Tuesday, 19 June 2012

Companies Focus – VM Basic Assessment (Part 1) - Reviewing the Fundamentals

The intention of this next two part weblog is to review the investment / investor standing of the world's best known auto-manufacturers.

Part 1 (herein) provides a “basic view” by using the standardised 'fundamentals' measure of the price-earnings calculation.

Part 2 (to follow) provides an “advanced view” by examining each companies' 'fundamentals' in greater detail. Through the construction of four graphs which depict the investment-auto-motives' perspective of 'coupled ratios'. This marrying two standard 'ratio' measures to better assess: a) Market Valuation, b) Profitability, c) Liquidity d) Debt.

The Global 'Macro' Picture -

By measure of international bourses, the global economy continues to 'shudder and shake' as a mix of very cautious macro sentiment mingles with what seem rapid 'risk-on, risk-off' equities vs bonds actions creating volatility.

In the USA, a much altered QE policy structure took the wind from the stock-market's sails, the presidential campaigning highlighting President Obama's desire to avert economic focus, whilst Romney obviously seeks to. The USA's previously strong bullishness has wained, America's prime indices the Dow Jones and NASDAQ illustrated that much turned mood. The DJ gave-away a sizeable 1000 points plus drop between its recent peak of 1st May and trough-bottom on 4th June, though has regained approximately half that lost value since. The NASDAQ peaked 26th March and bottomed on 4th June, showing a 366 point loss, and has regained a fifth or so of that loss since. So whilst the encouraging 'bottom-bounce' provides more confidence, the full extend of its strength is yet to be seen.

Europe of course continues to be blamed as the instigator of ongoing global economic drag. (Most notably as the prime disruptor of US prosperity, a bad citation by Obama given the EU's relatively small intake of US exports). However, the sovereign debt crisis continues to fester, the liquidity demands of the PIIGS debt-laden banking now exacerbated by Spain's calls for EcB monies and with the 'shorting' of Italy's 2-year government bonds; a flattening of the yield curve the same trend as seen prior to Greece's woes. Central of course is the fact that no general agreement has yet been obtained regards exactly how the E 1 trillion ESM (and old EFSF) could be made to operate, Germany's rightful viewpoint that there must be a type of securitization offered by recipient nations – ranging from gold to public assets – so as to avoid the 'moral hazard' problem that has already been witnessed by the empty promises of Greek and Spanish politicians, seeking to both gain liquidity yet also carry favour with voters by not implementing further austerity. Corporate stocks have undoubtedly suffered, with prices at record low, in turn delaying CapEx projects until greater stability appears. That has been indicated by the French, with the idea that yet another policy stimulus could primarily assist domestic producers. But that undoubtedly relies upon the release of ESM funding, so presently appears a PR tactic by President Hollande et al.

South America's desire to reduce its own cost-base and negate its exposure to 'cheap' Chinese imports has meant a quite severe policy response. This primarily via a hike in import duties, especially so upon non-Mercosaur-made vehicles, and efforts to try and re-foster a lean domestic industrial attitude, improving indigenous value-chain capabilities and prompting consumer spending on self-made goods – the previous weblog's mention of Brasil-Movimento motorcycles a good example. The national BOVESPA index hit a high of 68,394 on 13th March and hit a recent low of 52,481 as of 5th June, thus loosing 23% of its value, before rebounding to 55,651 recently.

At first glance, China's economic contraction appears even softer than expected given a growth slowdown to 6.5%, approximately half of its modern era double-digit rate. Yet the 22% YoY rise in vehicle sales in May illustrates what seems a dichotomy, when autos sales rates are supposed to typically reflect general GDP measures. The answer very probably lies with a possible over-statement of growth drop by the PRC government to stimulate 'incentivisation' by producers to maintain and grow consumption; none more so than the hyper-competitive automotive sector, reflected in the provision of a sales initiatives inland. Thus there seems a slowing of coastal generated growth off-set by new growth in 3rd and 4th tier cities and towns in more rural areas, thus a balancing of the national economy as coastal regions themselves seek to reduce cost-bases and so maintain a competitive differential in world markets in light of the deflationary forces in the Triad regions.

