Thursday, 6 November 2014

Companies Focus – The Global Eleven Auto-makers - Coupled Ratios Analysis: Q3 2014

The seemingly lengthy summer and autumn sell-off across various cyclical sectors - including autos – was driven by a perfect storm of macro-level (and for some micro-level) headwinds.

Yet entering Q4, the fear factors have good reason to subside, providing for improving socio-economic contexts and so investor optimism.

Q3 Economic Backdrop -

Initial concerns regards continued Ukrainian political friction, worries were escalated by the the further additions of slowed Sino-Euro productivity reports, and the overcast shadow that was the end of American QE. Hence the associated outlook of expected global deflation if the USA could not do the global 'heavy lifting', even this possibility then undermined by rumours of the Federal Reserve's 'hawkish stance' on rates to discourage internal inflation. This in turn was compounded by mixed North American consumer data at the everyday retail level of shopping and utilities, coupled with somewhat slowed big-ticket item sales (inc private cars) and slowed home mortgage applications.

So general recognition that whilst the USA would be able to serve its own economic interests – seen by the boom of domestically produced pick-ups underpinning blue-chip and SME investment confidence – much of the remaining world, would experience little immediate corollary.

With this previous outlook, though Q2 Coupled Ratios analysis did indeed demonstrate its rational, highlighting general global autos improvement to date and capturing those worthy companies will mid and long term appeal, the fact is that markets became very skittish given the lack of near-term support for seemingly high p/e valuations versus immediate doubt.

Brutal Q3 Market Reaction -

The summer-long sell-off of cyclically orientated companies has been somewhat brutal. Perhaps expectantly so given general sentiment about the previous current affairs and associated headiness and (vitally) the lack of a more subdued American market correction which investment-auto-motives hoped to have witnessed in late 2013. Without the required 5-8% correction then, the latter fall-out was all the more harsh, and importantly all the more widespread, impacting worldwide bourses.

Whilst affecting all auto-producers, the consequential stock-price drops seen – at one time-point -9% for BMW to -13% for GM and -24% for FIAT SpA (of old) – resulted from what at times seemed an overtly irrational perspective by some investors and specifically the pounce behaviour of short-termist traders; communities within the latter obviously intent on heavy 'shorting' of those companies which appeared weak over the mid-term (as exemplified by the targeting of UK supermarket Sainsbury's).

However, even under such pressures other actors within markets showed examples of well gauged rationality. As was the case with GM, wherein its necessary absorption of heavy cost charges associated with its broad “ignition switch” recall was countered by the welcome boost of Siverado sales with better than average per unit margins.

Return to Rationality -

Importantly, that somewhat short-termist and heavily distopian reaction has presented a return to greater investment rationality.

The expectation looking forward now being that with the end of American QE (though still seemingly dovish on rates) investors – at least in the US, if not in Japan or probably Europe - will increasingly return to a now more necessary, traditional approach: that of company “fundamentals” amid a calmer macro backdrop.

Whilst it appears that all but US-centric firms continue to suffer during the pan-global slow-down, from Q2 onwards and across the summer, investment-auto-motives equally recognised that those foreign firms that were directly exposed to North America (ie with local production or high export volumes) would be well placed to gain likewise.

Especially so if also supported by homeland fiscal and monetary policies; as has been - and now is again - the case with “Abenomics”, so intentionally deflating the Yen to boost Japanese auto-makers' and consumer electronics' own FX gain at the bottom-line; this seen in the 9% rise in the share price of Toyota, assisted by its very size of volume sales exposure to the USA.
So quite obviously such immediately specific investment opportunities have and do appear to exist per N.America; to quote of one Detroit sales chief via a Bloomberg report: “the US economy has steadily improved all year. Now we are poised for stronger expansion backed by an improved jobs market, higher consumer confidence and lower fuel prices”.

Such words welcome after such a summer of investor, or rather trader discontent.

