The current price of ENR places the company at a large trailing PE of 29.69x, more than 1.5 times above the Household Products’s average of 19.77x. But can investors make a closing judgement of the company’s value based on this bigger multiple? The answer is no, since important variables like the company’s potential to grow and debt levels are ignored in the PE’s calculation. Below, I will lay out some important considerations to help determine which multiple best suits ENR’s rapidly expanding business. Let’s dive in.
Is ENR making any money?
The PE multiple is useful for when a company is profitable, which is the case with ENR. This is because using PE to value an unprofitable business is flawed since the company has negative earnings (this will create a negative ratio). Companies like this are often valued based off other relevant factors, using multiples like P/S (price-to-sales) or P/FCF (price-to-free-cash-flow) depending on the business characteristics. ENR’s previous earnings record has seen negative numbers, until 2016 saw a breakeven period with earnings of US$127.70m, followed by the most recent bottom-line of US$127.20m. As earnings forecasts indicate the positive trend will continue, the PE multiple can be an acceptable tool to assess the ENR’s value, but let’s see if there is a better alternative.
Does ENR owe a lot of money?
For every $1 provided by investors, more than $2 is owed to creditors in some form. Thus, debt represents over two thirds of the company’s capital. This is highly risky, given that in the case of bankruptcy, there’s less of a chance you’d get anything back.
So, what does debt have to do with valuation? The company’s share price theoretically reflects the value of ENR’s equity only, but its important to account for debt, because debt also contributes to the company’s earnings capacity and risk. This can be done using enterprise value (EV) instead of share price. EV adds in debt and subtracts cash in order to recognise both sources of funding and is commonly used in the EV/EBITDA multiple.
ENR’s EV/EBITDA = US$4.38b / US$0 = 12.7x
Comparing ENR’s multiple to the 12.7x for the industry suggests the company is fairly valued, as opposed to the previous overvaluation indicated by the PE ratio.
Does ENR have a fast-growing outlook?
Yes. If analyst predictions are right, the company’s earnings are forecasted to grow by 37.92% every year for the next 5 years. The issue with using current earnings in the denominator of a multiple is that it doesn’t reflect this expected growth, which is a limitation for using past (or “trailing”) values of EBITDA. Since a stock’s value should be reflective of future earnings, not the past, it may be best to use upcoming earnings as the denominator. To shift our analysis to focus on the future, we will use a forward figure for EBITDA based off analyst forecasts for the year ahead.
ENR’s forward EV/EBITDA = US$4.38b /US$395.63m = 11.08x
ENR is undervalued when comparing its multiple to the 12.6x industry average. as opposed to the fair valuation indicated by the trailing EV/EBITDA ratio.