Mavuno Foods: When the Terminal Value Is the Valuation
An analyst at a Nairobi fund has valued Mavuno Foods, a listed FMCG company, on a five-year FCFF model. Explicit-period cash flows discount to KES 2,780m. Year-5 FCFF is KES 1,200m, WACC is 14.0% and the analyst applies a 4.0% perpetuity growth rate, citing 9% nominal GDP growth. The resulting enterprise value is KES 9,261m. On review you note that year-5 capital expenditure is KES 700m against depreciation of KES 950m, working capital absorbs 1% of incremental sales each year, and 40% of revenue is USD-linked while the discount rate is a shilling rate. The investment committee wants a defensible number before approving a KES 600m position.
1. Compute the terminal value and its share of enterprise value, and state whether this valuation can bear the weight the committee will place on it.
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Terminal value (Gordon):
TV = FCFF(5) x (1+g) / (WACC - g) = 1,200 x 1.04 / (0.14 - 0.04) = 1,248 / 0.10 = KES 12,480m
Discounting: 1.14^5 = 1.9254
PV(TV) = 12,480 / 1.9254 = KES 6,481m
Reconciliation: 6,481 + 2,780 = 9,261m, so the terminal value is 6,481 / 9,261 = 70.0% of enterprise value.
Judgement: 70% is not automatically wrong for a growing consumer business, but here it is concentrated in assumptions the analyst has not tested - the growth rate and, more seriously, the reinvestment embedded in year-5 cash flow. The committee is effectively underwriting a perpetuity, not five years of forecast. Any answer that simply reports 70% without saying the number is fragile misses the point: the correct action is to stress the perpetuity inputs before the position is approved.
2. The committee asks what the value becomes at 6% growth, and whether 4% is even internally consistent with the stated capex. Quantify both.
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Sensitivity to g at 6%:
TV = 1,200 x 1.06 / (0.14 - 0.06) = 1,272 / 0.08 = 15,900m PV = 15,900 / 1.9254 = 8,258m EV = 8,258 + 2,780 = 11,038m (+19.2%)
So 200bp on a single input moves equity value by roughly a fifth. A 4% versus 6% debate is worth about KES 1,777m - far more than the KES 600m position being debated.
Consistency test: growth must obey g = ROIC x reinvestment rate. Reinvestment = capex - depreciation + increase in working capital = 700 - 950 + positive WC = negative. Negative net reinvestment implies shrinkage, not 4% growth. With year-5 NOPAT of about 1,050m and ROIC of 15%, sustaining 4% requires a reinvestment rate of 4/15 = 26.7%, i.e. about 280m of net reinvestment, which means capex materially above depreciation.
Restating year-5 FCFF to roughly 770m: TV = 770 x 1.04 / 0.10 = 8,008m, PV = 4,159m, EV = 6,939m, about 25% below the reported figure - before the earlier years are corrected. The 4% rate is not defensible as modelled.
3. What is wrong with the currency treatment, and what would you require before signing off?
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Cash flows and discount rate are mismatched. Forty percent of revenue is USD-linked but the whole stream is discounted at a shilling rate, with growth pegged to shilling nominal GDP. Three consequences:
- If the shilling depreciates, shilling FCFF for the USD-linked 40% rises mechanically. Using a shilling WACC on unadjusted shilling cash flows overstates value by embedding depreciation benefits without costs of imported inputs; if the analyst has converted at today's spot, the effect is compounded.
- A 4% shilling perpetuity against, say, 2.5% USD inflation assumes persistent real appreciation of the shilling - a strong bet on a fragile variable.
- Nominal GDP is not a valid growth ceiling for a single firm; it is a ceiling for a maturing sector aggregate.
Required before sign-off: (1) forecast in one currency and discount in that currency's WACC, or convert at forward rates consistent with the inflation differential; (2) convert the terminal growth to the same nominal basis as the discount rate; (3) present a sensitivity grid on g (3%-6%) and WACC (13%-16%); (4) re-run with capex normalised to at least 105%-115% of depreciation. Only then is a number defensible.