FNBK 3400: Applied Investment Project

Dr. Jeff Bredthauer

February 21, 2018
Johanna Glaser, Amy Kohlscheen, William “Chase” Oliver

1. Macro-Environment Assessment
Global Economy
There are three countries with top economies that all other countries strive to emulate: the

United States, China, and Germany. For the purpose of this research analysis paper, we have

chosen five countries to focus on: the United States, China, India, Spain, and Brazil. For the

global economy, we will analyze China, the world’s second largest economy, as well as India,

Spain, and Brazil. India, Spain, and Brazil are not in the top five, but all have emerging

economies (7). The United States’ economy will be analyzed as our domestic economy.

China: A Broad Overview

China is very influential in the global economy. Not only is China one of the largest

economies in the world, but the largest export economy as well. After seven years of slowed

expansion, China’s economic growth increased 6.8% in the third quarter of 2017, which is well

above the projected 6.5% (1). This is due to an increase in exports, construction and consumer

spending (2). Forecasts for 2018 will remain the same as 2017 (6.5%), but economists are

expecting the economic slowdown to fade.

China’s agriculture sector increased 3.9% in 2017 (3). Final consumption expenditure

accounted for 58.8% of the total Gross Domestic Product (GDP). These increases will all play a

factor in China’s transition from an investment-led to a consumer-led economy. An increase in

production will affect the increase in consumer spending (4). This will not only push China’s

industrial side and food production to expand, but other countries as well.

India: A Broad Overview

India had a setback in late 2016/early 2017 when the Indian government exercised

demonetization, where the current form of money is no longer used, and a Goods and Services

Tax (5). There were initial cash shortages and citizens believed new jobs would not be created.

Currently, India’s economy is beginning to stabilize and projects to grow their GDP by 7.4% (6).

This is higher than the forecasted growth of China, which makes India the fastest growing

emerging economy in the world (6).

Spain: A Broad Overview

Spain’s GDP grew by 3.1% in 2017, which is down 0.2% from 2016 (8). A region in

northeastern Spain is attempting to become independent causing political uncertainty, which has

slowed consumer consumption and increased unemployment (already at 16.5%) (9). Due to this,

the growth for 2018 was forecast at 2.3% (9). Spain is a big tourist country. This has helped keep

their economy afloat. Maintaining their high tourist numbers and increasing exports has

increased the 2018 forecast to 2.5% (10).

Brazil: A Broad Overview

Brazil is the eighth largest economy globally and the largest economy within Latin

America. Brazil’s GDP growth has been down the past few years due to one of their largest

recessions which began in 2013. In 2017, the unemployment rate began to decline and inflation

decreased (11). Consumer confidence has increased since a new president was appointed.

Consumer confidence rose 10 points in the third quarter of 2016 and inflation fell from 6.3% to
5.4% in the first quarter of 2017 (12). As consumers become more confident and spending

increases, Brazil’s economy will stabilize and begin to grow more. This is not only a positive

sight for Brazil, as they work to pull out of their recession, but for the world. Exports will be able

to increase again and with more confidence in spending, many countries will benefit.

Global Economy Summary

Globally every country seems to be in a transitioning stage. The global economy will

benefit from all of the new emerging markets in these smaller countries. Their growth in the past

year has been greater than that of China and the other top economies. As consumers become

more confident, the emerging markets will increase, benefiting the global economy as a whole. It

will be interesting to see how their growth continues throughout 2018. We will now look at the

domestic economy. By looking at the Federal Reserve’s publication of the ​Beige Book​ and Value

Line’s ​Selection and Opinion​ we will be able to analyze the United States economy and what

factors make it the number one economy globally.

Domestic Economy

The January 2018 publication of the ​Beige Book b​ y the Federal Reserve reported that

there was moderate growth in the United States, but in the Dallas region economic activity grew

robustly (13). The ​Beige Book a​ lso reported that online retail sales expanded faster and

companies are investing more in information technology to support e-commerce. The labor

markets are tightening and experiencing challenges with finding qualified workers (13).

