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CORPORATE FINANCE Australian Valuations Valuation Practices Survey 2015 kpmg.com.au Contents Section 1: Foreword...................................................................................... 1 Section 2: Executive summary – equity valuations..................................... 2 Section 3: Commercial environment............................................................... 3 Section 4: Impairment issues............................................................................. 7 Section 5: Valuation methodologies.................................................................... 8 Section 6: Market approach.................................................................................... 9 Section 7: Income approach: discounted cash flow.............................................. 10 Section 8: Adjusting for country risk premium........................................................ 13 Section 9: Benchmarking the risk-free rate........................................................................ 14 Section 10: Understanding beta.................................................................................... 16 Section 11: The equity market risk premium................................................................. 19 Section 12: Discounts and premia...................................................................................... 23 Section 13: Analysing the small stock premium................................................................ 24 Section 14: Marketability discount......................................................................................... 27 Section 15: Control premium.................................................................................................... 28 Section 16: Minority discount..................................................................................................... 29 Section 17: Accounting, ESG and miscellaneous factors........................................................... 30 Section 18: All about imputation credits........................................................................................ 38 Real Estate Section 19: Introduction to real estate................................................................................................ 42 Section 20: Valuation methodologies.................................................................................................... 43 Section 21: Valuation cycle........................................................................................................................ 45 Section 22: Sales and leasing activity........................................................................................................ 47 Section 23: Leasing incentives....................................................................................................................... 48 Section 24: Yields.............................................................................................................................................. 49 Section 25: Rent................................................................................................................................................... 51 Tangible assets Section 26: Introduction to tangible assets........................................................................................................... 54 Section 27: Valuation methodologies...................................................................................................................... 56 Section 28: Cost approach........................................................................................................................................... 57 Section 29: Depreciation profiles................................................................................................................................... 58 Section 30: Replacement cost considerations................................................................................................................ 61 © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 1 | Australian Valuation Practices Survey 2015 Section 1: Foreword “It became evident that the survey was filling a real gap in the Australian market based upon the feedback and queries we received on the 2013 survey.” Welcome to KPMG’s Australian Valuation Practices Survey 2015. This is KPMG’s second survey and it builds on the findings of our inaugural 2013 survey. We hope it will offer a unique reference point for corporate financiers and financial analysts, providing insight into the valuation parameters and approaches currently being used. For the first time, the survey also covers real estate and tangible asset valuations. It became evident that the survey was filling a real gap in the Australian market based upon the feedback and queries we received on the 2013 survey. We trust that this will continue to be the case, especially given the continued volatility in the financial markets which makes assessments and assumptions around valuations, and in particular expected shareholder returns, very challenging. The last couple of years have also shown us that a standard textbook approach to valuation analysis does not always reflect commercial reality and has resulted in corporate financiers and analysts often deviating from these approaches. Thank you to everyone who completed the survey. Your time, efforts and insights are, as always, invaluable. Thank you also to those members of KPMG’s Valuation Services team who initiated the inaugural survey and lead this year’s analysis. Please feel free to discuss the results of the survey with us. All feedback is warmly welcomed. Sean Collins Partner in Charge, Valuation Services KPMG Corporate Finance © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | Section 2: Executive summary – equity valuations This year we have captured the views of 29 participants across a wide range of industries including Big 4 accounting firms, investment banks, infrastructure funds, valuation boutiques and large corporates. Their responses provide considerable insight into the valuation methodology adopted in the Australian market. For the first time we also included questions around general market expectations and asset valuations from a non-technical point of view. Key non-technical findings • The board has final say on doing deals. The biggest challenge to successfully completing deals over the next 12 months is the willingness of boards to do so, whilst the availability of assets and asset values will also be important determinants. “59 percent of the participants believe real estate was overvalued, 37 percent believed infrastructure was overvalued and 45 percent believe equities were overvalued.” • Deal activity on the rise. Most participants believe the number of deals will increase in 2015 and that scrip will be used in two thirds of transactions. • Independent expert reports to remain steady. The number of Independent Expert Reports (IERs) is expected to remain steady over the next 3 years compared to FY14. • Expensive assets abound. In terms of asset classes, 59 percent of the participants believe real estate was overvalued, 37 percent believe infrastructure was overvalued and 45 percent believe equities were overvalued at the end of 2014. • ASX on the decline. Accordingly, 68 percent of the participants believe the S&P/ASX200 index will decrease over the next 3 years when compared to FY14. • No sign of a decrease in impairment charges. Impairment charges are expected to remain steady during 2015 when compared to 2014. • Financial reporting influence. There has been an increase in the consideration of financial reporting implications when evaluating or advising on a deal. © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 2 3 | Australian Valuation Practices Survey 2015 Section 3: Commercial environment The biggest challenge “ to successfully completing deals over the next 12 months is the willingness to boards to do so, whilst the level of M&A activity and values will also be a determinant.” 1. What do you see as the biggest challenge to successfully completing deals in the next 12 months? Figure 1: What do you see as the biggest challenge to successfully completing deals in the next 12 months? Willingness of the company's Board of Directors 33.33% 22.22% Asset valuation Access to financing 11.11% 22.22% Active M&A market Other 0% 11.11% 5% 10% 15% 20% 25% 30% 35% % of participants © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 2. Are any of the following Australian asset classes, Figure 2: Are any of the following Australian asset classes, in your in your opinion, currently overvalued? (Select all that apply) opinion, currently overvalued? 37.9% Infrastructure 58.6% Real Estate 44.8% Equities Other In terms of asset clauses, “ more than half the participants believed real estate is over-valued.” 20.7% Bonds 6.9% 0% 10% 20% 30% 40% 50% 60% % of participants 3. Do you expect the number of deals completed to increase, decrease or remain steady in the next 12 months? Figure 3: Do you expect the number of deals completed to increase, decrease or remain steady in the next 12 months? Increase 41% 56% Decrease Remain steady 4% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. | The majority of “ participants expect the number of deals to increase over the next 12 months.” 4 5 | Australian Valuation Practices Survey 2015 A cash and scrip offer “ is expected to be the most common form of consideration to complete deals.” 