H&M BV Thesis 2015 PDF

EQUITY VALUATION
HENNES AND MAURITZ (H&M)
Mariana Brites dos Santos

Student Number: 152213009
Supervisor:
Professor José Carlos Tudela Martins
Dissertation submitted in partial fulfillment of requirements for the degree of MSc in

Economics with major in Finance, at Católica Lisbon, School of Business and Economics,
September 14th 2015
HENNES & MAURITZ AB
RECOMMENDATION: BUY
Company Data (31/12/2014)
Market Price 325.6 SEK

Ticker (Bloomberg) HMB SS
Market Cap (SEKm) 574.144
Shares Outstanding 1.655 million
Dissertation Valuation
Target Price 369.4 SEK 350 Last 10 Years Stock Performance
Equity (SEKm) 611.327 300
250
EV (SEKm) 598.953
200
150
JPMorgan Valuation 100
Date 27/03/2015 50
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Target Price 310 SEK
HMB SS stock price (SEK)
Recommendation Hold
Business Overview
H&M is a Swedish international company operating in the apparel retail industry. H&M
has owned 3.511 stores across 55 countries and employs more than 132.000 workers. The
company is considered the 33rd most valuable brand in the world. Nowadays the group
comprises six independent brands: H&M, COS, Monki, Weekday, Cheap Monday and,
more recently, & Other Stories.
Today and Future
In 2014, the group generated SEK 151.419m in revenues. Europe (76% of sales) has
represented by far the main source of the group’s revenues, being German (19% of sales)
the biggest market followed by the US (13% of sales). H&M expansion strategy is focus in
decreasing the group dependence on mature markets by raising its exposure to Asian
markets and by increasing its presence in the US.
The rapid development of the online market and the innovations taking place at the
intersection of fashion and technology, which are profoundly changing the apparel retail
industry, are nowadays one of the group major growth opportunities.
i
The Group Investment Risks
H&M future results may be negatively affected by some external factors.
- Negative macroeconomic changes: a decreasing in the consumer purchasing power

resulting from an economic downturn would directly affect the group’s sales.
- Climate change: deviations from normal weather conditions especially in transactions
between two seasons.
- External factors in production countries: The group does not own factories. All the
collections are produced by independent suppliers, especially in Asia and Europe, which
increases the group exposure to social tensions, corruption or political instability in
certain sourcing markets.
- Foreign currency fluctuations: fluctuations in the US dollar/euro exchange would affect
company sourcing costs (raw materials prices, transport costs and supplier’s capacity)
Valuation Summary
- DCF Valuation
2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
EBIT 25.403 28.305 30.816 32.036 31.640 38.001 43.801 48.759 52.713 55.498
Corporate tax rate 24% 24% 24% 24% 24% 24% 24% 24% 24% 24%
- Taxes on EBIT 6.136 6.837 7.444 7.739 7.643 9.180 10.581 11.778 12.733 13.406
= NOPLAT 19.266 21.468 23.372 24.297 23.997 28.822 33.220 36.981 39.980 42.092
+ D&A 5.769 6.597 7.338 8.068 8.770 9.234 9.627 9.938 10.155 10.273
- Changes in NWC 1.034 725 725 714 686 660 618 561 489 403
- Capex 9.636 11.018 11.299 11.968 12.517 11.713 11.728 11.597 11.318 10.899
= FCFF 14.366 16.322 18.686 19.683 19.564 25.683 30.501 34.760 38.328 41.063
H&M stock price computation H&M stock price computation

Sum PV FCFF 170 183 Rf 0,9%
+ PV Terminal Value 428 770 Equity Beta 0,85
= Enterprise Value (SEKm) 598 953 Rm-Rf 7,15%
+ Cash 12 374 Ke = WACC 6,98%
= Equity Value (SEKm) 611 327
# shares (m) 1 655
P0 (SEK) 369,4
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- Multiples Valuation
Aiming at observing the company from multiple angles, we also performed a relative
valuation. This procedure will complement and represent a useful check of the DCF
valuation.
In order to do so, we considered the EV/EBITDA and the Price Earnings multiple. The
target price reached was below the one obtained through the DCF valuation.
EV/EBITDA P/E
H&M MULTIPLES 2014 2015E 2014 2015E
Peer group harmonic mean 14,3 15,7 24,4 25,2
Critical Factor (SEK M) 30.628 31.172 19.976 19.795
# shares 1.655 1.655 1.655 1.655
Share Price 265 296 295 301
- Dividend Discount Model
H&M stock price computation

Sum PV FCFF 177.188
+ PV Terminal Value 420.748
= Equity value 597.937
# shares (m) 1.655
P0 (SEK) 361
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Abstract
Purpose:
The focus of this thesis is on equity valuation and on the different methodologies that can
be used to value companies. The final purpose is to estimate the value per share of H&M
and give an investment recommendation based on the results achieved.
Method:
In order to obtain H&M share price, three different approaches were applied. Firstly, the
Discounted Cash Flow (DCF) with the discount rate equal to the cost of equity (Ke). The
Trading Multiples were also used, a peer group based on cluster analysis was considered.
Finally, given that H&M distributes dividends in a regular basis we also perform the
Dividend Discount Model (DDM).
Each valuation technique yielded different share prices. However we considered the DCF
being the most reliable and complete approach to evaluate if H&M share price is under or
overvalued.
Results:
The target price obtained through the DCF valuation was 369, 4 SEK. The valuation
results were subject to a sensitivity analysis and were compared with the results obtained
from the investment bank JPMorgan.
We concluded that H&M share price was undervalued.
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Acknowledgement
Foremost I would like to thank to my supervisor Professor José Carlos Tudela Martins, for
the useful comments and precious suggestions through the learning process of writing this
thesis.
Furthermore a special thank you to Mariana and Joana, for their permanent
encouragement, emotional support and for always keeping me motivated in particular
throughout the last months.
Third, I would like to thank to my all my closest friends who on a way or another shared
their support.
Last but not least, the most sincere thank you for my family for giving me all the
opportunities and for the endless support during all my academic life.
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Table of contents
1. Introduction.........................................................................................................10
2. Literature Review ................................................................................................ 11

2.1. Introduction .................................................................................................................... 11
2.2. Valuation Models ........................................................................................................... 12
2.2.1. Discounted Cashflow Valuation .......................................................................... 12
2.2.2. Relative Valuation .................................................................................................. 19
2.2.3. Contingent Claim Valuation ................................................................................. 21
2.2.4. EVA ......................................................................................................................... 22
2.3. Conclusion....................................................................................................................... 23
3. The Industry ....................................................................................................... 24

3.1. Apparel retail industry overview .................................................................................. 24
3.2. Main drivers of growth .................................................................................................. 25
3.2.1. Omni-channel’s ...................................................................................................... 25
3.2.2. Asia’s middle class.................................................................................................. 26
3.3. Competitors..................................................................................................................... 26
3.4. Comparables ................................................................................................................... 27
4. H&M Overview .................................................................................................. 29

4.1. History ............................................................................................................................. 29
4.2. Group geographic presence .......................................................................................... 30
4.3. H&M key figures ............................................................................................................ 31
4.4. H&M Shares.................................................................................................................... 33
4.4.1. Ownership structure .............................................................................................. 33
4.4.2. Share Price Evolution............................................................................................ 33
5. H&M Valuation.................................................................................................. 35
5.1. Assumptions.................................................................................................................... 35
5.1.1. Stores expansion ......................................................................................................... 35
5.1.2. Net sales....................................................................................................................... 37
5.1.3. COGS .......................................................................................................................... 38
5.1.4. Operating Expenses ................................................................................................... 39
5.1.5. D&A and Capital Expenditures ............................................................................... 41
5.1.6. Working Capital.......................................................................................................... 42
5.2. Cost of Capital ................................................................................................................ 43
5.3. DCF Valuation Output ................................................................................................. 44
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5.4. Sensitivity Analysis ......................................................................................................... 45
5.5. Relative Valuation .......................................................................................................... 46
5.6. Dividend Discount Model Valuation .......................................................................... 48
6. Comparison with the investment bank .............................................................. 50
7. Conclusion .......................................................................................................... 52
8. Appendix ............................................................................................................ 53
9. References .......................................................................................................... 56
vii
Index of Tables
Table 1 - General Information ...................................................................................................... 28
Table 2 - General Information ...................................................................................................... 31
Table 3 - Key financial metrics ..................................................................................................... 32
Table 4 - The 4 largest shareholders ............................................................................................ 33
Table 5 - Net sales forecasts .......................................................................................................... 38
Table 6 - GOGS forecasts ............................................................................................................. 39
Table 7 - Personnel expenses forecasts ....................................................................................... 40
Table 8 - Rental expenses forecasts.............................................................................................. 40
Table 9 - Other expenses forecasts .............................................................................................. 41
Table 10 - Depreciation and Capex forecasts ............................................................................. 42
Table 11 - Working capital forecasts ............................................................................................ 42
Table 12 - Beta regression analysis ............................................................................................... 43
Table 13 - Cost of capital summary ............................................................................................. 44
Table 14 - FCFF output ................................................................................................................. 44
Table 15 - Price per share analysis ................................................................................................ 45
Table 16 - Sensitivity analysis: variables - perpetual growth rate and WACC........................ 46
Table 17 - Multiples valuation (SEK M)...................................................................................... 47
Table 18 - Historical dividends ..................................................................................................... 48
Table 19 - Dividends forecast ....................................................................................................... 48
Table 20 - Operational assumption comparison ........................................................................ 50
Table 21 - Valuaton comparison .................................................................................................. 51
Index of Figures
Figure 1 - Global apparel retail industry value, $ billion (2009-2014) ..................................... 24
Figure 2 - Evolution of online, offline and web influenced sales in the US apparel retail
industry ............................................................................................................................................. 25
Figure 3 - H&M timeline ............................................................................................................... 29
Figure 4 - Group Portfolio 2014 .................................................................................................. 30
Figure 5 - Revenues breakdown by region 2004-2014 .............................................................. 30
Figure 6 - Group Portfolio 2014 (*other comprises 37 countries) .......................................... 31
Figure 7 - H&M sales evolution, SEK Million (2010-2014) ..................................................... 32
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Figure 8 - HMB index and H&M share value performance (2001-2015) .............................. 33
Figure 9 - H&M historical net sales % breakdown by region .................................................. 35
Figure 10 - H&M net sales % forecasts breakdown by region ................................................ 36
Figure 11 - Relation between EUR/USD exchange rate and Gross Margin ......................... 39
Figure 12 - Depreciation and Capex forecasts............................................................................ 41
Index of Appendices
Appendix 1 - Centroids Output .................................................................................................... 53
Appendix 2 - Cotton prices, historical chart ............................................................................... 53
Appendix 3 - EUR/ USD spot exchange rate ............................................................................ 54
Appendix 4 - Forecasted Income Statement, 2011-2024 .......................................................... 55
List of Acronyms
APV Adjusted Present Value DPO Days Payables Outstanding
Ke Cost of Equity DSO Days Sales Outstanding
CAGR Compounded Annual Growth Rate ERP Equity Risk Premium
D&A Depreciation and Amortization EVA Economic Value Added
DCF Discounted Cash Flow FCFE Free Cash Flow to Equity
DDM Dividend Discount Model FCFF Free Cash flow to the Firm
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Equity Valuation – Hennes & Mauritz 2015
1. Introduction
The present dissertation is subject to the Equity Valuation seminar. The objective is to
present a consistent and reliable valuation of Hennes and Mauritz (H&M). The final
purpose is to estimate the market value of H&M, as of 31.12.2014.
The motivation to conduct this master thesis is related to my interest in explore several
topics that were introduced in some courses performed during the Master’s degree.
In order to do so, three different valuation methods were applied.
This dissertation begins with an overview of the main valuation models. We present the
advantages and disadvantages of each of them and their applicability to the specific case of
H&M.
Afterwards, we analyze the apparel retail industry, where H&M operates, the historical
performance, trends and the growth opportunities within the industry.
Subsequently, we present all the forecast and assumptions required to guarantee an

