Monday, 28 April 2014

A decent company 87.5% off its all-time high: Toyota-Caetano

Warren Buffet, Berkshire Hathaway Chairman and CEO, is famous for his "20 ticket punch card", by which he meant that if each investor could only act upon 20 ideas in his lifetime he would do much better. Similarly, his mentor Benjamin Graham said "you don't need to know a man's exact weight to know that he's fat". When I started analyzing Toyota-Caetano I automatically remembered both of this quotes and I will try to show you why. I will first present the business, past results and dividend policy with brief comments, then I will present some macroeconomic data and perspectives, ending with a valuation after which I will show how that compares to current price and what can be expected when buying at this levels.

Business description
This business description is adapted from Reuters and their Annual Report:
Toyota Caetano Portugal SA (Toyota Caetano) is a Portugal-based company involved in the automotive industry. The Company is engaged in the import, assembly and sale of passenger cars, heavy vehicles and industrial equipment, as well as in the sale of spare parts for motor vehicles and provision of related technical after-sales services. Toyota Caetano is active in the import and distribution of products under brand names Toyota, Lexus and BT (the warehouse equipment brand in the Toyota Material Handling family). It operates an industrial plant involved in auto production, pre delivery inspections and vehicle conversions. Additionally, the Company is engaged in the rental of industrial equipment for cargo movement (Light Passenger Vehicles, Light Commercial Vehicles and Industrial Machines).

Controlling shareholders:
- Grupo Salvador Caetano SGPS, S.A. 60,82%
- Toyota Motor Europe NV/S.A. 27,00%

Historical results:
I assembled a table with the company's results in the last 8 years, as presented by them in the consolidated report. The motive I did not go further back was because I wanted to present comparable numbers (values in thousand Euro €):

Sales&other op income
cash flow from operations
cash flow from investing (net)
interest paid
Net financial expense
Net income
Net debt
Book value
Total Assets
Toyota market share
Units sold (T+Lexus)

Additionally, it is worth noting that as of December 2013 over 90% of operational sales are related to the auto business, which is why I will focus mostly on that business.
So, we have a company whose sales increased up to 2007, fell in 2008-2009 and recovered in 2010, which as we all know is expectable because of what happened to the world economy in that period (the great recession). Also expectable is the sales declining from 2010 until 2012 due to the Portuguese debt crisis and recession. So, we have a cyclical company, strongly tied to macroeconomic performance involved in the automotive industry. Interestingly sales slowly started to increase in 2013, meaning that recovery might be underway. Toyota market share, which fell significantly in 2011, has also started to recover partially. It is possible that this market share reduction has not resulted from a real loss of mind share but only from a less recession proof vehicle mix, specially because of the progressive recovery that took place in the following 2 years. It could also mean a real mind share loss and as such it is something to take into account. About Toyota market share it is important to notice that in 2005 it was 5.6% and that the company projects 4.8% to 2014.
In addition, Total Assets have been declining with little interruption since 2006 and simultaneously cash flows from investing have been mostly positive (so, this company has been taking money out of the business instead of deploying more money in). Simultaneously, despite some fluctuation, book value has stayed roughly flat, which has resulted in the deleveraging of the company with net debt reducing 82%.
Earnings have been negative in 2011 and 2012 (approximately 2.2M and 2.9 M), however included there are workforce reduction charges of about 3M€ (3 million Euros) and 1.5 M€ in 2011 and 2012, respectively. Also, the company has accumulated 2.871.892€ in deferred tax assets, which should be translated into cash as the company returns to profitability (this as already started as in 2012 this number stood at 3.440.928€). In 2013 earnings have been near zero, meaning that the scaling down of the company seems to have stopped the bleeding and maybe better days lie ahead.
Moreover, since in 2013 sales increased a little it might be useful to look at current cash flow from operations as a reasonable bottom number. At 15.4 M€, and with interest expense falling due to the debt reduction, net debt of 19M€ could be fully paid by the first semester 2015 and all cash flows could then flow to the equity. It seems highly unlikely however taking into account the currently very low level of debt, that they would keep reducing it much further.