They presage the notion that whilst obviously US-centric – see Jay Leno's car enthusiast website for the pro-American SME message - the American domestic economy will also start to draw-in greater import demand; whether in “visible” goods such as premium German cars, Japanese capital goods and eco-engineering and via “invisible” services such as Asian IT and web consulting.

Previously burgeoning trends regards increased foreign direct investment (FDI) toward the Triad regions – especially so USA and pan-Europe - set to continue, as various EM firms across many industrial sectors seek ever greater market exposure in previously notionally 'post-industrial' countries; so replaying the yesteryear moves of the likes of Arcelor Mittal in steel during the 1990s, or Nissan and Toyota during the 1980s.

Furthermore, whilst the most recent raft of reports for China still appear glum, the previous geo-specific distress signals of the broader global economy across Europe, S.E. Asia and portions of S.America, may be reducing. Whilst seemingly slow given the need to convince often socio-reactionary politicians, various economic reforms have been tabled and are setting-out conditions for improvement. They in turn are transforming what were previously heavily regulated and so restricted sectors previously state-owned, much unionised or monopolised sectors, Greece's television sector just one example.

Europe's virtually stagnant growth rate and SE Asia's better controlled, slowed growth means that labour costs remain inflation constrained, so offering reduced headwinds and so improved conditions for local corporations and SMEs alike.

Critically, cash rich EM firms continue to seek out local and foreign Merger and Acquistion opportunities (as seen with the UK's United Biscuits sold to the Turkey's Yildiz Holdings) so in a timely manner following the likes of TATA Motors' previous purchase of Jaguar Land Rover.

And critically, the macro-economic climate brightens: primarily via the witnessed and expected effects of major QE programmes (previously in the US, currently with Japan, and expectantly so for Europe), such opportunistic conditions now enhanced with the notion of 'affordable oil'.

Here investment-auto-motives must be underline the fact that OPEC's actions to intentionally not constrain supply appears an implicit recognition by global commercial and political leadership that 'affordable oil' must itself acting as a 'prop' for the global economy; now that US QE ends, Abenomic 2.0 has limited worldwide effect and before any desperately needed 'Draghi Put' (beyond QE-lite) takes effect.

Although America's own 'miracle-growth' oil-shale sector is reportedly unable to compete at below $76 p/b or so, the drop of worldwide barrel prices to the present $83 (even if presently over-sold and returning to $88 or so) not only critically reduces and stabilises industrial input costs - so supporting manufacturers across Europe, MENA, Brazil and Asia - but China's recent oil bulk buying bodes well for renewed industrial activity, even if indicator signs are presently weak. Furthermore such “oil lows” for both pre-refined “Brent Crude” ('Sour') and post-refined “West Texas Sweet” will undoubtedly serve as a critical economic bridge for the UK and N.America between what has been artificial liquidity pumped growth, and a new nascent era of authentic investment confidence.

Thus with many share prices across cyclical sectors - and specifically automotive - “re-rationalised”, combined with the support of “affordable oil” and still ostensibly doveish central bank sentiment around the world, Q4 2014 appears to offer a steadier real-world investment impetus, economic optimism and investor sentiment..

To gauge which automotive companies are conservatively best placed from the 'bottom-up' / “fundamentals” perspective, investment-auto-motives presents 'Coupled Ratios Analysis' of Q3 2014 financial results.

Q3 2014 Positioning -

As is well recognised, 'Coupled Ratios' was formulated to coalesce the most popularly deployed investment measures across the four primary investment considerations; these being:

- Market Valuation Ratios
- Profitability Ratios
- Liquidity Ratios
- Debt Ratios

The first consists of P/E (price/earnings) vs P/B (price to book value). The second of Profit Margin vs RoE (return on equity). The third of Current Ratio vs Operational Cash-flow Ratio. The fourth of Total Cash vs Total Debt.

Those companies which appear most frequently within the optimal 'investment windows' are deemed as more risk averse and so preferable.

