29-Feb-16

Security Travis Perkins PLC

Ticket Symbol TPK.L

Market London Main

Sector Industrial

Sub-Industry Support Services

Analysts Elliot Valentine

Alexandros Kalos Bea Hardy Lucy Victoria Herriot

Sector-Heads Tommy Hoo

Carmen Lim Hui Jing

Recommendation Buy

Target Price 2150 GBX

Upside 19.98%

Stop Loss 1550 GBX

Allocation 750 GBP

Key Figures

Price 1792 GBX (as at 29 Feb 2015)

Market cap 4.31 bn GBP

P/E 16.58x

EV/EBIT 13.71

Div Yield 2.35%

ROE 9.84%

ROA 5.36%

Net margin 4.53%

D/EU 0.195x

WACC 7.30%

Company overview Travis Perkins Plc, incorporated in 1964, is a United Kingdom based company operating in the builders’ merchant and home improvement markets. The company is a leading supplier of basic products to the building and construction markets in the United Kingdom. Travis Perkins’ core business is focusses mainly on repair, maintenance and improvement (RMI) and they operate via 4 divisions, namely, General Merchanting, Plumbing & Heating, Contracts and Consumer.

Investment case 1. A series of modernising transformations of

business strategy including an optimization of their General Merchanting operations and supply chain capabilities, which constitutes their largest revenue stream.

2. Consistent growth in both housing transactions and mortgage approvals which provide medium to long term growth in RMI market.

3. Positive Prospects for UK Construction Industry which will benefit their new Contracts Division.

Catalysts

1. Consumer Confidence in the Housing Market.

2. Increasing Housing Transactions and Mortgage Approval rates.

3. Technological adaptability to reach more consumers who wouldn’t necessarily visit their physical stores.

Key risks

1. Housing Market Conditions and Consumer Confidence. The housing market is not experiencing the growth necessary to indicate stability in the housing consumer confidence anticipated to remain low over the next twelve months.

2. Supplier Dependency. There is a potential that European anti-dumping legislation efforts could be expanded to apply to more Asian countries, which could complicate supply issues or increase the costs of imported products.

3. Competitive Pressures. New channels have opened up in the distribution of goods and services due to technological advancements and economic policies.

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Valuation: Executive Summary

Forecasts:

COGS/Revenue is anticipated to increase as the 400 new stores being built over the next

few years (until 2018) will cause an increase in goods to sell. Considering the Group’s ability to maintain cost efficiency despite massive COGS increases, it is likely that COGS/Revenue will not skyrocket. Moreover, COGS/Revenue will decrease in the future as the stores are opened and begin to generate revenue.

SG&A/Revenue is going to follow a similar trend as COGS/Revenue. There is a nearly 25% increase in the number of stores that are going to be opened by 2018 and therefore costs will rise overall due to the increase in stores that need to be staffed, equipped and maintained. However, these costs will be manageable due to the Company’s ability to efficiently maintain their costs, and as these stores open, they will generate revenue and help decrease this ratio.

Interest/Debt will decrease as the Company pays off their debts, but should then increase as Travis Perkins is likely to take on more debt in the next few years. This is because a £550m loan that was issued in 2011 is coming due at the end of 2016, meaning that the company could be looking to issue more short term and long term debt to further fund operations.

With a 20% tax rate that became effective April 2015, Travis Perkins is likely to see a decrease in its effective tax rate. While its taxable income is likely to rise, it has a fair amount of debt outstanding to shield itself from taxes, and is likely to add more debt in the future. Moreover, Travis Perkins is conservative in setting aside its tax provisions, and thus this will help reduce its future effective tax rates.

Short Term Debt Growth: Only until year 2016, the 200m of their 550m debt will come due, and for that we wouldn’t expect the company to take in any short term debt so actually the debt would go down in 2015 and 2016. But after that, debt would increase as it is highly likely that they would need a new loan. So in year 2017 or 2018 there would be a large increase in debt.

