Why use EV/EBIT multiple when compared companies in the asset intensive industry?
Hi, can anybody explain me that Why use EV/EBIT multiple when compared companies in the asset intensive industry?
I've read a interview question about this:
Question:'TheEV/EBIT,EV/EBITDA,andP/E multiples all measure a company’s
profitability. What’s the difference between them,and when do you use each one?'
Answer: P/E depends on the company’s capital structure whereas EV/EBIT and EV/EBITDA are capital structure neutral. Therefore, you use P/E for banks, financial institutions,
and other companies where interest payments/expenses are critical.
EV/EBIT includes Depreciation&Amortization whereas EV/EBITDA excludes it – you’re more likely to use EV /EBIT in industries where D&A is large and where capital expenditures and fixed assets are"important"(e.g."manufacturing), and EV/EBITDA in industries where fixed assets are"less"important"and where"D&A"is comparatively smaller(e.g."Internet"companies).
I know the difference between P/E and EV/EBIT (EV/EBITDA), but I don't know why we use EV/EBIT in asset intensive industry, rather than EV/EBITDA?
Can anyone help me with this?
Thank you very much (This question bother me for a long time)...
because the tooth fairy doesn't pay for Cap Ex, and in capital intensive industries, you are more likely to see EBITDA consumed by D&A. Look at Five Star Quality Care, Inc. They are trading at a super low EBITDA multiple (5.0x) , but all of their EBITDA is locked in D&A.
Thanks for your response, and I have further question about it. When we compared the companies in the same industry (Asset intensive industry). Every company has huge D&A at the same time, so I think this situation may makes the EBITDA multiple still useful for comparing?
THANKS
not that it isn't useful. Just some metrics are more useful than others. Say Company A more efficiently utilizes its asset than Company B. Assuming both are in the same industry, and EBITDA is equal, earnings in company A are more valuable because less is locked in D&A.
OK, I got the point here... So, you were saying that because D&A is so important in this kind of industry, so the effect from the D&A should be eliminated when we compare the companies profitability.
Is that right?
D&A is a proxy for capex. Ideally, you would want to do EV / EBITDA - Maintenance Capex, but most company don't break down capex between growth and maintenance so D&A is the best proxy. So if a company is able to get more out of its assets, it will be spending less in capex (and therefore D&A) and be more profitable, hence why there can be a disconnect between EV / EBITDA and EV / EBIT and why EV / EBIT is more appropriate for capital intensive firms.
Can you give an example ? Appreciate it
2 firms trade at 10x EBIT, are in the same industry and have the same EBITDA
Firm A: EBITDA: $100mm D&A / Capex: $20mm EBIT: $80mm EV: $800mm Implied EV / EBITDA: 8x
Firm B EBITDA: $100mm D&A / Capex: $40mm EBIT: $60mm EV: $600mm Implied EV / EBITDA: 6x
Firm A is more efficient with its assets (ie. it's able to generate the same EBITDA as firm B with half the annual capex spend) and therefore trade at a premium on an EV / EBITDA basis.
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