Wednesday, 20 March 2013

Companies Focus – Investment Analysis – “Coupled Ratios” vis a vis the ‘Market Correction’.

The dynamic of equities markets, no matter where, is ever curious; driven as it is by an expanding cross-section of influences, from national politics to economic indicators at the macro-level, to company fundamentals, corporate guidance and director's deals at the micro, to chart-set technical analysis with the age-old maxim that “the trend is your friend”, pitted against “greater fool theory”; each conflated by (at extremes) the turbo-boosting and flash-crashes of IT based algorithmic trading, itself driven by the effects of global trading.

This expanded 'driver-set' in turn demands ever more 'quant-qual' intelligence to understand the background context - hence the dominance of data-driven IT. Seemingly a world away from theory-bound, old-school investing as laid-down in the first half of the 20th century by B. Graham with 'The Intelligent Investor' (et al), with even its greatest proponent Berkshire Hathaway willing to (some say) overpay for 'safety' in this era.

So whilst we should like to think a post-crash conservatism rules equities investment behaviour, with participants reviewing stocks with the cautious mentality of the 1950s local bank manager – a much needed re-instated perspective for retail banking itself – the recent western markets correction suggests that, like a cup of cappuccino, market 'froth' is an inescapable reality.

However, as investment-auto-motives posits, the difference today is that such froth whilst undoubtedly seen, appears relatively benign, and actually exists within the modern time-frame of “western geo-economic transition”. ie. within the critical transitory phase when QE-driven Wall Street confidence is slowly but painfully gained by Main Street via a 'supply-side trickle-down'.

[NB QE funding only truly productive, and achieving a multiplier effect, if trickled-down through future-facing, structurally lean and investor attuned private enterprises. It also suggests that it will be those companies which have true competitive advantage within their respective business sphere (whether up-stream supplier, mid-stream assembler/integrator, or down-stream retailer) that will be able to generate true value and wealth for the broader economy].

Thus far deeper due diligence is the order of the day for both sides of the intermediary banking equation assessing lending and equity-stake possibilities; for both the commercial/personal retail banking sector and relationship/market investment banking arena.

“Coupled Ratios” Analysis -

However, with regard to the broader stock market, and its plethora of participants, investment-auto-motives once again seeks to demonstrate that the 'old-school' based, new-era modelling of “Coupled Ratios” analysis is of positive use. As ever, focused upon the prime players of the automotive industry.

As illustrated in 2012 in Q1 and Q3 earnings seasons, it offers a common-sense evolutionary perspective which marries standard ratio metrics for Valuation, Profitability, Liquidity and Debt.

Measures which when graphically depicted in both X-axis and Y-axis formats, complimented by the “optimal investment window”, provides for a more meaningful understanding and interpretation of company, inter-company and sector standing.

The Automotive 'Global 11' as at FY 2012 -

The following summary for the eleven mainstream producers is derived from value-plotting seen on the temporarily displayed accompanying graphic (top right).

Whilst the charts last year depicted the change in individual corporate performance between from Q1 to Q3 2012, visual clarity means that this third data set cannot be super-imposed yet again.

Instead the graphic seeks to obviously show the dynamic between Q3 and Q4 / FY 2012. Doing so by retaining the company specific circle indicators for Q3 2012 and using same coloured square indicators for Q4 2012.

Market Valuation Ratios -

This measure combines P/E and P/B figures, and identifies those companies placed within or very near the allotted 'investment window'.

Here the most statistically attractive players are PSA and Hyundai, though for very different reasons (as mentioned in previous posts). The former presently sitting at lows of 0.1 p/e and 0.22 p/b given its previous catastrophic income fall given its high exposure to a collapsed EU market place. The latter with 0.89 p/e and 0.29 p/b resulting not from its fundamentals, but from limited trading of GDR (ie bank held) shares on the pan-European bourse; however recent S.Korean KOSPI index fears given the N.Korean military threat will have weighed down sentiment.

The most optimally placed thereafter are Volkswagen on 3.2 p/e and 0.95 p/b, moving little since Q3. Volkswagen has sat effectively 'static' since Q3, with slight p/b rise, its attractiveness ironically assisted by the recent market correction and more dour corporate guidance, which eradicated VW share 'froth' and helped to keep it within investment window Its low p/e and 'aligned' p/b demonstrating stability and value, thus maintaining a general attractiveness proactively managed by VW seniors.

Lastly, just beyond the investment window's delineation are Renault on 8 p/e and 0.6 p/b, and Daimler on 7.9 p/e and 1.1 p/b . Renault's valuations since Q3 have moved substantially since Q3 as a result of the 'Draghi Put' and speculators seeking to buy before the effects of an EU cyclical rise became tangible. Daimler, previously sat close to the edge of the 'window' saw a smaller upward revaluation sees its position move to just beyond.

[NB as a side note, only BMW remained effectively static in its market valuation (remaining outside the notional 'window') with Toyota and Honda moving only slightly upward (also beyond the frame), all retaining a high valuation standing given their relatively defensive status and expectation of US market derived sales boost, also assisting GM and Ford valuations].

