Monday, 14 July 2014

Companies Focus – The Global 11 Auto-makers - “Coupled Ratios” Assessment - : Q1 Positioning Before Q2 Reporting.

This weblog returns to the previously established practice of assessing the general investment attractiveness of the eleven major auto-players head-quartered in the US, Europe, Japan and S.Korea.

Awaiting European Traction -

At a time when broad European economic traction has been questioned once again via the fragility of Portuguese banks and the reinvigoration speed of the 'TLTRO', it is undoubtedly desired that Germany's win of 'Brazil 2014' will buoy further internal economic confidence amongst businesses and consumers so as to assist Europe en mass.

Like the Germany vs Argentina final itself, this process will continue to be drawn-out given the overall complexities of the situation, ranging from the need for competitiveness policy reforms to serve sovereign debt structures, to the need by the European banking system itself to critically assess the operational and sector-competitive capabilities of the myriad of large and SME companies.

Whilst the best-run firms have been self-sustaining from 2008 onward, it seems that the all too problematic 'zombie' status of many throughout various supply and value chains will inevitably be eventually subsumed through merger and acquisitions and asset divestment, when TLTRO and possibly enlarged EU QE measures filter downward.

Stocks As Primary Instruments -

In the meantime, whilst awaiting the liquidity feed, equity stake-hold investment demonstrates itself as the prime economic instigator. In doing so the black, red and gold colours of the German national flag provides the appropriate metaphor. Cultural history posits that these colours represent the journey from darkness, through fire and into light.

An appropriate philosophical perspective for the necessary strategic and financial diligence today's raft of equity investors must undertake – from hedge fund to institutional to privateer. To ensure that the still relatively constrained levels of valuable liquidity are directed toward the best prospect companies.

Though the wide macro-environment still obviously has effect – from 'economic dashboard' growth indicators to the new unsettling of the Middle East – continental Europe seeks to reach its own “escape velocity” through relatively conventional fiscal means, so far without a major QE exercise.

The intended by-pass of such immediate economic pump-priming, which arguably over-serves financial community interests (and worrisome yesteryear memories), means that though guilty of creating short-term 'zombification', over the medium and long-term EU governments seek to create non-inflated economic conditions, which in turn places the topic of fundamental corporate valuations high on the re-invigoration agenda.

The Importance of Autos -

As seen with various refunding initiatives to date, such as the dual Chinese-French stakes in PSA, the automotive sector is of immense financial, technical and trade value to Europe. The sector consists not just of the obvious volume manufacturers, but a plethora of up-stream tier 1, 2 and 3 generalists and specialists across materials and the wide range of down-stream entities via distribution, retail and after-sales providers. Additionally, a spectrum of business and product service providers aligned with mass and niche firms, the former including those hi-value research firms 'creating tomorrow', often by translating motor-sport efforts into new mobility endeavours.

Classical Investing Over Pure Speculation -

Thus, whilst short-term traders may indeed await and hope that the 'Draghi Put' comes to fruition, thereby invariably inflating the DAX, CAC and other national indices, medium and long-term investors such as industrial holding companies and sector-specific private equity, have been scouring Europe for potential deals; with multi-fold valuation methods applied vis a vis situational context.

Beyond the review of present and past P and L statements, balance sheets and 'cash-book' statements, such a necessary “company fundamentals” driven approach spans the four critical areas:

A. Market Valuation
B. Profitability Levels
C. Liquidity Levels
D. Debt Levels

“Coupled Ratios” Analysis -

As is now well established, investment-auto-motives' creation of “Coupled Ratios” Analysis - used for the purpose of analysing the global eleven auto-makers - provides an immediate snap-shop of each company's relative health these four critical topics.

Done so via the mating of the two most popular assessment ratios per assessment criteria.

A. Market Valuation Ratios : Price to Earnings vs Price to Book
B. Profitability Level Rations: Profit Margin and Return on Equity
C. Liquidity Level Ratios: Current Ratio vs Operational Cash Flow Ratio
D. Debt Level Ratios: Total Cash vs Total Debt

For various reasons – the focus on other important macro topics and micro case studies, and the range-bound 'barrel-roll' of US auto-equities (awaiting a Main Street derived corporate earnings catchup) – investment-auto-motives did not provide 'Coupled Ratios' analysis for Q3 and Q4 2013.

Furthermore, the provision of Q1 2014 is deliberately delayed given the impact of a lower winter auto sales impact in North America, the likewise slowing of what have been impressive UK and Germany sales, and the still deflated (though improving) picture elsewhere in Europe.

Contrast and Compare Q1 to Q2 -

So as to provide a better comparison for company specific and cross-sector positional performance between Q1 and a soon to be released Q2, the Q1 charts are provided herein, with resized 'investment windows' as appropriate to improved general economic conditions.

As is the norm, investment-auto-motives spotlights the number of appearances made by a specific VM within each 'investment window'. Those with the most appearances gaining most favour.

[NB to re-confirm, data is drawn from standard publicly available sources: market data intel companies and individual corporate accounts. In periods of poorer profitability and cash-flow creations such as Q4 and Q1 periods for some, limited transparency inevitably emerges. Thus if not stated openly within accounts or presentations, the standard basic formula of Operational Cash Flow is simplistically calculated as best possible: from EBIT – (Capex + Financial Investments)].

The attached chart presents the four graphs, with a depiction of how each VM has altered (or not) its respective position regards the eight overall measures.

Market Valuation Ratios -

Here it can be seen that the majority of companies saw their P/E levels rise over the previous months as once tentative investors continued to return with greater confidence into the 'common-sense' cyclical realms of capital markets.