[NB Those that may appear beyond any single 'investment window' may be undergoing “turnaround” progress, or conversely (temporarily) over-valued by the market, experiencing mid-term liquidity problems or burdened with comparatively heavy debt]

Hence, whilst “Coupled Ratios” condenses usual 'fundamentals analysis', it obviously excludes 'top-down' macro influences and the details of internal, company specific actions or strategic directions.

All must be considered by the practising investor.

Resultant Outcomes -

See attached picture for the requisite 4 distinct graphs. Information gleaned from Q3 2014 company intelligence as presented, external information agencies and modelled by investment-auto-motives as necessary to provide estimates of absent information.

Market Valuation Ratios:

Herein, almost in an almost 'ad infinitum' manner, Hyundai and Volkswagen appear most strongly within the 'investment window'. In addition Honda retains its place, moved only slightly lower to take-up Volkswagen's previous coordinate position. FCA gains by moving to just within the 'window', previously hovering on the cusp, whilst Renault re-enters after previous absence. Daimler gains slightly to sit upon the boundary-line, thus gaining further credibility, whilst PSA is shown as overtly high (effectively unmoved) given the lack of available data. Seen to leave the investment space are Toyota, becoming rapidly notionally over-valued, and BMW shifting off the border as its p/b rises. GM sees little re-positioning beyond the window, at its relatively high p/e driven by American investor economic confidence, whilst Ford also beyond experiences a slightly reduced p/e and positive substantial re-rating of its p/b.

Past successive 'coupled ratios' analysis witnessed VW drift ever more upwards as per the general pack relative to improving economic conditions. However as described in the analysis detail in Q2's observation, with an older model mix, awaiting new launches in late 2014 and beyond, VW was unable to ride the American vehicle market upturn through Q3. This, plus the previous 'sell-off' sentiment of cyclically biased big-caps is seen by VW's p/e and p/b marginally lower re-rating.

Honda's relative p/e and p/b stability over Q2 and Q3 appears to demonstrate its management's dedication to managing investor interest and expectations relative to its far bigger Japanese peer. With internal recognition that though smaller in production capacity, its broader commercial activities (cars + motorcycles + power products), whilst advantageously partially anti-cyclical, must be strategically managed to avoid top and bottom line volatility at the consolidated group level, and so provide the operational levers by which to try and maintain a steady investment story, within the 'window'.

FIAT's metamorphosis into FCA (Fiat Chrysler Automobiles NV) and its new NYSE listing, is timely indeed given its re-positioning into the top of the investment window. Its reduced p/e gained from slowed trading volumes versus improved P&L and income statement, thanks unsurprisingly primarily to USA vehicles sales and relative success in Asia. As expected, aided by investment bank insights, FCA then has been moulded and timed to befit stock market conditions.

Renault re-joins the investment space from what were overtly high p/e valuations created by early-bird investors awaiting both the possibility of ECB QE and at worst the group's eventual sales and revenues upturn. Those high p/e's however dragged down by the recent brutal sell-off. However, (as with PSA) with input costs better constrained and revenues improving, risk-averse 'heavyweight' institutional investors will become increasingly drawn, with most investor types presuming an uptick in share price as a result of either stronger than guided results or a necessary advent of full Euro QE.

Hyundai, having enjoyed unparalleled advantage versus western VM competitors shortly after 2008/9 and across latter years, experienced a massive gain in share price. But the rebound of American and European players has undermined the S.Korean's competitive advantage in western markets whilst other target EM markets which likewise enjoyed Hyundai-Kia's previous lower price-point have obviously experienced slowing local vehicle markets. Together this combination has heavily impacted Hyundai's fortunes across Q2 and Q3, its record share price on the Xetra bourse loosing approximately 30% over recent months as investors perceive Hyundai's worldwide challenges. Nonetheless it still sits lower-centre within the 'investment window', a function of its prevailing conglomerate discount, though awaiting a sales and revenue rebound.

Profitability Ratios -

Herein, it is seen that there has been an improvement over Q2 for most auto-makers, even though many do not yet qualify within the 'investment window'.