Here in the UK new deflationary concerns have resurfaced. The broad manufacturing sector (exempting autos) - previously a start performer throughout 2010 & 2011 - now showing signs of a marked slowdown given lacklustre domestic demand and now decreased EM export demand. That has generated political calls for sector-specific task-forces similar to that of the now politically much applauded Automotive Council, yet it must also be noted that whilst of definite value to the UK economy, the ramp-up in UK factory production of whole vehicles has been because of foreign VM (ie Nissan, Honda, Toyota) domestic capacity constraints previously caused by the Japanese tsunami. Previously the national economy had partially relied upon that important 'visible-trade' export buoyancy, both indigenously owned and foreign owned, but the weakened order book for UK companies and a possible contraction of UK vehicle exports as Japan returns to strength indicates declined value-creation. The BoE's £80bn 'funding for lending' scheme appears a moderate response given the need to both urge lending and contain a growing 3% RPI rate, yet given the caution of SME borrowing – described as the “UK's mittelstand-off by the FT – it is probable that the liquidity is instead directed at the UK stock market, across the FTSE100, 250 and possibly AIM, seeking new growth enterprises.

The World 'As Is' For Automakers -

The fragility of both consumer retail markets and the world's stock markets has for some time now created a delicate balancing act for automaker's CEO's, COO's and CFO's. With much of the Triad region's banking sector and consumers in respective 'deleveraging' mode, and wholesale finance erratic and expensive and dwindled deposit provision by car buyers, the need to protect corporate 'cash cushions' – build-up from CapEx minimisation and deferral - to provide self-financing has been the order of the day. Such internal funds used as no-cost “incentivisation levers” toward car buyers in regions where such prompting initiatives prove useful.

However, the mere existence of those cash cushions on balance sheets have not underpinned the stock-price positions of all, only those that are strategically best positioned. Others heavily exposed to retracted markets, notably Southern and 'fringe' Europe, aswell as 'core' France, have seen their stock values decline in relation to their EU exposure. This in turn, via a cross-sector dynamic, has dragged down the better positioned German companies' MarketCap valuations, though the strongest of those 3 tends to rebound soon after any bad news is absorbed, a sign of institutional investors' constant 'flight to quality', and profiteering reaction of day-traders.

Assessing the Auto-Makers -

Thus, given the erratic state of market dynamics, it would prove useful to gain greater insight into each company's “fundamentals”, so as to stave-off over-reaction to sentiment driven 'buy' or 'sell' actions in the broader marketplace.

Basic Comparison -

The following conveys the basic yet prime stock information per company:
(Prices as of market-close 15.06.2012).

Price P/E EPS Dividend

GM $21.74 6.54 3.32 none
Ford $10.35 2.23 4.71 1.93%
VW E116.80 3.25 36.50 2.47%
BMW E55.96 7.21 7.77 4.11%
Daimler E34.04 6.11 5.57 6.73%
FIAT SpA E3.66 3.23 1.13 none
Renault SA E31.10 4.05 7.68 3.73%
PSA E7.51 2.39 2.56 none
Toyota $76.50 33.67 2.27 1.65%
Honda $32.36 21.89 1.48 2.35%
Hyundai (EDR) E22.60 0.69 32.82 0.73%

Here we see a wide span of current valuations, much of course dependent upon the enterprise value of the firm and the amount of shares (of different classes) made available. Even so, the affect of recent history is readable within present valuations.

'New' GM's Chapter 11 financial restructuring via seen in its price, even though down 30% from its IPO price, it still holds credible price-earnings ratio when compared to its smaller Detroit counterpart, and relatively close to the sector average.

Ford's price essentially limited by the critical inhibitors of weighty debt servicing (by far the most amongst its peers) and the extra-ordinary gains of tax exemption which has boosted profitability, but not directly from the top-line. Though its much improved dividend has been welcomed by institutionals, its 'bottom of the class' price-earnings highlight future regional and PaT concerns.