4. What do you expect the preferred deal structure to be in deals Figure over 4: the What do you expect the preferred deal structure to be in deals over the next 12 months? next 12 months? 33% Cash offer Scrip offer 48% Cash and Scrip offer 19% The number of IER’s is “ expected to remain steady over the next 3 years compared to FY14.” 5. During FY12, FY13 and FY14 the number of Independent Expert Figure 5: completed During FY12, FY13 and the number Reports were 204, 182 andFY14 200 respectively. Do of youIndependent Expert Reports expect the number of Independent Experts completed completed was 204, 182 andReports 200 respectively. Do you expect the to increase, decrease remain steady Expert over the Reports next 3 years number oforIndependent completed to increase, compared to FY14? decrease or remain steady over the next 3 years compared to FY14? 32% Increase Decrease 60% Remain steady 8% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 6. During FY13 FY12, and FY14 the total the total S&P/ASX200 Figure 6:FY12, During FY13 andreturn FY14ofthe return of the S&P/ASX200 accumulation index were -6.4%, 21.6% and 19.7% respectively. accumulation index was -6.4 percent, 21.6 percent and 19.7 percent Do you expect the total return of this index increase, decrease or respectively. Do you expect the total return of this index to increase, remain steady over the next 3 years compared to FY14? decrease or remain steady over the next 3 years compared to FY14? 0% | 6 68 percent of the “ participants believe the S&P/ ASX200 accumulation index will decrease when compared to FY14.” 32% Increase Decrease Remain steady 68% Figure 7: As a general observation, do you believe that the prices paid for Australian Infrastructure assets (e.g. ports; toll roads): 7. As a general observation, do you believe that the prices paid for Australian Infrastructure assets (e.g. ports & toll roads): 0% 37 % 63% Only 37 percent of the “ participants believe that the prices paid for Australian Infrastructure assets represent fair value.” Represent fair value Indicates there may be a bubble and the market is overheating Provides room for further increases in value © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 7 | Australian Valuation Practices Survey 2015 Section 4: Impairment issues 8. Has the volume of impairment related work, conducted by your Impairment related work “ and impairment changes are expected to remain at the levels experienced in 2014.” firm,8: increased, decreased or of remained steady related in the past 12 conducted by your firm, Figure Has the volume impairment work months? increased, decreased or remained steady in the past 12 months? 25% Increase 63% Decrease 40.74% Remain steady 12% 55.56% Figure 9: Do you expect impairment charges to increase, decrease or remain steady in the next 12 to months? 9. Do you expect impairment charges increase, decrease or remain steady in the next 12 months? 19% 0% Increase Decrease Remain steady 81% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. | Australian Valuation Practices Survey 2015 8 Section 5: Valuation methodologies Income and market approaches are the most popular In 2015, the income approach (or discounted cash flow (DCF) approach) and the market approach (eg: price earnings ratio) proved to be equally popular as the primary valuation methodologies used by the participants. The survey shows the income and market approaches are used ‘always’ or ‘sometimes’ by 100 percent of participants. In contrast, 20 percent never use the asset based methodology. While this is similar to our 2013 Valuation Practices Survey findings, the bias then was towards using the income approach. Figure 10: Survey 2015 – How often do you use the following valuation approaches assuming a going concern? 10. How often do you use the following valuation approaches assuming a going concern? Other 70% 30% Other Asset based 4% methodology Figure 11: Survey 2013 – How often do you use the following valuation approaches assuming a going concern? Market approach (e.g. Price Earnings ratio) 70% 30% Income approach (Discounted Cash Flow) 70% 30% 50% Asset-based 10% methodology 20% 76% 50% Market approach (e.g. Price Earnings ratio) 76% 14% 48% Income approach (Discounted Cash Flow) 48% 65% 4% 35% 11.11% 0% 20% 40% 60% 80% 100% 120% 20% 0% % of participants Always Sometimes 40% 60% 80% 100% % of participants Never Always Sometimes Never Other methodologies used by participants: • Cross-check to a RAB multiple or similar • Valuation benchmarks – ie. value per unit of resource/reserve • Rule of thumb for smaller valuations • Probability Weighted NPV; Real Options © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 9 | Australian Valuation Practices Survey 2015 Section 6: Market approach No change to multiples In looking closer at the market approach, our 2015 findings show no material change for a number of the valuation multiples. Revenue, price to book ratios, and price to pre-tax earnings all remain fairly steady. The most favoured multiple – Enterprise Value/Earnings Before Interest Tax Depreciation & Amortisation (EBITDA) – has only increased its popularity. Every participant always or sometimes uses it, with three quarters always. 11. When using the market approach, how often are the following Figurevaluation 12: Survey 2015 – When using the market approach, multiples used? how often are the following valuation multiples used? 29% Other Price / Book value of equity 10% Price / Pre-tax earnings Price / Earnings 71% Other Price/Book value of equity 55% 35% 22.22% 32% EV/EBIT 23% 45% 11.11% 55% 22% 35% 10% 21% 9% 57% 36% Price/Pre-tax 5% earnings 68% 32% Figure 13: Survey 2013 – When using the market approach, how often are the following valuation multiples used? 55% 27% Price/Earnings 23% EV/EBIT 23% 68% 18% 59% 73% 5% 22.22% EV/Revenue 5% 0% 25% 75% EV/EBITDA 11.11% 20% 55% 40% 40% 60% 80% 61% EV/EBITDA EV/Revenue 5% 100% 0% Always Sometimes 50% 20% % of participants 39% 45% 40% 60% 80% 100% % of participants Never Always Sometimes Never Other multiples used by participants: • EV/RAB • EV/Production • EV/Reserves • EV/passenger © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 10 Section 7: Income approach: discounted cash flow Capital asset pricing model still the way to determine the cost of equity So far as the income approach is concerned, there is no obvious change in the methods employed when calculating the cost of equity to value future cash flows to equity. Not surprisingly, the capital asset pricing model is as popular as ever when deriving a cost of equity estimate. A substantial 83 percent of participants prefer it to any other method. In direct contrast the arbitrage pricing theory still has no support at all. 14. Which the following employ when Figure 14:ofSurvey 2015method(s) – Whichdo ofyou theusually following method(s) do you usually employ calculating the cost of equity the to value cash flows to equity? when calculating costfuture of equity to value future cash flows to equity? Other 13% Premium to the risk free rate 4% Arbitrage Pricing Theory (APT) 0% Capital Asset Pricing Model (CAPM) 0% 83% 20% 40% 60% 80% 100% % of participants Always Never © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 11 | Australian Valuation Practices Survey 2015 Going for Gordon Growth The Gordon Growth model (or perpetuity method) continues to be popular when calculating the Terminal Value in a DCF valuation. The survey shows 58 percent always use it while 42 percent sometimes use it. In using this method, the Consumer Price Index (CPI) is commonly used as a proxy for the perpetuity (or residual) growth rate. 16 When calculating the Terminal Value in a DCF valuation what While amethod(s) large proportion of respondents use the Exit Multiple model (85 percent), most (60 percent) only sometimes use it. are considered? Figure 15: Survey 2015 – When calculating the Terminal Value in a DCF valuation what method(s) are considered? Figure 16:Gordon Survey 2015 method – If the is Gordon Growth is employed, how 17 If the Growth employed, howmethod do you usually determine (residual) growth rate? do the youperpetuity usually determine the perpetuity (residual) growth rate? 43% CPI/Inflation 100% Other Long term bond yields Exit multiple model 60% 25% 13% 15% 17% GDP growth Gordon growth model (perpetuity method) 58% House view 42% 9% 11.11% 0% 20% 40% 60% 80% 100% Other 17% % of participants Always Sometimes Never 0% 10% 20% 30% 40% % of participants Other growth rates used by participants: • Unless there is a reason to expect a decline we allow for inflation and some real growth (subject to reasonableness). • Long term asset growth prospects • Asset specific growth depending on various factors such as growth capex, etc. © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 50% Australian Valuation Practices Survey 2015 | 12 Midyear discounting preferred When conducting a DCF valuation, you can choose between the mid-point or end-of-year convention for the purposes of discounting. According to the survey, most respondents (88 percent) usually prefer mid-year discounting. That’s not altogether surprising given it assumes that cash flows are generated evenly throughout the period. 18. When conducting a DCF valuation what discounting convention is usually employed? Figure 17: Survey 2015 – When conducting a DCF valuation what discounting convention is usually employed? 