
The Strength, Weakness, Opportunity, and Threat (SWOT) analysis was performed by listing the attributes
attributable to each category, and then assigning a value from 1 to 3 to each attribute with 3 having the
strongest effect on the company. The SWOT Graph shows the aggregate of each of the attributes.
0
5
10
15
20
25
Strength
Weakness
Opportunity
Threats
MJN SWOT Analysis
Strength Research & Development 3
Innovation 3
Gegraphic Diversity 2
Economies of Scale 3
Product Quality 3
Promotional Effectievness 2
Brand Recognition 2
Brand Loyalty 3
Dividend Increases 2
Share Buybacks 1
Profitability 1
Subtotal 25
Weakness Emerging Market Exposure 3
Capacity limitations 1
Dependence on Commodity Price 3
Alleged Violation of Foreign corrupt
Practices Act 2
Subtotal 9
Opportunity Emerging Markets 3
China 3
New Product Introductions 2
Increased Capacity 1
Expanded Product Line (post
childhood) 2
Forward Intigration (e-
commerce/direct sales) 2
Backward Integration (Dairy Farms) 1
Subtotal 14
Threats Substitutes 2
Competition 3
Global Economic Downturn 3
China 3
Currency Fluctuations 3
Subtotal 14
Strength 25
Weakness 9
Opportunity 14
Threats 14
26. Appendix: Porter’s Five Forces
0
1
2
3
4
5
Bargaining
Power of
Customers
Intensity of
Competitive
Rivalry
Baragining
Power of
Suppliers
Threat of
Substitutes
Barriers to
Entry
Porter's Five Forces Threat of Substitutes – (Moderate): Infant formula
substitutes include breast milk, and homemade and store
brand products. Infant formula is used to supplement
breast milk, or replace it in the case where breast feeding is
not a realistic option, as in the case when mothers return to
work. As such, this poses a low threat to be substituted.
Homemade and store brand formula does not have the
research or testing that has accompanied the premium
infant formula, which is what separates the two products.
While these could be a substitutes, the larger threat is from
competitors who are of similar quality. Brand loyalty keeps
the threat of substitution to the moderate level.
Intensity of Competitive Rivalry – (High): The super-premium infant formula industry is populated by four
main companies that are in intense competition. This is especially true for emerging markets where there is
the greatest opportunity for growth. The low dairy prices and weak economy in many emerging markets is
strengthening the intensity of competition as each of the main firms tries to solidify their market share through
marketing, advertising, and price point. It is important to secure this market share early in the infants life for
the parents tend to be brand loyal for products targeting later childhood nutrition as well as products for
subsequent children.
27. Appendix: Porter’s Five Forces
0
1
2
3
4
5
Bargaining
Power of
Customers
Intensity of
Competitive
Rivalry
Baragining
Power of
Suppliers
Threat of
Substitutes
Barriers to
Entry
Porter's Five Forces Bargaining Power of Customers – (Low): Customers are
fragmented across multiple nations, and the product is
highly differentiated from competition. This causes lowered
negotiating power by individual retailers, since there are
many avenues to distribute the product including e-
commerce.
Bargaining Power of Suppliers – (Insignificant): The largest
cost of production for input costs is directly tied to dairy,
which is a commodity. As such, the bargaining power is
minimal as the suppliers can be substituted readily at
inconsequential switching costs.
Barriers to Entry – (Significant): The global infant formula industry requires companies to have multinational
manufacturing, distribution, and compliance systems in place, which requires a very large capital commitment.
The research and testing necessary to bring products to market also requires large capital investment along
with a prolonged timeline to meet regulatory and market acceptance.