VW Group's valuation the result of its inherent global reach, B2C & B2B product portfolio reach, and the controlling families' historical desire to be very hands-on by seeking to limit the number of shares in circulation. BMW has come under much pressure recently given the concerns about the impact of global economic contraction upon 'mass-premium' vehicles, yet also reflects the trait of 'family influence' and German institutional holding so as to seek to avoid the long-lasting damage of “vulture-like” short-selling. Its low price-earnings value seemingly a result of heavily constrained liquidity within Europe, which takes a heavy toll on such a large company - as opposed to the firm's innate operational efficiency.

Daimler's price-earnings figure shows strong resilience to both the general squeezed liquidity conditions, and investor concerns about the possible severe impact of a continued global down-turn upon. This probably because Daimler's broad exposure to various private-spend, commercial-spend and public-spend vehicle segments, means that it is also equally well placed for any new European economic revival when it arrives, especially regards early phase spending on HGVs and publicly funded Bus & Coach.

FIAT SpA (FIAT-Chrysler) share price reflects the double impact of high exposure to heavily retracted EU and Brazilian sales. Critically though, ongoing concerns about Italy's core market ability to balance austerity, introduce labour reform and rebound growth; even under the new 'technocratic' administration. This critical to FIAT so as to mimic USA traction by Chrysler.

Renault similarly suffers from an anaemic homeland, but has been assisted by the very supportive earnings gained from Nissan, so better supporting its share-price and price-earnings. Moreover, since partly government owned, there is a markets expectation that Renault stands as natural primary recipient of any supportive direct or indirect government assistance.

PSA's share-price has suffered more so, as Europe's #2 auto-maker and with greater EU market exposure and apparent lack of a 'government backstop' taking a greater toll and adding uncertainty. Though GM's announced intended 7% acquisition ironically induces short-term price reduction until the purchase is actually made – GM enjoying the fact – it also argues for long term value via disposal of PSA assets to GM and possibly others; though. the “platform-share” story still does not convince.

Toyota's price highlights its dichotomy: as a cornerstone of the Japanese economy, yet endured the earnings ravages of the 'tsunami effect' which assisted continued industrial restructuring using off-shore production. Its share price seen as the 'entry cost' by Japanese pension and insurance houses for ongoing stable dividend and for governmental recognition of national patriotism. However, as its earnings increase with a US and China sales rebound, and a possibly improved dividend yield, the result may be reduction the hefty price-earnings ratio that slowly attract foreign interest.

Honda's price and price-earnings ration reflects its less domestically entrenched position, its better dividend arguably showing its greater organisational flexibility and faith in its renewed interest to North American buyers; much needed given its 1.6% car-market share slip since 2010 to current 9%.

Hyundai shows itself to still arguably be an anathema as traded on European bourses; whilst a respective pillar of the Korean economy (with the biggest production plant in the world) it is not yet listed as an ordinary or preferred standard stock, but instead as a form of GDR (Global Deposit Receipt) seeking Euro capitalisation (a EDR); thus not commonly traded, but its underlying value characteristics suggest that Hyundai Motor may seek an ordinary listing in time.

Displaying the table again, investors could seek to simplistically plot the crop of global auto-makers, purely from the prime measure of price-earnings.

Price P/E EPS Dividend

GM $21.74 6.54 3.32 none
Ford $10.35 2.23 4.71 1.93%
VW E116.80 3.25 36.50 2.47%
BMW E55.96 7.21 7.77 4.11%
Daimler E34.04 6.11 5.57 6.73%
FIAT SpA E3.66 3.23 1.13 none
Renault SA E31.10 4.05 7.68 3.73%
PSA E7.51 2.39 2.56 none
Toyota $76.50 33.67 2.27 1.65%
Honda $32.36 21.89 1.48 2.35%
Hyundai (EDR) E22.60 0.69 32.82 0.73%

To plot as such, promotes the usual modelling of depicting the archetypes of 'growth stocks' and 'value stocks'. Given the maturity of the sector, its barriers to entry etc, a true 'growth stock' is rarely ever truly seen. Perhaps only in China between 1999-2008 when certain emergent indigenous auto-companies such as BYD Auto intentionally mustered high profile international PR brand campaigns around the apparent adoption of eco-tech/high-tech, supported by renowned names such as Warren Buffet. Instead, because of the inescapable cyclical impact of macro-conditions on the auto-sector, seasoned long-term investors tend to seek-out unloved auto-stocks during a dour economic climate such as today.