12% Mid-point discounting End-of-year discounting 88% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 13 | Australian Valuation Practices Survey 2015 Section 8: Adjusting for country risk premium Discount rate adjusted for country risk Consistent with KPMG’s 2013 survey, most participants (41 percent) tend to adjust the discount rate for country risk by determining an appropriate risk-free rate using country credit ratings or (32 percent) by adding a premium to the cost of equity and the cost of debt. 19. How do you generally adjust for country risk when valuing an asset in a Figuredeveloping 18: Survey 2015 – How do you generally adjust for country risk when valuing country? an asset in a developing country? 60% 55% 50% 45% % of participants 40% 41% 35% 30% 32% 25% 20% 15% 10% 5% 14% 9% 5% 0% Adjusting the cash flows Determining an appropriate risk free rate with reference to default yield spreads on USD denominated sovereign Eurodollar bonds Determining an appropriate risk free rate with reference to implied premiums using country credit ratings 9% Add an appropriate premium to the cost of equity and cost of debt Other 2013 Other methodologies used by participants: • All of the above • Host country 10 year bond yield vs USD 10 year bond yield © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 14 Section 9: Benchmarking the risk-free rate 10-years still a preferred proxy Most participants continue to use the yield on 10-year government bonds as a benchmark for the risk-free rate in Australia with a substantial 88 percent choosing to do so as a general rule. Figure 19: Survey 2015 – Which of the following are generally used as a benchmark for the risk free rate in Australia? 100% 88% % of participants 80% 60% 40% 20% 8% 4% 0% 0% 10 year government bond 5 year government bond Cash rate Other 2013 Other benchmarks used by participants: • House view of long-term rate • 10 year or duration matched © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 15 | Australian Valuation Practices Survey 2015 On the spot Similar to KPMG’s 2013 survey, there is some variation in how the risk-free rate is derived. A little more than a third of the participants (39 percent) use the spot government bond yield as a proxy for the risk-free rate. However, 35 percent choose to favour a combination of the spot, historic average and forecast to benchmark the risk-free rate. Figure 20: Survey 2013 / 2015 – How do you derive the risk free rate when using the yield on a government bond as a proxy? 60% 50% % of participants 40% 39% 35% 30% 20% 13% 10% 9% 4% 0% Spot Historic average Forecast A combination of the above Other - please specify 2013 Other approaches used by participants: • Either spot or historic average depending on the nature of the valuation • Look at both spot and historical average © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 16 Section 10: Understanding beta Bloomberg takes top honours for beta information When it comes to sources of information for beta estimates, the preferred service providers are clear: Bloomberg attracts almost 60 percent of participants’ votes, while Capital IQ stands next in line with almost 45 percent. Figure 21: Survey 2013 / 2015 – Which of the following service providers are used as a source of information? 60% 58.6% 50% 44.8% % of participants 40% 30% 27% 20% 20.7% 17.2% 10% 0% 3.4% 0% Aspect Huntley Australian Graduate School of Management Bloomberg Capital IQ Reuters/Factiva In-house calculation/research Other Other methodologies used by participants • Fact set © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 17 | Australian Valuation Practices Survey 2015 All in the leverage The vast majority of participants (79 percent) unlever and relever the observed equity betas to apply them to their subject company. A mere 21 percent choose to apply equity betas sourced directly from comparable companies. This is consistent with our 2013 survey. Figure Survey 2015 – Do you apply equity sourced directly from 20. Do 22: you apply equity betas sourced directly frombetas comparable comparable companies, or first unlever and relever the observed equity companies, or first unlever and relever the observed equity apply to thecompany? subject company? betas tobetas apply to the subject 21% Source equity beta directly Unlever then relever observed equity beta 79% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 18 Timeframes for adjusting beta The majority of participants (38 percent) make reference to monthly observations over a five year period when calculating beta. However, it is worth noting that one quarter rely on a data provider’s default output. 28. When calculating the Beta, generally what period and frequency Figure 23: Survey 2015 – When calculating the Beta, generally what period and do you deem to be most appropriate? frequency do you deem to be most appropriate? 40% % of participants 35% 38% 30% 25% 25% 20% 15% 21% 17% 10% 5% 0% 2 year weekly 5 year monthly Rely on data provider default output Other - please specify Other methodologies used by participants: • Multiple time periods and frequencies and understand reasons for differences • 48 monthly observations • Both 2 year weekly and 5 year monthly – depends on the sector • 5 year monthly or based on sensitivity analysis (correlation to market of stocks) © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 19 | Australian Valuation Practices Survey 2015 Section 11: The equity market risk premium Australian market risk premium steady at 6 percent Survey participants continue to show a clear bias towards using an equity (market) risk premium (EMRP) for Australia of 6 percent. This stands in contrast to the United States and the United Kingdom where a relatively wide range appears to be used. Participants use an equity risk premium for the US of between 5 and 6 percent. The UK, on the other hand, sits mainly at 5 percent but with some using 6 percent. Figure 24:Survey 2013/2015 – What equity market risk premium do you use when making use of the Capital Asset Pricing Model in percentage terms when valuing assets in the following countries? United States 80 70 70 60 60 % of participants % of participants Australia 80 50 40 30 50 40 30 20 20 10 10 0 0 % 0. 4. 5. % 0. % 0. 6. .% 7.0 % 0. % 0. 8. 4. % 6. MRP 2013 % .% 0. 0. 5. % 0. 7.0 8. MRP 2015 2013 2015 United Kingdom 80 % of participants 70 60 50 40 30 20 10 0 % 0. 4. % 0. 5. % 0. 6. .% 7.0 % 0. 8. MRP 2013 2015 © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 20 Mixed rationale behind market risk premia While a small portion (10 percent) indicate the use of the historic equity bond spread and others (19 percent) rely on the expected premium, a large majority of participants (71 percent) use a combination of the two when setting the market risk premium. Figure 25: Survey 2013/2015 – Which of the following would you consider to be the rationale for selecting the market risk premium? 80% 70% % of participants 60% 50% 40% 61% 30% 20% 26% 10% 0% 13% 0% Historic equity bond spread Expected premium Combination of above 2013 Other – please specify 2015 © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 21 | Australian Valuation Practices Survey 2015 The alpha effect For the most part, participants tend to add a premium to reflect unique risks not modeled in forecast cash flows. The survey indicates that no participant ‘never’ makes an adjustment for such risks. 24. How often do you adjust the CAPM rate of return by a Figurepremium, 26: How you adjust theare CAPM rate of return tooften reflectdo unique risks that not modelled in the by a premium, to reflect unique risks that are not modelled in the forecast cash flows (alpha)? forecast cash flows (alpha)? 0% 40% Always Sometimes 60% Never © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 22 23 | Australian Valuation Practices Survey 2015 Section 12: Discounts and premia Preferred discounts and premia Almost 80 percent of participants consider minority discounts and control premia when conducting valuations. However, a marketability discount is also considered by 52 percent, as is a small stock premium to a lesser extent. 33. Which of the following discounts/premia are often Figure 27:considered Which of the following discounts/premia often considered when conducting valuation are analysis? Select all when conducting valuation analysis? that apply 50% 79.3% 40% 30% 51.7% 20% 34.5% 10% 0% Minority discount/ Marketability control premium discount Small Stock Premium (SSP) © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 24 Section 13: Analysing the small stock premium Small stock returns The 2015 survey results are consistent with those of 2013. Most participants adjust the overall expected rate of return on equity capital to reflect the additional risks associated with smaller companies. Figure 28: In relation to the S mall Stock Premium (SSP) which factor is adjusted? 100 % of participants 80 80% 60 40 20 10% 10% Beta Equity market risk premium 0 2013 Overall expected rate of return on equity capital 2015 © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 25 | Australian Valuation Practices Survey 2015 Small stock premium inverse relationship It is clear that there is an inverse relationship between the size of the SSP and the size of the entity. The 2015 results suggest an increase in the SSP applied to companies with a market cap less than $250 million. A large number (44 percent) of participants rely on in-house views regarding the SSP. Together with subjective assessments of the premium, this accounts for two thirds of the participants who responded to this question. Figure 29: Survey 2015 – What is the benchmark SSP applied given the size of the entity? 