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].

Thursday, 7 March 2013

Macro Level Trends – The Geo-Economic Transition – The Long-Awaited Shift to 'Western Fundamentalism'

Recent weblogs sought to initially provide general global macro-economic backdrop, into which each of the ‘Global 11’ auto-makers could be respectively contextualised. The obvious premis re-counted by investment-auto-motives is that presently the world economy sits within a transition period, whereby the Triad regions partly regain their notionally lost dominance.

[NB S.Korea now obviously seen as a critical constituent of that 'Triad'].

Worldwide Geo-Economic Transition -

The noted slow-down of previously stellar performing (credit fuelled) EM regions, re-affirmed again by China recently, has become counter-balanced by a renewed, yet cautious, faith in western economies.

This obviously reflected by stock-market dynamics , each bourse notionally acting as ‘leading indicator' given historical precedence for markets to either foretell or prompt industrial and consumer activity. The fact that such 'faith' is accompanied by the investment community’s increased vocalisation for deep structural change, at corporate and national levels, simply demonstrates a 'real world' recognition of the immediate challenge if the once 'advanced economies' are to rebound as before – before the BRIC and CIVETS story.

The phenomenon is perhaps most prevalent and publicly visible within the automotive sector.

The US played a demonstrative role with the wholesale deconstruction and reconstruction of GM, necessitating a similar 're-engineering' both downstream and upstream of the value chain, so that a new era of better value creation might begin.

Whilst very 'old news’ now, that effectively pre-packaged bankruptcy, its cross the board re-structuring and corporate re-emergence, effectively set the tone for a necessarily slimmed, partially re-imagined global auto-sector. Given the geo-economic power of the US, that singular action created a domino effect. The Japanese mass manufacturers had to follow, and did so in response to the challenges imposed by the natural disasters domestically and in Thailand. Europe likewise, though without a Chapter 11 process and thankfully no major natural disasters, the process is slower. And today S.Korea, faces unsettling behaviour from N.Korea, which itself may well sap economic confidence and so enforce a round of commercial re-structuring.

European ‘Catch-Up’ -

With the US and Japan relieved of operational drag issues, it has been evident that the mainstream European players have had to respond likewise. Given the greater intensity of regional competition this has been a slower process, Brussels offering little more than rhetoric, itself recognising that each European auto-maker, self-governed, parentally owned, or with an inferred national remit, must balance short-term over-capacity and so unit margin destruction, against the longer-term intent and capability to serve an ever-expanding EU empire; in doing so fulfilling local and national economic obligations.

Hence the circular European dilemma, one which is compounded by the abject disintegration and fractiousness of EU politics, which itself has created a 'core' vs 'periphery' split – itself re-emphasised recently by Italy's not so comical political situation. So seemingly little possibility of any pan-European political and industrial stabilisation 'pact' - effectively offered by German economic and manufacturing might - such an ideology effectively undermined by powerful American industrial influence, eg FIAT-Chrysler and PSA-GM; aswell as the host of PE companies scouring S.Europe for 'firesale' industrial assets (as foretold by investment-auto-motives in 2008).

Whilst politically the Euro project marches onward ideologically with geographic expansion, the pragmatism of economics and finance means that the region is actually less commercially cohesive than at any time since 1989. Beyond the major auto-player alliances with America, the weaker industrial players of that notionally unified 'single market' are being swallowed by external American and BRIC private equity interests. Good for the companies in question, with access to new financing, co-operation within conglomerate / holding company structures, with often access to new markets that can revive much needed export sales

Such an economically generated commercial reality, together with obvious intra-EU political ill-will, obviously undermines the idea of true pan-European industrial and commercial cohesion...for all the efforts of Volkswagen Group (with SEAT, Skoda, Lamborghini, Bugatti and Ducati).

This complex reality seemingly well understood by Brussels’ given the Commission’s two-headed approach toward the auto-industry: calling for plant rationalisation yet also allowing state support; thus a pseudo- laissez-faire approach to national industry and cross-border competition; preferring a policy of remote interaction which in this instance seemingly allows for free-market reign; itself dependent upon the time-frame of central bank QE actions and liquidity availability. The first to do so – ie the the USA – able to capture and influence the optimal industrial assets.

Industrial Dichotomy -

Critically, European auto-players well appreciate that the present near and mid-term western economic deflation – instigated by “debt deleveraging”- will be eventually be counteracted by ‘re-inflation’ – and so perceived growth –as a direct and indirect result of trickle-down QE (itself key to the process of industrial restructuring). So, ironically with 'jam tomorrow' effectively creating a disincentive to permanently cut swathes of local capacity, instead companies having to dramatically cut general fixed and variable overhead costs and so manage working capital keenly, in order to survive and re-engage investors.