To this end, whilst during normal times (in the West) many asset classes are valued at 10x annual earnings, today the demarkation level of 5x has far more resonance given the market headwinds of cautious sentiment and tight liquidity.

Using this as a very simplistic guide, we see a ranked order of theoretical attraction: Hyundai (EDR*) @ 0.69, Ford @ 2.23, PSA @ 2.39, FIAT @ 3.23, VW @ 3.25 and Renault @ 4.05.

Beyond the 5x level, are: Daimler @ 6.11, GM @6.54, BMW @ 7.21, and far beyond the 10x level are Honda @ 21.89 and Toyota @ 33.67.

However, whilst figures give a good desk-top comparison, all must be seen in context, thus it is critical to view the bigger macro picture by reading between the lines of corporate actions vis a vis regional markets and economies.

The following provides a short picture of recent issues per VM.

Corporate “Headlines” -

- Presently evaluating internal successor to Akerson.
- Akerson recognises 'profitability chasm' relative to best mainstream companies
- Reducing pension burden via group annuity contract with Pru Insurance (20% 1st tranche)
- Facing increasingly tough battle in all important China
- Bochum plant 'life extension' to 2016 for frozen union costs
- Seeking to once again re-animate Cadillac vs dominant German & Japanese premium models
- Notions of any new Republican administration 'dumping' its 26% holding unlikely, expected staged sales at predetermined price-points to ensure corporate price stability.

- Mulally expected to remain
- Expected to follow the 'annuity contract' route
- Already de-risked pension liabilities by re-weighting to fixed-income
- Critically recent entrant to China so holds consumer appeal
(its May YOY sales marginally above the surprising 22% market climb)
- Seeking to once again re-animate Lincoln (like GM's strategic need)
- Studying indigenous brand for China with JV partners
- Ford Credit regains 'investment grade' status (Moodys) raising $1.5bn recently
- Announced re-alignment of EU market plan appears slow reaction

- Governance issues regards Mrs Peich's Boardroom election seem to diminish
- Successor to Winterkorn expected from restructured divisional management.
- EU May sales slide less than industry average (5.7% vs 8.7%)
- China's Jan-May sales boosted by 9.3% YoY (44% for Audi)
- Continued major China expansion via plant openings (4m unit target for 2018)
- Rational acquisition of Ducati followed by exploration of Navistar Truck holding.
- Remaining stake of Porsche AG to cost E4.5bn (E0.6bn increase).

- Reithofer maintains conservative stability
- Senior R&D and Purchasing execs swap roles to strengthen internal capabilities.
- New sales records for Q1: Asian growth of 9.1% Jan-May 2012
- China sales for May up 31.5% YoY
- Concept store opens in Paris on “George Cinq”
- i8 hybrid 'supercoupe' expected at E100,000 price level
- JV agreement with Toyota on Lithium battery R&D ratified

- Zetsche maintains strategic leadership
- Bernhard retained on board as head of Mercedes Cars until 2018
- New car sales record in May, up 4% YoY
- Truck sales up 20% in Q1
- Long awaited introduction of 'conventional' A-class range
- New Citan small van allows entry against VW & PSA-FIAT Eurovans
- Smart brand to include scooters as of 2014
- Car2go / Europcar rental scheme spans 12 cities / 4000 vehicles

FIAT SpA (Chrysler)
- Marchionne continues as corporate lynch-pin & figurehead
- Cut in CapEx by E0.5bn to E7bn given European market compression
- Introduction of Serbian Kragujevac plant adds lower cost capacity
- Italian sales incentives include new petrol discount scheme
- EU sales down 17% Jan-May 2012
- Chrysler board expanded
- US sales for Chrylser up 30% from very low base in 13.4% market rise
- European R&D slows as US R&D maintained
- Annuity contract pension changes seen as uneccessary

