Friday, 29 June 2012

Companies Focus – Global VM's Assessment (Part 2) - Reviewing the Advanced Fundamentals

The previous weblog provided a general outline of regional macro environment presently seen, the 'corporate headlines' which partially affect the micro conditions of the auto-sector and individual companies, and importantly the recent price-earnings (P/E) values each of the eleven global VMs hold.

Having reviewed each item in a basic form, the accompanying graph sought to depict the competitive position of each firm from an simplistic investment principles perspective; by way of juxtaposing the 'micro' and the 'macro' : each company's P/E value set within a 'headwinds' vs 'tailwinds' context.

The chart presented was deemed to speak for itself regards the investment attractiveness of each corporation.

“Basic Assessment” Summary -

With the great macro-economic tailwind of affordable and increasingly attractive vehicles (so assisting revenue) and by far the lowest P/E of 0.69 was Hyundai Group. But as noted the stock is only available on European markets by way of an GDR/EDR (Global Depository Receipt / European Depository Receipt, so not easily open to the general investor because of the specialist instrument. (Use of the GDR/EDR itself highlights Hyundai's desire to raise capital within Europe at lower cost capital so to very probably boost capacity production plans).

Second, but still far ahead of its rivals, was Volkswagen Group, its global reach, market dominance in key China and broad product mix highlighting powerful sales traction backed by impressive cash cushion for CapEx and consumer incentivisation (mostly via vehicle specification improvements and less so price reductions) as locally required. The commercial and balance sheet advantages not reflected by its comparatively low P/E of 3.25

Toyota and Honda sat in what could be described as a macro position of “positive emergence' with the much improving tailwind gained by the internal cost reduction of the industrial Fukushima effect, and new buoyancy in Japanese and North American consumer markets.But with intrinsically high P/Es of 33.67 and 21.89 respectively, Toyota and Honda presently appear as offering little share price growth – as has been the recent history story – but offering Japanese institutionals small annual yield in a stagnant domestic environment.

The firms with reduced headwind but still little tailwind – so notionally “macro middling” – were, in rising P/E order : Ford at 2.23, Daimler at 6.11, GM at 6.54, BMW at 7.21. Ford's low value deemed relative to heavy debt position, whilst the remaining with substantially higher values are very probably seen as being safe places to park cash given the solid asset base of all, prospective share-price rebound in time and in GM's case the already shed and ongoing reduction of intrinsic debt burden.

Entering that “macro middle” is Renault with a P/E of 4.05. Part government owned, with the raised possibility of a new French vehicle market stimulus plan, means that it would likely be a lead recipient of any expansionary monetary policy.

The macro-based laggards were deemed respectively as FIAT at 3.23 and PSA at 2.56. Both suffering to a greater extent given organisational size, heavy dependence on respective French and Italian domestic markets and rather dashed EM promise given post-boom sluggishness. However, unlike FIAT's intendedly delayed new product pipeline, PSA has sought to bring on the new 208 early to steal 'share of mind' and seek to synthesise with the future upturn of the national and EU sales cycle.

This then purveys a “basic assessment”.

The following portion of this weblog however, seeks to provide a more “advanced” assessment.

“Advanced Assessment” -

Undertaken by looking more closely at corporate figures using conventional ratios to possibility identify mid and long-term 'invisible value'

The standard (more informed) 'cousin' to the P/E assessment is that of EV / EBITDA (Enterprise Value / Earnings Before Interest, Tax, Depreciation & Amortisation). This then shows the critical relationship between a meaningful corporate valuation divided by operating revenue.

[NB The former represented as (ordinary share-holder + preferred share-holder + minority interests + debt + unfunded pension liability) - (cash + liquid instruments + associated companies)].

By this reckoning the lower the final measure the greater the theoretical attractiveness of a company to the investor. The results are:

GM $16.81bn / 13.4bn = 1.25
Ford $116.93bn / 11.79bn = 9.91
VW E105.08bn / 17.94bn = 5.85
BMW E92.76bn / 10.77bn = 8.61
Daimler E88.14bn / 11.19bn = 7.88
FIAT E13.14bn / 6.07bn = 2.16
Renault E31.11bn / 2.75bn = 11.31
PSA E27.52bn / 3.39bn = 8.12
Toyota $244.64bn / 17.93bn = 13.64
Honda $94.40bn / 6.98bn = 13.52
Hyundai E29.31bn / 9.10bn = 3.22

However, rather than typically comparing companies on a singular criteria alone (such as P/E), or small set of criteria (ie P/E and EV/EBITDA), investment-auto-motives believes that a far better and more holistic investment picture is formed from the merging of prime indicator ratio measures.

Thus the juxtaposed coupling of 2 genre-specific ratios; spanning:

a) Market Valuation
c) Liquidity
d) Debt.