accurate analysis. Later in this section, we analyze the valuation results, and a sensitivity
analysis to the DCF valuation is performed.
Finally, in the last section we compare the valuation results obtained with the ones
presented by JPMorgan equity research.
10
2. Literature Review
‘Valuation is the process by which forecasts of performance are converted into

estimates of price. A variety of valuation techniques are employed in practice, and
there is no single method that clearly dominates others. In fact, since each
technique involves different advantages and disadvantages, there are gains to
considering several approaches simultaneously’ (Papelu and Healy, 2012)
2.1. Introduction
The estimation of a company’s value is arguably one of the most complex tasks for
analysts, essentially as a result of the wide variety of approaches that they may use. Each
valuation technique naturally has its own set of advantages and disadvantages. Some are
more reliable, while others are easier to perform. In this context, Young et al., (1999)
defend that decide on the most adequate method for each case should be faced as the most
important challenge in a valuation process. Accordingly, analysts must choose carefully the
right methodology that invariably depends on which industry the company operates, how
mature the company is and how detailed the valuation should be (Frykman and Tolleryd,
2003).
Aiming at observing a company from multiple angles, analysts frequently try to triangulate
a company’s value by using simultaneously more than one valuation method, allowing them
to gain better insights about the value of a firm. Taking an integrated approach, by using
several complementary methods, will result in a more accurate and consistent statement of
a company’s value, improving the quality of the valuation.
Although the choice of the right model reveals to be a key issue in the valuation process, it
is also important to remember that “models do not value companies: you do”1. According
to Damodaran (2002), the huge amount of information available regarding the forecast of
the company performance makes the analysis more difficult. Selecting the data and the
information that matters from the one that does not, reveals to be in the end as important
as the decision concerning which valuation model and techniques that they should use.
Therefore, using the most appropriate method for a specific firm will only result in a
trustworthy valuation if the judgments and assumptions related to the forecasts are
reasonable. “Any analysis, however, is only as accurate as the forecasts it relies on. Errors
1 (Damodaran, 2002)
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in estimating the key ingredients of corporate value…can lead to mistakes in valuation”

(Koller et al., 2010).
2.2. Valuation Models
Besides the existence of different valuation techniques and the disagreement regarding
which is the best valuation model. There is in some form a general consensus regarding the
existing ones. These models are frequently based on different assumptions about the
fundamentals, and the valuation outcome will undoubtedly differ according to which
approach is used, however it is possible do group them according some characteristics that
they may share (Damodaran, 2002).
Following Damodaran (2002) line of thought, it is possible to identify three main valuation
approaches. The first, discounted cashflow valuation, in this method analysts try to predict
the value of an asset today, based on projections of future cashflows on that asset. The
second, relative valuation, suggests that the asset value should bear some resemblance to
other assets in a similar class, then this approach estimates the value of an asset by looking
at the pricing of 'comparable' assets relative to a common variable like earnings, cashflows,
book value or sales. Finally, there is the contingent claim valuation, which is the application
of option pricing models to measure the value of assets that share option characteristics.
This last approach is especially recommended to measure equity in troubled firms, such as
a firm with a significant chance of bankruptcy, in natural resource companies or in high
growth firms for instance a startup firm.
Apart from the three methods mentioned above, this dissertation will also make reference
to excess return models, in particularly, the Economic Value Added (EVA), which have
received significant importance over the last years.
2.2.1. Discounted Cashflow Valuation
The basis of this valuation procedure relies on the principle that the intrinsic value of an
asset is the present value of the expected cash flows on that asset. In this sense, it assumes
that the value of an asset must be correlated to the returns that we expect to gain from
holding it.
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Despite being relatively easy to perform in the case of companies with regular and positive
cashflows, the DCF valuation becomes more difficult to apply specially for cyclical, private
and distressed companies.
Even with some limitations, Damodaran (2002) argues that this approach is the foundation
on which other valuation approaches are built, therefore it is crucial to understand the
fundamentals of DCF valuation to apply correctly other valuation methods.
Potentially, a public traded firm has an infinite life, however we cannot estimate cash flows
forever. As result, after the growing period we estimate a terminal value in order to capture
the value at the end of the period.
t=n
CFt Terminal Value
Firm Value = ∑ t
+
(1 + WACC) (1 + WACC)n
t=1
(Equation 1)
Where:
CFn+1
Terminal Value = WACC−g
In general, there are two methods of using cash flows for discounted cash flows valuation.
You can either value the firm as whole and consequently use the free cash flow to the firm
(FCFF) which is the cash flow available to equity and debt-holders, or on the alternative
way you can value equity capital directly using free cash flow to equity (FCFE) which by
definition represents the cash flow that is available to the company’s equity holders only.
Regardless of the method used, if everything is computed right, you can always get from
the firm value to the equity value (Damodaran, 2002).
2.2.1.1. Free Cash Flow to the Equity (FCFE)

FCFE is the cash flow remaining to equity holders after all reinvestment needs and debt
repayments have been satisfied. Damodaran (2002) suggests the following formula to
compute FCFE.
FCFE = Net Income − (Capital Expenditures − Depreciation) − (Change in NWC)

+ (New Debt Issued − Debt Repayments)
(Equation 2)
Therefore, by discounting FCFE at the required rate of return on equity (Ke), we can
obtain the equity value (Stowe et al., 2007).
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∞
FCFE
Equity Value = ∑ + Terminal Value
(1 + k e )t
t=1
(Equation 3)
Where:
k e = Cost of equity
2.2.1.2. Dividend Discount Models (DDM)
“A stock is worth the present value of all the dividends ever to be paid upon it, no
more, no less... Present earnings, outlook, financial condition, and capitalization
should bear upon the price of a stock only as they assist buyers and sellers in
estimating future dividends.”- The Theory of Investment Value by John Burr
Williams (1938)
Considered by many as a particular case of FCFE, where the dividends are considered to
be cash flows to equity. Dividend discount model assumes by definition that the value of a
stock is the present value of expected dividends on it. Usually, investors expected to get
two types of cash flows, dividends during the stock holding period and an expected price at
the end of the holding period.
According to Foerster and Sapp (2006) the reasoning of this model is that typically firms
pay dividends as a mean of returning profits to equityholders, consequently the
fundamental value of a firm’s equity should be intrinsic dependent to its expected future
dividend payments.
∞
E(DPSt )
Value per share = ∑
(1 + k e )t
t=1
(Equation 4)
As the above formula suggests, the cost of equity and the expected dividends per share are
the two fundamental inputs of the model.
Derivations of the model

1. The Gordon Model:
According to Damodaran (2002), the use of the Gordon Model is specially reasonable for
the case of firms with a well-established payout policies that plan to continue into the
future.
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E(DPS1)
Value of Stock =
ke − g
(Equation 5)
Where:
g = Steady state growth rate forever after year n
The main assumption of this version of DDM is that it assumes a constant growth rate –
dividends grow at a rate that is sustained forever. Consequently, for companies with higher
dividend growth, the Gordon Model may not be appropriate. In this scenario, the Two
Stage Dividend Model would be the best option.
2. Two-stage Dividend Discount Model:

The basic premise of this variation of DDM is that it assumes two stages of growth.
Initially it predicts an extraordinary growth phase that lasts for n years, and then it slow
down to another growth, stable, that lasts forever.
t=n
E(DPS1) Pn
Value of Stock = ∑ t
+
(1 + k e ) (1 + k e )n
t=1
(Equation 6)
Where:
DPSn+1
Pn = ;
(k e − g)
Pn = Price (terminal value) at the end of year n
One limitations of the two stage model is the unrealistic assumption regarding the growth
rate. In practice, the shift from a high growth to a stable growth does not happens
immediately but instead gradually overtime (Damodaran, 2002).
Comparing the Dividend Discount Model with the Free Cash Flow to the Equity we can
easily observe the similarities. However the outcome of the valuation will be significantly
different when firms have dividends that are different from the FCFE. For instance for
firms with high probability of changing corporate control, the valuation using the FCFE
will provide a better estimate (Damodaran, 2002)
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2.2.1.3. Free Cash Flow to the Firm (FCFF)