2011 2012 2013 2014 2015 Average 2016 2017 2018 2019 2020

Revenue Growth n/a 51.58% 1.38% 6.27% 8.39% 16.91% 8.49% 8.51% 8.64% 8.78% 8.81%

COGS / Revenue (%) 66.02% 70.22% 69.79% 70.24% 70.42% 69.34% 72.50% 74.00% 74.00% 72.00% 70.00%

SGA / Revenue (%) 21.43% 24.12% 24.42% 23.74% 23.94% 23.53% 24.00% 25.00% 25.00% 23.00% 23.00%

D&A / Non-Current Assets (%) 2.08% 2.31% 2.45% 2.50% 2.57% 2.38% 2.25% 2.25% 2.50% 2.50% 2.50%

R&D / Revenue (%) 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

OOE / Revenue (%) -1.82% -1.33% -1.43% -1.38% -1.35% -1.46% -1.33% -1.23% -1.36% -1.46% -1.50%

0.00%

Interest / Debt (%) 2.83% 3.72% 4.58% 5.08% 4.26% 4.09% 4.09% 3.80% 3.60% 4.60% 4.30%

Tax Rate (%) 25.78% 21.51% 18.47% 14.92% 17.31% 19.60% 19.00% 20.00% 20.00% 17.00% 16.00%

Cash & Cash Equiv / Revenue 2.00% 1.71% 3.13% 1.55% 1.99% 2.08% 2.15% 2.15% 2.25% 3.00% 2.35%

Required Cash / Revenue 2.00% 1.71% 3.13% 1.55% 1.99% 2.08% 2.15% 2.15% 2.25% 3.00% 2.35%

Current Assets / Revenue 39.99% 28.02% 28.29% 29.34% 30.01% 31.13% 31.13% 30.50% 29.50% 28.50% 30.00%

Non Current Assets / Revenue 87.95% 57.97% 58.47% 55.42% 52.63% 62.49% 55.00% 55.00% 57.00% 58.00% 60.00%

Short Term Debt Growth (%) n/a -15.87% 522.80% -98.54% 650.00% 264.60% -30.00% -30.00% 50.00% 25.00% 25.00%

Current Liabilities / Revenue 37.23% 26.95% 33.81% 26.16% 25.66% 29.96% 30.00% 30.00% 30.00% 30.00% 30.00%

Long Term Debt Growth (%) n/a -21.38% -67.37% 115.98% 4.36% 7.90% 6.00% 6.00% 5.00% 4.00% 4.50%

Capex / Non-current Assets 1.90% 3.94% 2.91% 3.76% 5.61% 3.62% 5.50% 4.50% 3.70% 2.80% 2.50%

Cash Flow Statement

Drivers

Income Statement

Balance Sheet

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WACC:

In order to calculate the Weighted Average Cost of Capital for Travis Perkins, we used “Comparable Business Mix” to calculate beta, then referred to the Yield on the latest corporate bond issue to give calculate the cost of debt.

Beta was calculated in respect to the three industries that Travis Perkins serves: Retail Building, Supply, Home Building, and Building Materials. Next, we used the issuance of a 7 year, investment grade bond that was issued with a 4.375% yield to calculate the cost of debt. Through these, we calculated that WACC was 7.3%, which is a very healthy cost of capital because this means that the cost of capital is low and therefore the present value of future cash flows is more valuable.

DCF Assumptions:

We estimate that revenue growth will lie in a conservative 8.49% to 8.78% range. Our estimate was

drawn from current and predicted growth in the market that Travis Perkins serves, and from the

company’s expected growth over the next few years due to expansions and acquisitions that are

presently occurring. We estimate that operating margins may marginally decline as new outlets and

programmes are unveiled and opened, but these margins will increase drastically once the new

outlets are functioning and begin to capture more of the market share across the United Kingdom.

DCF Sensitivity:

The DCF output shows that the shares are undervalued and have a potential to increase by nearly

26%. Therefore, we are confident that Travis Perkins offers an excellent investment opportunity that

will generate tremendous returns over the long term due to its future growth of its business and the

industry overall.

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Company Profile Quick Summary Travis Perkins Plc, incorporated in 1964, is a United Kingdom based company operating in the builders’ merchant and home improvement markets. The company is a leading supplier of basic products to the building and construction markets in the United Kingdom.

Product Base

The company operates via 4 divisions:

Travis Perkins operates 21 businesses with over 2000 sites across the UK and 19 product brands including Benchmarx, Wickes, Plumb Nation, Toolstation, Tile Giant, Keyline and F&P Wholesale.

Customer Base

Travis Perkins’ serves a range of customers via both online and offline outlets in a diverse set of industries, whose key requirements are product range and availability, competitive pricing and customer service. The customers of General Merchanting businesses under Travis Perkins are primarily professional tradesmen, ranging from sole traders to national house builders.

In 2014 the company served over 280000 account customers and millions of cash customers.

General Merchanting Plumbing & Heating Contracts Consumer

Supplies products for:

various RMI (repair, maintenance + improvement) projects

traders for new builds and construction

kitchen and joinery products to specialist joiners, local authorities and house builders.