The 2018 publication of Value Line’s ​Selection and Opinion s​ tates, “the economic trends

are still positive, on balance” (14). There is a gain in personal income, along with an increase in

consumer spending. GDP produced a modest 2.6% rise last quarter. The report shows that
consumers are “upbeat” about 2018 (14). The report also stated that a low supply of houses on

the market should spur homebuilding. A drop in corporate tax rates should boost job

opportunities. Since the U.S. dollar is declining, it will make U.S. goods more competitive and

lift exports (14). The report also showed concerns with trade disputes and raising tariffs. They

are predicting a chance for strong GDP growth, but it will be accompanied by higher inflation.

This will impact borrowing costs over the next few months.

Leading Indicators

In January 2018, the average hours of production of nonsupervisory employees in

manufacturing was 41.7 hours. This slightly decreased over the past few months (15). The

average weekly initial claims for unemployment insurance has been trending downward and is

currently at 230,000. Unemployment has not been this low since 1973 (16). The value of

manufactures’ new orders for consumer goods are on the rise (17), along with new orders for

nondefense capital goods (18). The number for new private housing units authorized by local

building permits have been steady at 1,250 permits per month (19).

The yield curve has been increasing with GDP above 2%, but in 2018, it is predicated

that GDP will fall below 2% (20). The Dow Jones is at an all-time high of 26,000 points. This is

very concerning on Wall Street because the stock market may be in danger of overheating (21).

Consumer confidence slightly declined in December of 2017 from previous months by 6.5%

(22), but the confidence is still strong. Current unemployment levels are at 4.1% (22). In the next

six months, consumers are predicted to purchase big-ticket priced items, which shows that

consumers are still confident in the economy (22).

Coincident Indicators
 In December 2017, personal income increased $58.7 billion (0.04%). This caused

disposable personal income (DPI) to increase. Those factors lead to an increase of personal

consumption expenditures (PCE) by $54.2 billion or 0.4% (23). This is a reflection from having

wage increases in most employment fields. In December 2017, the industrial production

increased by 0.9%. Originally, it was expected to be a 0.4% increase (24). This indicates that the

overall economy is in a moderate growing phase.

Lagging Indicators

The economy is on the rise, but interest rates are still catching up. During the financial

crisis, interest rates in the United States dropped. In 2009, interest rates went to 0.25% and

stayed there until the beginning of 2016. The Federal Reserve is slowly increasing interest rates.

With the start of 2018, interest rates are at 1.5% (25). The Federal Reserve is at a delicate stage

in which they are trying to raise interest rates without increasing inflation. This creates an

unknown future for the economy regarding how it will react to these interest rate increases over

the next few quarters.

Domestic Economy Summary

After reviewing the indicators, we have determined that the United States is currently in

an expansion phase. The indicators point towards a growth approaching 2%, along with the stock

market entering a bull market. One concern is that the economy may be approaching a peak,

where inflation starts to send prices up (26). If the Federal Reserve starts to increase interest

rates, this may create inflation. This could cause the economy to go towards a peak or a

contraction phase. The last time the United States had a recession, the Federal Reserve lowered

interest rates to help lower the impact. Since interest rates are so low now, there is not much
room for error. The current stage of the economy is still recovering from the previous recession,

which is why the next few quarters will be worth monitoring.

2. Industry Assessment
Business Cycle
According to ​Investments​, published by Zvi Bodie, Alex Kane, and Alan J. Marcus, the

global economy moves through a constant cycle of recessionary and recovery periods, which are

characterized by peaks and troughs (41). In times of recession, consumers across the globe will

alter their budgets and spending with the goal of surviving financial crisis. These reductions in

spending create negative effects on production and output, which can ultimately impact a

country’s employment levels and overall GDP. Some industries, however, respond to periods of

recession and recovery differently. Cyclical industries, those that are more sensitive to an

economy’s condition, will see a more dramatic impact during recession periods than industries

that are less volatile. Defensive industries, on the other hand, experience less noticeable effects

in a period of economic trough.