Liquidity position and investment properties:
If the company is to recover to their previous state it is likely they will need to re-leverage, at least partially. Their debt position consists of:
1-Real estate guaranteed bank loans:
Other than their real estate properties included in their fixed assets, they hold on their balance sheet 16.502.727€ of investment properties. The proceeds from these assets of 3.246.319€ in 2013 (19.67% on assets). These assets have been evaluated in 2011, 2012 and some of them in 2013 by American Appraisal. Their fair value according to the company has been estimated at 52.967.400€ (6.1% on assets) . Should this number appear on the balance sheet the equity would be 36.5 M€ higher (28.6% higher). As of December 2013 they had a used amount of 9.736.842€ in real estate guaranteed debt. This debt is due annual payments (1.842.105€ in 2014) ending in June 2017.
2-Guaranteed account: 10M€.
3- Leasing contracts: related to the purchase of facilities and equipment. Total capital to be paid: 6.167.509€. Total interests to be paid: 692.200€.
4- Refundable subsidies: 818.034€
5- Credit lines: 51.7M€ unused credit lines that can be used for operational or financial purposes without restrictions.

Consolidation perimeter changes and investment assets
Since the company as clearly divested, it is important to know which areas the company totally divested and its impact to profits, otherwise comparisons might be incorrect. Similarly it is important to know if the company would have to re-increase total assets (with either debt or equity) to 2006 level to go back to 2006 earnings. It also helps to understand better the company's capital allocation. So the chronology of perimeter changes follows:
2006: no changes.
2007: focusing in Toyota units by selling their financial participation in various companies for 14.541.000€and one industrial unit for 8.850.000€. This operation resulted in a capital gain of 1.810.601€. In 2006 this companies had sales of 101.352.430€, operating income 2.387.553€, net interest expense of 833.810€ and net income of 603.552€. Operating cash flows were 1.015.329€ and investment cash flows were - 947.593€. Total assets were 69.497.466€, net debt of 19.243.911€ and equity was 22.761.068€. So they sold at a small premium (3%) to book value a group of companies with a combined leveraged ROE of 2.65%.
2008: acquisition of Movicargo for 1.130.000€ whose book value was 518.003€ and cash acquired was 1.744.539€. It was responsible by BT industrial machines sales and was integrated in the industrial equipment unit.
2009: no changes.
2010: Saltano (99.98% owned) bought 5,21% more of Caetano Auto.
2011: liquidation of Salvador Caetano UK, Ltd (no activity in 2010).
2012: acquisition of Caisb - Companhia Administradora Imobiliária São Bernardo, SA as a Caetano Auto subsidiary.
2013: they have liquidated Caetano Components (2012 total assets were 4.589.101€, book value was 1.485.000€ and net income was a negative -318.000€ and the company faced a 6 month lay-off in 2012). This liquidation settled loans granted by Saltano amounting to 1.99 M€. Additionally they bought the remaining 50% of Caetano Retail Norte II and fused all Caetano Auto subsidiaries into Caetano Auto. This four subsidiaries in 2012 had negative book value of -1.726.647€ and negative net income of -623.085€. This had a negative impact in the company's book value, but after the fusion there was an improvement in 2013 Caetano Auto's sales (20.8%, 9.7% if all subsidiaries are included) and net income (-1.9M versus -2.15M or -2.8M joint result).
So it seems that most divestment was in negative earnings subsidiaries. Exception to the year 2007 when the biggest divestment took place implying a small reduction in operating earnings (and a much bigger reduction in assets). Taking everything into account the result was a big divestment in unprofitable subsidiaries.
The company also had, and still has, some available for sale investments. The company had invested 5.958.067€ Portuguese bank stocks valued at 15.698.383€ in 2006 which were sold in 2010 for 5.305.021€ they partially rebought this stocks in 2010 spending 588.451€ which they sold in 2011 for 588.451€. They still have a participation in a real estate fund bought in 2010 for 3.013.947 and valued in 2013 at 3.274.639€. Their pension plan also has a 10.878.417€ participation (37.7% of the portfolio) in the same real estate fund. The movement with bank stocks also explains a part (about 10M€) of the reduction in total assets since 2007.
Taking everything into account I will treat earnings since 2006 as comparable but after having read this it is up to the reader to decide if the scale is balanced. In addition, asset sales in 2007 combined with the loss on bank shares between 2007 and 2010 account for almost 80 M€ of the reduction in total assets between 2006 and 2013 (42% of the 188.5M€ reduction). This means that to generate a similar level of profitability the company now probably needs a smaller investment.