Supplies plumbing, heating and related products for:

plumbers independent

merchants large contractors house builders public services

Also supplies:

power tools hand tools site equipment

Supplies specialist contractors and the construction industry with:

heavy building materials

drainage solutions

interior building products inc. drywall + insulation

fire protection products

Supplies domestic building and decorative materials through retail stores.

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Revenue Streams

In 2014 Travis Perkins exhibited strong profit growth and good strategic progress. Revenue grew 8.4% on the previous year to £5.6 billion.

Strongest revenue growth was seen in the General Merchanting and Contracts divisions which both significantly outperformed the market with increases of 13.7% and 12.1% respectively.

Acquisitions and Business Growth

Travis Perkins’ undertook acquisitions in 2012, 2013 and 2014 of Toolstation, Solfex and Primaflow respectively. Primaflow was acquired for £16m and is expected to bring in £50m in revenue in its Plumbing and Heating business and further solidify the firm’s presence in the Plumbing construction and improvement business.

Additionally, the company have been undergoing a series of modernising transformations of business strategy including an optimization of their General Merchanting operations and supply chain capabilities, which constitutes their largest revenue stream - this modernization effort will continue to drive revenues. This will also be enhanced by plans for optimisation of their online merchandising system and online brand development.

54 new company sites opened in 2015 with a further 47 implants added to the network

A trend towards smaller family units in the UK results in around 230,000 new households being formed each year. The combination of under-investment in existing dwellings and new household formation provides a reasonable expectation, even from this early point in the recovery of the UK construction industry, of sustainable medium to long term growth in both the new build housing and the repair, maintenance and improvement (“RMI”) markets.

Business model

Travis Perkins operates an advantageous business model in terms of scale, competitive pricing and convenience:

• The size of the Group allows it to benefit from economies of scale in common and direct product sourcing and selective centralised distribution

• The Group operates from 2,000 locations enabling it to conveniently offer products for collection or delivery to customers anywhere in the UK and increasingly integrate its developing online operations into its branch and store network. Efficiencies passed onto customers by ensuring each of its businesses offers competitive prices in their respective markets.

In terms of revenue streams 34% comes from General Merchanting, 24% Plumbing + Heating, 23% Consumer and 19% Contracts. Source: Derived from Annual Report 2014

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Industry Analysis

Travis Perkins has built itself into the UK's largest builder merchant and it relies on Repair, Maintenance and Improvement market (RMI) for 80 per cent of its sales. Secondary housing transactions and consumer confidence remain the key indicators that most closely correlate to this industry’s future performance. This industry is shaped by trends involving housing prices and transactions, mortgage approvals, consumer confidence, climate for purchases, new construction orders, trade confidence, amongst others.

Housing Transaction:

In late 2013 and early 2014, government actions and returning confidence led to a rapid increase in housing transactions. Following this initial increase, secondary housing transactions have been broadly consistent at around 100,000 transactions per month. Consistent growth in both housing transactions and mortgage approvals in the UK since 2013 has boosted almost every point in the property cycle and hence stimulated growth in the Builders Merchants and Home Improvement markets.

However, the RMI market has yet to feel the full effects of the housing renaissance. Although currently at an 11-year high, consumer confidence in the housing market is, in comparison to other markets, relatively low. Consumers are thus demonstrating investment in their current housing assets with small DIY operations and display aversion to investment in large projects on their current housing assets or investing in new ones. However, it is still relatively early in the recovery of UK construction industry and there has been a sustained improvement in the key lead indicators.

Moreover, there is usually a lag of around nine months between a change in those key indicators and a corresponding uplift in demand volumes. Therefore a sustained improvement in the housing market is required in order to see a significant improvement in the performance of the House Building market operated in by Travis Perkins.

In addition to the positive outlook on both housing transactions and mortgage approval rates, the market trend has indicated that the UK has been significantly under-investing in its housing stock. Indeed, according to a recent survey by the Office of National Statistics, there are approximately 28 million homes in the UK and only 60% of these are maintained to a satisfactory standard. Moreover, it is estimated that 230,000 new households are formed every year due to a trend towards smaller family units. These two factors lead to expectations of a sustainable long-term growth in the RMI market.

Also, with consistent growth in housing transactions and mortgage approvals rate together with the lag in key indicators and the underinvestment in housing market, there is a positive prospect for the UK Construction Industry. Travis Perkin’s Contract division which was formed in 2014 will benefit from such prospects as the Contract Division, which takes about 20% of Group’s Revenue, is in charge of supplying products to large construction companies and project contractors. With such diversification, Travis Perkins will have the capability to cover a Spectrum of the building materials distribution markets from retail customers in the Consumer division to major construction companies purchasing large scale building products from the Contracts division.