12% 11% 10% Premium Range 9% 10.0% 8% 8.9% 7% 6% 5% 4% 3% 2% 2.9% 1% 0% Estimated (MVE) ($m)<=150 Estimate MVE ($m) 150-250 Estimate MVE ($m) 251-500 2.4% Estimate MVE ($m) 501-1000 1.9% Estimate MVE ($m) 1001-2000 0.9% Estimate MVE ($m) 2001+ Market Value of equity (MVE) Figure 30: Survey 2013 – What is the benchmark SSP applied, given the size of the company or entity? 6% Premium range 5% 4% Up to 5% 3% Up to 3% 2% Up to 2% 1% 0% Estimated MVE ($m)<=250 Estimated MVE ($m) 251-500 Estimated MVE ($m) 501-1000 0% 0% 0% Estimated MVE ($m) 1001-2000 Estimated MVE ($m) 2001-4000 Estimated MVE ($m) 4001+ Market value of equity (MVE) © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 26 37. Which sources do you generally consult in estimating an appropriate SSP? Figure 31: Which sources do you generally consult in estimating an appropriate SSP? 50% 40% 44% 30% 20% 22% 22% 10% 11% 0% Ibbotson Associates In-house Subjective Other – please specify Other methodologies used by participants: • All of the above © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 27 | Australian Valuation Practices Survey 2015 Section 14: Marketability discount Marketability discount inverse relationship The 2015 results are consistent with those of 2013. It is clear that there is an inverse relationship between the size of the marketability discount being applied and the size of the stake being valued. 38. Discount for lack of marketability Figure 32: Survey 2015 – What benchmark discount is applied given the size of the stake being valued (unlisted companies)? 50 45 40 Discount range 35 40% 30 25 20 15 30% + Median 15% 10 + Median 10% + Median 0% 5 0 20% 1% – 24% 25% – 49% 50% 10% + Median 0% 5% + Median 0% 51% – 74% 75% – 99% 0% 100% Size of stake Figure 33: Survey 2013 – What benchmark discount is applied given the size of the stake being valued (unlisted companies)? 45% Discount range 40% 30% + Median 20% 30% + Median 15% 15% 20% + Median 5% 10% + Median 2.5% 0% 1% – 24% 25% – 49% 50% 5% + Median 0% 51% – 74% 75% – 100% Size of stake © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 28 Section 15: Control premium The benchmark premium The premium range being considered by participants is consistent with that observed in the 2013 survey. However, it is worth noting that the median control premium decreased in 2015, from 22.5 percent, for a 51 percent to 74 percent stake, to 15 percent and 30 percent, for a 75 percent to 100 percent stake, to 25 percent. Figure 34:Survey 2015 – Control Premium. Please indicate the benchmark premium normally applied given the size of the stake being valued. 50% 45% 40% Premium range 35% 40% 30% 25% 30% Median 25% 20% 15% 10% Median 15% 5% 0% 51%–74% 75%–100% Size of stake Figure 35: Survey 2013 – What benchmark control premium is applied given the size of the stake being valued? 50% 45% 40% Premium range 35% 40% 30% 25% 30% Median 30% 20% 15% 10% Median 22.50% 5% 0% 51%–74% 75%–100% Size of stake © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 29 | Australian Valuation Practices Survey 2015 Section 16: Minority discount Not so minor discounts The 2015 results are consistent with those of 2013. It is clear that there is an inverse relationship between the size of the minority discount being applied and the size of the stake being valued. 32. Minority interest discount Figure 36: Survey 2015 – Minority interest discount 50 45 40 Discount range 35 40% 30 25 Median 25% 30% Median 25% 20 15 10 Median 5% 5 0 20% Median 15% 1% - 24% 25% - 49% 50% joint venture Size of stake Figure 37: 2013 – What benchmark discount is applied given the size of the 32. Survey Minority interest discount stake being valued (unlisted companies)? 50 45 50% 40 Discount range 35 30 25 Median 20% 30% Median 25% 20 15 Median 10% 10 Median 0% 5 0 10% 1% - 24% 25% - 49% 50% joint venture Size of stake © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 30 Section 17: Accounting, ESG and miscellaneous factors Environmental, social and governance factors While all participants are clearly considering Environmental, Social and Governance (ESG) factors when performing valuations, most (60 percent) appear to be doing so qualitatively. This is similar to 2013, although our latest survey shows that a further 30 percent adopt a qualitative and quantitative approach. Figure 38: Survey – How Social do you account (ESG) for Environmental, Social 33. How do you account for2015 Environmental, & Governance factors when performing valuations? Governance (ESG) factors when performing valuations? & 10% 30% Quantitatively Qualitatively Both 60% Figure 39: Survey 2013 – Do you consider Environmental, Social & Governance (ESG) factors when performing valuations? 5% 32% Yes – Quantitatively Yes – Qualitatively No 63% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 31 | Australian Valuation Practices Survey 2015 Getting serious about the impact of accounting standards It would appear the 2015 survey participants give more consideration to the impact of accounting standards on future financial statements when evaluating or advising on a deal. More than half (53 percent) of participants critically evaluate this impact. This differs significantly to the 2013 survey where only 21 percent of participants undertook a critical evaluation. Figure 40: Survey 2013/2015 – To what extent do you consider the impact of accounting standards on future financial statements when evaluating or advising on a deal? 80% % of participants 70% 60% 50% 53% 40% 47% 30% 20% 10% 0% Ignore Consider 2013 Critically evaluate 2015 © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 32 More hedge books get marked to market While almost half the 2013 participants (47 percent) preferred to include hedge books in the cash flows at contracted commodity prices, about two thirds (67 percent) of this year’s participants are choosing to treat them as mark-to-market. 35. Please indicate how you treat hedge books in business valuations: Figure 41:Survey 2015 – Please indicate how you treat hedge books in business valuations: 80% 70% 67% % of participants 60% 50% 40% 33% 30% 20% 10% 0% 0% Mark-to-market Included in cash flows at contracted commodity prices Other 2013 © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 33 | Australian Valuation Practices Survey 2015 The value of employee options When it comes to employee options, half the survey’s participants choose to adjust the market value of equity by the market value of the options. This remains consistent with the 2013 findings. Nonetheless, there has been a notable rise in the number of participants who treat it as an expense in the income statement or cash 36. How do you treat employee options in the valuation? flow statement – 42 percent in 2015, compared to 26 percent in 2013. Figure 42: Survey 2013/2015 – How do you treat employee options in the valuation? 60% % of participants 50% 50% 40% 42% 30% 20% 10% 8% 0% Estimate the value of the options and adjust the market value of equity As an expense in the income statement/cash flow statement Other 2013 © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 34 Pricing in commodities Participants continue to be divided in terms of how they estimate expected commodity prices for a valuation. While just over half (51.7 percent) look to a consensus of forecast prices by brokers and economists, a substantial 34.5 percent turn to a commodity pricing expert for assistance. Then again, the spot price or forward prices also make for popular methodologies with nearly 58.6 percent of participants (17.2 percent and 41.4 percent respectively) using either one. Figure 43: Survey 2013/2015 – Please indicate how you determine expected commodity prices for valuation purposes: 60% % of participants 50% 51.7% 40% 41.4% 34.5% 30% 20% 17.2% 10% 3.4% 0% Spot price Forward prices Consensus of Commodity forecast prices pricing expert by brokers / economists Other 2013 Other methodologies used by participants: • Combination of spot, forward and consensus © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 35 | Australian Valuation Practices Survey 2015 Working out the exchange rate Most of the participants (55.2 percent) choose to rely on a consensus of forecast prices by brokers and economists to determine the expected foreign exchange rate. 51.7 percent look to forward prices for guidance. This is consistent with the approach followed to determine expected commodity prices. 38. 44: Please indicate how expected foreign exchange Figure Please indicate howyou you determine determine expected foreign exchange rates rates valuation purposes forfor valuation purposes. 60% 55.2% % of participants 50% 51.7% 40% 30% 20% 24.1% 24.1% 10% 3.4% 0% Spot price Forward prices Consensus of Commodity forecast prices pricing expert by brokers / economists Other Other considerations by participants: • Combination of spot, forward and consensus © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 36 Third party bias It’s not always easy to rely on third party valuations. For our participants, the main concerns relate to the questionable use of subjective inputs and an apparent lack of commerciality or commercial reasonableness. A little more than 55 percent 39. What are the most common issues encountered when underlined subjectivity as an issue, while about 48 percent questioned the reviewing third party valuations? commercial quality of the valuations. Figure 45: What are the most common issues encountered when reviewing third party valuations? 