[NB So as to provide meaningful parallel, inter-relationship and comparison to the previous chart, the figures deployed are drawn from the same informational sources as the previous P/E numbers; intentionally not updated 'to the minute', and thus dated 16.06.2012].

Thus, four charts are shown in the accompanying graphic. Each giving a broad 'panoramic' view for evaluating the theoretical investment attractiveness of a company. Standard value demarkation lines have been included, as has the use of an indicators' based “selection window” (coloured yellow). Those companies within this window or upon the edge of the line deemed theoretically attractive.

Market Valuation Ratios -

This chart uses a combination of P/E and P/B (Price to Book) measures as the axis base.

P/B compares stock-price against the per share value of the 'bare bones' of the company [(total assets) – (liabilities + intangible assets)], thus its effective bankruptcy 'break-up' value. Thus, the demarkation of “1” reflects a point at which a stock-price equals break-up value. Increasingly above “1” and the price will either reflect increasingly positive earnings, market expectations of eventual earnings or may be viewed as over-valued. The farther below “1” reflects either increasing market under-valuation or perception that a corporate turnaround will be hard to achieve.

Here it is noted that amongst the 11 VMs, 6 companies sit inside or at the edge of the P/E & P/B investment window. Hence, the general order of theoretical attractiveness in ascending order (reading bottom left) is: Daimler, VW, Renault, FIAT, PSA, Hyundai.

Of these Daimler, VW and Hyundai could be classified as generally healthy but trading “under book” so displaying automatic value, whilst Renault, FIAT & PSA (hit hard by EU problems) are viewed as more operationally fragile, but with greater possible opportunity therein given the far greater disparity from “book”. In short Hyundai at 0.18 P/B and PSA at 0.12 P/B demonstrate extremes of “under-valuation” and “fragile valuation”.

Profitability Ratios -

This chart uses a combination of Profit Margin % vs Return on Equity %, and the 'investment window' sits square in the centre, between the demarkation lines which illustrate the orthodox expectation levels of 5% profit margin on mainstream vehicle producers and 10% on premium product manufacturers. This then excludes those low performing firms on both measures (PSA, Toyota, Honda & FIAT), and any firm which has experienced momentary, abnormal returns in the period (ie Ford)

The window then views the general ascending order of attractiveness (reading top right) as: Renault, GM, Daimler, BMW, Hyundai & VW. Of these, Renault & GM sit on the verge of 5% margin (assisted respectively by partner Nissan and US government intervention), Daimler & BMW show depressed earnings (given the relative low-point of the global economic cycle seeing retracted commercial and personal spend on premium), and Hyundai & VW showing impressive notionally 'above par' earnings (thanks to industrial scale, and markets & segments expansion).

So as others flounder, these German and S.Korean entities demonstrate their innate worth during these troubled times, whilst Renault & GM could be said to teeter on the edge of sought earnings when faced with what proved a harder Q2 2012.

Liquidity Ratios -

This chart uses a combination of Current Ratio and Operational Cash Flow Ratio to set the assessment ground for corporate liquidity levels. The Current Ratio consists of the basic determinate of Current Assets / Current Liabilities, so showing the near-term shape of the balance sheet, whilst the Operational Cash Flow Ratio reflects Operational Cash Flow / Total Debt shows the balance of near-term liquidity relative to short-term and long-term obligations.

The standard demarkation line of “1” is set for the Current Ratio demonstrating the balanced equation point of assets vs liabilities. Under that point and a firm is seen to be structurally “under-water” reliant upon its EBITDA for confidence, whilst upon the line a firm is viewed as efficiently 'sweating its assets', and above the line a firm may be viewed as increasingly 'secure' – the phrase 'asset-heavy' used in boom times). The Operating Cash Flow Ratio has been ascribed increments of 0.05 (effectively 5%), with a break to include a 0.8 marker to capture any firm with a temporarily abnormal measure.

The window perimeter spans what is seen as an optimal position and distance upon each axis. It reflects the standard demarkation of “1” for assets vs liabilities reaching to 1.5. And the elected demarkation of 0.1 to 0.25 regards cashflow vs total debts.

Within this range the only corporations to sit comfortably within or on the window are Honda, Toyota, Ford, BMW, VW and Renault.. Honda and Toyota demonstrate the good post-Fukushima re-bound, overweight in asset-bases that can either be disposed, used for contract manufacture (or other 3rd party functional services) or re-grown into. Ford, BMW and VW appears overweight in assets as what seems a defensive requirement providing for future capacity expansion – the European expectation. Renault, sat on “1” appears to both efficiently 'sweating its assets' through this recent phase of the European recessionm whilst still produce a 10% measure of operating cashflow relative to total debt.