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Porter’s five forces

Supplier Power

The market is price sensitive as it is driven by competition, energy & fuel costs, volatile prices of raw materials and product availability. The economic recovery and consistent growth in housing transactions since 2013 has led to supply chain issues and shortages for some products such as bricks & blocks, timber and roof tiles. This suggests that Travis Perkins’ supplier power is relatively high as demand can be intermittent and raw material prices are volatile.

Moreover, the majority of the markets Travis Perkins competes in are highly fragmented and Travis Perkins has relatively low market shares. This could suggest that supplier power is high as suppliers can try to lower their prices by going to many other groups in the industry ready to buy their raw materials. However, many of Travis Perkins’ businesses hold market leading positions and those that do not are generally the number two in their respective market. This means that Travis Perkins probably has good supplier relations and contracts and can remain competitive against other firms by obtaining the best prices from suppliers.

Buyer Power

Travis Perkins is the largest builder merchant in the UK; this by nature suggests customer loyalty. Moreover, the fact that Travis Perkins is a UK company exclusively based in the UK means that it is more likely to target its consumer accurately and build a brand tailored to its market. Moreover, the fact that Travis Perkins competes in highly fragmented markets and that the group’s businesses are distributed in various sectors such as General Merchanting, Plumbing and Heating, Contracts and Consumer means that no single customer accounts for a large percentage of the group’s revenue. Travis Perkins’ large customer base indicates that buyer bargaining power is relatively low.

Competitive Rivalry

Travis Perkins faces competition from a number of firms who operate within the same market including Kingfisher, a firm with a 7.49bn market cap and own the B&Q and Screwfix DIY chain’s, and Wolseley, with a 8.66bn market cap, who own various brands such as Plumb Centre and Parts Centre. Indeed, given that Travis Perkins’ market cap is around 4.31bn, these are much larger firms and could represent a threat to Travis Perkins, working in tandem with these firms plans for improving its business practices is essential in order to remain competitive. However, these companies are international while Travis Perkins is only in the UK, which gives Travis Perkins the upper hand in the UK RMI market.

Threat of Substitution

Travis Perkins’ strategy is to further invest online channels, new formats and better service. Online penetration of building material supply to the trade remains relatively low at around 3% and 7% for the DIY sector. However, industry forecasts predict that online penetration is expected to grow and mainly for lighter or higher value items where the cost and ease of distribution is not restrictive. Despite the expectation of relatively modest growth in penetration of online sales, the Group is constantly monitoring and will respond to changes in technology, buying behavior and supply arrangements. This strategy is ultimately aimed at leading online gateway in the future, which means that Travis Perkins is evolving to meet market demand, and hence lowering its threat of substitution.

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Threat of New Entrants

A new entrant in the Builders Merchant and Home Improvement industry would require an incredibly large amount of capital in order to buy expensive machinery, employ high-skilled workers, develop high-tech technology and offer retail facilities. Moreover, this industry is heavily reliant on raw materials and competing with large companies to obtain low raw material prices from suppliers would be an incredibly difficult task. Hence, it is reasonable to assume that the industry that Travis Perkins competes in has high barriers to entry in nature and so the Group should focus on current competitors rather than new entrants.

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Competitors Analysis

Similarities

Travis Perkins, Kingfisher and Wolseley are clearly comparable companies given their engagement in more or less the same product markets. They all also operate to some degree within the UK market place, therefor placing them in direct competition. Indeed, Kingfisher and Wolseley have much larger market cap’s then Travis Perkins at around 7.49bn and 8.66bn respectively in comparison to Travis Perkins’ 4.31bn, but only part of these market cap’s can be attributed directly to the UK market in which they compete with Travis Perkins as can be seen in figures 1 and 3. A further notable feature is that all three companies organise themselves into various trading brands in order to target specific market segments.

Kingfisher VS Travis Perkins

Unlike Travis Perkins, Kingfisher operates in multiple markets around the world as can be seen in figure 1, showing its revenue decomposed into regions. This spread of revenue streams poses a threat to Travis Perkins as it means that Kingfisher better positioned to withstand changes in the UK market. In addition, Kingfisher has a market cap of around 7.49bn, almost double the 4.31bn market cap of Travis Perkins, therefore posing a potential threat from Kingfisher using its scale to attack the market share of its competitors such as Travis Perkins. According to Kingfisher, it’s total market share is 5% across all of the markets it operates in.