The United States’ economy is currently in an expansion phase, but the threat of reaching

a peak makes investment in non-cyclical industries more appealing. If the economy were to

reach a peak and possibly a contraction, it would be wise to invest in less risky investments with

the goal being a minimization of losses. As stated in ​Investments​, industries that are necessary

for human well-being, such as pharmaceuticals, food and beverage, and things like gas and

utilities, will perform best in periods of economic uncertainty (41). One thing is certain,

nourishment is the most vital aspect of human well-being, which makes it an industry that will

produce at all stages of any economy.

 A unique aspect of the modern-day food and beverage industry is the fact that the “only

the strong survive” ideology does not necessarily apply (27). Small to mid-cap food and

beverage companies are finding success in having the ability to chase trends, which are having

an increasingly large impact on food and beverage sales. Large corporations like McDonald’s

and Coca-Cola have found success in the mass production of a relatively small number of

products, but a continuously changing range of consumer preferences is giving smaller

companies an opportunity to capture market share.

According to a market analysis executed by RSM, 45% of US leading food and beverage

manufacturers believe that their revenue will increase by double digit percentages in 2018 (14).

Consumers on a global scale have begun to move towards healthier alternatives, which led to the

reformulation of more than 180,000 products to meet changes in consumer preference in 2017

alone (28). Such statistics show that the food and beverage industry will continue to advance,

and if PCE continues to grow, the opportunity for food and beverage companies to increase

revenues will continue to present themselves.

The global beverage market is dominated by household names, such as, Coca-Cola Co.

and PepsiCo Inc. According to a market report by Rabobank, the beverage industry considered to

be in the mature phase and highly competitive. However, opportunities exist for small to mid-cap

companies in specific sectors of the beverage industry like energy drinks and alcohol. Today,

small food and beverage manufacturers hold only 19% of the market share, but are driving more

than 50% of market growth (29), which leads us to believe that investments in small beverages

companies may lead to high returns on investment in the future.

3. Security Selection High Level

 In the beverage industry, there are a variety of major players. A snapshot of the vast

differences in the beverage industry include, Monster Beverage, PepsiCo Inc., Constellation

Brands Inc., and Dr. Pepper Snapple. From energy drinks to sodas and adult beverages, this

industry has something for everyone. The mid-cap companies include National Beverage,

Dunkin’ Brands Group, SodaStream International and MGP Ingredients. The mid-cap companies

offer different ways of buying beverages, such as buying it in grocery store, fast-food drive thru,

or even make it yourself. The small-cap company includes Craft Brew Alliance. In the beverage

industry, there is always room for new products and flavors.

Table 3.1 compares the different types of beverage industries. These numbers are valid as

of February 12, 2018 (Google Finance, Yahoo! Finance, and Value Line).

Table 3.1
Company Classification P/E ROI ROE ROA
Ratio

Monster Beverage (MNST) Large-Cap 41.4 20.06% 52.77% 17.16%

PepsiCo, Inc Large-Cap 20 28.94% 53.73% 8.56%

Constellation Brands, Inc. (STZ) Large-Cap 23.34 20.44% 24.84% 7.98%

Dr. Pepper Snapple Large-Cap 29.28 18.29% 34.43% 9.06%

National Beverage (FIZZ) Mid-Cap 34.2 39.55% 43.58% 29.91%

Dunkin’ Brands Group Mid-Cap 15.6 7.58% 7.38 7.56%

Sodastream International Mid-Cap 7.54 11.98% 15.34% 9.06%

MGP Ingredients Mid-Cap 38.14 19.47% 25.21% 11.83%

Craft Brew Alliance (BREW) Small-Cap 193.68 1.4% 1.87% 1.17%

4. Security Selection Specific

 According to our industry assessment, the best opportunities in the beverage industry will

most likely exist in small to mid-cap company range. It is apparent that Craft Brew Alliance has

the highest P/E ratio, but their ROI, ROA, and ROE are far below other industry participants. We

have decided that MGP Ingredients (MGPI) shows the most potential, as it deals mostly with a

subset of the beverage industry: alcohol. However, the company also produces an array of

industrial alcohols, which is another emerging industry, as well as numerous wheat and grain

products. This diversity in the company's portfolio will assist in mitigating its risks, which is

important to providing stable revenues.

