Why I think Toyota Caetano is cheap: bullet points

Why I think Toyota Caetano is cheap: bullet points - as promised in the last post

1-They operate in Portugal: starting a recovery from the worst recession in the last 40 years (after the dictatorship fell). Still 14% unemployment (official numbers, as understated as they were when it was 17%).  – plenty of upside for consumption.

2- They have paid out as dividends 90% of net income since 2006: expected to continue. Likely to be well paid to wait.

3-  Big debt reduction, divestment and restructuring efforts since the crisis: divestment apparently is still in progress. Debt is currently low. Costs have been trimmed.

4- Parent company has higher debt and has had to negotiate with banks: pressure on the parent should mean high pressure on costs, debt reduction to progress and dividends to shareholders/parent company should be high as profits increase

5- Accompanying the recovery seems to be possible with little fixed asset investment, working capital investment should accompany sales. Investment in the improvement of the industrial unit is expected if new models are received (under negotiation with Toyota): such an investment would likely be on the currently active factory and as such I would expect it to be low in comparison with the profits added – it should be a kicker and not bad news.

6- Despite the depressed environment, they trade (at 1.3€) at around 35% of book value, at 12,5x first semester annualized net income (8% earnings yield, expected to be paid out) and at an annualized EV/EBITDA of 3,9.

And a few new data (as also promised in the last post):

August car sales are out:

- Toyota+Lexus 473 vehicles (298 last year, a 58.7% increase YOY in line with the 56% increase in July), totaling 1417 vehicles in two months and with a substantial market share increase to around 5% .

And I finally found some data on industrial machines sales:

-July forklift sales (global market) seem to have increased 225% YOY. This number most likely includes some areas where Toyota Caetano does not operate (and vice versa) but it is always better to see a substantial rise than a substantial fall.

Disclaimer: read my previous disclaimers in Toyota Caetano posts

Toyota Caetano Q2 results are out

Toyota Caetano Q2 results are out. This post is mostly going to be a bullet points style post. I will post in the following days a 5 or 6 bullet points thesis explaining why I believe Toyota Caetano is so cheap and adding some recent sales data, some of which I still do not have. So let’s start:

-          Remember that in June I mentioned that the big gap in monthly car sales between April and May could (in a not so farfetched scene) be due to acquisitions for the rent a car business of Toyota Caetano? It seems it actually happened but in June (210 RAC vehicles where acquired to total 1226). So sales did not increase as much.

-          Net debt increased in Q2 compared to Q1: mostly explained by the increase in transportation equipment, most likely in the renting division both auto and industrial equipment. The good news is that they are selling 560 RAC vehicles until yearend and most likely the difference in timing is justified by business seasonality, so I expect:

o   The 210 RACs investment will only have effects in the second half results, as stated

o   Bigger profits from renting due to the increased number of vehicles in the Summer season

o   Continued divesting (with a 350 RAC vehicle reduction to 666 vehicles) in a less profitable business that requires substantial capital invested

o   A onetime profit in the sale of the 560 RACs (“This sale will give rise to significant gains”)

o   Net debt will decrease

o   Remaining debt will be structured mostly either in lease contracts or in mortgage contracts, with substantial reduction in short term debt. Leasing contracts have seen a 2579k increase despite 513k payments in 1S.

-          The net debt increase is also partially explained by both an inventory and accounts receivable increase. Relevant here is:

o   Non-cash working capital (excluding both short term debt and cash) increased to 56M from 50.65M (a 5.35M increase versus Q1). This 5.35M increase is due to the increase in sales (increased 21% or 13.8M).

o   Operating income has stayed mostly flat despite a  21% increase in sales: as such the extra 5.35M tied up in working capital generated almost no additional profits (only 28K pre tax).

-          Gross margin has fallen substantially in Q2 compared to Q1:

o   This explains the absence of change in operating income

o   The extra working capital needs will only generate earnings if margins recover

o   They state: this reduction “may be justified by the change of product mix traded, particularly with the increase in car sales.” This explanation makes sense since car sales have a lower margin than the remaining businesses the firm is involved with. Other explanation could be a pricing effort to sustain or recover market share. Market share is important not only because of scale in car sales but also because of future services revenue for the firm. In such situation, this investment (5.35M) could end up bringing future profits or at least avoiding a future reduction.