Macroeconomic data and 2014 targets:
Since April 2013 the Portuguese economy has steadily been recovering resulting in unemployment rate going from 17.6% in February 2013 to 15.3% in January 2014. Auto units sold increased 12% in 2013 and Toyota market share increased 0.2% to 4.6%. Lexus sales increased 77%. A maintained market share also means that if sustained they will end up mimicking the national context.
In 2013 annual report they assume the national auto market will increase 13% in 2014 and propose a 16% increase in Toyota sales (4.8% market share) and an 80% increase in Lexus sales. About this objectives it is worth noting they propose "to keep the growth pace of the activity, as substantiated in actual data from the first quarter of the year." As a double check I searched for the first trimester auto sales: total auto sales in Portugal increased from 28144 to 40460 units (43.8% ) versus the same period in 2013 (provisory data). Toyota sales increased from 1063 to 1515 (42.5%). Lexus sales increased from 37 to 62 (67.6%).
Toyota Caetano also sells industrial machines equipment (for which I did not find data for the period), and has an industrial unit that at the moment is only manufacturing Toyota Dyna. The industrial unit has been lagging in recent years, having started to manufacture the new Dyna 200 model in the second half 2013. I have not found credible information about future new models for the factory and as such I would rather take the company's expectations. Their industrial unit has been substantially reduced and their expectation is to "at least keep the existing jobs as well as growing production volumes, expecting improvement in Net Results."

Dividend policy and board alignment with shareholders:
From 2012 annual report:
"In brief, despite being always conditioned by its own payable net profits and by the expectations thereby created for subsequent period(s), up until 2005 the Company had been paying dividends within a percentage range of 30% to 50% of the profits.
Taking into account the level of equity achieved in the meanwhile, from 2006 the Company has been paying dividends within a percentage range of 75% to 96% of payable net profits obtained. In 2010 this percentage is around 82%.
In relation to 2011 and 2012, and given the income ascertained for the financial year, the Board of Directors does not submit any proposal for the payment of dividends."
So, since 2006 the company has paid out most of its earnings because they had reached their desired level of equity. As I have noted, despite some fluctuations equity has stayed roughly flat since then. It seems to be expected that the company returns to profitability, otherwise we would see equity distributions instead of net income distributions to shareholders (meaning dividends in excess of net income) - however, should the divestment continue at the same pace, net debt would probably be paid quickly with the remaining flowing to shareholders, but I see that as unlikely.
The board is mostly composed of Caetano family members and Toyota representatives. The majority of the capital (60.82%) is owned by Grupo Salvador Caetano SGPS, S.A. whose interests are probably aligned with the shareholders. Toyota Caetano however is only a part of their business with its total assets being approximately 27% of their total assets in 2012. Grupo Salvador Caetano has public reports available, where we read they make use of leverage at the parent and have entered renegotiation with a bank in 2012 and accepted "certain restructuring operations". In fact they had at the time some net debt/EBITDA covenants (7.0X in 2012-2014) that were over the target but they were ending a new deal. This would make us expect dividends to be paid by Toyota Caetano if needed to reduce debt on the parent. A parent company intention to deleverage could also explain the quick deleveraging that happened at Toyota Caetano, which they consolidate. The liquidation and fusion of subsidiaries, as well as the cost cutting, could also be related to some efficiency driven restructuring. Some people say debt makes you operate more efficiently, otherwise things go wrong: in this case we have the debt pressure on the management but don't have the debt (since it belongs to the parent).