This perhaps best seen with the near doubled p/e increase of Volkswagen. Whilst the same effect appears the case with Renault, it is far more likely that the substantial p/e level rise to 32 has been pushed up by more overtly 'early-bird' speculative monies awaiting the broad growth of the French economy from its present low base-line.

As can also be seen, other company valuations are being extended with such confidence, the p/e and price to book levels of Daimler, BMW, Toyota, Honda and FIAT crowded within or just beyond the top right hand corner of the 'investment window'.

Of these because of price to book levels Daimler and BMW sit just beyond the acutely conservative boundary (though still p/e relevant), whilst Toyota, Honda and (a re-entered FIAT) sit respectively well within and just on the margin. GM and Ford presently sit as theoretical outliers, GM because of its sector high p/e (near 20x) and Ford because of its sector high p/b (near 1.5x). The lack of useful PSA data means that it sits effectively 'undetermined' (as was), although for 'early-birds' the relatively recent French-Chinese equity take provides a form of investment assurance over the long term. Hyundai sits most central within the investment window, although its low p/e reflects its heavy conglomerate nature, so slow but steady upward progress made.

Profitability Ratios -

Mixed fortunes here as the previous high-flyer of VW stalled, sliding far to the margin of the 'window', whilst Hyundai's lower cost base and large cash cushion gave it comparative ability to better maintain its good profitability level, its RoE subsumed to profit margin; so near stationary position YoY. BMW and Daimler remained inside the window, though BMW saw greater profit improvement over the Q3 2013 to Q1 2014, as Daimler slipped a little. Toyota improved to align itself with BMW, with Honda also shifting into the 'window', albeit just onto the boundary. GM and Ford remained outside the “stock pen” with blue oval improving profitability over 'the General'. Renault saw a small decline, whilst FIAT's profit margin stayed static, but with a noted improvement in RoE.

Liquidity Ratios -
As regards liquidity generation, Toyota pulled far ahead of others in Q1 (Japan's “Abenomics” with a devalued Yen a strong tailwind). Thereafter in order were: GM, BMW, VW, Daimler and Hyundai.

Ford and Honda were set to eventually enter the 'investment window' but were presently sat beyond the margins. Renault saw improved liquidity levels YoY, unlike FIAT and PSA experiencing cash-burn.

Debt Ratios -

A story of cash depletion between Q2 2013 and Q1 2014 appears the case for most, an outcome of of necessary market incentives, reduced by present CapEx demands and extra-ordinary expenditure on high profile product recalls.

GM, Hyundai and FIAT shared the high-ground of cash reserves vs debt levels, all sat within the 1:2 arena. Renault slid YoY to a new position at the lower edge of 1:3, whilst VW improved cash levels to also sit within the 1:3 area. Within 1:4 were Honda and PSA. Whilst just beyond the boundary were BMW, Daimler Ford and tailing Toyota.

Results -

Market Valuation Ratio:
The once closely positioned VW and Hyundai have separated over the past 12 months, as investor traction gained for Europe's biggest producer even as both company's profitability declined somewhat from previous strength. Hence the middle-ground of the 'investment window' has been hollowed-out (rather akin to mainstream car markets. Nonetheless, within investment bounds at Q1 were: VW, Hyundai, Toyota and Honda.
(FIAT, BMW and Daimler close contingents).

Profitability Ratios :
By Q1 2014 it was seen that Hyundai retained its leadership, with BMW and Toyota sharing near equal second place, Daimler stationary, VW on the window edge, and Honda similarly placed with VW when newly entering the territory.
(Ford set on a vector for later entry)

Liquidity Ratios:
Herein Toyota led, with GM, BMW, VW, Daimler and Hyundai
(Ford and Honda expected to enter over successive quarters)

Debt Ratios:
Here GM, Hyundai and FIAT demonstrate their conservative approach to self funding.

'Investment Window' Appearances -

Hyundai: 4
VW: 4
Toyota: 3
Honda: 2 (but approaching 3)
BMW: 2 (but approaching 3)
Daimler: 2 (but approaching 3)
GM: 2
Renault: 1
Ford: 0 (but approaching 2)
PSA: 0

Conclusion -

Herein for Q1 2013, Hyundai and VW continued to mark themselves out as the strongest candidate, but with the rapid advancement of Toyota in recent quarters.

Thereafter, the three most prevalent 'progressives' are: Honda, BMW and Daimler, themselves presently appearing twice but fast approaching the likelihood of thrice. So apparently offering greater near-term upside for investors given respective advancement.   

As seen, each of the 'premier trio' has had a different share price journey over the intervening 3 month period.

Hyundai, thanks in large part to its high profile sponsorship of 'Brazil 2014' and so expected 'share of mind' in real world car markets has seen its stock rise since Q1 in its usual steady manner from about E46 to E55, even with previous QoQ profit contraction.

VW has seen its share price move in a volatile manner, from E185 to top-out repeatedly at E194 and return recently back to E185. VW executives now doubt hoping the German World Cup win will provide new homeland consumer confidence and so sales impetus to break the E194 ceiling.

Toyota, previously much assisted by the BoJ's QE exercise, Yen deflation and subsequent accumulated cash reserves, now effectively armed for battle in the US market, hopes to see its share price continue to march upward from its low of $104 in April, now at $119.

To End -

Thus, as always stated by investment-auto-motives, the corporate fundamentals must be set within the context of the broader macro environment, with recognition of the often subtle internal and external forces which can help or hinder corporate performance.

A raft of inter-related dynamics exist beneath the surface of these seemingly clinical, graphically depicted numbers, yet the numbers themselves derive from the actual and perceived complexities of the internal corporate and external market worlds.

The investment mind obviously seeks to re-assemble such obvious and opaque informational strands to form tomorrow's picture, and the immediacy of Q2 2014.