Alternatively to equity valuation models, we can value the entire business by discounting
the free cash flows to the firm at the weighted average cost of capital.
The free cash flow to the firm (FCFF) includes the cash flows available to all owners of the
company, the equity and debtholders, after the firm pays all the operating expenses and
expenditures needed to sustain the business, such as fixed assets investments and working
capital needs (Ross et al., 2001).
The FCFF are defined according to the following formula:
FCFF = EBIT(1 − T) + Depreciation − Capital Expenditures − Changes in Working Capital
(Equation 7)
Following the same principle of FCFE, in this procedure the value of the firm can be
written as stated below:
∞
FCFF
Firm Value = ∑ + Terminal Value
(1 + WACC)t
t=
(Equation 8)
2.2.1.4. Adjusted Present Value (APV)
The adjustment present value is an alternative model to the weighted average cost of capital
(WACC) approach. The conceptual advantage of this valuation procedure is the distinction
between the unlevered value and the value of any financing side effects.
Therefore, Damodaran (2002) presents the following formula, which illustrates that this
approach assumes that the primary benefit of borrowing is the tax benefit and the main
cost is the added risk of bankruptcy.
EV = Value of a business with 100% equity financing + Present value of expected tax benefits of debt –
expected Bankruptcy Costs
(Equation 9)
This model can be divided into three steps. The first one is the value of the unlevered firm
(𝑉 𝑢 ). This can be done, by discounting the expected free cash flow to the firm, in this
scenario the WACC will be the same as the cost of equity since the company has no debt,
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therefore the cash flows can be discounted at the unlevered cost of equity. After this, the
debt effects are incorporated by adding the expected tax benefit associated with the use of
a certain level of debt – present value of interest tax shields (PVTS). And finally by subtracting
the value of bankruptcy costs, which measures the risk associated with an increase in the debt
level (Damodaran, 2002).
This final step is considered the main issue in the adjustment present value valuation. It
requires the estimation of the probability of default according to the debt level that the
company is using, as well as the cost of bankruptcy. The problem arises because neither the
probability of bankruptcy nor the bankruptcy cost can be estimated directly. Consequently,
some analysts choose to ignore them, which can lead to wrong conclusions regarding the
optimal debt ratio for the company (Damodaran, 2002).
Besides being considered more conservative than the weighted average cost of capital,
knowing that the debt to equity ratio is not an issue in H&M, I will not consider this
approach in this dissertation.
2.2.1.5. Further Issues
The Discount Rate
In a DCF based valuation, the discount rate is one of the crucial inputs. Therefore it should
be carefully estimated to guarantee that the cash flows are properly discounted.
 Cost of Equity (Ke)

The cost of equity denotes the required return that equity investors demand in order to be
compensated for the risk they undertake by investing in the company. The Capital Asset
Price Model (CAPM) is considered the standard approach to estimate it.
K e = R f + β[E(R m ) − R f ]
(Equation 10)
Where:
R f = Risk free rate
E(R m ) = Expected return on market portfolio
β = Company Beta
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For an asset to be risk free two criteria must be satisfied. There can be no risk of default
associated with its cash flow as well as no reinvestment risk. The risk free rate used to
predict the expected returns should be a default free (government) zero coupon rate.
Another important criterion to select an appropriate risk free rate is the consistency with
the currency in which the cash flows are estimated (Damodaran, 2002). As result, in the
H&M valuation it will be used the Sweden government bond rate of return of 10 years.
The risk premium is the premium that investors required for investing in the market
portfolio instead of investing in a riskless asset. Therefore it is the difference between the
actual returns earned on stocks over a long time period and the actual returned earned on a
risk free asset (Damodaran, 2002).
The beta coefficient measures the correlation between a stock and the market. Accordingly it
represents how as security returns respond to swings in the market. A stock with a high
beta must have excess returns higher than the market risk premium. To estimate beta,
(Damodaran, 2002) suggests that the most common approach is to regress stock returns
against market returns. And therefore, the slope of the estimated regression represents the
riskiness of the stock, the beta.
 Cost of Debt (Kd)

The cost of debt is the interest paid by a company on the debt outstanding (bonds, loans
and other forms of debt). It is determined by the risk free rate plus a risk component which
incorporates the default risk of the company and the tax advantage associated with debt.
The simplest procedure to estimate the cost of debt is to use the yield-to-maturity of a
firm’s long term bonds. Alternatively, it is possible to use the firm’s credit ratings and the
default spread associated (Damodaran, 2002).
 WACC
In order to discount properly the enterprise cash flows, analysts should use a rate that
includes the required return of each investor. The WACC is a weighted average cost of
capital, therefore it represents the opportunity cost of all financial investors (shareholders
and debtholders) face for investing their funds in a specific company (Koller et al., 2010).
The formula is the following:
18
E D
WACC = k e × + Kd × × (1 − T)
E+D E+D
(Equation 11)
Where:
T = Corporate tax rate
D = Market value of Debt
E= Market Value of Equity
After looking to the formula we easily conclude that the tax benefit from debt is captured
in the weighted average cost of capital in the cost of debt reduction due to the marginal tax
rate.
Terminal Value
“As a firm grows, it becomes more difficult for it to maintain high growth and it
eventually will grow at a rate less than or equal to the growth rate of the economy
in which it operates”(Damodaran, 2002)
Estimating the firm value requires some assumptions regarding the growth rate in
perpetuity. Even in an optimistic scenario where firms are reinvesting substantial portions
of their earnings and earn high returns on these investments, in the long run (infinite) they
tend to disappear.
Following this line of thought, Damodaran (2002) suggests that one alternative to find the
terminal value is consider a liquidation of the firm’s assets in the terminal year and estimate
what others would pay for the assets that the firm has accumulated at that point in time.
Besides this approach, other two are suggested. The first one applies a multiple to earnings,
revenues or book value to estimate the value in the terminal value. The other assumes that
the cash flows will growth at constant growth rate forever.
2.2.2. Relative Valuation
Relative valuation is considered by many authors as the easier and more intuitive valuation
approach. According to Petitt and Ferris (2013), relative valuation gives to analysts a “quick
and dirty” way to estimate the value of a company. The basic assumption of this method is
19
that similar companies should have similar valuations. This methodology consists
essentially on the use of multiples, and by definition a multiple is no more than a ratio
between two financial variables.
There are two basic types of multiples - enterprise value and equity value. Enterprise multiples
express the value of an entire firm. They are relative to a statistic that relates to the entire
enterprise, such as sales or EBIT. In contrast equity multiples, have both the numerator
and the denominator as “equity” measure, they express the value of shareholders’ claims on
the assets and cashflows of the business. Price-to-earnings (PER), Price to cash flow (PCF),
price to book value (PBV) are examples of equity multiples.
Damodaran (2002) highlights that despite being easy to use, four basic steps should be
assured, in order to obtain a useful analysis of comparable multiples.
Firstly is of utmost importance to ensure that the multiple is defined consistently, make
sure that there is a connection between the numerator and denominator for instance an
EV/ Net Income multiple is meaningless because the numerator and the denominator are
not aligned, the denominator accrues only to shareholders, while the numerator applies
both to share and debtholders. The second step is related to the cross sectional distribution
of the multiple, which in fact is fundamental to make judgments on whether it is too high
or too low. The third step is to analyze the multiple and understand not only what
fundamentals determine the multiple but also how changes in these fundamentals translate
into changes in the multiple. The final step is defining a right peer group. It is considered
by many authors as the most critical and crucial step in relative valuation. A well define
peer group should include firms that share the similar industry, business and financial
characteristics with the firm under analysis. Comparisons between corporations that do not
share the fundamentals, regarding risk, growth and cash flow characteristics are irrelevant,
since the same multiples vary considerably from industry to industry.
Despite the simplicity of this method, not only concerning the effort needed to perform
but also the fact of being easy to understand, it also presents some downsides.
A multiple represents a snapshot of where a firm is in a given point in time, which means
that it is a static method that does not consider future estimates, failing in capturing
changes that certainly will occur. Additionally, Suozzo et al. (2001) argue that multiples are
difficult to compare due to external reasons such as, different accounting policies that may
result in diverging multiples for companies operating in the same businesses, even with a
20
right peer group make comparisons can be a challenge and the outcome may not be as
accurate and truthful as we may desire.
When compared with the cashflows approach there is a consensus that both techniques
have pros and cons. Damodaran (2002), argues that discounted cashflows continue to
deliver the best results. Nevertheless several authors agree that when that comparative
analysis is careful and well-reasoned, it not only provides a useful check of DCF forecasts
but also provides a complement and critical insights into what drives value in a given
industry.
2.2.3. Contingent Claim Valuation
A consensual limitation of the approaches detailed above, is their weakness in capturing the
value of future options that are usually associated with many investments, they generally
ignore the dynamic behavior of asset prices.
By definition, an option is an arrangement which allows the owner to decide whether to

buy or sell an asset at a fixed price anytime on or before a given date (Ross et al., 2001).
Option valuation is often used to make decisions such as whether or not to explore an
opportunity, regarding for instance, natural resources, new technologies or, R&D
investments. It is therefore a crucial component in a business decision-making process
(Luehrman, 1998).
Over the last years, researchers consensually considered that options need not only to be
measured explicitly and valued, but also that the value of these options can have an
important impact in the investment decision.
As far as the cash flows analysis is concerned, a project or an investment should only be
accepted if the net present value is positive, despite NPV measures the risk through
discount rate, it does not consider that the firm will make operating decisions on a project
over its entire life, the future decisions regarding the option to delay, expand or abandon a
project (Damodaran, 2002; Ross et al., 2001).
Luehrman (1998), defend that despite the important and unquestionable insights of this
approach, there are some factors such as: “… active competitors, uncertainties that do not
fit near probability distributions, and the sheer number of relevant variables” that make the
21
use of the Option Theory not generally applicable. And when applied should be considered
as complement and not a substitute for other existing methods.
2.2.4. EVA
“Aspiring to earn a high return is not enough” – (Stewart, 1999)
Over the last years, the use ‘excess returns’ models to determine the value of a business,
have received a significant importance. Recent studies have showed that growth without
excess returns creates no value.
The economic value added approach is a particularly case of an excess return valuation
which suggests that the value of a business can be simply stated as a function of the excess
returns.
An attractive rate of return is undoubtedly one of the key figures that investors are looking
for when they face the decision of invest or not in a company. However, this model
suggests that shareholders should receive a return that compensates the risks that they have
by making a certain investment. Otherwise, there is no real profit made and actually the
company operates at a loss from the shareholders point of view. (Damodaran 2006)
According to Damodaran (2006), in order to measure the economic value added, three
basic inputs should be considered, the return on capital earned on investments, the cost of
capital for those investments and the capital invested in them.
Therefore, the firm value can be written as following:
t=∞ t=∞
EVAt Assets in Place EVAt Future Projects
Firm Value = Capital InvestedAssets in Place + ∑ t
+∑
(1 + WACC) (1 + WACC)t
t=1 t=1
(Equation 12)
From a valuation perspective, the rate of return can be considered an adequate measure to
evaluate if a project should or not be accepted, but as Stewart (1999) states in his book
from a performance measure side it is far from being the perfect tool. Therefore the big
plus of this method, when compared with the other ones is that it can be very useful as a
performance measure. Despite DCF also includes the opportunity cost of equity, it is
exclusively based on cash flows.
22
2.3. Conclusion
After describing the main valuation models, is important to conclude which of them are
going to be used in the context of this dissertation.
First of all, we decided to perform a DCF valuation. As previously said it is the most
commonly used approach and it is considered to be the basis on which other valuations are
built.
Secondly, a relative valuation will be considered, in order to analyze how H&M in

positioned in the apparel retail industry. Furthermore, this approach is considered to
provide a complement and a useful check of DCF. By using these two approaches
simultaneously, we can guarantee a more accurate valuation output.
Finally, we will complement this dissertation by performing the Dividend Discount Model.
23
3. The Industry
3.1. Apparel retail industry overview
Aiming at performing an accurate valuation of H&M it becomes fundamental to
understand the apparel retail industry, how it behaves and what are the opportunities and
challenges that it faces.
The apparel retail is one of the most important and dynamic industries in the economy
due to its contribution to the employment, trade, investment and revenue all over the
world. The industry is involved in the sale of clothing, accessories and footwear. The sale
of womenswear is the most profitable segment in this sector, accounting for almost 50% of
the industry overall value.
In 2014 the global apparel retail industry had total revenues of $1.162.80billion,
corresponding to a CAGR of 2.4% between 2009 and 2014.
Figure 1 - Global apparel retail industry value, $ billion (2009-2014)
1 400 5,0%
4,3%
4,1%
1 300 4,0%
3,1%
2,6%
1 200 3,5% 3,0%
2,0%
1 100 2,0%
1 000 1,0%
2009 2010 2011 2012 2013 2014
$ billion % Growth
Source: MarketLine – Apparel retail: global industry guide
Despite the global economic downturn that some countries have been facing during the
last years, the size of the global apparel business is growing and the industry performance is
expected to accelerate in the upcoming years. By the end of 2019 the industry is expected
to value $1.654billion, corresponding to a CAGR of 4% between 2014 and 2019.
24
3.2. Main drivers of growth

