Henkel AG Financial Analysis: WACC, Beta & Valuation

Introduction to Henkel AG and Valuation Framework

Henkel AG is a multinational company focusing its brands and technologies on three business areas: Beauty Care, Laundry & Home Care, and Adhesive Technologies. Established in 1976, the company holds global market positions in both consumer and industrial products, with well-known brands that include Loctite, Persil, and Schwarzkopf. Henkel's headquarters are in Düsseldorf, Germany, and the company employs over 47,000 people globally. The company is widely considered among the most "internationally aligned German-based companies in the global marketplace" (Henkel, 2012).

The objective of this paper is to use various financial models to carry out the financial analysis and valuation of Henkel AG.

One method for carrying out the valuation of a company is the enterprise discounted cash flow (DCF) approach. The DCF can be executed using WACC (Weighted Average Cost of Capital), which represents the opportunity cost that investors face when they decide to invest their funds in the capital market. To determine WACC, three components are used: the after-tax cost of debt, the company's target capital structure, and the cost of equity. Since none of these variables is directly observable, various models, approximations, and assumptions are used to estimate each component.

To carry out the valuation of Henkel AG, this report uses market data for the company and examines the most appropriate methods for conducting that valuation.

The cost of equity is built on three factors: the market risk premium, a company-specific risk adjustment, and the risk-free rate. A commonly used model for estimating the cost of equity is the Capital Asset Pricing Model (CAPM). To apply CAPM, it is necessary to estimate the following:

This report determines the risk-free rate by using U.S. Treasury rates.

Cost of Equity and Risk-Free Rate Estimation

Theoretically, the risk-free rate is the rate of return on an investment that carries no risk of financial loss. It represents the total interest that investors would expect from a completely safe investment over a given period (Damodaran, 2008).

In other words, a risk-free rate is the return obtainable from an investment with limited credit risk. The U.S. government Treasury bill — a short-term instrument backed by the U.S. government — is considered the standard proxy for the risk-free rate. U.S. Treasury securities are generally regarded as the safest of all investments because they are fully backed by the federal government (Fleming, 2000). Owing to this safety, Treasury bill interest rates are generally lower than those of other capital market securities.

This paper uses the three-month U.S. Treasury bill to carry out the valuation of Henkel AG. The three-month Treasury bill is chosen because it carries the least risk, as it is less affected by fluctuations in interest rates and macroeconomic conditions such as inflation. When the investment horizon on U.S. Treasury bills extends beyond three months, risk increases, as the bills become more exposed to interest rate risk and inflation. The three-month Treasury rate stood at 0.07% as of April 5, 2013. The company's cost of debt is 4.1%, calculated using a three-month risk-free rate of 8%, with a company beta of 0.7.

Table 1: Three-Month Treasury Risk-Free Rate

Bank Discount / Coupon Equivalent data — Source: U.S. Treasury (2013).

This paper performs a regression analysis of ten-year monthly returns of Henkel AG's personal products segment against the MSCI World Index. The results are summarized in Table 2.

Table 2: Summary Output of Regression Analysis

Regression Statistics: Multiple R = 0.3089; R Square = 0.0954; Adjusted R Square = 0.0950; Standard Error = 14.4724.

ANOVA: Regression SS = 55,994.17; F = 267.34; Significance F = 3.3E-57.

Coefficients: Intercept = 37.424 (t = 129.19; p = 0); X Variable 1 = 0.01150 (SE = 0.000703; t = 16.35; p = 3.3E-57; 95% CI: 0.01012–0.01288).

The regression analysis of Henkel data since 2003 against the MSCI World Index reveals an estimated company beta of 0.70. The cost of equity is 8.5%, and the company's WACC is 8.0%.

To determine Henkel's corporate beta more precisely, the paper re-levers the industry average beta using Henkel's year-by-year debt-to-equity ratio. The debt-to-equity ratio measures a company's financial leverage — specifically, its ability to meet short-term and long-term obligations. The formula is:

Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity

This ratio is particularly important in calculating levered beta. As a company's debt increases, its debt-to-equity ratio rises, which in turn increases the company's beta. A high debt-to-equity ratio indicates that a company is aggressively financing its growth through debt, which leads to higher beta values.

Beta Estimation and Debt-to-Equity Analysis

Henkel Debt-to-Equity Ratio (2003–2013)

Current Ratio: 0.91 (2008), 1.13 (2009), 1.34 (2010), 1.58 (2011), 1.31 (2012), 1.31 (2013).

Quick Ratio: 0.41 (2008), 0.69 (2009), 0.77 (2010), 0.93 (2011), 0.56 (2012), 0.56 (2013).

Financial Leverage: 2.83 (2003), 3.07 (2004), 2.60 (2005), 2.43 (2006), 2.31 (2007), 2.46 (2008), 2.42 (2009), 2.20 (2010), 2.12 (2011), 2.05 (2012/2013).

Debt/Equity: 0.56 (2003), 1.10 (2004), 0.82 (2005), 0.72 (2006), 0.65 (2007), 0.37 (2008), 0.52 (2009), 0.45 (2010), 0.41 (2011), 0.26 (2012/2013). Industry Debt/Equity: 0.63–0.65. Beta: 0.70.

Since 2003, Henkel's debt-to-equity ratio has declined considerably. In 2003 it was 0.56, and by 2012/2013 it had fallen to 0.26 — a decrease of approximately 115% over the decade. Henkel's current risk indicators are summarized below.

Table: Henkel AG Current Risk Indicators

Risk-Adjusted Performance: (0.02); Market Risk-Adjusted Performance: (0.19); Mean Deviation: 0.8342; Semi-Deviation: 1.46; Downside Deviation: 1.45; Coefficient of Variation: (3,393); Standard Deviation: 1.12.

Analysis of the Henkel portfolio reveals that the company's stock has volatility of 1.12 and is 1.35 times more volatile than the DAX. Approximately 16% of all portfolios and equities are less risky than Henkel. A comparative analysis against global equities reveals that the volatility of Henkel's historical daily returns is 16% lower than that of all global equities. The beta of Henkel AG is 0.70, reflecting the volatility of Henkel stock relative to the broader market. As illustrated in Figure 1, Henkel has performed better than the S&P 500 since 2003.

Henkel's 2012 annual report noted:

"Henkel shares showed a very positive performance overall in 2012. Over the course of the year, the DAX rose by 29.1% to 7,612.39. The index for consumer goods stocks — the Dow Jones Euro Stoxx Consumer Goods — increased 26.0%, closing at 423.06. Against this market backdrop, the price of Henkel preferred shares increased to 62.20 Euros, closing the year 39.5% higher on a year-on-year basis. Our ordinary share price likewise posted strong gains, ending the year 38.9% higher at 51.93 Euros. As such, our shares performed clearly better than both the DAX and other shares representing the consumer goods sector." (Henkel, 2012, p. 1).

Fig. 1: Henkel Performance Compared to the S&P 500.