Friday, 15 January 2010

Macro-Level Trends – Auto Equities 2010 – Navigating a Turbulent Sea: Demanding Convincing Strategy & Low Cost Funding

The new year and decade is underway, Detroit, Delhi & Brussels show their vehicle wares and the investment community starts to once again critically assess the current state of play for the auto-sector prior to Q4 & FY2009 earnings season - the
SAA enclave a hub of activity.

As is the annual cree, the intercept of financial bottom-lines is set against big picture trends.

From a macro-trend perspective, its eyes are on Chinese economic policy given its role as perhaps the global economic engine and the concomitant decisions of the PRC, itself caught domestically in a similar position to the west between 'bubbling' capital markets and worrisome consumer citizens.

From a micro perspective, its eye on corporate balance sheet top lines, hoping that fundamental sales growth can start to power earnings further to quarter after quarter of cost-savings. It desperately wants to see liquidity generated from B2B and B2C transactions as apposed to liquidity gained from relatively high cost bond, hybrid & stock sales.

In short it wants to see the fundamentals underpin the sentiment at a time when p/e values are once again ahead of themselves across many sectors. That may be a result of Asian liquidity being re-directed westwards as it seeks lower p/e targets and regionally comparative theoretical better buys.

So having seen 9 months of western stock market rally, the very mixed bag of macro-economic signs continues to add haze, even if not witnessed by the stable Vix index – that sign in itself demonstrating the paradox of what seems a relatively calm surface with turbulent under-currents.

Yet compared to recent history, the subsided storm has created navigable channels across asset classes, even if much of it be thus far sentiment driven. The music re-appeared and market players quickly rose to dance.

2010, looks to be a tough year as stimulus spending is retracted and the reality of the global economy becomes more transparent, and the growth schism between Triad and BRIC regions is viewed and tested once more to see if the QE exercises undertaken has indeed kick-started western economies.

The veteran investors with experience and gravitas, the likes of Buffett, Soros, Rogers etc, seem to be re-running, or possibly intending to re-run, their investment plays of yesteryear.

Warren Buffett jumps back onto the railroad in true Benjamin Graham style. George Soros (or a proxy) is surely sizing-up the fundamental strength of the UK Pound given the Euro-skeptic Tories who must surely seek to maintain a differential between the Pound & Euro counterpart / competitor. And Jim Rogers appears to be picking over the (to re-quote him a year on) “finished” UK economy to seize any under-valued UK companies or assets within globally buoyant sectors.

Given the level of commercial contraction the west has experienced, the accordant Schumpertarian spirit of 'creative destruction' (for re-construction) is surely underway by the most progressive of investment banks, private equity players and trade-buyers. First witnessed within banking itself, now across B2B and B2C enterprise.

investment-auto-motives believes that the west is, even if not immediately apparent, undertaking its first tentative steps into a new economic epoch which can be rationally followed by investors across a logical, intrinsically cyclically structured, growth path.

[NB Buffet's buy into initially banks via Goldman Sachs, latterly into Burlington Northern Sante Fe and now evaluating GMAC Mortgage Services appears to echo investment-auto-motives' own hypothesis].

Though ideally that growth path will be properly moulded via aligned intra-national governmental policy and private enterprise, that leads to a new eco-led 'belle epoch'. This is still a medium to long term destination, but it is the sound industrial decision-making and responsible capital allocation of today that will lead us there.

Arguably the players at the vanguard, and so most visible, of this march are those within the Auto sector, and within them, those that act as ideology leaders.

At either ends of the commercial spectrum – product vs strategy - Toyota did it with Prius and today VW does it with Suzuki.

[NB Obviously VW's win-win intention is to develop its eco-credentials with small cars whilst simultaneously entering the massive EM demand for 'people's cars'. In this vein the new 'Up!' (now probably front engined given the Suzuki alliance) will act very much as the original Beetle did].

[NB*. The alignment of EM & Triad consumer demand, to enable massive economies of scale, is perhaps the driving force of the first half of the 21st century, and so demands the creation a mid-point, global-reach 'prototype' and genre. ('Proto-type' in its original Latin sense of 'original', 'start of new series') This is the case in all consumer fields, from TVs to washing machines as EM peoples 'move up' the consumption ladder & Triad people's 'down-scale'. The TATA Nano seen perhaps as the most visible example, even if the real market weight' sits in the B segment which India has orientated itself toward ].

As for global Auto sector investment interests specific to corporate equities, the powerful market movers and so industry-enablers in the form of pensions fund and insurance fund 'institutionals ' are having to critically assess the leadership & management competences, and tangible & intangible asset-bases, in the harsh-weather short haul and fairer weather long-haul.