3.2.1. Omni-channel’s
Over the last few years, the innovations taking place at the intersection of fashion and
technology are profoundly changing the apparel retail industry. In this context, one of the
main challenges that the fashion retail industry is facing nowadays is the Omni-channel
retailing. By definition it is an approach that use a variety of channels either online or
offline, to engage customers providing them with the same experience and message no
matter the channel that they are using (mobile app, social media portal, website or physical
store).
If on one hand it is a great opportunity of growth and penetration among existing markets,
on the other it represents an unique challenge for retailers given the investment needs
required to provide a true Omni-channel environment where every decision (planning,
purchasing, allocation, replenishment, promotions, price optimization and event
management) is calculated on a global level and only then broken down into the various
channels of the retail process.
Consumers are spending less time in stores and moving toward e-commerce sites in
particularly via mobile devices due to the convenience of browsing and purchasing. The
following figure focus that over the last years the web-influenced sales in US increase
significantly.
Figure 2 – Evolution of online, offline and web influenced sales in the US apparel retail industry
100%
80%
60%
40%
20%
0%
2010 2011 2012 2013 2014 2015 2016
Online Web-influenced Offline Offline only
Source: Statistic
25
Over the next years the web influenced sales are expected to continue to increase. We
predict a perfect and total connection between channels, making impossible to distinguish
from which channel the purchase was done. Therefore invest in the use of combined
channels and update the online retailing infrastructures, with the main focus on mobile
optimization by creating responsive site designs with a functional purchase, distribution
and return system is certainly one of the biggest challenges that the industry is facing
nowadays.
3.2.2. Asia’s middle class
Seeking out for new market opportunities, given the saturation of the existing ones, leads
to an exponential investment in Asian markets consequence of the changing profile of
Asian consumers who are migrating into the middle class and starting to view clothes as an
extension and expression of their new lifestyle represents.
Asia is no longer seen as just a manufacturing base as it was in the past. It represents today
the world’s largest consumer market and therefore a window of opportunity for global
retailers.
In 2009 Asia’s middle class consumption accounted for 23 percent of the expenditures of
the global middle class, while in 2030 it is expected to account 59 percent. Proving that
much of the industry growth expected for the upcoming years is coming from the
exploding buying power among Asian consumers.2
3.3. Competitors
The apparel retail industry is highly competitive and a huge number of small players arise
due to the low barriers to entry. However, large companies represent the major share of
total industry revenues as a result of their economies of scale in purchasing, distributing
and marketing their products.
Despite being a very dynamic industry, Inditex, the Spanish fashion group, is consensually
considered the closest peer of H&M. Both are continental European-listed fashion retailers
2
China’s Emerging Middle Class: Beyond Economic Transformation
26
with global operations and aggressive store rollout programs. However, despite the
similarities between the two giants, differences arise after analyzing their business models
and their geographical exposure. While Zara’s business model is focuses on in house
production, H&M’s is completely focused in outsourcing their production and therefore is
more expose to fluctuations in exchange rates.
Apart from Inditex and H&M other players have also a considerable share in the global
apparel retail industry: UNIQLO from Japan (Fast Retailing), Gap from US and L Brands,
the American fashion retailer owner of Victoria’s Secret.
In the last years, other companies that only operate on the web fashion business such as
ASOS from UK and Zalando from Germany, are also becoming fierce competitors due to
the increasingly importance of e-commerce in the industry.
3.4. Comparables
In order to apply multiples to compare companies, it is fundamental to establish a peer
group, which should include companies belonging to the same industry.
To guarantee a more realistic relative valuation, the peer group should not include all the
companies that are competing in the same industry. A more restrictive analysis should be
performed.
In order to do so, we started by using the Bloomberg’s peer list of H&M’s competitors
and over this list we selected the top 25 companies from the apparel retail industry,
ordered by total sales. Since H&M has operations worldwide we did not restrict to any
particular region. Therefore this list comprises companies operating in the same industry,
from all over the world.
Over this group of peers, we applied the cluster analysis in order to “clean” the sample
(Appendix 1). For this purpose we selected four variables: EBITDA margin – a measure of
growth, WACC, return on assets – a profitability measure and finally the debt to equity
ratio in order to exclude companies with a capital structure considerably different from
H&M.
27
With this analysis we were able to ensure that the companies were similar in terms of the
risks and the perspectives of growth. According to Damodaran compare companies which
do not share these fundamentals is pointless.
Finally, with these four variables and with three centroids we arrived to the following peer
group.
Table 1 – Peer group general information
PEER GROUP EBITDA margin ROA D/E WACC

FOOT LOCKER INC 13% 15% 5% 8%
INDUSTRIA DE DISENO TEXTIL 23% 17% 0% 12%
HENNES & MAURITZ AB-B SHS 20% 28% 0% 8%
FAST RETAILING CO LTD 12% 8% 8% 11%
ROSS STORES INC 16% 22% 17% 9%
URBAN OUTFITTERS INC 15% 11% 0% 8%
Source: company data and own analysis
Urban Outfitters is an American firm with operations in eleven markets, both in Europe
and in the United States. Its products are more targeted to hipster and vintage styles, since
its clothes are more exclusive, its prices are higher than H&M. Ross Stores is also an
American company and is considered the largest off-price retailer in US. Contrarily to the
previous firm, the group is only present in the US. Regarding to Foot Locker, again an
American company, has operations in Europe and in Asia. However the company is focus
in sportswear retailer. Finally Fast Retailing, commonly known by UNIQLO, a mixture of
unique and clothing, is a Japanese company with operations worldwide. When compared to
the other companies of the peer group, is the one more similar to H&M and Inditex,
despite not being and European company, they have the same target public, and they
follow the same expansion strategy, not only in terms of geographic presence but also in
terms of e-commerce investments.
28
4. H&M Overview
4.1. History
Hennes and Mauritz (H&M) is a Swedish multinational company founded by Erling
Persson in 1947. At the very beginning it was only a women’s clothing store but from
1968 onwards the company started to diversify its portfolio to other products, which
nowadays also includes menswear, childrenwear, footwear, accessories, cosmetics and
home furnishing.
H&M does not own factories meaning that all the collections are produced by independent
suppliers especially from Asia and Europe, which collaborate and work with the company.
At present, H&M has already owned 3.511 stores, is present in more than 55 countries and
has around 132.000 employees. In 2015 was considered the 33rd most valuable brand in the
world with a brand value of about 18.54 billion US dollars.
Despite being already an unquestionable giant in the apparel industry, the bet on
innovation reveals to be one of main drivers for the group success and growth. Therefore,
in 2004, the company started to collaborate with high profile designers and style icons in
order to create specially collections. The success of each of these campaigns was
unquestionable. In 2011 the Versace collection sold out in 30 minutes, both in Dubai and
Beijing.
Figure 3 - H&M timeline
1st store opened in Enters

First Online sales China and Major South
Hennes H&M is are expansion of Korea and
store listed on the introduced H&M’s online sales Turkey
opened Stockholm in Sweden
Stock
exchange
1947 1964 1974 1976 1998 2004 2006 2008 2010 2013 Future
H&M Store
First Design H&M
enters in H&M expands number 3000
Collaboration Home is
Norway outside the opens in
launched
Nordic Region China
Source: company data
29
In 2006, aiming at increase its global share by targeting new customers away from its core
young and price conscious shopper, the group started adding new brands. Nowadays,
H&M comprises six independent brands which allow the customers to access to an
extensive and varied range of products.
Figure 4– Group portfolio 2014
Number of stores 3.261 114 92 22 5 17

Number of countries 55 25 12 7 4 10
Shop online countries 13 19 18 18 18 13
Source: H&M annual report
4.2. Group geographic presence

The H&M internationalization process dates back 1964 when the first H&M store opened
in Norway. Nowadays the company is operating in more than 50 countries across four
continents. H&M’s strategy of global expansion is focus in increasing the group’s position
in new markets allowing for a decreasing in the group’s dependence on mature markets. In
this way the company is less exposure to the risks and the effects of the economy
slowdown that European countries have been facing.
Figure 5 – Revenues breakdown by region 2004-2014
100%
80%
60%
40%
20%
0%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
EUROPE AMERICA ASIA FRANCHISE
Over the years, Europe has represented by far the main source of the group’s revenues.
30
In order to reinforce the previous analysis a revenues breakdown by country was

performed. According to the 2014 company report, 60% of the group total revenues are
coming from only 5 countries, Germany, USA, UK, France and China.
Figure 6– Group portfolio 2014 (*other comprises 37 countries)
50%
19,4%
7,4% 10,9%
6,8% 5,3%
Germany France UK USA China Other*
4.3. H&M key figures

During the last year H&M continued to reinforce its international position. The group
entered in two new markets, Australia and Philippines and created 12,252 new jobs. H&M
opened 379 new stores and expects to open 400 in 2015.
By looking at the right side of graphic 3 it is possible observe the evolution of the annual
growth of the historical capital expenditures. The increase is significant, particularly in 2012
and 2014. This behavior is consequence of the solid investment that company has been
making in IT and online, and in increase the company product range.
Table 2 – H&M general information