5. SWOT Analysis

Strengths:

MGP Ingredients’ biggest strength is their diversified portfolio of products. They

produce food grade alcohol, ingredient solutions (specialty wheat starches and proteins), and

plant based biopolymers and composites (33). With all of these different products MGPI is able

to serve a wide range of customers. They have created a Non-GMO Project Verified Grain

Neutral Spirits (GNS) beverage which gives them a distinct labeling advantage (34).

The company has a strong focus on research and developing new products. Their research

is focused on naturally derived ingredient solutions and product formulation. MGPI wants to

develop their products based on the needs and ideas of their customers, so they are

ever-changing, improving products, and creating new ones. While focusing on the development

of products, MPGI also looks for solutions that will improve agricultural material processing,

personal health and safety. This is not all done on their own, MGPI also collaborates with the
University of Nebraska, University of Kansas, Iowa State University, and other local and

surrounding colleges, as well as some internationally (33).

With this focus in specialty ingredients and innovation in grain and plant science, MGP

Ingredients has created a strong market presence. Consumers are looking for new products that

have that healthy factor, and MGP Ingredients is producing that. With an already strong base in

specialty ingredients, MGP Ingredients is in a good position for future expansion.

Weaknesses:

Although MGP Ingredients has a strong diversified portfolio of products, their biggest

weakness is their debt obligation. Since 2015, their total debt has increased from $9.6 million to

$43.7 million, with a debt to equity ratio of .2598 or 25.98%. Net sales increased from 2016 to

2017 (9.17%), but from 2015 to 2016 their net sales decreased 2.85%. Without strong inflows of

cash and cash equivalents the operations of the company could fail (30).

Opportunities:

With a large increase in the consumption of alcohol in the United States, MGP

Ingredients has the opportunity to grow their food grade and fuel grade alcohol market. Using

natural grains and having gluten free options could be very appealing to customers. Developing

and introducing new products will help strengthen their portfolio. Within the last two years MGP

Ingredients has introduced a new bourbon whiskey brand, Arise​Ⓡ ​wheat protein isolates, and

Optein​Ⓡ​ lightly hydrolyzed wheat protein, which are partial egg replacers, and many others

(33)(34). Increasing development in these products will open the doors for more expansion in the

future.

Threats:
 MGP Ingredients is in a very competitive market of not only alcohol beverages but also

starches and proteins. There are many large-cap companies that have strong financial, marketing,

and other resources. Product quality needs to remain strong in order to compete with the other

companies in pricing and customer loyalty. Distinguishing themselves is the way to grow and

push away from competitors.

Although consumption of alcohol is trending upwards, consumer demands and

preferences can change rapidly. In order to be successful, MGP Ingredients needs to increase

their assets so that they can change as demands change. Without sufficient resources, they could

be unable to do this. In this industry they are also subject to many laws and regulations. By

having a team to continually check these laws as they develop new products is very important.

Failure to comply with the smallest regulation could result in heavy penalties, which could hurt

the company financially and all their operations.

6. Risk Assessment

It is important to consider the degree of operating leverage when assessing MGP

Ingredients business risk. Looking at their 10-K report, we have found that MGPI increased their

identifiable assets by nearly $15 million being composed mostly of distillery products and

ingredient solutions (30). $4.5 million was used to purchase property, plant, and equipment (30).

This shows how much money it takes to develop their products and increase their company’s

long- term assets.

Using data from MGP Ingredients most recent 10-K Annual Report, the degree of

operating leverage is calculated in table 6.1 (30).

 Table 6.1 ​(Dollars in thousands)

MGPI’s net sales have increased substantially since 2016, but their Degree of Operating

Leverage (DOL) is greater than investors would like to see. However, their DOL is significantly

lower than their competitors Craft Brew Alliance (5.16) and National Beverage (2.02). A DOL

greater than one indicates that a company is risky, and a risky company pays higher interest rates

on new capital. If MGPI is able to decrease their DOL investors will be more interested and

willing to buy stock or bonds in their company.

Data used is from the company’s most recent 10-K Annual Report (31)(32).