Furthermore, Kingfisher has announced that it’s reorganisation, which comes after a review of its business practices, has the potential to create £500m of sustainable profit uplift, therefore expressing a strong desire to grow and become a more effective business. However, it is also

Travis Perkins PLC competitors: Overviews

Kingfisher PLC

Kingfisher sells home improvement products and services throughout Europe and China. It organises its brands into three geographical segments: UK & Ireland, France and Other International (comprised of: ). It’s primary brands include: B&Q, Castorama, BricoDepot and ScrewFix. Recently Kingfisher has carried out a review of its business practices, leading it to launch ‘ONE Kingfisher’, a strategy that works towards unifying the company in order to most efficiently satisfying customer needs, and this is explicitly noticeable in the company’s guiding principles. From this review the company also deduced that they should primarily focus on Europe, citing the facts that show ‘plenty of scope for growth’.

Wolseley PLC

Wolseley is trade distributor of plumbing & heating and building products throughout North America, UK and Continental Europe. It places a significant focus on providing a multi-modal sales platform, priding itself on its ‘excellent service’. It organises itself into trading brands such as: Ferguson, Plumb Centre and Stark in order to target specific market segments/consumer groups. They specifically state that their business is managed on a regional basis in order to suit the ‘individual require of customers in local markets’, therefore explicitly contrasting with Kingfisher’s strategy.

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estimated that this reorganisation is likely to cost the company around £800m initially, therefore representing a significant investment and consequently a significant risk.

As part of this reorganisation and expansion process, Kingfisher has announced that it intends to open a further 200 Screwfix stores at a rate of around 60 per year in order to cater for the trade market, therefore posing a significant threat to Travis Perkins whose own brands operate in the same market. Additionally, Kingfisher are also trialling the Screwfix brand in Germany with a four store pilot. This information suggests a strategy of rapid expansion for Kingfisher. In the consumer segment, recent news has suggested that Kingfisher’s brand B&Q is focusing on customer loyalty schemes in order the improve its customer retention, again, posing a threat for Travis Perkins.

As can be seen in figure 2, the three-year stock price trend chart in figure two, we can see that Kingfisher has not performed as well as Travis Perkins since mid-2014.

Wolseley VS Travis Perkins

As can be seen in the revenue decomposition by revenue chart in figure 3, the UK market, where it competes with Travis Perkins, represents a relatively small share of its business overall, again, similarly to Kingfisher, giving Wolseley the benefit of spreading risk. However, given that the building materials industry as a whole is fragmented, 14% does represent a significant interest for this type of market. In addition, the company also cites benefits of scale as one of its most attractive qualities, as it allows them to benefit from operating synergies that enhance its business practices.

Noticeably, Wolseley also places a notable amount of emphasis on its ‘strong execution culture’, frequently referencing its strong relationships with

13%

13% 2%

58%

14%

Wolseley revenue by region 2015

Nordic Region Canada

Central Europe USA

UK

20%

42%

38%

Kingfisher revenue by region 2015

Other international UK & Ireland France

Figure 1

Figure 2: three-year stock price chart featuring Travis Perkins and Kingfisher

Figure 3

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vendors and customers, therefore showing that the company is aiming to retain and increase customer loyalty, therefore potentially detracting from Travis Perkins’ customer base in the long-run.

Both Wolseley and Travis Perkins have stated that they have identified their fragmented market place as a means for developing their businesses, therefore representing a further example of where the firms will be competing in the future.

Similarly to the Travis Perkins/Kingfisher three-year stock price chart, we can see that Travis Perkins has outperformed Wolseley, although in this case they have outperformed them for the entire three years, suggesting a more effective business practice.

Figure 4: three-year stock price chart featuring Travis Perkins and Wolseley

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Revenue Model

Revenue Model

Travis Perkins divides its revenue streams into four categories: General Merchanting, Consumer, Plumbing & Heating and Contract. For the purpose of this model we have merged the General Merchanting, Consumer and Plumbing & Heating categories to form revenue stream one as these categories are most similar to one another given that they are all serving individuals or small firms, as demonstrated in Travis Perkins’ annual report. This leaves their Contracts category to form revenue stream two.

For some guidance about forecasting the firm’s revenue we looked at a number of factors.

1. Historical growth data First of all, we found that the previous growth rate for revenue stream 1 was 7.5% while revenue stream 2 was 12.1%. These figures then provided an anchor for our forecasts.