Capex YoY %
General information 2010 2011 2012 2013 2014
19% 17% 19%
Capex 4.812 5.103 6.071 7.110 8.488
Number of stores 2.206 2.472 2.776 3.132 3.511 6%
Net openings 218 266 304 356 379
Number of marktes 38 43 48 53 55
2010 2011 2012 2013 2014
Online markets 8 18 19
Number of employess 59.440 64.874 72.276 81.099 93.351 -13%
31
The last year’s investments have been positive effects in sales growth. H&M sales have
been showing record values, in 2014 H&M had total revenues of 151419 million SEK,
corresponding to a CAGR of 9% between 2010 and 2014.
Figure 7– H&M sales evolution, SEK million (2010-2014)
160000 151 419 20%

18%
140000 128 562
120 799 16%
120000 108 483 109 999 18%
14%
100000 12%
10%
80000 10%
7% 6%
60000 8%
6%
40000
4%
1%
20000 2%
0 0%
2010 2011 2012 2013 2014
Net sales % growth
Table 3 - Key financial metrics
SEK m 2008 2009 2010 2011 2012 2013 2014 Gross Margin %
Net sales 88.532 101.393 108.483 109.999 120.799 128.562 151.419 63%
Sales growth 12% 15% 7% 1% 10% 6% 18%
60%
59% 59%
Gross Profit 54.468 62.474 68.269 66.147 71.871 76.033 89.052 59%
Gross Margin 62% 62% 63% 60% 59% 59% 59%
EBIT 20.138 21.644 24.659 20.379 21.754 22.168 25.583

EBIT Margin 23% 21% 23% 19% 18% 17% 17% 2010 2011 2012 2013 2014
Source: Company data
One important analyze to be performed is related to the operating performance of H&M.

By observing the previous graph we may conclude that over the last years H&M gross
margin slight decrease proving its instability. This is mainly due to external factors such as
the currency exchange rate. 80% of H&M purchasing cost are done in US dollars while the
primarily currency in terms of sales is the euro. The incapacity to react to currency
movements, given its strategy to always have the best customers offering, will naturally be
reflected in greater gross margin volatility.
32
As far as the capital structure is concerned, it is important to point out that H&M does not
carry any financial debt on its capital structure since 2002
4.4. H&M Shares

4.4.1. Ownership structure
The Persson family is the main shareholder of H&M. They have a total 623 million shares
where 194 million of them are class A shares. The company’s shares consist of both A and
B shares. The A shares are entitled to ten votes while B shares to one vote. Therefore,
despite only having 38% of total H&M shares, they control 70% of the overall votes.
Table 4 - The 4 largest shareholders
Name Nr. Of A shares Nr. Of B shares % of total shares % of voting shares

Stefan Persson and family 194.400.000 429.449.332 38,69 69,71
Lottie Tham and family - 88.080.400 5,32 2,59
Alecta pensionsforsakring - 67.650.000 4,09 1,99
swebank robur fonder - 37.568.801 2,27 1,1
others * - 837.923.467 49,63 24,61
Total 194.400.000 1.460.672.000 100 100
Source: H&M investor relations report (* comprises 16 shareholders)
4.4.2. Share Price Evolution

Figure 8- HMB index and H&M share value performance (2001-2015)
2000 400
1800 350
1600
300
H&M share price
1400
OMX Index
1200 250
1000 200
800 150
600
100
400
200 50
0 0
OMX Index HMB SS Equity
Source: Bloomberg terminal and company data
H&M is listed on the Stockholm stock exchange since 1974. OMX index comprises the 30
most actively traded stocks on the Stockholm Stock Exchange and H&M is nowadays the
33
company with the second higher market capitalization of the OMX Stockholm 30 Index,
behind the biopharmaceutical company, Astrazeneca.
In the previous graph we may observe how H&M’s stock price behave in line with OMX
index. In broader terms there was only one period where H&M’s stock price dropped
significantly, which was in 2008, a natural consequence of the collapse of the financial
crises. From that period onwards the share price continuously keeps rising and in March
2015 it reached a historical high of 365,4 SEK.
34
5. H&M Valuation
5.1. Assumptions
In the following section will be explained all the assumptions required to arrive to the
FCFF. The explicit period considered was 10 years (2015-2024), the expansion path
expected for the upcoming years suggests that with a shorter explicit period H&M will not
be already in its stable stage. That being said, the explicit period was divided into two
stages. A first period of 5 years, reflecting H&M’s expansion stage, and then a second
period of another 5 years, where H&M reaches its steady stage.
5.1.1. Stores expansion
Despite being present in 55 countries, Europe continues to represent the main market for
H&M. In 2010, more than 80% of H&M stores where in Europe and only 2.7% in Asia.
However, over the last 5 years the dependence of European markets has been decreasing,
and in 2014, a net total of 86 new stores opened in China, reflecting the group plans of
increasing its presence in Asian markets.
Figure 9 - H&M historical net sales % breakdown by region
2,3% 2,8% 3,2% 3,5% 3,7%

100%
11,9% 11,8% 11,9% 12,0% 12,4%
2,7% 4,2%
80% 6,2% 8,7% 11,3%
60%
40% 83,1% 81,2% 78,7% 75,8% 72,6%
20%
0%
2010 2011 2012 2013 2014
Europe Asia Pacific North and South America Franchise
Source: H&M reports and own calculations
35
Considering both the H&M’s worldwide expansion strategy together with the increasingly
importance of the online business specially in China and US, we believe that for the
forthcoming years, the H&M presence in these regions will continue to face the expansion
path verified over the last years.
Franchise stores are mainly stores in Middle East and Africa, according to H&M reports
franchising is not part of the group expansion strategy, therefore we will not consider any
significant change.
The group expansion towards American continent is essentially focus in North America,
despite some new markets in South America, such as Chile and Peru, the group consider
that South America is a huge challenge due to legal questions, import costs and local
salaries. Therefore, the focus will be expanding through online in US and Canada.
That being said, in order to forecast the stores expansion by geographic region, we
considered the historical stores expansion of H&M peers, mainly Inditex, the GDP growth
rate projections per region, historical data since 2010 and some inputs specified in the
group annual reports, regarding the group growth target for the next years (10-15%). This
analysis is in accordance with the group ambitious of expansion towards new markets in
particular in China and US.
Figure 10 - H&M net sales % forecasts breakdown by region
100%
80%
60%
40%
20%
0%
2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E
Europe Asia Pacific North and South America Franchise
36
5.1.2. Net sales
Estimating revenues is probably the most important assumption one can make about a
company future cash flows.
According to the methodology commonly used in the retail industry, the overall growth
rate of revenues is a combination of three factors: currency effect, like-for-like sales
growth 3 and new space contribution. However, the expansion path verified in the last
years and expected for the upcoming ones forced the group to stop include like-for-like
sales data in its reports due to the complexity associated with the group stores network.
Moreover the rapid expansion through the online platform makes difficult to compare
store sales.
As result, H&M revenues growth will be projected based on factors such as the group
historical sales growth, the growth target established for the upcoming years (10-15%) and
the historical growth of H&M main competitors, Inditex and Uniqlo.
The reason to consider this last figure is related to the fact that over the last years H&M,
has not kept pace with its peers in terms of IT investment, products diversification and
geographic expansion into high growth markets. And only now is starting to recover from
its expansion stagnation period.
Consequently, in the first two years of the explicit period revenues growth was considered
to be the average of the two competitor’s growth over the last 3 years (14.3%). A value we
consider to be in accordance with the group growth target.
After two years of high growth, one may foresee that for the remaining 3 years of the first
stage of the explicit period, net sales growth will start to slowdown converging to the
company historical CAGR (8.7%). For the last 5 years of the explicit period, a phase where
revenues growth is expected to decrease 1% per year until it reaches its steady stage where
revenues are projected to growth at same level as the industry (4%).
3 A statistical measure that allows determining what portion of new sales has come from sales growth and what portion
can be attributed to the opening of new stores.
37
Table 5- Net sales forecasts
2010 2011 2012 2013 2014 CAGR

Net sales 108.483 109.999 120.799 128.562 151.419
8,7%
H&M YoY growth 7% 1% 10% 6% 18%
2015 2016 2017 2018 2019 CAGR
Net sales 173.146 197.991 220.246 242.161 263.214
11,0%
H&M YoY growth 14% 14% 11% 10% 9%
2020 2021 2022 2023 2024 CAGR
Net sales 283.465 302.439 319.660 334.664 347.025
5,2%
H&M YoY growth 8% 7% 6% 5% 4%
5.1.3. COGS
The production cost for H&M are mostly influenced by external factors in particular the
raw material prices and the fluctuations in the foreign currencies.
With respect to raw materials, cotton is the one that H&M uses the most. Despite the
unusual behavior of this commodity in 2011, where its price achieved historical highs, from
that year until now, cotton prices have been relatively calm and stable (Appendix 2) and are
expected to remain stable in the forthcoming years.
Another important issue to address in order to forecast H&M costs of goods sold is the
group exposure to foreign currencies. According to H&M 2014 annual report, half of
group’s sales are made in Euros while the majority of H&M’s clothes are purchased in US
dollars. Therefore a dollar appreciation against other currencies in particular the Euro
would represent an increase in the company sourcing costs. Despite the extremely difficulty
in forecasting the fluctuations in the US dollar/Euro exchange rate, we consider
fundamental include the speculations of a parity between the two currencies, a scenario that
is not verified since 2002 (Appendix 3).
Over the years, we may verified a strong correlation between the gross margin and the US
dollar/Euro exchange rate and therefore the gross margin will be projected based on the
exchange rate expectations. For 2015, we considered that H&M gross margin will behave
in line with the value verified in 2002. In 2016, we will assume that the euro will effectively
reach parity with the US dollar, and consequently the gross margin will decrease and remain
constant for the remaining explicit period.
38
Figure 11 – Relation between EUR/USD exchange rate and Gross Margin
1,6 64%
62%
1,4
60%
1,2 58%
1 56%
54%
0,8
52%
0,6 50%
2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024
EUR/USD Gross margin
Source: H&M reports, own calculations and European Central Bank
Having the forecasts for revenues and for the gross margin, we can easily deduct the value
of COGS.
Table 6- GOGS forecasts
2015 2016 2017 2018 2019 2024