60% 55.2% 50% % of participants 48.3% 40% 30% 34.5% 34.5% 34.5% 20% 17.2% 10% 10.3% 6.9% 0% Overly simplistic analysis Lack of Questionable commerciality/ use of commercial subjective reasonableness inputs Questionable methodologies adopted Insufficient detail to reconstruct report analysis Too much jargon Report or analysis too heavily disclaimed (i.e. no opinion given on inputs or analysis) Other Other issues encountered by participants: • Misunderstanding of basic concepts • Errors with pre-tax and post-tax discount rates. • Poor understanding of the nature of some risks. • Incorrect use of most likely cash flows instead of expected cash flows. • Poor understanding of standards of value. • Related party transactions are not adequately reviewed © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 37 | Australian Valuation Practices Survey 2015 Relying on a company’s credit worthiness When it comes to working out the cost of debt in a given valuation, there are a number of methodologies that find favour. However, participants commonly 40. percent) How do you determine thethe cost of debt forcredit valuation purposes? (48 choose to use company’s rating. Figure 46: How do you determine the cost of debt for valuation purposes? 16% 16% 20% 48% Incremental cost of debt of company being valued Cost of debt of comparable companies Implied cost of debt given credit rating of company being valued Other Other considerations by participants: • All of the above • Cost of debt for generic owner of set of assets © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 38 Section 18: All about imputation credits Regarding imputation credits There is little sign of change in how participants choose to treat imputation credits when valuing a business. While 35 percent ignore them altogether, just as many separately determine the market value of the benefit and add this to the estimate of the value. In direct contrast, infrastructure-related investments are treated quite differently. Very few (6 percent) ignore imputation credits, the sizeable majority (69 percent) choosing to include imputation credits attaching to dividends at an assumed utilisation rate. Figure 47: Survey 2013/2015 – How do you treat imputation credits in business enterprise valuations (other than infrastructure investments)? 50% % of participants 40% 30% 35% 35% 20% 18% 10% 6% 0% Ignore Adjust the equity market risk premium 6% Separately Adjust cost determine the of equity market value for gamma of the benefit and add to estimate of value Other 2013 Other methodologies used by participants: • Depends on the potential buyer © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 39 | Australian Valuation Practices Survey 2015 Figure 48: Survey 2013/2015 – How do you treat imputation credits when valuing 80% an infrastructure investment? 70% 69% % of participants 60% 50% 40% 30% 20% 19% 10% 0% 6% 6% Ignore Adjust the equity market risk premium 2013 0% Separately determine the market value of the benefit and add to estimate of value Adjust cost of equity for gamma Other © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 40 Making the most of franking credits The survey shows some disparity regarding the utilisation rate of imputation credits. Nonetheless, similar to the 2013 survey, there is a clear concentration with 74 percent of participants using 70 – 80 percent of the benefit. Figure 49: Survey 2015 – Where imputation credits are included in the cash flows, what utilisation factor do you assume? 50% 47% % of participants 40% 30% 27% 20% 10% 13% 13% 0% 0% 100% 90% 0% 80% 70% 60% 50% 0% 0% 40% Less than 40% Utilisation factor 2013 © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 41 | Australian Valuation Practices Survey 2015 Australian Valuation Practices Survey 2015 Section 19: Introduction to real estate | 42 Real Estate Our inaugural real estate section provides some interesting insights. The survey was provided to a range of real estate advisors including valuers, investors and consultants. Fourteen real estate advisors completed the survey. Key findings It’s all about capital and cash. Capitalisation and discounted cash flow approaches are the most utilised primary and secondary methods of valuation across all asset classes respectively. When adopting these approaches, valuers use excel-based models more than industry accept software. The cost of licenses for the software may be a reason for this, particularly for the smaller and independent practices. However, more likely is the need to factor in specific issues relating to an individual property, which may not be possible in the framework of a structured software program. • Adopting a standard approach to valuation. Valuers generally adopt a similar approach to valuations across all asset classes. This includes: −− using 2 years of pending lease expiries to make capital adjustments −− using 50 basis points difference between the capitalisation rate and terminal yield when using the DCF approach, and −− waiting either one or more years between the revaluation of assets either for internal or external purposes, (although 2 or more years is considered more acceptable for external valuations). • A buoyant real estate market. The common view is that both sales and leasing activity has increased across all asset classes over the past 12 months. Valuers believe this trend will continue over the forthcoming 12-month period. • Steady returns to continue. While an uplift in activity is welcomed by landlords/ investors, both leasing incentives and face rents have remained steady and valuers expect them to continue to do so over the next 12 months. • Yields on the decline. Valuers believe yields have decreased across all asset classes in both the primary and secondary markets over the past 12 months and will continue to do so over the next year, albeit with variations between the asset classes. This means they have experienced growth in capital values and there is an expectation this will continue. © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 43 | Australian Valuation Practices Survey 2015 Section 20: Valuation methodologies Deriving market value The capitalisation approach is clearly the predominant method applied in deriving 45. What are yourallmost utilised primary methods of valuation? market value across real estate asset classes. Figure 50: What are your most utilised primary methods of valuation? Primary Method of Valuation 80% 77% 75% 72% 70% 60% 50% 40% 30% 25% 17% 15% 11% Retail Cost Approach 0% Direct Comparison Direct Comparison Discounted Cash Flow Capitalisation Approach Cost Approach Direct Comparison Discounted Cash Flow Capitalisation Approach Office 0% Capitalisation Approach 0% 0% 0% Discounted Cash Flow 8% 10% Cost Approach 20% Industrial Cash is important The DCF approach is the second most preferred method applied in deriving market value across real estate assets. This is followed byof thevaluation? direct 46. What are yourallmost utilised secondary methods comparison approach. Figure 51: Secondary What are your most utilised secondary methods of valuation? Method of Valuation 70% 60% 58% 50% 50% 50% 40% 31% 30% 30% 25% 20% 10% 13% 8% 8% 6% 10% 10% Office Retail Cost Approach Direct Comparison Discounted Cash Flow Capitalisation Approach Cost Approach Direct Comparison Discounted Cash Flow Capitalisation Approach Cost Approach Direct Comparison Discounted Cash Flow Capitalisation Approach 0% Industrial © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 44 Consideration to capital adjustments Our survey indicates that the majority of participants use 2 years of pending lease expiries to make capital adjustments for valuations across all sectors. Adjustments that extend beyond this time frame appear more prevalent in the industrial sector than in office or retail. 47. When using the capitalisation approach, within how many years Figure 52: When using the capitalisation approach, within how many years of pending lease expiries do you typically make capital adjustments of pending lease expiries do you typically make capital adjustments in the valuation? in the valuation? Typical Unexpired Terms For The Provision of Capital Adjustments Using the Capitalisation Approach 90% 86% 82% 80% 75% 70% 60% 50% 40% 30% 20% 25% 14% 9% 10% 9% 0% 0% 0% 1 Year 2 years >3 years 1 Year Office 2 years >3 years 1 Year Retail 2 years >3 years Industrial 50 bp the norm for DCFs In all sectors, the majority of valuers use a 50 basis points difference between the capitalisation rate and terminal yield when adopting the DCF approach to valuation. While a smaller portion are happy to employ a 25 basis points difference, there is 48.support Whenfor using the discounted cash flow approach, what is the no 100 basis points. typical spread between your capitalisation rate and terminal yield? Figure 53: When using the discounted cash flow approach, what is the typical spread between your capitalisation rate and terminal yield? Typical Spread Between Capitalisation Rate and Terminal Yield in a DCF 80% 71% 70% 57% 60% 50% 50% 50% 43% 40% 30% 29% 20% 10% 0% 0% 0% 0% 25 bp 50 bp Office 100 bp + 25 bp 50 bp Retail 100 bp + 25 bp 50 bp 100 bp + Industrial © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 45 | Australian Valuation Practices Survey 2015 Section 21: Valuation cycle A good time to revalue The typical period between the revaluation of assets for either internal or external purposes is 1 or more years for office and retail assets and more than 2 years for industrial assets. However, some participants consider it necessary to carry out 49. What iswithin the typical period revaluations revaluations 12 months of abetween previous valuation, acrossofallassets, asset classes. whether it be internal or external? Figure 54: What is the typical period between revaluations of assets, whether it be internal or external? Typical Period Between