Those that remained strongly within are Hyundai (though profiting slightly less than Q2), Toyota (much improved over Q2) and BMW (marginally under Q2 performance). Arriving from the bottom boundary are Daimler and a re-entering is Volkswagen.

On the very cusp is Honda (with static QoQ profitability but slightly improved RoE). Just beyond is Ford (with likewise static QoQ profitability but substantially decreased RoE), whilst Renault sees a profitability jump. Further below the 5% profitability boundary are GM (effectively static) and a lower placed FIAT (slightly improved).

PSA remains far below, and though viewed as improving as per its scant 'Back in the Race' results material, is still estimated as yet to reach break-even.

Liquidity Ratios -

The majority of auto-makers experienced a major decline in OCF (operational cash-flow) over Q3. The only three to escape this trend were BMW (effectively static QoQ) and Toyota ) moderately reduced) and Daimler. The three pointed star in fact bucked the trend thanks to its earlier investment efforts and cost absorption, pro-cyclical exposure to all 'on-road' vehicle segments, and strong newer model mix, so gaining substantially in OCF.

Remaining within the 'investment window' are Daimler, BMW, Toyota and (a much estimated) PSA.

Whilst experiencing substantial OCF fall-back, Volkswagen and Honda at least remained in positive OCF territory. Tumbling into negative OCF were – in ranked order of loss – Renault, Ford, GM, FCA and Hyundai.

[NB as is the usual calculation Operational Cashflow is simply deduced from the calculation of OCF = EBIT – (CapEx + Financial Investments). However given the lack of transparency offered by some corporations, the FI portion has been omitted so as to provide simplistic but comparable calculations].

Debt Ratio -

Relatively little change for six of the eleven auto-makers. These being: GM and FCA, respectively well within and upon the border of the 1:2 segment (of cash to debt), PSA and Renault respectively well within and upon the border of the 1:3 segment, and Toyota upon the 1:4 border with BMW statically positioned outside the 'investment window'.

Negative changes seen with Honda, previously upon the 1:4 boundary but slipping in cash and debt terms, with Ford likewise slipping at far higher levels.

Positive change for Volkswagen, rising from the 1:4 boundary to 1:3 line, and for Daimler, its cash generation added to its cash cushion along with slightly added debt, moving from well outside the 'investment window' to its outer 1:4 border.

Results -

As is the norm, investment-auto-motives illustrates the number of 'investment window' appearances for each company.

Four Appearances:

Three Appearances:
Volkswagen, Daimler, Hyundai, Toyota

Two Appearances:
FCA, BMW, Renault, PSA, Honda,

One Appearance:
GM, Ford,

Conclusion -

The depicted graphs, representative of matched and merged data sets, highlights the rational investment attractiveness of each of the global eleven players utilising Q3 (and as necessary Q2) results with recent stock price and associated data.

Unlike the quarters of previous 'recession rebound' years which ostensibly dissected auto-makers into obvious winners and losers – the likes of VW and Hyundai vs the likes of Renault or FIAT – more recent quarters have seen the combined effects of both internal auto-sector structural change and the boost effects of demonstrated and expected QE.

So essentially starting to level-out what was once a very one-sided playing field, and providing those mainstream manufacturers which have large American and European market exposure respectively sound and improving revenues impetus.

As a result, the once polarised investment attractiveness toward star performers of the previously split pack has diminished, with numerous investment stories of differing size, stature and time-scales continuing to appear.

Within this more complex yet wholly positive backdrop, attuned investors will be seeking out those specific firms which show greatest contextual promise. The once lack-lustre Daimler presently a shining example of organisational metamorphosis, with combined: the divestment of non-core EADS stake, reduced engineering development and production costs, 'back room' efficiency efforts and critically renewed focus on well targeted products across a broad vehicle spectrum.

Clearly the Stuttgart firm's recent performance provides contemporary prominence, but each corporation, within its own context, has its own obviously very specific investment tale. De-constructing the very fabric of the micro and macro with insightful aplomb is then vital for investors.