COGS 74.453 87.116 96.908 106.551 115.814 152.691
% Sales 43% 44% 44% 44% 44% 44%
Gross margin 57% 56% 56% 56% 56% 56%
EUR/USD 1,097 1 1 1 1 1
Source: Own calculations and Bloomberg terminal
From the previous analysis we may conclude that the expectations of a positive operational
momentum can be negative influenced by the expectations of a strong US Dollar, thus
negatively affecting H&M gross margin due to the H&M’s strict price police that not allow
for prince changes in order to manage the gross margin in the short term.
5.1.4. Operating Expenses
The group operating expenses are mainly related to personnel and rental expenses.
Therefore, in order to better estimate the overall operating expenses, we discriminated into
personnel, rental and other expenses. Other expenses may include several items such as
advertising, training indicatives, research and development expenses.
For the personnel expenses projections we considered both the historical employee per
store ratio which varies between 26 and 27 and the personnel expenses per employee which
39
is also relatively stable along the historical period. Therefore, from 2015 onwards it was
assumed that both of these rations will be constant and equal to the corresponding
historical period average.
Afterwards, we multiplied the total number of employees by the personnel expense per
employee and we got the total personnel expenses.
Table 7 - Personnel expenses forecasts
2015 2016 2017 2018 2019

Personnel expenses 28.725 32.061 36.055 40.745 46.148
# of employees 103.402 115.409 129.785 146.668 166.118
Personnel exp/employee 0,28 0,28 0,28 0,28 0,28
Employee/store 26 26 26 26 26
2020 2021 2022 2023 2024
Personnel expenses 47.405 48.660 49.992 51.368 52.775
# of employees 170.641 175.159 179.954 184.908 189.972
Personnel exp/employee 0,28 0,28 0,28 0,28 0,28
Employee/store 26 26 26 26 26
Source: Own calculations
Regarding rental expenses which correspond to operating leases charges, the same
methodology were applied, firstly we computed the rental expenses per store and for the
forecasting period we assumed the average of the historical period. Given this input and
the total number of stores we may arrive to the total rental expenses.
Table 8 - Rental expenses forecasts
2015 2016 2017 2018 2019

Rental expenses 20.301 22.763 25.603 28.894 32.726
# stores 3.925 4.401 4.951 5.587 6.328
Rental expenses/store 5 5 5 5 5
2020 2021 2022 2023 2024
Rental expenses 33.611 34.523 35.463 36.432 37.431
# stores 6.499 6.675 6.857 7.045 7.238
Rental expenses/store 5 5 5 5 5
The projections for other expenses were done in accordance with net sales evolution.
Therefore for the forthcoming years we assumed these values to be equal to the
corresponding average of the historical period.
40
Table 9 – Other expenses forecasts
2015 2016 2017 2018 2019

Other 24.264 27.745 30.864 33.935 36.885
% Sales 14% 14% 14% 14% 14%
2020 2021 2022 2023 2024
Other 39.723 42.382 44.795 46.898 48.630
% Sales 14% 14% 14% 14% 14%
5.1.5. D&A and Capital Expenditures
To forecast depreciation we considered PP&E as the forecast driver. To do so we started

by analyze PP&E as a percentage of revenues historically. For the first five years of the
explicit period, a high growth stage, we assumed this ratio to be constant and equal to the
value verified in 2014 (17.8%). For the last five years, a stage in which we consider that
H&M will continue to invest but at a more moderate level, we assumed that the ratio will
constantly decrease 0.4% a year until it reaches the historical average (15.81%).
Afterwards, depreciation was computed as a percentage of the forecasted values for PP&E,
the 2014 ratio (18.72%) was assumed to remain constant over the entire explicit period.
Concerning capital expenditures, which for H&M are essential related to investments in
equipment, buildings and land, we may observe that they have been increasing year over
years, consequence of the group expansion strategy.
In order to forecast capex we also linked it to future projections of PP&E, by summing the
depreciation to the annual increase in PP&E.
Figure 12- Depreciation and Capex forecasts
14 000
12 000
10 000
8 000
6 000
4 000
2 000
0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Capex Depreciation
41
Table 10 - Depreciation and Capex forecasts
2010 2011 2012 2013 2014 2015

PP&E 15.469 17.393 19.131 22.186 26.948 30.815
% net sales 14% 16% 16% 17% 18% 18%
D&A 3.061 3.262 3.705 4.191 5.045 5.769
% PP&E 20% 19% 19% 19% 19% 19%
Capex 4.812 5.103 6.071 7.110 8.488 9.636
2016 2017 2018 2019 2023 2024
PP&E 35.236 39.197 43.097 46.844 54.246 54.872
% net sales 18% 18% 18% 18% 16% 16%
D&A 6.597 7.338 8.068 8.770 10.155 10.273
% PP&E 19% 19% 19% 19% 19% 19%
Capex 11.018 11.299 11.968 12.517 11.318 10.899
5.1.6. Working Capital
In order to compute the working capital we considered both operating current assets and
liabilities. In the company report is stated that any liability is interest bearing, therefore for
the working capital computation we assumed the following items – current receivables,
deferred tax receivables, inventory, current liabilities and deferred income tax.
Table 11 - Working capital forecasts
2015 2016 2017 2018 2019

Current receivables 7.319 8.369 9.310 10.236 11.126
DSO 15 15 15 15 15
Deferred tax receivables 2.074 2.371 2.638 2.900 3.153
DSO 4 4 4 4 4
Inventory 23.325 27.292 30.360 33.381 36.283
DSI 114 114 114 114 114
Current liabilities 24.932 29.173 32.452 35.681 38.783
DPO 120 120 120 120 120
Deferred income tax 3.584 4.193 4.664 5.129 5.574
DPO 18 18 18 18 18
Net working capital 5.729 6.453 7.179 7.893 8.579
Change in NWC 1.034 725 725 714 686
2020 2021 2022 2023 2024
Current receivables 11.982 12.784 13.512 14.146 14.669
DSO 15 15 15 15 15
Deferred tax receivables 3.395 3.622 3.829 4.008 4.156
DSO 4 4 4 4 4
Inventory 39.075 41.690 44.064 46.132 47.836
DSI 114 114 114 114 114
Current liabilities 41.767 44.563 47.100 49.311 51.132
DPO 120 120 120 120 120
Deferred income tax 6.003 6.405 6.770 7.088 7.349
DPO 18 18 18 18 18
Net working capital 9.239 9.857 10.419 10.908 11.311
Change in NWC 660 618 561 489 403
42
In order to forecast receivables it was assumed the historical average of DSO (Days sales
outstanding) ratio and then net sales were used as the forecasting driver. The same
methodology was applied for inventory and payables however, for this we considered DSI
(Days inventory outstanding) and DPO (Days payable outstanding) respectively and COGS
as forecasting driver.
5.2. Cost of Capital

As previously mentioned, H&M does not carry any financial debt on its capital structure
since 2002. Accordingly, we will assume that the capital structure will remain constant and
consequently the company will have zero debt in the future.
Therefore the cost of capital will only depend on the cost of equity which was estimated
according to the CAPM model (formula 7-literature review).
For the risk free rate was assumed to be equal to the 10 year Swedish Government bond
yield 0.93% (30-12-2014).
In order to determine beta, the linear regression approach was used. The H&M returns
were regressed against the Sweden market index (OMX), which we assumed to be
representative of the market portfolio. To do so, historical, daily, weekly and monthly
returns since 2011 were collected from Bloomberg.
Despite the higher r-squared associated with the daily data regression, we decided to use a
longer return interval (weekly) in order to avoid the bias that may occur due to the non-
trading problem of daily data, which could affect the beta.
Table 12 - Beta regression analysis
SUMMARY
Daily Weekly Montly
Beta 0,82 0,85 0,78
R2 0,55 0,54 0,38
Source: Own calculations and Bloomberg terminal
Regarding the market risk premium (MRP) we used a mature market equity risk premium
of 5.75% from Damodaran database and for the country risk premium we did a weighted
average taking into account the group revenues by geography and the respective country
43
risk premium. We ended up with a country risk premium of 1.4%. Thus, both values were
taken together and we arrived to a MRP equal to 6.75%.
Table 13 - Cost of capital summary
WACC
Rf Equity Beta Mature market ERP CRP Rm-Rf Ke = WACC
0,9% 0,85 5,8% 1,4% 7,2% 7,0%
Source: Damodaran website, Bloomberg terminal and own calculations
5.3. DCF Valuation Output

After considering all the forecasts presented in the above section, it was possible to
compute the FCFF.
In order to do so a constant effective tax rate of 24% was considered, over the last years
the value has been stable between 23% and 25%, and therefore an average value was
assumed.
Table 14 - FCFF output
2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
EBIT 25.403 28.305 30.816 32.036 31.640 38.001 43.801 48.759 52.713 55.498
Corporate tax rate 24% 24% 24% 24% 24% 24% 24% 24% 24% 24%
- Taxes on EBIT 6.136 6.837 7.444 7.739 7.643 9.180 10.581 11.778 12.733 13.406
= NOPLAT 19.266 21.468 23.372 24.297 23.997 28.822 33.220 36.981 39.980 42.092
+ D&A 5.769 6.597 7.338 8.068 8.770 9.234 9.627 9.938 10.155 10.273
- Changes in NWC 1.034 725 725 714 686 660 618 561 489 403
- Capex 9.636 11.018 11.299 11.968 12.517 11.713 11.728 11.597 11.318 10.899
= FCFF 14.366 16.322 18.686 19.683 19.564 25.683 30.501 34.760 38.328 41.063
As previously said in the literature review the value of the firm was obtained by discounting
the all the FCF at the appropriate discount rate (6,98%). For the terminal value a perpetual
growth rate of 2%4 was assumed. We considered that after 2024, H&M growth rate will be
constant and equal to the expected inflation rate.
4 CBO – An Update to the Budget and Economic Outlook:2014 to 2024
44
By summing these two components we arrived to an Enterprise Value of 598.956 million

SEK. Giving that H&M has is a debt free company, in order to get the equity value we
need to sum the excess cash, thus we added 12.374 to the enterprise value and the output
was an equity value of 611.327 M SEK.
Finally, in order to get the value per share, we divided the equity value by the total number
of shares. Given that over the last 5 years the number of shares has been constant, we will
assume that it will not change in the future. Therefore, the result is a price per share of
369,4 SEK.
Table 15 - Price per share analysis
H&M stock price computation

Sum PV FCFF 170.183
+ PV Terminal Value 428.770
= Enterprise Value (SEKm) 598.953
+ Cash 12.374
= Equity Value (SEKm) 611.327
# shares (m) 1.655
P0 (SEK) 369,4
We may conclude that the target price is 13% above of the company current market price
(326 SEK). That being said, a buy recommendation will be given
5.4. Sensitivity Analysis