[NB basic theory posits that the greater the imposed fiscal austerity and the greater the available monetary plenty, the stronger and long-lasting the eventual economic rebound].

So those mainstream regional players: VW, PSA, FIAT, Renault, GM and Ford seek to balance their respective 'here and now' position with that of their inevitably positive forecast future; and that is invariably interlinked with policy-led expansion of American and European money supply .

Reduced QE -

Whilst 'Abenomics' seeks to provide Japan with its own version of the American renaissance play-book, the fact that Federal Reserve and the Bank of England have diminished QE efforts in a phased manner over previous years. This the tail-end of very necessary policy tool intervention which simultaneously inflate monetary policy (money supply) whilst deflating what had become over-extended (ie debt-ridden) fiscal policy. Both designed to act in concert so as to create what could be termed an economic 'transition stage'.

Those QE programmes, in their various guises, have obviously been executed in decreasing tranches, yet at dose measured deemed powerful enough to counteract what even until now have been often inverse industrial and consumer activity reports – formerly the demand side shrinking as the supply side rose. That has now reversed for the UK and fortunately an even better balanced for the US with job growth; as the Fed's 'beige book' analysis shows.

So optimism is in the air.

Here in the UK the BoE's Monetary Policy Committee countering departing Governor Mervyn King's expectation of another QE injection, leaving the base rate at 0.5%, thus inferring cautious positivism; itself stemming from impressively rebounding retail sales, including big ticket items such as cars and buoyancy in the housing market.

Speculation vs Fundamentalism -

At long last the optimism and 'traction' of Wall Street appears to be infusing Main Street, and whilst a noted liquidity shortage has affected SME's (requiring their own cash cushions to see them through), improved credit, debt and equity conditions have undoubtedly bolstered the fortunes of listed companies of all sizes across most western markets.

However, recent events in Southern Europe have once again raised investor concerns.

Greece recently missed its budget obligations whilst paradoxically seeing youth unemployment fall, good for momentary popularity, but creating investor concerns regards the slackening of austerity measures. And of course Italian voters unable to decisively democratically elect a convincing leader, the loss of an unelected yet still effective technocrat and subsequent loss of secure policy direction whilst promising an 'austerity unwinding' (as possibly seen in Greece) only adds confusion. Such events, whilst seemingly reducing national pain temporarily only serve to lengthen it, as their respective economies fail to demonstrate initiatives in meeting the evident global productivity gap (vs N.EU nations and EM countries).

So whilst the ECB promise to “do whatever it takes” to overcome the sovereign debt crisis, seen in falling government bond yields, the fact is that such events shake investor confidence. Previous confidence evident in the return of volume stock purchasing has withered and stock shorting seemingly re-appeared (FIAT SpA hit hard). And the plethora of zombie-like private SME companies become ever more zombie-esque. The failure of the public to fully appreciate the internal workings of the national economic machine have given a return opportunity the market speculators that had previously departed. Without orderly reform that speculation trend will only continue and the industrial base grow ever more weaker, so prone to what Germany would call a 'vulture fund' attack.

As stated, fortunately the opposite appears true for N.America and N.Europe.

Increasingly it will be a fundamentals-based investment perspective, and not feverish market speculation or rumour-mongering that will underpin the far more stable present and future dynamics of national bourses. A far more clear-sighted and very necessary practice, given the fact that future western economic expansion and the concomitant wealth-effect will have been based upon specific new-era drivers.

- regional and international QE circulation

- risk-weighted credit availability

- the returned importance of (regulatory influenced) investment banking

- changes in intermediary banking (with “consumer brand banking” and new start-ups)

- obvious re-structuring of commerce where required

- a cost-compliant workforce

- introduction of new regulatory demanded employee pension schemes

- wear and tear capital goods and IT replacement

- improved Triad and EM trading in specialist arenas

- sizeable EM originated FDI into western commercial sectors.

A New 'Platinum' Era ? -

As mentioned previously, 2012/2013 may in the distant future become viewed as having been the true economic turning point for what have been pummelled western economies.

A time when the previous 'rebound fever' of QE inflated stock markets ceases, and the far more rationalised investment behaviour of a broader and deeper investor base, itself increasingly representing the interests of the masses, finally emerges. Participants and markets largely re-attuned to once again become more disciplined and discretionary.

Importantly, far more attuned to sector and company fundamentals.

With this as the 'returned rationality', the next weblog will re-run investment-auto-motive's proprietary investment methodology...”Coupled Ratio Analysis”...running the numbers over the 'Global 11' auto-makers.