Profitability Ratios -

The measures herein are Profit Margin % and Return of Equity %.

Well inside the 'investment window' are VW, Hyundai Motor and BMW, with Daimler edging into consideration.

Though down a notable degree from previous (extra-ordinary) standing, Volkswagen maintains its profitability lead over its competitors, with an 11.3% margin and 31% RoE. Unsurprisingly, it is Hyundai Motor that follows with 10.6% margin and 21.4% RoE.

BMW sees a slight decline in profitability but rise in RoE, sitting at 6.4% and 17.5% respectively. Daimler moves positively onto the border of the investment window, with 5.3% profitability and 15% RoE.
Elsewhere, Ford's performance slightly declined, as GM's grew slightly better, with the remaining majority remaining stood effectively static; FIAT seeing a slight decline in profitability (assisted by Chrysler in N.America) with PSA seeing a dramatic fall-off in profitability (not fully shown).

Liquidity Ratios -

The measures used are Current Ratio and Operational Cashflow Ratio.

[NB When necessary the 'OCFR' is derived from the acknowledged calculation for Operating Cashflow...OCF = EBIT – (CapEx + financial investments costs). However in certain instances direct Q4 data is unavailable, so reliance upon previous information necessary

Also note the numerical value change to the bottom axis to reflect generally better cashflow positions, requiring the negation of Q3 data, with the 'investment window' subtly altered.

Basic calculations are based on very scant information and very general estimations indicate that Honda is by far best positioned regards its corporate liquidity standing, with an extra-ordinarily high cashflow rate. This seen by investment-auto-motives as resulting from the massive sales boost from post-crisis Japan, without the demand for heavy Japanese-centric Capex; its RoW CapEx demands arriving later than its counterpart Toyota.

Thereafter, within the normal area spanned by the investment window are – in optimised order – Hyundai Motor (rated at approx 1:7), Volkswagen (rated at approx 1:4), BMW (rated at approx 1: 2.5) and FIAT (rated at approx 1.4 : 2.5).

Ford sits just outside the window (rated at 1.6 : 2.8), with GM slightly adrift (rated at 1.3 : 0.9).

Daimler, Renault and Toyota sit in a more remote cluster, with PSA still in negative cashflow territory as of Q4 2012, effectively unchanged from Q3.

Debt Ratios -

The measures herein are Liquidity and Debt levels.

This snap-shot better ascertains each company's perspective regards the retention of (income derived) cash vs debt, whereas previous liquidity measures included the availability of credit lines.

So the following indicates cash (only) vs debt.

Obviously today's relatively low cost of capital from debt markets provides for relatively 'easy money', with the debt servicing ability of highly profitable firms easily absorbed. But even in a funding rich climate, the ability to increasingly self-finance is a central concern to investors wary of creeping future inflation demanding heavier than expected repayment schedules. Thus ideally seeking lean balance sheets for the majority of those players in the present low margin environment of the auto-sector.

Leading the self-financing ideal are GM and Ford, both well within the 1:1 cash to debt ratio. A surprising close follower within the 1:2 quotient is FIAT SpA.

Whilst Hyundai Motor and PSA and Renault occupy the 1:3 sector. Volkswagen and Honda sit on the extremes of 1:4. Daimler sits just outside the investment window, whilst BMW and Toyota sit more distant still.

Results -

As ever, the most attractive investment case stems from those companies which have the most consistent appearance within the investment windows of the four graphs. The following re-iterates those that appear in the optimal ranked order.

Market Valuation Ratio : Hyundai, Volkswagen and (a statistically) inferred PSA

Profitability Ratio : Volkswagen, Hyundai, BMW and (an of interest) Daimler

Liquidity Ratio : Honda, Hyundai, Volkswagen, BMW, FIAT

Debt Ratio : GM, Ford (and thereafter) FIAT

Conclusion -

Unsurprisingly, given consistent previous 'investor friendly' standing and results, it is Hyundai and Volkswagen that appear in three of the four categories.

[NB Their respective absence in the fourth (Debt Ratio) possibly of little previous concern to investors given their sector leading profitability, so able to service debt levels; though this may become an increasing issue if inflationary trends drive-up interest rates].

Thereafter BMW and FIAT each appeared twice.

The former positioned well in Profitability and Liquidity stakes, with the latter strong on Liquidity and Debt.

These Q4 FY2012 figures have to a certain degree now been absorbed and 'baked into' market dynamics, yet they still demonstrate those individual auto-players with both retained impressive potential and newly emerged potential, above a 'sector average'; and arguably well positioned within what is now seen to be the “Western Economic Transition” period (see previous web-log)

Post Script -
It must be recognised that beyond the increasingly important 'micro-level' analysis, as seen by the Greek-Cypriot sovereign debt concern, the winds of continental and global 'macro-economics' still have powerful effects upon investor sentiment, even if not upon corporate standing and expected performance.

[NB The Greek-Cypriot administration should theorise upon what structural shape a localised auto industry might emerge; in order to rebalance the local economy away from a devastated finance sector and toward a low cost value-adding economy].