Of the other VMs, FIAT show itself as both cashflow vs debt impressive, though invariably overweight in plants and facilities given its domestic and EM woes. PSA whilst well placed on the “1” demonstrates low cashflow to debt levels seen as a result of French and EU sales contraction and EM CapEx demands. Whilst Daimler, with an Op C-F measurement in negative territory for Q1 appears to be both defensive of current plant aswell as heavily investing in BRIC & other EM countries, aswell as the toll of offering a sector leading dividend (see previous post). Hyundai sits under “1” illustrating its liabilities burden (partly created by an ever more demanding homeland labour-force), yet presently offers a cashflow to debt ratio only marginally better than the 'suffering' European producers, presumably because of its global expansion costs.

Debt Ratio -

This chart uses a combination of Total Cash available vs Total Debt burden. The intention is to identify those company's which are in a cash positive position to either: a) undertake an acquisitional spending spree, b) present re-launched or improved dividends, c) possible mixture of both.

To assist analysis an elected demarkation levels of cash to debt have been shown, at intervals of 1:1, 1:2, 1:3 & 1:4. The investment widow takes a triangular shape to the optimum side of the notional division at 1:4.

Unsurprisingly GM is best placed by far thanks to its Chapter 11 resurrection and relatively buoyant domestic sales in 2011, holding a ratio of 0.45, well within 1:1, indicating that it holds a cash cushion twice the size of its debt obligations. FIAT is next best placed with a cash hold two-thirds its debt. Hyundai follows with 39% of its debt obligation in cash. VW holds 33% of cash to its debt. Honda holds 30%. And Renault holds 27%.
The other VMs sit outside the elected 25% threshold. Ford could be said to sit on the fringe with 23%, whilst Daimler at 20%, PSA at 19%, Toyota on 18% and BMW with 16%. This reflects what appears CapEx cash depletion by the German companies, the after-effects of Fukushima on the Japanese with lost sales and new CapEx projects, and PSA enduring operational cash burn through the EU downturn.

Assessment Results -

It was clear from the previous weblog that of the 11 VMs, only Volkswagen and Hyundai were able to present a sound investment case based on the 'basic' (yet simplistically sound) view that married the micro-perspective of P/E with the macro-perspective of global PESTEL conditions.

However, greater detail provides greater appreciation, and so this weblog sought to better assess the standing of the 11 VMs by investigating various key components of their Q1 2012 accounts so as to ascertain whether there may lay within 'invisible value' from underlying criteria.

As regards Market Valuation, Daimler, GM show themselves as reflecting fully “priced in” market valuations by virtue of their P/E and P/B standing. their share-price being at or marginally over respective book-value. BMW sits higher still whilst Honda and Toyota sat in the metaphoric stratosphere. All these then essentially rely upon future earnings growth to maintain and grow share-price. Conversely VW, FIAT, Renault, PSA and Hyundai were increasingly under their book values, reflecting what a mixture of constrained investment liquidity for all – taking a specific toll on VW - and the severe concern about the time it will take to see French and Italian manufacturers rebound, whilst the S.Korean producer is seen to sit at a lowly price because it has been overlooked on the Xetra exchange because it is only accessible by GDR / EDR. Hence the two that stand out as probable opportunities are VW and Hyundai.

As regards Profitability, VW and Hyundai were clear winners offering 10% EBITDA and 20%+ RoE. BMW and Daimler maintained the mid-ground with 6-7% EBITDA and 15-20% RoE. GM offered 5% EBITDA with approximately 20% RoE, whilst Renault gave 5% EBITDA with approximately 10% RoE. The remaining companies fell well below the 5% demarkation. Level.

As regards Liquidity, it was Toyota that sat in an optimum position (well inside the investment window, whilst Renault, VW, BMW, Ford and Honda sat on the fringe in descending order of attractiveness. GM and FIAT showed extremely good cashflow rates, but these are viewed as a temporarily anomaly created by cash boosts incurred from GM's re-birth 'sweet-spot' and FIAT's deferred CapEx demands. Though diversely positioned both Daimler and Hyundai appear less attractive on a liquidity basis because of CapEx investments, Daimler especially so making use of the global downturn to heavily return cashflow into the business. Whilst PSA's standing is a direct result of local sales contraction.

As regards Debt, GM stood positively apart from its peers, well within the assigned 1:1 area. FIAT was the only firm to sit within the 1:2 area. Hyundai and VW sat within the 1:3 area. Honda and Renault sat within the 1:4 area. Ford sat just outside but effectively on the fringe of 1:4. Toyota, Daimler, BMW and PSA all sat well outside this specific determinant area.

Criteria Winners -

Market Valuation : Hyundai and VW
Profitability : VW and Hyundai
Liquidity : Toyota
Debt : GM

Consistancy: VW and Renault

Sources -

The data from which the above assessment was made was sourced from Reuters, Bloomberg and Capital IQ pertaining to 16.06.2012