Table 6.2​ (Dollars in thousands)

Table 6.2 indicate that MGPI’s net sales are on a steady rise, it is not as extreme as

National Beverage, but it is an improvement from the loss they suffered from 2015 to 2016
(mentioned in the SWOT analysis). They need to focus on lowering their debt ratio to ensure that

they can meet their financial needs at all times. Having business risk will affect MGPI’s investor

returns and could potentially lead to more risk in the future.

Business and financial risk are both closely related. We can see from the table 6.3 that

MGPI’s leveraged capital is very high. This indicates that profits are not high enough and this

will lead to problems repaying their debt. Tabe 6.3 is a comparison of the debt to equity and debt

to asset of three companies.

​Table 6.3

Table 6.3 shows that National Beverage is the most attractive with zero debt. Their risk

level (DOL) is higher than MGPI’s. MGPI does not look very attractive, and this is all due to

their level of debt. MGPI’s focus on the quality of their products is what keeps them profitable.

MGPI’s next step needs to be focusing on their business and financial risk: paying back debt and

improving their DOL.

7. Management Assessment

The first thing that stood out when researching the management team at MGPI was the

composition of the board of directors. It is important that publicly-traded companies work to

eliminate conflicts of interest when constructing management teams, so that profits are not

misappropriated. The goal of all publicly-traded companies should be to maximize shareholder

wealth, and it is vital that management align their goals with those of shareholders. Most
successful board of directors are composed of industry experts that work outside of the business.

This creates a strong corporate governance that leads the company towards a successful future..

MGPI, however, has their President and CEO sit on the board, which could be considered a

weakness of the company’s board of directors.

When analyzing MGPI’s most recent 10-K, it was apparent that the company was very

upfront in regards to disclosing the risks involved with their industry and business structure. It is

important that companies do not mislead their shareholders when it comes to future risk. MGPI

discussed market segments where they were successful, but also talked about areas where they

will work to improve in the future.

MGPI’s management is also in charge of determining their financing strategies.

According to the company’s most recent 10-K, the company uses a majority of their cash for

process improvements, capital expenditures, and investments. However, the company does have

a Credit and Note Purchase Agreement in place to finance short and long term financing needs.

As of December 31, 2017, MGPI’s current assets exceed current liabilities and all required debt

ratios from creditors were achieved (35). Going forward, the company believes will be able to

cover operations and short-term obligations using cash from operations. The enactment of the

Tax Cuts and Job Act lowered MGPI’s tax obligation, which will aid in boosting profits in the

future. Overall, the company’s management financing strategy and ability to meet such goal is

strong.

Finally, we determined that MGP Ingredients profit margin in 2017 was around 8.7%

(35). The company completed an addition to their Kansas branch in 2016, and its profit margin is

expected to continue growing as the new plant reaches maximum capacity and performance.
According to MGPI’s 10-K, their dark liquor segment saw a growth of sales around 18% in 2017

(35) and plans to capitalize on this growth in market segment in the future. MGPI has also

diversified their portfolio into starches and industrial alcohol segments and plans to grow into a

strong competitor into such markets with the goal of increasing profits.

8) Economic Assessment:

MGP Ingredients operates in the beverage industry, which is highly diversified. This

makes the company competing in a perfect competition. When looking at the beverage industry,

there are currently 32 other publicly traded companies on the NASDAQ (36). What makes MGP

Ingredients stand out is their products. A majority of their protein and starch products are

registered trademarks, which means only MGP Ingredients has the sole rights to those products.

MGP Ingredients has an advantage when creating products that use those proteins and starches,

since no one else can imitate them.

Now this does not make MGP Ingredients an oligopoly, since there are many other

companies in the beverage industry. MGP Ingredients specializes in adult beverages, which sets

them apart from most of their competitors. The larger corporations in the beverage industry

provide products such as energy drinks, sports drinks, sodas, teas, and water. This is where MGP

Ingredients stands out because they are creating a different target market. MGP Ingredients is

appealing towards different consumers, which is making them successful with their products.

9. Product Assessment:
 MGP Ingredients has two major industries they are involved in: food and alcohol. Within

those two industries there are also sub-industries. For the food industry, there is a protein sector

and a starch sector. For the alcohol industry, there is a beverage sector and a food grade

industrial sector. Table 9.1 shows what products MGP Ingredients makes.