We then went on to look at a number of drivers that we and Travis Perkins (as can be found in their annual report) expect to have an impact on their revenue going forward. These drivers are as follows:

1. UK Housing transactions

Figure 4

Source: HM Revenue & Customs Annual Property Transaction Statistics

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It is widely assumed that the building materials market is driven by housing transactions as it is after these transactions that many people wish to make renovations to their homes, therefore using the products and services provided by firms such as Travis Perkins. As can be seen in figure 4 above, housing transactions have been on an upswing since around 2010, therefore creating a positive environment for Travis Perkins to operate in looking forward.

2. Mortgage Approval Rate The rate of mortgage approval is important for similar reasons to the rate of housing transactions. As many consumers require a mortgage to secure a dwelling, this rate is likely to significantly impact the rate of housing transactions, therefore consequently potentially impacting Travis Perkins’ revenue. The UK mortgage approval rate has a general upward swing over the past five years, however, a peak in 2014 was followed by a trough towards the end of 2014, and from there the rate has been relatively volatile. However, despite this volatility, it is again on an upward swing and Travis Perkins is likely to benefit from this.

3. Mortgage rate Recent news articles have suggested that mortgage rates could fall below 1% in 2016, therefore representing a record low, beating the rate of 1.05% seen in August 2015 and being a stark contrast to the rate of 6.75% seen in June 2008. This low rate makes it a very attractive time to borrow, therefore likely aiding the recovery and growth of the housing market, again, relating to the rate of housing transactions and potentially representing a positive climate for Travis Perkins’ revenues.

4. Consumer

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Figure 5: showing consumer confidence over 5 years

Consumer confidence is currently around the highest it has every reached in the past 25 years. Looking more closely, as can be seen in figure 5, we can see that there has been a significant general upward swing in consumer confidence since around the start of 2013. This is positive for Travis Perkins as it means that consumers are more willing to make purchases. However, this upward swing does appear to be levelling off around the start of 2016 suggesting that consumers may be becoming relatively more cautious again and we must take this into consideration when forecasting Travis Perkins’ future revenue.

5. UK Economic Recovery

Figure 6: showing a summary of UK economic prospects

Figure 7: showing projections for consumer spending

A further element that we took into consideration when making our forecast for Travis Perkins’s revenue growth is the general economic outlook. As can be seen in figure 6, GDP was forecast to grow at a rate of between 2.4% and 2.5% in 2015 and between 2.3% and 2.4% in 2016 by three different entities, therefore giving us some impression of what to expect in the coming years.

Figure 7 shows that disposable income was forecasted to grow at a rate of 3.5% in 2015, gradually tailing off to around 1.8% over the next five years. Disposable income is an important driver for Travis Perkins’ revenue forecasts because it dictates how much money consumers will have to spend on the products and services provided by Travis Perkins. This downward trend in overall household disposable income can also be seen in real household expenditure forecasts which suggested a fall from 2.9% in 2015 to 2.3% over the following five years. It is important to note that this reduction is

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less pronounced than that seen in disposable income, therefore suggesting that despite an overall fall in disposable income, consumers may be less concerned about saving their money and consequently potentially buoying Travis Perkins’ revenues over the next few years.

6. Small market share Travis Perkins has a small market share at around 8.6% Therefore meaning that there is plenty of scope for growth within the market by improving their competitive advantage, as they can be seen to be doing with their various future development projects including developing online platforms and unifying their fragmented market place through acquisitions.

7. Adapting to changes in tech Travis Perkins has noted that it it committed to adapting to changes in technology. It is doing this by implementing new online platforms and developing those that already exist within their business. This will enable them to reach more consumers who wouldn’t necessarily visit their physical stores. In addition, this may also allow the group to develop its business outside of the UK as many of its competitors have done, again, representing a significant opportunity for growth in the business.

There are, however, drawbacks to this change. Firstly, it can be costly to implement an effective system that will enhance the businesses operations rather than hinder their growth and potentially negatively affect their image. In addition, they have also noted that online penetration is ‘modest at 3% and 7% for the DIY sector’. However, it is forecast that this will increase and so despite these drawbacks, adapting to changes in technology will still help to grow the group’s revenues.

Final Valuation

Having reviewed these factors, we have projected that both streams will gradually have a growth rate for 2020 that is 0.2% greater than the growth rate in 2016.