As stated in the first section of this dissertation, “models do not value companies, you do”.
That shows how important can be the judgments and the assumptions made regarding the
company forecasts. “Errors in estimating the key ingredients of corporate value…can lead
to mistakes in valuation”
In this context, we will test how sensitive the DCF outcome is to changes in certain
variables.
First of all, we will analyze the impact of changes in the discount rate and in the perpetuity
growth rate. These two variables are considered to be the two main input factors and
therefore the impact on the outcome is large. In the following table we may see the result
of the sensitivity analysis regarding those two factors.
45
Table 16 - Sensitivity analysis: variables - perpetual growth rate and WACC
Growth rate
0,5% 1,0% 1,5% 2,0% 2,5% 3,0% 3,5%
5,48% 413,4 447,8 491,0 546,5 620,7 724,8 881,6
5,98% 371,0 398,0 431,1 472,4 525,6 596,7 696,5
W
6,48% 336,0 357,5 383,4 415,0 454,6 505,7 573,8
A
6,98% 306,4 323,9 344,6 369,4 399,7 437,7 486,6
C
7,48% 281,3 295,6 312,4 332,2 356,0 385,1 421,5
C
7,98% 259,6 271,5 285,3 301,3 320,3 343,2 371,1
8,48% 240,8 250,8 262,2 275,4 290,8 309,0 330,9
In bold we can see the base case assumptions, 6.98% for the cost of equity and 2% for the
perpetual growth rate. The table clearly shows that even small changes, 0.5% in each factor,
will largely affect the share price.
For instance, if we increase the WACC by 0,5% and simultaneously decreasing the
perpetual growth rate also by 0,5% will result in a 15% decrease in the initial share price.
If now, we analyze each factor separately, we conclude that if we keep the WACC constant,
the impact of changes in growth rate fluctuates between -17% (growth rate equal to 0,5%)
and +32% (growth rate equal 3,5%). On the other hand, by holding the perpetual growth
rate constant and increasing the WACC by 1,5% will result in a 25% decrease in the share
price. In the other extreme case, a decrease of 1,5% in the WACC will lead to an increase
of 48% the share price.
That being said, one may conclude that changes in weighted average cost of capital have a
bigger impact than changes in the perpetual growth rate.
5.5. Relative Valuation

In the following section another valuation approach will be presented. As previously said,
this valuation technique will provide a complement of the procedure above specified, in
particular, it will represent a useful check of DCF.
H&M peer group was defined and presented in section 3. The next step is to choose which
multiples to use. For H&M valuation we decided to use the enterprise multiple
(EV/EBITDA) and the equity based multiple (P/E ratio). The price to earnings ratio is
the more commonly used multiple. However, it presents some drawbacks, such as the
46
vulnerability to changes in the company capital structure. In this case, since the peer group
comprises companies with low levels of debt and therefore with similar capital structures,
we considered reasonable the choice of the price earnings ratio. The EV/EBITDA was
also used, contrarily to the P/E multiple, since it is not based on earnings, it is less affected
by one-time events and therefore it is considered to make a more accurate measurement of
a company’s value.
Both, historical (2014) and forward looking multiples (2015), were analyzed. The last ones
were based on the projections made in the context of the DCF valuation.
Table 17 - Multiples valuation (SEK M)
EV/EBITDA P/E
H&M MULTIPLES 2014 2015E 2014 2015E
Peer group harmonic mean 14,3 15,7 24,4 25,2
Critical Factor (SEK M) 30.628 31.172 19.976 19.795
# shares 1.655 1.655 1.655 1.655
Share Price 265 296 295 301
Source: Bloomberg and own calculations
After multiplying the critical factor (net income and EBITDA) by the respective multiple
we arrived to the share price.
Looking at the results, we may conclude that in both scenarios, historical and forward
looking multiples, the target price reached is below the current H&M share price (326
SEK), suggesting that the market is overvaluing H&M, a result considerable different from
the one obtained in the DCF valuation.
The divergence between the results can be firstly explained by the fundamentals of each
approach. While DCF captures growth prospective and future estimates, the multiple, as
stated in the literature review, is a static method. Secondly, as mentioned in the section
regarding H&M’s industry, the only truly comparable firm is Inditex, meaning that, the
other companies belonging to the peer group may not be good indicators of H&M value.
That being said, we will base our recommendation in this approach outcome.
47
5.6. Dividend Discount Model Valuation

This section will present the H&M valuation output resulting from the dividend discount
model. As stated in the literature review, applying more than one valuation technique will
allow for a better and more consistent analysis of a company’s value.
Over the years, H&M has been paying part of its FCF as dividends. Between 2010 and
2014, its dividend payout ratio was about 90% on average, significantly above the group
dividend payout policy. In 2014 the dividend paid was equivalent to 11% of the group
sales. Given the lack of information available regarding the group’s future dividend policy,
we considered reasonable to assume that in the future the dividend payout ratio will be in
line with the value verified in 2014 (81%).
Table 18 - Historical dividends
2010 2011 2012 2013 2014

Net income 18.681 15.821 16.867 17.152 19.976
EPS 11,29 9,56 10,19 10,36 12,07
Payout Ratio 84% 99% 93% 92% 81%
DPS 9,5 9,5 9,5 9,5 9,75
# shares 1.655 1.655 1.655 1.655 1.655
Total Dividends 15.723 15.723 15.723 15.723 16.137
Source: Company report and own calculations
In order to overcome the constraints associated with a stable growth over the entire period,
a two stage dividend model was used. Firstly, we computed the expected dividends and
after summing them, we applied a discount rate equal to the cost of equity, (6,68%). For
the terminal value we considered a perpetual growth rate equal to the one applied in the
DCF valuation (2%) since it reflects the stable growth stage of the company.
Table 19 - Dividends forecast
2015 2016 2017 2018 2019 2024

Net income 19.795 22.696 25.206 26.425 26.028 49.881
EPS 11,96 13,71 15,23 15,97 15,73 30,14
Payout Ratio 81% 81% 81% 81% 81% 81%
DPS 9,66 11,08 12,30 12,90 12,70 24,35
# shares 1.655 1.655 1.655 1.655 1.655 1.655
Total Dividends 15.991 18.334 20.362 21.347 21.026 40.295
48
Afterwards, both components were taken together and we arrived to an equity value equal
to 597.937 million SEK. We divided by the total number of shares and we got a share price
of 361 SEK, slight below the one obtained in the DCF valuation.
49
6. Comparison with the investment bank
In this section we will present a comparison between the valuation outcome obtained in
this dissertation with the one published by the leading investment bank JPMorgan on
March 27th, 2015.
At starting note we must refer that this comparison will focus in the operational
assumptions. The share price achieved by JPMorgan was not obtained through the
discounted cash flow method. In the investment bank report, the price target was obtained
by applying a 10% discount to Inditex valuation. The discount reflects the JPMorgan
forecasts of a decline in H&M‘s gross margin, a contrast when compared with the stable
gross margin of Inditex
In this context it is pointless to make comparisons regarding the valuation assumptions.

Although the difference in the valuation approach chosen to value H&M, we are confident
that our analysis is considerably more realistic and complete. As stated in section 3, despite
the similarities between Inditex and H&M, their business model cannot be compared.
There are some factors, such as the exchange rate movements, that impact both companies
in different levels.
Furthermore, given that the investment bank only present forecasts for the next three
years, we will only compare the operational assumptions made for the same forecasting
period (2015-2017).
Table 20 – Operational assumption comparison
SEKm CAGR (14-17) 2015 2016 2017

Net sales thesis 13% 173 146 197 991 220 246
Net sales JP. Morgan 13% 178 674 198 329 220 145
EBIT thesis 6% 25 403 28 305 30 816
EBIT margin 15% 14% 14%
EBIT JP. Morgan 10% 28 680 30 843 34 015
EBIT margin 16% 16% 15%
D&A thesis 13% 5 769 6 597 7 338
D&A JP. Morgan 13% 5 953 6 608 7 335
CAPEX thesis 10% 9 636 11 018 11 299
CAPEX JP. Morgan 14% 10 500 11 567 12 729
Net Income thesis 8% 19 795 22 696 25 206
Net Income JP. Morgan 10% 22 339 24 020 26 478
Source: JPMorgan report and own calculations
50
By observing Table 20, we can conclude that the differences in the operational inputs are
not significant.
Regarding to growth rate of revenues, if we analyze the CAGR (14-17) we verified that it is
almost equal (13%), however, in 2015 the investment bank is more optimistic, while we
assumed an annual growth rate of 14%, they believe that H&M sales will growth 18%.
Concerning to EBIT, we forecasted a more pessimistic scenario than the investment bank.
This can be justified with our assumptions regarding the exchange rate impact on COGS.
The forecasts for D&A and Capex are very similar in both reports, however we are slightly
more conservative concerning H&M capital expenditures
Given the lack of information regarding the assumptions made by JPMorgan, we cannot
present a more detail comparison.
Despite the similarities regarding the operational assumptions, the use of a different
valuation methodology leads to a considerable different target price, and consequently a
different investment recommendation.
Table 21 – Valuaton comparison
Dissertation JP. Morgan

Methodology DCF Discount over ITX valuation
Date 31-12-2014 27-03-2015
Estimated period 2015-2024 2015-2017
Estimated Price (SEK) 369 310
Recomendation Buy Neutral
Source: JPMorgan report and own calculations
51
7. Conclusion
The work performed under this dissertation allows for two major conclusions. First of all,
we conclude that the valuation method used will have a huge impact in the final outcome.
Three different approaches were used and three different target prices were obtained. This
highlights how fundamental is to choose the right methodology. There are no perfect
methods but we should carefully understand how adequate each method is for each
company. Secondly, with this dissertation we may also realize that even choosing the most
appropriate method, given the inexistence of certainties in valuation, the assumptions made
regarding the future of the company play a key role.
For H&M we concluded that the DCF valuation was the most complete and trustworthy
method. The relative valuation was performed in order to complement the DCF method.
We obtained a target price considerably below the DCF target price. However, since we
believe that H&M business model is not truly comparable with any other firm operating in
the industry. It becomes difficult to establish an accurate peer group. Therefore, we will not
base our investment recommendation in the outcome obtained through this procedure.
Furthermore, the Dividend Discount Model was also applied. The outcome was a target
price of 361 SEK, slightly below of the DCF valuation result, 369SEK.
We may conclude that DCF provided the highest price, however the sensitivity analysis
performed shows that the DCF outcome is very sensitive to the assumptions made
regarding the perpetual growth rate and the discount rate.
In the end, we believe that despite the risks associated with fluctuations in the exchange
rate and with external factors that may negatively affect the productions countries, we are
confident that the current positive performance and the investment opportunities will
ensure a promise future for H&M.
52
8. Appendix
Appendix 1 - Centroids Output
Name Distance to 1 Distance to 2 Distance to 3 Minimum Allocation Validation