Revaluation of Either Internal or External Assets 60% 50% 50% 38% 40% 30% 38% 36% 36% 27% 25% 25% 25% 20% 10% 0% 0-1 yrs 1-2 yrs 2+ yrs 0-1 yrs Office 1-2 yrs 2+ yrs 0-1 yrs Retail 1-2 yrs 2+ yrs Industrial The need for regular external valuations Our survey shows that external valuations are required relatively frequently across the board. In all asset classes, they are overwhelmingly sought after 2 or 50. Inyears. your experience, how often are external valuations sought? more Figure 55: In your experience, how often are external valuations sought? Frequency of Exetrnal Valuations 80% 75% 70% 63% 60% 55% 50% 40% 20% 27% 25% 30% 25% 18% 13% 10% 0% 0% 0-1 yrs 1-2 yrs Office 2+ yrs 0-1 yrs 1-2 yrs Retail 2+ yrs 0-1 yrs 1-2 yrs 2+ yrs Industrial © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 46 Excel leads the way in office and retail valuations The survey findings show that a higher proportion of participants use excel-based proprietary models compared with industry accepted software when undertaking a valuation of either office or retail assets. As regards industrial assets, both are used equally.applying the capitalisation approach and DCF approach, 51. When do56: you or your valuers use industryapproach accepted or do you Figure When applying the capitalisation andsoftware DCF approach, excel or based proprietary models? your valuers use industry accepted software or excel based proprietary models? Type of Software Used to Perform Valuations Using the Capitalisation and DCF Approaches 70% 64% 57% 60% 50% 50% 50% 43% 40% 36% 30% 20% 10% 0% Industry Accepted Excel based Industry Accepted Excel based Industry Accepted Excel based Software Proprietary Models Software Proprietary Models Software Proprietary Models Office Retail Industrial Real estate remains active The 2015 survey shows that participants have experienced an overwhelming increase in sales and leasing activity across all asset classes over the past 12 months. Only 14 percent experienced a decline in the Office sector, 13 percent in the Industrial sector, with no reported decline in the Retail sector. 52. How would you describe sales and leasing activity in your Figure 57: How you describe sales activity in your sector/s of sector/s ofwould expertise over the lastand 12leasing months? expertise over the last 12 months? Sales and Leasing Activity Patterns for the Previous Twelve Months 80% 73% 70% 60% 50% 57% 50% 38% 40% 29% 30% 20% 27% 14% 13% 10% 0% 0% Increasing Remaining Decreasing Increasing steady Office Remaining Decreasing Increasing steady Retail Remaining Decreasing steady Industrial © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 47 | Australian Valuation Practices Survey 2015 Section 22: Sales and leasing activity Valuers confident market will continue to strengthen A high proportion of participants continue to be bullish about all sectors of the real estate market, predicting a continued rise in sales and leasing activity over the next 12 months. 53. Where do you see sales and leasing activity moving in Figure 58: Where do you see sales and leasing activity moving in the next the next 12 months? 12 months? Market Expectations for the Next Twelve Months 90% 82% 80% 70% 60% 50% 63% 57% 43% 38% 40% 30% 18% 20% 10% 0% 0% 0% 0% Increasing Remaining Decreasing Increasing Remaining Decreasing Increasing Remaining Decreasing steady steady steady Office Retail Industrial © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 48 Section 23: Leasing incentives No change to leasing incentives The survey findings show that leasing incentives have mostly remained steady over the past 12 months across all asset types. 54. How have leasing incentives changed in your specific sector Figure 59: How have leasing incentives changed in your specific sector over the last over the last 12 months? 12 months? Leasing Incentive Patterns over the Last Twelve Months 80% 73% 71% 71% 70% 60% 50% 40% 30% 29% 18% 20% 0% 14% 14% 9% 10% 0% Increased Remained steady Decreased Increased Office Remained steady Decreased Increased Retail Remained steady Decreased Industrial More of the same Similar to the previous period, participants expect incentives to remain steady across all asset classes over the next 12 months. 55. What are your expectations in respect of leasing incentives in the next 12are months? Figure 60: What your expectations in respect of leasing incentives in the next 12 months? Incentive Expectations for the Next Twelve Months 90% 86% 82% 80% 71% 70% 60% 50% 40% 30% 29% 20% 9% 10% 0% 9% 14% 0% Increasing Remaining Decreasing Increasing steady Office 0% Remaining Decreasing Increasing steady Retail Remaining Decreasing steady Industrial © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 49 | Australian Valuation Practices Survey 2015 Section 24: Yields Yields take a dip In the main, participants have witnessed yields decrease across both primary and secondary asset markets over the past 12 months. 56. Where have you seen investment yields moving across both Figure 61: Where you seen investment yields across both primary and primary and have secondary markets in the lastmoving 12 months? secondary markets in the last 12 months? Movement of Investment Yields Across Primary Asset Markets Over the Last Twelve Months 100% 88% 90% 82% 80% 71% 70% 60% 50% 40% 29% 30% 18% 20% 10% 0% 13% 0% 0% Increasing Remaining steady 0% Decreasing Increasing Primary Office Remaining steady Decreasing Increasing Primary Retail Remaining steady Decreasing Primary Industrial Movement of Investment Yields Across Secondary Asset Markets Over the Last Twelve Months 100% 90% 83% 80% 70% 70% 60% 57% 50% 43% 40% 30% 30% 17% 20% 10% 0% 0% 0% Increasing Remaining steady 0% Decreasing Increasing Secondary Office Remaining steady Decreasing Increasing Secondary Retail Remaining steady Decreasing Secondary Industrial © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 50 Low expectations for yields Similar to the previous 12 months, most participants expect yields to continue their decline across both primary and secondary asset classes over the next 12 months. However, a small proportion believe the retail and industrial markets will not perform 57.well Where youmarket. see investment yields moving in both primary as as thedo office and secondary markets in the next 12 months? Figure 62: Where do you see investment yields moving in both primary and secondary markets in the next 12 months? Expected Movement of Investment Yields Across Primary Asset Markets Over the Next Twelve Months 80% 70% 64% 57% 60% 50% 50% 43% 38% 40% 27% 30% 20% 13% 9% 10% 0% 0% Increasing Remaining Decreasing Increasing steady Primary Office Remaining Decreasing Increasing steady Primary Retail Remaining Decreasing steady Primary Industrial Expected Movement of Investment Yields Across Secondary Asset Markets Over the Next Twelve Months 80% 70% 70% 67% 60% 57% 50% 40% 33% 29% 30% 20% 20% 14% 10% 10% 0% 0% Increasing Remaining Decreasing Increasing steady Secondary Office Remaining Decreasing Increasing steady Secondary Retail Remaining Decreasing steady Secondary Industrial © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 51 | Australian Valuation Practices Survey 2015 Section 25: Rent Stable face rents According to the survey’s participants, face rents have largely remained steady across both primary and secondary markets for all asset classes over the past 12 months. 58. Where have you seen face rents moving across both Figure 63: Where you seen face rents both primary and primary and have secondary markets in moving the lastacross 12 months? secondary markets in the last 12 months? Movement of Face Rents Across Primary Markets Over the Last Twelve Months 80% 73% 67% 70% 57% 60% 50% 40% 20% 33% 29% 30% 18% 14% 9% 10% 0% 0% Increasing Remaining steady Decreasing Increasing Primary Office Remaining steady Decreasing Increasing Primary Retail Remaining steady Decreasing Primary Industrial Movement of Face Rents Across Secondary Markets Over the Last Twelve Months 90% 82% 80% 71% 71% 70% 60% 50% 40% 30% 20% 14% 14% 14% 14% 9% 10% 9% 0% Increasing Remaining steady Decreasing Secondary Office Increasing Remaining steady Decreasing Secondary Retail Increasing Remaining steady Decreasing Secondary Industrial © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 52 No about face for rents Face rents are expected to remain steady across both primary and secondary markets in relation to all property classes over the next 12 months. 