Already, we've witnessed a decade of credit driven, 'value-false' autos growth from 1997-2007, but in reality it was also a period of value-destruction for the auto-sector, given the level of car buyer 'incentivisation' that went on up until late 2007 often enabled itself by the level of corporate leverage car-makers themselves were undertaking. This only to be substituted (thankfully at a lower level) by pan-government car-buying schemes, and in GM's case partial nationalisation, which assists an unwinding of leverage, even if not as speedily or broadly as investment value hunters would have preferred from 'natural collapse'.

As of 2010, QE with have at least been seen (within the halls of power) to serve its purpose of allaying public fears from economic collapse. With only a portion of the big-number figures reported actually spent – reportedly one-third in most cases - thus limiting the real case for latter-day inflationary pressures, and allowing new entry administrations to re-balance what seem abysmal western PSBR levels, trade accounts, national balance sheets and national budgets.

That minimal / anti-inflationary scenario is of course good news, as are presently vibrant bond markets, from investment-grade to high-yield 'junk'. Thus creating a welcome environment for investment, even if awaiting the drag of consumer pick-up. The question on all debt and stock analysts lips is: “which auto-sector companies are best positioned to obtain/use liquidity and strategically on-course to deliver a 'deep investment utility-boost'”. The answer derives from:

X. the ability to access either 'zero-cost' working capital, cash-book liquidity or low WACC capital from amenable external sources.
Y. a company's own strategic and operational position(s).

In reality all auto-companies are of course positioned differently given the innate complexities involved. Yet analysts obviously seek to model their probable futures, simplistically metaphorically plotting companies on these aforementioned X & Y co-ordinates.

Though that may be conjectural good news at a macro-economic level, the western Auto sector itself still remains under tremendous pressure given the level of over-capacity that exists today and in the face of ever-optimistic CEO forecasts 'beemed' to Wall St, the City, Paris, Milan & Frankfurt. Forecasts and good news presentations that place themselves as prime little change there.

Perhaps most 'at risk' is the European auto-sector, still bloated even with nominal capacity cuts and sold-off divisions. Having over the last decade witnessed the rationalisation of S.Korean Autos, the rise of Chinese Autos, the forced restructuring of US Autos and the new self-reorganising of Japanese Autos (led by Toyota), the Europeans will spend 2010+ fighting-it-out amongst themselves in a bid for regional & global scale to achieve economies of procurement, manufacture and retail.

This is a scenario which, by economic rationale, should have been set underway some time ago, at the economic fracture of late 2007. Instead regional governments became the irrational vote-seeking white knights and so only delayed the inevitable. However, it did assist analysts to sort-out the corporate 'wheat from the chaff', in terms of assessing those who were intrinsically strong enough to ride the deep recession and come out best placed leaner, stronger and more competitive. That exercise will be repeated once more in 2010 as the massaged boost of 2009 15m unit TIV is once again deflated to what seems a consensually agreed 13-13.5m amongst CEO's.

But if we forward the argument that there has been much 'pull-forward' of 2010/11 sales into 2009, and that western consumers once again retract personal spending on big-ticket items, and the once enthusiastic CEE private buyers have realistically vanished, there is a real possibility that 2010 TIV could be as pitiful as 11-12m. That is not a forecast per se, simply that all manufacturers – the EU contingent most notably - must base their EU business plans (and so additional regional cost cuts) on such thin numbers.

investment-auto-motives beleives that that 12m TIV is also a real possibility for North America, well under Detroit's expectation of 13.5m, yet aligned within Wilbur Ross's similarly conservative expectations. We highglighted the possibility of a CARS2 programme emerging from Washington, something Mr Ross also sees as a possibility, but critically we do not support such an initiative, the natural economic course must be allowed to evolve via market led deflation & re-inflation.

Thus, only by doing so, and manufacturers re-organising to below estimated par, will profits be maintained faced with the realistic possibility that European & US sales are hit harder than expected.

So, 2010 looks to continue the theme of separating 'winners' and 'losers'. This undoubtedly the much discussed topic during the now calendar aligned Delhi, Detroit and Brussels Auto Shows, whose alignment reflect the increasing global alignment of manufacturers' products and brand identities.

For the moment at least, it is that ideology and critically the ability to execute with cash and capability, that will enable value-creation, that will continue to separate the winners from losers in the near and medium term.

The consequences of 2008/9 mean that in 2010 onward the global economy effectively enters a new epoch; one created by a complex myriad and interplay of macro & micro factors.

Automakers stand in the middle of this dynamic: affected by the expected re-balancing of global liquidity that has started to affect corporate bond markets and possibly stock support, to the emergence of internationally aligned consumer tastes from media influence within McLuhan's much fabled (only recently arrived) global village.

For it is today's circumstances and challenges which will test all spheres of the auto-sector, and result in individual future success or not. As new-car market demand falls, input costs slowly rise and the large 'spread' in the cost of capital continues given the variability of corporate exposure, the story will be seen to unfold.

However, for the most part those corporate moulds already appear set.