- Carlos Ghosn cites “3-4 years stagnation” in Europe
- This negativity viewed as pressuring ministers to evoke state aid.
- Able to service Nissan with components during tsunami aftermath
- Star performer division Dacia cuts production to re-balance slower sales
- Renault badged (Dacia) Duster performs well in slowed Brazil
- EU sales down 19% Jan-May 2012

- Varin continues strategic efforts for major cost reduction and asset divestment
- Downsizing of 6000 posts by YE2012, Sevelnord plant & elsewhere
- Expected to dispose of 50% of GEFCO logistics subsiduary to PE consortium
(8 candidates emerged, 2-3 probably sharing the deal to preserve cash)
- China sales up approx 20% Ytd in May
- EU sales down 15% Jan-May 2012

- $2.5bn bond issue announced to run between 2012-14
- Massive 87% YoY rise in US sales in May 2012
- NAFTA plants increase production by 64% Jan-May 2012
- Japan sales boosted by 125% (exc kei cars)

- President & CEO Takanobu Ito highlights share-holder value: to be seen
- NAFTA plants increase production by 67% Jan-May 2012
- Japan sales boosted by 48% (exc kei cars)
- Recall of Civic and other regulatory safety investigation in US

- Chairman Mong Koo Chung (holding 25% share-base) maintains solid control
- Worldwide sales up 8.1% in May YoY
- All new Sante Fe and Sonata models released helping model mix
- Doubling of production with Kibar Holding in Turkey
- Small car product recall in China, possibly used to cross-sell products / services
- S.Korean union calls to reduce flexible labour content (and so 'competence advantage').

[NB. European auto-execs meet this week under European Union supervision to discuss the possibility of a “factory-closure blueprint”; so as to discourage member states from offering incentives to protect local jobs at the cost of the broader efficiency of the Eurozone.

However, even as Marchionne (the idea's originator) cites, such an agreed outcome given the present conditions, looks unlikely.

Although it will be an opportunity for 'suffering' VMs (FIAT, PSA, Renault) to discuss JV projects. Additionally Brussels is also examining whether to introduce yet higher standards of CO2 emissions targets for new cars, a topic no doubt welcomed by FIAT & PSA]

Plotting VM Positions -

The accompanying chart provides a simplistic perspective of the respective positions of the global VMs vis a vis each other. The respective axis used are: the 'micro' of a company's price-earnings (P/E), and 'macro' which assimilates the general picture of that company's prime challenges / opportunities ('headwinds' vs 'tailwinds' with mid “transition zone” seperating the two). Though the P/E is a well recognised as an objective pseudo-scientific metric (and the 5x vs 10x demarkation has been mentioned), conversely, the assessment of exactly where a company sits in the macro picture depends upon a generalistic subjective summary, weighted by exposure to contracting, stable or expanding regional economies; and its competitive advantage / disadvantage therein.

Results -

Expectantly, the lower down the vertical P/E axis a firm sits the more enticing the value proposition appears for the investor, but this must be viewed against the 'real world' context.

Today that low price-earnings figures could be said to be either the outcome of innate pessimism regards a corporate turnaround, or the sign of cautious slow moving “viscous” market liquidity, or indeed a combine of both. Thus anything under 5x deserves close evaluation of operational health and prospects.

Those firms with higher P/E numbers between 5x & 10x presently tend to:

1. Have an intrinsic governmental 'safety-net' (ie too big to fail)
2. Comprise of anti-cyclical divisional-based business model
3. Historically demonstrated consistent value-creation

Contrastingly, the Japanese firms with (to western eyes) extreme P/E ratios above 20x or so are located in an ostensibly deflationary 'low-growth' homeland, which has experienced decades long 'pumped liquidity' programmes.

[NB This in turn has appeared to 'normalise' a Japanese firms valuation relative to the seemingly 'frothy' valuations of far newer high growth companies in China and across SE Asia. These notionally comparable valuations in turn assisting the book-building process behind ever ongoing M&A, cross-holding and JV process which has built modern industrial Asia].

Ironically, it may well be the massive differential between the 'poor' West and 'valuable' East that kick-starts the European revival in the mid-term future.

The chart and each respective corporate position speaks for itself.