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Financial Ratio Analysis

Cost of Goods Sold/Revenue Relative to its peers, Travis Perkins has a moderate COGS/Revenue ratio. While it is not the lowest ratio in the chart, Travis Perkins has managed to keep a consistent COGS/Revenue ratio despite a rise in COGS from nearly doubling from 2bn to 3.9bn in four years. This means that Travis Perkins has managed to keep cost efficiency and increase its revenues consistently over the past four years. The spike in 2011 was due to COGS

rising from 2bn to 3.3bn in one year, and despite this Travis Perkins was able to keep this ratio level. This is a good indicator that Travis Perkins can maintain cost efficiency and growing revenue streams at a consistent level. Net Interest Expense/Debt Travis Perkins has the highest Net Interest Expense to Debt ratio of all of its competitors. The huge spike in 2012 can be attributed to a £155m reduction in debt relative to its interest expense payments, thereby causing a spike in interest expense relative to debt as debt dropped from £607m to £452m by the end of 2012. The drop that followed by a further reduction of debt in 2013, and leveled off due to an issuance of £250m in debt in 2014. This indicator means that relative to its debt, Travis Perkins is paying more out in interest to its bondholders than its competitors, which is attractive to new bondholders but may mean that the company needs a higher yield due to a higher perceived risk.

Operating Margin Travis Perkin’s operating margin has decreased from 7% to about 6% over the past years, which can be attributed to increased expenses associated with expansion. Presently, their operating margins are higher than KingFisher, which is impressive considering that KingFisher has a significantly larger operation. It is notable that in 2014 Travis Perkins began a modernization programme in order to upgrade its business and capabilities; had it not done this

program, operating margins would have been 10% higher than they presently are, indicating tremendous profits and growth on top of already higher profit margins. The modernization programme will ensure that costs are minimized in the future, and thus can predict that the operating margins will increase over the next few years, while KingFisher’s continues to decrease.

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0

2

4

6

8

2010 2011 2012 2013 2014 2015

Operating Margin

TPK.L WOS.L KFG.L

0.55

0.6

0.65

0.7

0.75

2010 2011 2012 2013 2014 2015

COGS/Revenue

TPK.L WOS.L KFG.L

0.00%

2.00%

4.00%

6.00%

2010 2011 2012 2013 2014 2015

Net Interest Expense/Debt

TPK.L WOS.L KFG.L

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Capital Expenditure/Revenue Relative to its peers, Travis Perkins has a higher Capital Expenditure to Revenue ratio. Capital Expenditure to Revenue measures how a company reinvests in revenue-producing assets relative to its total sales. KingFisher’s ratio has decreased since 2012, meaning it is slowing down its investments into its business. On the other hand, Travis Perkins is increasing its investments into itself, which can be seen through its modernization programme and the opening of 400 new stores over the next four years, which will require more investment in property, plants and equipment. This is a good indicator of growth for the company, as it is confidently investing in itself to drive growth.

Current Ratio With a Current Ratio of 1.19, Travis Perkins is in a very healthy position, and is comparable to its peers. This ratio means that Travis Perkins would be able to pay down its liabilities with assets on hand without requiring support. While this is a good sign that Travis Perkins is credit worthy and financially healthy, this current ratio also means that Travis Perkins could be taking on more liabilities in order to expand its businesses further to drive growth and create returns for shareholders. At the same time, it is notable that Travis Perkins is acquiring new

companies and building new stores to expanding operations, and thus is driving growth for its shareholders. Return on Invested Capital Travis Perkins is generating a 9.38% return on invested capital, which is on par with its competitors. This ratio is not particularly great, considering that in2015 its Weighted Average Cost of Capital was 13.38%. A WACC that is greater than ROIC means that the firm is not creating value for every dollar spent on capital. While this is low right now, it is attributable to large investments that have not started generating revenues for the firm yet- these include the 2014 modernization programme, and the acquisitions of PrimaFlow and Rudridge. While right now this is producing a low ROIC, these programs will generate positive returns for the future, and thus will boost ROIC for the next few years.