This company does not seem to have a classical moat, with pricing power and high return on capital. However, I believe their shareholding structure gives them a decent protection. In fact while the majority of the capital (60.82%) is owned by Grupo Salvador Caetano SGPS, S.A., Toyota Motor also owns 27% of the company. As such I see no motivation for Toyota to find another reseller. This results in Toyota Caetano having their share of Toyota's Portuguese business relatively guaranteed. As long as Portuguese people and companies buy Toyota's products, Toyota-Caetano will probably keep selling, which makes up for a decently protected niche.

First quarter unit sales increase in both Toyota and Lexus vehicles of 42.5% and 67.6% should provide a significant increase on net income from break even.
The very low debt achieved, together with the expected profits, should allow for dividend distribution next year after two off years.
If the profits do not recover, cash flows should continue similar (or better if restructuring costs stop) and the company will probably be net debt free in about a year.

First of all, it is important to note the shareholding structure: 35M shares, no dilutive shares, no preferred shares, no options, no shares repurchased. It should be noted that the defined benefit pension fund owns 623.626 shares of the company.
Since the company distributes most earnings, I would say that a good way to value them is by doing a discounted cash flows valuation of their net income. Estimating the net income is the harder part. Seems to me that by averaging their 8-year net income we get a conservative estimate of their earning power (it includes two boom years but also the subprime crisis and the worst recession since the start of Portuguese democracy in 1975 when the system changes induced recession) that should be seen as a worst case (worst than liquidation in my opinion). At 5.6M€  (0.16€/ share) and using a discount rate of 10% and a growth rate of 2% (inflation), fair value would be 55.63M€ (1.59€/share). If, however, we take into account the exceptional nature of the period analyzed use only data from 2006-2010 (and still include the subprime crisis), average earnings would be 9.96M€ (0.285€/share), which probably would be a more accurate figure. Using the same assumptions we would reach a fair value of 98.94M€ (2.83€/share) and still not being overly optimistic.
However, discounted cash flows, as the name implies, would be more correctly used to the cash flow statement. As I have showed above, cash flow from investments has been mostly positive in analyzed period. Some of this positive cash flow from investments is due to divestment, but an important factor at this level might be the fact that their transportation equipment is stated at cost less depreciation and they always report "Gains in the disposal Tangible Fixed Assets" (trending down from 5.359.877€ in 2006 to 1.274.484€ in 2013). It seems overly optimist to state that cash flow from investments will continue to be positive (even if it has happened in most of the last 10 years, at least) and as such I will assume it will net on zero (probably optimistic). Last 8 years average cash flow from operations less interest paid stays at 12.5M€ (0.357€/share), which includes above stated recessions, thus balancing my optimistic assumptions about cash flow from investing. Using the same assumptions fair value stays at 124.2M€ (3.55€/share).
Another way would be to value the company at book: it is not a high quality company, but their competitive position is relatively stable. Book value per share would be a decent proxy. In fact, since there is a 36.5M difference between deemed fair value of the investment properties and their valuation on the books, and since the company states that their inventory (43.3M€) is below market value ("Goods, raw, subsidiary and consumable materials are stated at acquisition average cost, which is lower than market value"), then book value might actually be a conservative way to value the company. Book value was 127.75M€ (3.65€/share) at year end 2013.
My favorite way to value, however, is to set a time horizon from 3-5 years (usually 3 years) and try to do an educated guess of how much a company will be worth by then and then calculate the rate of return. I like it probably because it allows me to avoid false precision and use my subjective interpretation of everything I read. So:
Will the company, in three years' time, have returned to normal profits? Yes (otherwise autos and equipment in the country would be so old by then that a new boom would be needed). How much do I think those normal earnings will be? Around 10.5M€ - 0.30€/share - (2007, 2009 and 2010 approximate result, even if sales don't recover to that level, recent cost cutting should allow for that). Will the company have distributed dividends in the meantime? Most likely, around 7M€ (0.20/share) would probably be a conservative estimate. Which multiple would I pay for then earnings? 10 would still be a conservative multiple since they pay out most of their earnings. So 112M€ (3.20€/share) in 3 years would be the value I would use to calculate a conservative rate of return, and I would still leave space to recalculate as time passes by.