59. Where do you faceface rents moving primaryand and Figure 64: Where do see you see rents movingin in both both primary secondary secondary markets in the next 12 months? markets in the next 12 months? Anticipated Movements of Face Rents in the Secondary Market Over the Next Twelve Months 100% 91% 90% 86% 80% 71% 70% 60% 50% 40% 30% 20% 14% 14% 14% 9% 10% 0% 0% 0% Increasing Remaining steady Decreasing Increasing Primary Office Remaining steady Decreasing Increasing Primary Retail Remaining steady Decreasing Primary Industrial Anticipated Movements of Face Rents in the Secondary Market Over the Next Twelve Months 90% 80% 80% 71% 70% 71% 60% 50% 40% 29% 30% 20% 20% 14% 14% 10% 0% 0% 0% Increasing Remaining steady Decreasing Increasing Secondary Office Remaining steady Decreasing Increasing Secondary Retail Remaining steady Decreasing Secondary Industrial © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 53 | Australian Valuation Practices Survey 2015 Australian Valuation Practices Survey 2015 Section 26: Introduction to tangible assets | 54 Tangible Assets This second Valuation Practices Survey extends its reach to tangible assets. Once again, the findings are revealing, offering unique insights for practitioners and clients alike. Nine tangible asset valuers completed the survey. Key insights • The usual suspects. With a financial year characterised by no ‘extraordinary’ tax and accounting requirements or regulations, participants indicate that they performed valuations in a variety of sectors and industries. All of them were exposed to the lead sectors of our region such as energy and natural resources, industrial markets and telecommunications. • Hundred percent. We found that all participants use a combination of indirect and direct approaches in performing their valuations. • Digging for data. More than 80 percent of the participants are doing research to determine the most appropriate useful/economical life of their assets. As such, about 27 percent rely on client information, 23 percent engage external technical people and about 31 percent use data from previous engagements. Only 15 percent rely solely on publications. • Need for funding? Of the participants, 66 percent do not usually include finance costs, in addition to all direct and indirect costs, when building a full replacement cost new estimate. • Try to optimise. About 86 percent of the participants often apply optimisation adjustments during replacement cost analyses. For example, they optimise the number of assembly lines or entire network of assets. The remaining 14 percent apply them in every engagement. • Cost to capacity. About 43 percent of the participants use the 0.6 exponent factor in utility/cost to capacity calculations in lieu of supporting information/benchmarks. The remaining 57 percent rarely or never use this kind of calculation. • Never old enough. Of the participants, 67 percent indicate they prefer to extend the Normal Useful Life (NUL) rather than the Remaining Useful Life (RUL) when considering a long life asset that is already in excess of its NUL but still in good condition. © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 55 | Australian Valuation Practices Survey 2015 Business as usual Last year, no particular sector dominated the market, according to the survey’s findings. All the participants performed work for clients in different industries and were exposed to multiple sectors over the past 12 months. This factor highlights and is symptomatic of a financial year characterised by no external requirement or regulation for tax or accounting compliance. 60. Which of theoffollowing sectors workin?in? Figure 65: Which the following sectorsdo doyou youfrequently frequently work Energy and natural resources Industrial Markets (Transport & Logistics, Pharmaceuticals, Automotive, Chemicals, Building Materials, Healthcare) 38% 44% 56% 63% 3.70% Consumer Markets (Agribusiness, Retail and Consumer Products) 11% TMT (Technology, Media and Telecommunications) 22% 38% 63% 67% 3.70% Other 20% Always Sometimes Never 80% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 56 Section 27: Valuation methodologies Market, cost and… The survey shows that the market and cost approaches are the most commonly adopted methodologies to value tangible assets. However, the majority of the participants they sometimes also consider and/or utilise income 61. Whichindicate of the following methodologies does your firmthe frequently approach to perform their valuations. employ when conducting valuation analysis? Figure 66: Which of the following methodologies does your firm frequently employ when conducting valuation analysis? Income approach Market approach 11% 22% 44% 56% 67% 3.70% Cost approach 44% Always 56% Sometimes Never © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 57 | Australian Valuation Practices Survey 2015 Section 28: Cost approach Comfort in the accounting data The Fixed Asset Register (FAR) is the first reference point for all the participants. When they apply the cost approach, the indirect approach is always used as a comparison to the direct approach. On the other hand, when participants review a third party valuation, they complain about extensive use of the indirect method and of relying on FARs that are deemed inaccurate. 62. When applying cost approach, which is more commonly used? Figure 67: When applying cost approach, which is more commonly used? Indirect 0% Direct 0% 100% Combination of both indirect and direct 0% 20% 40% 60% 80% 100% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 58 Section 29: Depreciation profiles Keen to use market based depreciation methods The straight line and the diminishing value are the most commonly used depreciation profiles. However, if possible, all the participants are keen to use depreciation methods based on market based observations. These may include units of production and condition adjusted depreciation, sums of the years’ digits, among 63.others. Which of the following depreciation profiles do you frequently use? Figure 68: Which of the following depreciation profiles do you frequently use? Reducing / Diminishing balance 100% Straight line 13% 88% Iowa Other 100% 33% 67% Never Sometimes Always © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 59 | Australian Valuation Practices Survey 2015 Life experiences There are different factors influencing an asset’s life, its ultimate length depending on the mechanical efficiency, technological potential and commercial adequacy of the product. The survey participants are most likely to draw on their own experience to determine the useful life of data rather than turning to the taxation or accounting rulings that may or may not appropriately reflect the technical/economic lives of the assets. 64. Where do you often source your normal useful life data? Figure 69: Where do you often source your normal useful life data? Client management/ site personnel 27% 15% Publications Own experience/ prior engagements 31% External/ consulting engineers Other 23% 4% 0% 5% 10% 15% 20% 25% 30% 35% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 60 61 | Australian Valuation Practices Survey 2015 Section 30: Replacement cost considerations Not everything black on white The findings show participants investigate and determine the life of assets from a variety of sources including sector experts, client management/site personnel and external/consulting engineers. They do not solely rely on data from publications such as American Society of Appraisers, Marshall and Swift, and Australian 65. Where dopublications. you often source RCN data? Taxation Office Figure 70: Where do you often source RCN data? 23% 20% 23% 23% 10% 0% 5% 10% 15% 20% 25% Client management / site personnel Publications On line research – comparable projects Own experience / prior engagements Others © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 62 Others Figure 71: Publications being consulted 7% 50% 43% Rawlinsons Cost manuals Other Financing the project The International Valuations Standards Council (IVSC) guidelines allow for finance costs and interest during construction to be calculated using typical debt to equity ratios, cost of debt, and draw down schedules over the construction period. The participants indicate that they do not usually consider these costs in their valuations. 66. Do you typically include finance costs in addition to all direct indirect costs when building a fullfinance replacement Figureand 72: Do you typically include costscost in addition to all direct and indirect new estimate? costs when building a full replacement cost new estimate? 33% Yes No 67% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 63 | Australian Valuation Practices Survey 2015 Figure 73: When considering application of finance costs, do you typically apply time is? 67. When considering application of finance costs, do you typically these when the project construction apply these when the project construction time is: 33% 50% 17% 3.70% No threshold (always applicable) Only when greater than 12 months Never applied Figure 74: Do you consider interest during construction applicable to the portion of would be funded by? 68. Do you consider interest during construction applicable to the theconstruction total construction cost that portion of the total cost that would be funded by: 40% 60% Assumed debt portion only Both debt and equity © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 64 Optimising the cost The survey findings highlight the fact that research and/or other sources are not the most accurate starting points when trying to determine the cost of replacing something new. Often – if not always – participants need to apply optimisation adjustments during replacement cost analyses, for example, by optimising the number of assembly lines or entire network of assets (that is, by reconfigurating them). 69. How often do you apply optimisation adjustments during replacement Figure 75: How often do you apply optimisation adjustments during replacement cost analyses e.g. optimise number of assembly lines or entire analyses optimise number of assembly lines or entire network networkcost of assets? (i.e.e.g. reconfiguration) of assets? 