0.00%

2.00%

4.00%

6.00%

2010 2011 2012 2013 2014 2015

Capital Expenditure/Revenue

TPK.L WOS.L KFG.L

0

0.5

1

1.5

2

2010 2011 2012 2013 2014 2015

Current Ratio

TPK.L WOS.L KFG.L

-10

0

10

20

2010 2011 2012 2013 2014 2015

ROIC

TPK.L WOS.L KFG.L

29-Feb-16

EV/EBITDA Travis Perkins’ EV/EBITDA has risen in the past five years, but remains at a healthy level overall. The average EV/EBITDA for the industry was 11.42, meaning that at 10.78, Travis Perkins’ EV/EBITDA value is relatively healthy. The EV/EBITDA rose drastically in 2013 because while EBITDA has been growing at a steady pace, Enterprise Value rose from 2.7bn to 4.9bn between 2012 and 2013, therefore causing the huge spike. This meant that from 2012 to 2013, the overall price of the firm rose 1.2bn. This was due to stock price rising 798 January 2012 to 1832 at the end of 2013, increasing the overall value of the firm. These stock prices were also a result of exceptional performance during that year. Debt/Equity Travis Perkins maintains a Debt to Equity Ratio of 0.195 meaning that it is not highly leveraged. This means that, with £400m in long term debt, Travis Perkins is not at a high risk of being unable to make payments on its debt. This also means that they are not susceptible to changes in interest rates and credit conditions. In 2014, Travis Perkins issued £250m worth of investment grade bonds that matures in 2021. While this will increase its debt to equity ratio for the future, overall the company is still at a very low debt to equity ratio. This means that Travis Perkins has the capability to take on more debt in order to expand operations, which is something that the company should consider in order to expand operations and generate positive returns for shareholders and bondholders.

0

50

100

150

200

250

300

2010 2011 2012 2013 2014 2015

EV/EBITDA

TPK.L WOS.L KFG.L

0

5

10

15

2011 2012 2013 2014 2015

EV/EBITDA

TPK.L WOS.L KFG.L

0

0.5

1

2010 2011 2012 2013 2014 2015

Debt/Equity

TPK.L WOS.L KFG.L

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Key risks Housing Market Conditions and Consumer Confidence The entirety of Travis Perkin’s business relies on the housing market and consumer confidence, as the business relies on consumers being able to either build or renovate their homes. The UK Home building has reached a 7 year high, with 166,900 housing starts in 2015, which is a statistic that does indicate strong growth in the economy overall. However, this number still falls short of the 222,630 housing starts in 2007. Additionally, consumer confidence fell in February, and household expectations about the economy over the next 12 months have dropped to the lowest levels since 2013. This means that despite an increase in housing starts, the housing market is not experiencing the growth necessary to indicate stability in the housing markets, and with consumer confidence anticipated to remain low over the next twelve months, there may be a risk of slowed business for the Group. Supplier Dependency Travis Perkins has a large range of suppliers to support its business. In most cases, it is the largest customer to most of its suppliers, and these suppliers have large enough orders with the company that they can cause significant supply disruptions should economic factors or operational factors affect these suppliers. Moreover, while Travis Perkins has attempted to remedy this problem with establishing supplier relationships with overseas factories to expand its sourcing capabilities, there is a potential that European anti-dumping legislation efforts could be expanded to apply to more Asian countries, which could complicate supply issues or increase the costs of imported products.

Online Substitution and Technological Limitations: Travis Perkins has nearly 2000 outlets and millions of products in inventory distributed throughout the United Kingdom. As a result, it relies on an increasingly complex and wide range of Information Technology systems in order to maintain its inventory and to conduct trade in a profitable manner. As the Group expands, it must constantly maintain and update both the hardware and software for these IT services, including hiring technology consultants and staff to maintain and address any limitations in these systems. Any delays or failures to maintain or modernize these systems in the future will negatively impact its ability to trade, which will affect profits and cause consumers to look elsewhere to purchase goods. Travis Perkins is investing in online channels in order to meet the new and changing needs of consumers that use the internet to shop for their building material supplies, and is investing in modernization programs to address technological limitations in their current systems. However, consumer preferences are shifting rapidly towards the internet, and these trends may make storefronts redundant or less effective in the long term. Competitive Pressures and Substitution Travis Perkins has remained a market leader through innovating and adapting to changes in market trends and consumer preferences for decades. However, new channels have opened up in the distribution of goods and services in this industry due to technological advancements and economic policies. In order to remain cost efficient, many consumers may rather purchase materials through different supply channels rather than through the Group or traditional competitors, which may make stores and branches less profitable or relevant. These supply channels, whether through new entrants via overseas markets, businesses seeking to enter the market, or through manufacturers directly dealing with consumers, may pose a threat to the profitability and overall relevance of Travis Perkins in the future, especially with new mediums of trading becoming relevant.

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Appendix

Revenue Model Mortgage Rate source: http://www.dailymail.co.uk/news/article-3464467/Get-ready-sub-ONE-CENT-mortgage-Borrowing-set-fall-lowest-levels-thanks-bank-price-war-rock-bottom-rates.html

Global Assumptions: We set the upper and lower WACC within a deviation of 1%. The terminal rate was 1%, with a high terminal rate of 2% and a low terminal rate of 1%. The risk-free rate was set at the UK 10 year Gilt yield, which is currently 1.39%, and the corporate tax rate of 20% reflects the updated tax laws as of April 2015.

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