History of stock market price, current market price and expectations
Here ( at Euronext site you can see the stock quotes since 2003. It traded between 3.5€ and 4 € in 2004-2005, and appreciated from 4€  to 9€ in 2006-2007. In 2008 it traded around 9 but ended up hitting 10.00€ per share, where it traded for some time. Since then value as come down hitting 0.53€ per share on anecdotal volume. On decent volume the minimum was 0.70€ per share. It currently trades at 1.25€. So, what does this mean?

Discount to value
Expected rate of return/implicit discount rate
Most conservative DCF
Reasonable DCF
55 %
DCF (operations-interest)
Book Value

3 year estimate
60.9% (in three years)
All time high

This table gives us a reasonable estimate of expected returns in Toyota-Caetano. I included the all time high because it doesn’t seem impossible that the stock goes back to that value in some years time, if it did and took 10 years to do it we’d be facing a 23.1%/year return for 10 years (excluding dividends received), it is however unlikely.  Unlikely on the negative side seems to me the most conservative assumptions used for DCF purposes (but still a decent rate of return). So the most likely (in my opinion) estimates propose a return over 25% a year.
In face of expected returns like this in the midst of a bull market we usually think it's either a fraud or a company at risk of going bankrupt. Toyota Motor holds a significant portion of the stock so it is unlikely it is a fraud. Also I have heard about Grupo Salvador Caetano since I can remember . In their 2011 annual report they state the following:
"Celebration of 40 years of activity in October, attended by the Prime Minister, the Minister of the Economy and Employment, the Executive Vice President of Toyota Motor Corporation and the Vice President of Marketing and Sales for Toyota Motor Europe."
In face of this quote I would be surprised if it was a fraud.
About the risk of bankruptcy, the company has paid down most of their debt and scaled down their business reducing risk. It does not seem likely. In fact, a bankruptcy would probably give equity holders a nice portion of their (said to be understated) book value and, as I have mentioned above, the discount to book value is 56.4%.

Trading information:
This stock trades in Euronext Lisbon which makes it easily accessible for trade. Since it is a low liquidity stock it trades on double call auction. From the Euronext FAQ we can see that "Unlike continuous trading, a call auction provides a transaction that generates a price at a set time once or twice each day (11:30am and 4.30pm for companies listed on NYSE Euronext)." "The system then compares the totals of each order book side in order to determine the limit that would allow the largest number of stocks to be traded. This limit then becomes the stock's price, and all the stocks included in the total are immediately traded at this price." After each of this moments, during 30 minutes the stock can be traded at the last price established.
If in a given year there are more than 2500 trades the company is invited to switch to continuous trading.

Writing this article has increased my expectations of return. While I was studying this stock I knew this was a very fat pitch, even if I had not put a number on its weight. Fat as it was, I considered that it deserved a place in my 20 ticket punch-card. I still believe it does.

Disclaimer: a quick check will show you that this company last trades have been slightly above the 1,25€ I used on my assumptions. I used this number because I am convinced that an order placed at such price would be filled sooner rather than later, but I might be wrong. I own shares in Toyota Caetano and will most likely sell before it reaches my estimate of fair value since that would make it too big a portion of my net worth. I do not intend to sell soon thought and might buy if I think appropriate. I believe the numbers I post are correct, but always double check (I leave the links below). Always read the blog introduction post.


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