Table 9.1
Food Alcohol

Protein:
Optein®
Arise® 5000, Arise® 6000,
Arise® 8000, Arise® 8100,
Arise® 8200
FP™ 300, FP™ 600
HWG 2009™
TruTex® 750 Series, TruTex®
1500 Series, TruTex® 2240
Series, TruTex® RediShred
Series
Starch:
FiberRite® RW, Fibersym® RW
Midsol™ 1, Midsol™ 4,
Midsol™ 46, Midsol™ 50,
Midsol™ Adhere, Midsol™ Krisp
Pregel™ 10, Pregel™ 40,
Pregel™ 46, Pregel™ Adhere
2000
Beverage:
Bourbon:
Bourbon (45% Wheat), Bourbon (49% Barley Malt),
Bourbon (21% Rye), Bourbon (36% Rye),
Bourbon (99% Corn)
Whiskey:
Corn Whiskey (15% Rye), Light Whiskey, Malt Whiskey
(100% Barley Malt), Rye Whiskey (49% Barley Malt),
51% Rye Whiskey, 95% Rye Whiskey, 95% Wheat
Whiskey, Grain Neutral Spirits, Non-GMO Project
Verified Grain, Neutral Spirits
Distilled:
Heritage 100 Distilled Gin, Heritage 200 Distilled Gin,
Heritage 300 Distilled Gin, Heritage 400 Distilled Gin,
Distilled Citrus Berry Gin, Distilled Cucumber Gin,
Distilled Lemon-Lime Gin, Distilled Orange Gin
Food Grade Industrial:
190 Proof U.S.P., 200 Proof U.S.P.
SDA:​ S
​ DA-1, SDA-2-B, SDA-3-A, SDA-3-B, SDA-29,
SDA-35-A, SDA-40-2, SDA-40-B, SDA-40-C,
SDA-40-C, Reagent Alcohol

MGP Ingredients has numerous registered trademarks, and trademarked products. Since

they have unique products that cannot be recreated, it allows for their products to be one of a

kind.
 MGP Ingredients is very bullish in the long-term of their company. In November 2016,

MGP Ingredients announced an acquisition of George Remus Whiskey Brand, “King of the

Bootleggers” (37). This allows MGP Ingredients to grow and invest more in their products. MGP

Ingredients is also expanding their whiskey warehouse by investing $29 million in their facility

(38). The company is continuing to aggressively put away whiskey, by adding an additional

$22.6 million in 2016. This brings their aging whiskey inventory to $50.9 million (38). In 2016,

MGP Ingredients had net sales of $318 million, with a gross margin of 20.5% (38). When

comparing this to previous years, MGP Ingredients is lowering their cost of sales and becoming

more efficient with their processes of production of goods.

Along with expanding their warehouses and finding more ways to generate profit, MGP

Ingredients creates strong partnerships. In January 2018, they announced a partnership with

Breakthru Beverage Minnesota for the introduction of TILL® American Wheat Vodka and

George Remus® Bourbon (39). This shows that MGP Ingredients is continuing to expand their

Midwest market. In February 2018, MGP Ingredients announced a partnership with Quail

Distributing in Arizona for the introduction of TILL® American Wheat Vodka and George

Remus® Bourbon (40). This is a major step in product development and outreach for MGP

Ingredients. Arizona will be MGP Ingredients’ first market outside of the Midwest. The future of

MGP Ingredients is expanding from being solely in the Midwest to more states in the United

States.
10. Financial Statement Analysis/Ratio Analysis:

Table 10.1 compares MGPI, Craft Brew Alliance, and National Beverage with several

useful ratios and metrics. All data was retrieved and used for calculations from Value Line and

Mergent Online (42)(43).

Tabel 10.1

MGPI’s valuation metrics show tremendous growth from 2015 to 2016, while their

dividend yield has remained constant. MGPI’s debt to liquidity ratios are not as attractive as

Craft Brew Alliance and National Beverage. MGPI’s total debt to equity is substantially higher

than National Beverage and only slightly greater than Craft Brew Alliance. This shows that
MGPI has been using debt as a leverage to increase its value. This in turn is associated with high

levels of risk. MGPI’s beta is average compared to Craft Brew Alliance and National Beverage.