TJX COMPANIES INC 1,4 1,1 7,1 1,1 Centroid I OK
INDUSTRIA DE DISENO TEXTIL 4,0 2,2 6,8 2,2 Centroid II OK
HENNES & MAURITZ AB-B SHS 2,2 1,3 5,6 1,3 Centroid II OK
KOHLS CORP 1,2 2,3 5,6 1,2 Centroid I OK
NORDSTROM INC 1,6 2,5 5,0 1,6 Centroid I OK
FAST RETAILING CO LTD 2,7 1,7 7,1 1,7 Centroid II OK
ROSS STORES INC 1,5 0,7 5,6 0,7 Centroid II OK
CHOW TAI FOOK JEWELLERY GROU 0,3 1,7 6,1 0,3 Centroid I OK
FOOT LOCKER INC 0,8 1,4 6,2 0,8 Centroid II OK
DILLARDS INC-CL A 0,7 1,3 6,1 0,7 Centroid I OK
NEXT PLC 6,3 6,0 0,0 0,0 Centroid I OK
SIGNET JEWELERS LTD 0,6 1,7 5,9 0,6 Centroid I OK
SHIMAMURA CO LTD 0,7 2,3 6,8 0,7 Centroid I OK
ASCENA RETAIL GROUP INC 0,6 2,4 6,6 0,6 Centroid I OK
URBAN OUTFITTERS INC 1,3 0,9 6,3 0,9 Centroid II OK
AMERICAN EAGLE OUTFITTERS 0,8 1,8 6,8 0,8 Centroid I OK
MEN'S WEARHOUSE INC/THE 2,2 3,6 6,0 2,2 Centroid I OK
SHANGHAI YUYUAN TOURIST-A 2,0 2,5 7,2 2,0 Centroid III OK
ZALANDO SE 1,5 2,6 7,3 1,5 Centroid III OK
CHICO'S FAS INC 0,7 2,3 6,7 0,7 Centroid I OK
ANN INC 0,6 2,1 6,7 0,6 Centroid I OK
DSW INC-CLASS A 1,2 2,4 6,4 1,2 Centroid I OK
Appendix 2 - Cotton prices, historical chart
250
200
150
cents/lb
100
50
0
2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Bloomberg terminal
53
Appendix 3 - EUR/ USD spot exchange rate
1,8
1,6
exchange rate
1,4
1,2
0,8
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Bloomberg terminal
54
Appendix 4 - Forecasted Income Statement, 2011-2024
INCOME STATEMENT 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Net sales 109.999 120.799 128.562 151.419 173.146 197.991 220.246 242.161 263.214 283.465 302.439 319.660 334.664 347.025
% growth 1% 10% 6% 18% 14% 14% 11% 10% 9% 8% 7% 6% 5% 4%
Cost of Goods Sold 43.852 48.928 52.529 62.367 74.453 87.116 96.908 106.551 115.814 124.725 133.073 140.650 147.252 152.691
% of sales 40% 41% 41% 41% 43% 44% 44% 44% 44% 44% 44% 44% 44% 44%
Gross Profit 66.147 71.871 76.033 89.052 98.693 110.875 123.338 135.610 147.400 158.740 169.366 179.009 187.412 194.334
Gross Margin 60% 59% 59% 59% 57% 56% 56% 56% 56% 56% 56% 56% 56% 56%
Operating Expenses 45.768 50.117 53.865 63.469 73.290 82.570 92.522 103.574 115.759 120.739 125.565 130.251 134.698 138.836
% growth 5% 10% 7% 18% 15% 13% 12% 12% 12% 4% 4% 4% 3% 3%
Operating ratio 42% 41% 42% 42% 42% 42% 42% 43% 44% 43% 42% 41% 40% 40%
Operating profit 20.379 21.754 22.168 25.583 25.403 28.305 30.816 32.036 31.640 38.001 43.801 48.759 52.713 55.498
Operating margin % 19% 18% 17% 17% 15% 14% 14% 13% 12% 13% 14% 15% 16% 16%
Interest Income -568 -536 -367 -328 -328 -328 -328 -328 -328 -328 -328 -328 -328 -328
Interest Expense 5 5 9 16 16 16 16 16 16 16 16 16 16 16
Pre tax profit 20.942 22.285 22.526 25.895 25.715 28.617 31.128 32.348 31.952 38.313 44.113 49.071 53.025 55.810
Income Tax Expense (Benefit) 5.121 5.418 5.374 5.919 5.920 5.921 5.922 5.923 5.924 5.925 5.926 5.927 5.928 5.929
Net profit 15.821 16.867 17.152 19.976 19.795 22.696 25.206 26.425 26.028 32.388 38.187 43.144 47.097 49.881
55
9. References
Articles and Books
Damodaran, A., 2006. Valuation Approaches and Metrics: A survey of the Theory and
Evidence.
Damodaran, A., 2002. Investment Valuation: Tools and Techniques for Determining the
Value of Any Asset, 3rd ed. Wiley.
Foerster, S.R., Sapp, S.G., 2006. Dividends and Stock Valuation: A Study From the
Nineteenth to the Twenty-First Century.
Frykman, D., Tolleryd, J., 2003. Corporate Valuation: an easy guide to measuring value, 1st
ed. FT Press.
Koller, T., Goedhart, M., Wessels, D., 2010. Valuation: Measuring and Managing the Value
of Companies, 5th ed. McKinsey & Company.
Luehrman, T., 1998. Investment Opportunities as Real Options: Getting Started on the
numbers.
Papelu, K.G., Healy, P.M., 2012. Business Analysis & Valuation: Using Financial
Statements, 5th ed.
Petitt, B.S., Ferris, K.R., 2013. Valuation for Mergers and Acquisitions, 2nd ed.
Ross, S.A., Westerfield, R., Jaffe, J.F., 2001. Corporate Finance, 6th ed. The McGraw-Hill.
Stewart, G.B., 1999. The Quest for Value: A Guide for Senior Managers.
Stowe, J.D., Robinson, T.R., Pinto, J.E., McLeavey, D.W., 2007. Equity Asset Valuation.
Suozzo, P., Cooper, S., Sutherland, G., Deng, Z., 2001. Valuation Multiples: A Primer.
Young, M., Sullivan, P., Nokhasteh, A., Holt, W., 1999. All Roads Lead to Rome: An
Integrated Approach to Valuation Models. Goldman Sachs Invest. Res.
56
Websites
Apparel retail sales in the U.S. 2004-2016, by type. URL

http://www.statista.com/statistics/239827/apparel-retail-sales-in-the-us-by-type
Online Retail Is Front and Center in the Quest for Growth - Consumer Products & Retail
Featured Article - A.T. Kearney URL https://www.atkearney.com/consumer-
products-retail/ideas-insights/featured-article/-
/asset_publisher/KQNW4F0xInID/content/online-retail-is-front-and-center-in-
the-quest-for-growth/10192
About H&M URL http://about.hm.com/en/About.html#cm-menu
Apparel retail sales in the U.S. 2004-2016, by type Statista. URL

http://www.statista.com/statistics/239827/apparel-retail-sales-in-the-us-by-type/
Corporate Governance URL http://about.hm.com/en/About/Corporate-

Governance.html#cm-menu
Investor relations URL http://about.hm.com/en/About/Investor-Relations.html
World Bank Group World Bank Group. URL http://www.worldbank.org/
Reports
MarketLine, n.d. Apparel Retail: Global Industry Guide
H&M Annual Reports
Inditex Annual Reports
Fastretailing Annual Report
JPMorgan Europe Equity Research (H&M)
Others
Bloomberg terminal
57
(“Investor relations,” n.d.)
(“Corporate Governance,” n.d.)
(“About H&M,” n.d.)
(“World Bank Group,” n.d.)
58

H&M BV Thesis 2015 PDF

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EQUITY VALUATION

HENNES AND MAURITZ (H&M)

Mariana Brites dos Santos

Dissertation submitted in partial fulfillment of requirements for the degree of MSc in

Market Price 325.6 SEK

Today and Future

H&M future results may be negatively affected by some external factors.

- Negative macroeconomic changes: a decreasing in the consumer purchasing power

H&M stock price computation H&M stock price computation

- Dividend Discount Model

H&M stock price computation

We concluded that H&M share price was undervalued.

2. Literature Review ................................................................................................ 11

3. The Industry ....................................................................................................... 24

4. H&M Overview .................................................................................................. 29

6. Comparison with the investment bank .............................................................. 50

In order to do so, three different valuation methods were applied.

Subsequently, we present all the forecast and assumptions required to guarantee an

‘Valuation is the process by which forecasts of performance are converted into

in estimating the key ingredients of corporate value…can lead to mistakes in valuation”

2.2. Valuation Models

2.2.1. Discounted Cashflow Valuation

2.2.1.1. Free Cash Flow to the Equity (FCFE)

FCFE = Net Income − (Capital Expenditures − Depreciation) − (Change in NWC)

2.2.1.2. Dividend Discount Models (DDM)

Derivations of the model

2. Two-stage Dividend Discount Model:

2.2.1.3. Free Cash Flow to the Firm (FCFF)

The FCFF are defined according to the following formula:

FCFF = EBIT(1 − T) + Depreciation − Capital Expenditures − Changes in Working Capital

2.2.1.4. Adjusted Present Value (APV)

2.2.1.5. Further Issues

The Discount Rate

 Cost of Equity (Ke)

 Cost of Debt (Kd)

The formula is the following:

2.2.2. Relative Valuation

2.2.3. Contingent Claim Valuation

By definition, an option is an arrangement which allows the owner to decide whether to

“Aspiring to earn a high return is not enough” – (Stewart, 1999)

Therefore, the firm value can be written as following:

Secondly, a relative valuation will be considered, in order to analyze how H&M in

Figure 1 - Global apparel retail industry value, $ billion (2009-2014)

Source: MarketLine – Apparel retail: global industry guide

3.2. Main drivers of growth

Online Web-influenced Offline Offline only

3.2.2. Asia’s middle class

Table 1 – Peer group general information

PEER GROUP EBITDA margin ROA D/E WACC

Figure 3 - H&M timeline

1st store opened in Enters

Figure 4– Group portfolio 2014

Number of stores 3.261 114 92 22 5 17

4.2. Group geographic presence

Figure 5 – Revenues breakdown by region 2004-2014

EUROPE AMERICA ASIA FRANCHISE

Source: company data and own analysis

In order to reinforce the previous analysis a revenues breakdown by country was

Figure 6– Group portfolio 2014 (*other comprises 37 countries)

Germany France UK USA China Other*

Source: company data

4.3. H&M key figures

Table 2 – H&M general information