14% 86% 0% 0% 20% 40% 60% 80% 100% Always Often Never © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 65 | Australian Valuation Practices Survey 2015 EPCM The survey provides evidence that participants use Engineering Procurement Construction Management (EPCM) in a consistent manner throughout different 70. Please indicate typical EPCM estimates for P&E in the sectors and industries. following sectors: Figure 76: Please indicate typical EPCM estimates for P&E in the following sectors: Oil and Gas Mining 25% 40% 50% 60% 25% Manufacturing Heavy infrastructure (ports/roads) 20% 20% 40% 20% 60% 40% <10% 10% - 30% 31% - 50% >51% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 66 Figure 77: Cost to capacity estimates are often used in lieu of supporting information/benchmarks, how often do you use the 0.6 exponent factor 71. Cost to capacity estimates are often used in lieu of supporting information/benchmarks, how often do you use the 0.6 exponent for inutility/cost to capacity calculations? factor for inutility/cost to capacity 0% 14% Always 43% Often Sometimes Rarely Never 43% Salvaging value When considering residual values applied to certain asset classes, the majority of participants research market comparables of a similar age and/or consider a typical scrap/salvage value at end of life, taking into account its removal from the location. Figure 78: When considering residual values applied to certain asset classes do you: 29% Consider a typical scrap/salvage value at end of life, taking into account removal from location (i.e. no installation cost) 43% Research market comparables of a similar age (end of NUL) 0% Always apply same % Other 29% 0% 20% 40% 60% 80% 100% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 67 | Australian Valuation Practices Survey 2015 Long life assets When considering a long life asset that is already in excess of its NUL and has all engineering records showing it is likely to continue in use for the foreseeable future without any significant capital expenditures (capex), participants consider two options. Most (67 percent) prefer to extend the NUL of the asset to its future retirement date (i.e. age + RUL); the remainder choose to use the same NUL but increase the RUL (the effective age). They do not use any other type of adjustment. Figure 79: If you considered a long life asset that is already in excess of its NUL, however, all engineering records show that the item is likely to continue in use for the foreseeable future without any significant capex. Would your preferred methodology be? 67% 33% 0% 0% 0% 20% 40% 60% 80% 100% Extend the NUL of the asset to its future retirement date (i.e. age + RUL) Use the same NUL but increase the RUL (effective age) Increase the residual value and keep the NUL constant to represent the asset is at the end of its NUL but is still in use for the foreseeable future Other © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 68 Functional obsolescence The survey’s participants are consistent in the approach they take to assessing functional/technological obsolescence as regards utility analysis, net present value (NPV) of excess operating costs, and where the assumption is that the replacement cost captures any adjustments. They did not highlight any particular situation that gives rise to functional obsolescence. Figure 80: Which of the following approaches do you frequently use to assess functional/technological obsolescence? Inutility analysis Assume replacement cost captures any adjustments NPV of excess operating costs 100% 14% 14% 86% 86% Always Sometimes Never Figure 81: From your experience over the last 12 months, which of the following situations have given rise to functional obsolescence? 17% 26% Lack of utility Excess capacity 17% Change in design Efficiency Technological change 22% 17% 3.70% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. 69 | Australian Valuation Practices Survey 2015 Assessing economic obsolescence The survey participants equally favour inutility analysis, overall profitability of cost generating units (CGU)/business (enterprise value), and market sample/evidence vs. depreciated replacement cost (DRC) when determining any form of economic obsolescence. Figure 82: What approach or approaches do you most commonly use to assess economic obsolescence? 6% 29% 29% Inutility analysis Overall profitability of CGU / business (enterprise value) Market sample/evidence vs. DRC Other 35% 77. Over the last 12 months, which sectors have the assets that required Figure 83: Over the last 12 months, which fallen sectors assets required economic obsolescence adjustments into?have (Select all thatthat apply) economic obsolescence adjustments? 14% Energy and natural resources Industrial Markets (Transport & Logistics, Pharmaceuticals, Automotive, Chemicals, Building Materials, Healthcare) 32% Consumer Markets (Agribusiness, Retail and Consumer Products) 32% TMT (Technology, Media and Telecommunications) Other (Please specify) 18% 5% 0% 5% 10% 15% 20% 25% 30% 35% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 Future economic expectations Based on their recent experiences and discussions with the management of different companies they have worked for, all plant and machinery (P&M) participants expect economic obsolescence related issues (in general) to either 78. Do you expect economic obsolescence related increase or remain constant over the next 3 years. issues (in general) to increase, decrease or over the nextobsolescence 3 years? Figure remain 84: Do constant you expect economic related issues (in general) to increase, decrease or remain constant over the next 3 years? Increase Decrease 43% 0% Remain constant 0% 57% 10% 20% 30% 40% 50% 60% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. | 70 71 | Australian Valuation Practices Survey 2015 Believe it only if you see it The majority of participants attribute great importance to the site visit. They consider that the inspection of a single site should cover at least 50 percent of the value of the assets, while in the case of multiple sites, they indicate that a participant should visit more than 50 percent of them. Fourteen percent of participants underline insufficient site visit sampling as an issue. 79. What % of value capture is considered reasonable for a site Figure 85: What percentage inspection (single site)? of value capture is considered reasonable for a site inspection (single site)? 90% 80% 83% 70% 60% 50% 40% 30% 20% 10% 0% 0% Less than 10% 0% 10-30% 17% 30-50% More than 50% 80. For multiple site/large portfolio engagements what size of site Figure 86: For multiple portfolio engagements what size of site inspection inspection sample site/large is considered reasonable (as percentage sample is considered reasonable (as percentage of Cost/NBV)? of Cost/NBV)? 70% 67% 60% 50% 40% 30% 33% 20% 10% 0% 0% 0% Less than 10% 10-30% 30-50% More than 50% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Australian Valuation Practices Survey 2015 | 72 Making it immediately clear The trend shows participants are concerned by the lack of the information and disclosures in reports. On the issue of reviewing third party valuations, one comment made was that while they find the participants have completed an adequate process, the report fails to document the matters considered, assumptions and judgments made. Figure 87: What are the most common issues encountered during the review of third party valuations? 20% 18% 18% 18% Insufficient site visit sampling Extensive use of indirect DRC (“trend and bend”) Lack of benchmarking (RCNs and market/fair values) and support FARs deemed inaccurate but heavily relied upon Mathematical errors 16% 14% 14% 12% 11% 11% 11% Valuation approach(es) deemed unreasonable Valuation inputs deemed unreasonable (useful lives, residuals, depreciation profiles) 10% 8% 7% 7% 6% 4% 4% Valuer lacking credentials/designation (ASA, API, RICS etc.) Other 2% 0% 82. Have 88: you seen recent scenarios where P&E fair value for Figure Have you seen recent scenarios where P&E fair value for accounting accounting purposes differed significantly from market value purposes differed significantly from market value for tax purposes for tax purposes (stamp duty, tax consolidation etc.) (stamp duty, tax consolidation etc.) 33% Yes No 67% © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. kpmg.com.au Contact us Sydney Brisbane Sean Collins Partner in Charge Valuation Services, Corporate Finance +61 2 9335 7447 [email protected] Bill Allen Partner Valuation Services, Corporate Finance +61 7 3233 3174 [email protected] Ian Jedlin Partner Valuation Services, Corporate Finance +61 2 9335 8207 [email protected] Perth Melbourne Jason Hughes Partner Valuation Services, Corporate Finance +61 8 9263 7452 [email protected] Adele Thomas Partner Valuation Services, Corporate Finance +61 3 9288 6139 [email protected] KPMG Corporate Finance is a division of KPMG Financial Advisory Services (Australia) Pty Ltd ABN 43 007 363 215, Australian Financial Services Licence No.246901. The information contained in this document is of a general nature. It has been prepared to provide you with information only and does not take into account your objectives, financial situation or needs. It does not constitute, nor should it be regarded in any manner whatsoever, as advice and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on the information contained in this document. Before acting or relying on any information, you should consider whether it is appropriate for your circumstances having regard to your objectives, financial situation or needs and also whether or not any financial product is appropriate for you. To the extent permissible by law, KPMG Financial Advisory Services (Australia) Pty Ltd, KPMG and its associated entities shall not be liable for any errors, omissions, defects or misrepresentations in the information or for any loss or damage suffered by persons who use or rely on such information (including for reasons of negligence, negligent misstatement or otherwise). © 2015 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. May 2015. VICN12815ADV.