Having a beta of 1 indicates that the security’s price moves with the market. MGPI’s margins are

all well below average for the alcoholic beverage industry: average gross margin is 44.95%,

average EBITDA margin is 23.36%, and average operating margin is 19.25% (44). MGPI is not

strictly an alcoholic beverage company, so their profit margin overall, will not look as impressive

when comparing them to the alcoholic beverage industry. MGPI is increasing their margins and

continue to compete with their competitors, Craft Brew Alliance and National Beverage.

11. Traditional Valuation Approach:

Adding onto the financial ratios, another method to calculate the intrinsic value of MGPI

is illustrated by the table 11.1.

Table 11.1
 When we changed the market risk premium from 0.08 to 0.06 the intrinsic value

increased to $227.25. Then when we changed the market risk premium from 0.06 to 0.04 the

intrinsic value increased dramatically to $326.76. From the chart above, we kept the market risk

premium at 0.08. We felt that since this is a B+ rated stock, that the market risk premium for this

stock should be higher than average, since there is more risk involved.

12. Value Investing Approach

The value investing approach was introduced by Ben Graham and consists of three

elements used to determine the value of a firm. The three elements involved are: the value of

assets in place, the Earnings Power Value, and the value of growth.
 The value of assets in place is calculated by subtracting the firm’s liabilities from current

assets, which yields the “net-net working capital.” This approach ignores fixed assets with the

goal of providing an investor with confidence in the firm’s immediate liquidity value. Firm’s that

hold enough current assets to cover their liabilities are considered to be highly liquid, and worthy

of an investor’s attention.

The Earnings Power Value, or EPV, approach values a firm based on its adjusted current

cash flows rather than estimated future cash flows. When looking at current cash flows instead of

estimated future cash flows, investors gain insight on the value of a firm as it sits, which

provides an intrinsic value of a specific firm adjusted for its current cost of capital or WACC.

The final element is the value of a firm’s growth. According to Graham, growth does not

add value to a firm unless that firm has a competitive advantage in its respective market. In an

open market, firms must invest substantial capital into gaining an advantage. Such investments

lower the amount of capital available to shareholders, which is the opposite of what a firm

should set out to do. Overall, Graham believes that the value of a firm’s growth is unreliable and

should be excluded when valuing a company that does not hold a competitive advantage.

Table 12.1 displays the value of each element of Graham’s value investing approach, explained

above, for MGP Ingredients.

Table 12.1 ​(Dollars in thousands)

Net-Net Current Assets - Total Liabilities 63,144
134,742 - 71,598

Earnings/WACC Earnings (per share) / WACC 20.00

1.70 / .085

Forward P/E Next Earnings (per share) * P/E Ratio 59.85

1.90 * 31.50
 It is obvious, based on the company’s positive “net-net working capital,” that MGP

Ingredients is highly liquid. However, the company’s EPV was calculated at a mere $20.00,

which is nowhere near the price the stock trades at, today. We believe that the company’s recent

acquisitions and expansions are keeping EPV low. MGP Ingredients would have to obtain capital

at around 2% to hold its EPV close to current stock price ranges, and a lender willing to lend at

this rate to a risky, growing company would be difficult to find.

13. Risk Assessment: Margin of Safety vs. Return Variation/Beta

According to the Graham/Buffett method of valuation, if the current trading price is

between 30%-50% of its intrinsic value then it would be a safe buy. The current trading value of

the stock as of April 9th, 2018, is $84. The intrinsic value of the stock from Table 11.1 was

$172.96. This information shows that the stock is currently listed below market value. This value

fits with the Graham/Buffett 30%-50% rule. Since this stock is B+ rated, there is risk involved

with it. MGPI has invested a lot of money with acquisitions and expansion of their facilities. This

shows a lot of potential for growth in the future, but there is also contradicting facts that show

otherwise. Since the EPV is so low this shows a major risk with the stock. At this time we

concluded that this stock should be a buy. MGPI fits with the Graham/Buffett rule and it is to

believe to be still in the growth phase and could potentially lead to even more profits.

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