-          Net income increased in Q2 but a different effective tax rate was the main responsible

o   The funny thing is that the use of deferred tax assets was in Q1 but the tax was lower in Q2

o   Net income is what usually determines the dividend chosen, so in what comes to dividends it does not seem to matter where the net income came from

-          My 0.06€/ share 1S profit prediction failed by 0.008€/share. This is not meaningful and I do not overly rely on quarterly fluctuations but I will explain what generated the miss:

o   “a 40% increase in sales (assuming a fixed sales mix)” – a change in sales mix might have changed margins. The sales increase in a consolidated level was lower than 40% because of the 210 RACs deal. It seems I made a mistake in the numbers in the previous post. I assumed a 3638 Toyota+Lexus sales and it seems that number was only for the Toyota sales. Anyway those 210 vehicles are about one third of the increase. The commerce unit had a 33% profit reduction despite the sales increase.

o   The industrial unit had a 505k operating loss in Q2 versus an 802k loss in Q1 (a 300k reduction). I had guess-estimated a bigger reduction in losses. I have no comparison between quarters for auto transformation but they have reduced substantially in the semester. What I do not like about the industrial unit is that not only operating income is negative but also EBITDA is substantially negative. The good news is that an increase in production reduced losses. The bad news is that the company needed to use overtime work in May and June and as such new increases will require higher wages. The other good news is that there might be a lag between production spending increase and sales and maybe the some of the profits (or lower losses) will come in Q3.

o   Except for industrial equipment services all remaining units performed worse than in Q1.

o   Taxes were lower than estimated

-          Other bullet points:

o   Auto industrial unit: “In the meanwhile and as an estimate of the activity to be developed for the 2nd half of the current financial year, over 900 Toyota physical units and about 1,000 conversions are expected to be assembled, thus achieving levels of productive occupation which will enable a significant improve in income for this plant.”

o   Toyota auto commercial unit: “For the second half of the year, the outlook is favourable due to the launch of new products, which we see as core products: - Aygo (new generation); - Yaris (restlyling).”

o   Lexus auto commercial unit: “For the second half of the year, a even more favourable development is expected for the make's sales performance due to the launch of a new model: the new SUV Lexus NX 300h.”

o   Industrial equipment sales: At a global level, Toyota / BT sales grew by 41.9%, above the market, enabling to keep and strengthen Toyota + BT leadership with a market share of 27.8%.” – industrial services is the most profitable unit of the company and increased market share allows future services revenue

o   Costs have remained low despite the sales increase: the increase in payroll expenses in Q2 were more than offset by a reduction in external services

Disclaimer: read my previous disclaimers in Toyota Caetano posts, nothing has changed since the last one.

Toyota Caetano: 2nd quarter preview and some more data

I have not posted for some time about Toyota Caetano. I have been adding to my position so I did not feel posting about it would be a good idea. 

So what more do we now know?

Q2 Toyota+Lexus auto sales were 2123 units, a 40 % increase over Q1 (1515 units).

Q2 Toyota auto production were 513 units, a 107% increase over Q1 (248 units)

Why do I compare with Q1 instead of comparing with the previous year? Because we have the Q1 results to compare and we know that the cost structure was similar. So what happened in Q1?

Industrial unit:

Q1 sales were 3916k and operational loss was 802k. So we know this is the lagging unit on the company. Industrial sales are composed of auto production + auto transformations. Auto production numbers are readily accessible. Auto transformations we can only know by reading the quarterly reports. It seems plausible however that auto transformations should be closely related with national auto sales. In fact in most years auto units transformed have been around 40% of domestic auto units sold (I can be wrong here), but in some years they have been higher. If this is true, then we can deduce that industrial sales will increase at a pace somewhere between the 40% auto sales and the 107% auto production increases. Unfortunately gross margin and fixed costs are not available on a segmental basis, making  accurate predictions impossible. We know however that due to the mostly fixed nature of  depreciation, wages and some other costs, the sales increase should be much lower than the earnings increase. Earnings might continue negative, but since 350k is 0.01€/share, if operational losses were reduced to 100K that would be 0.02€/share increase in operational earnings in the quarter (0.08€ annualized).

Domestic marked auto sales- Commerce unit:

Q1 sales were 69.396k and operational profit was 795k. So a 40% increase in sales (assuming a fixed sales mix) would mean about 97M in sales in Q2. A disproportional increase in operational profits should be expected, and a double might be reasonable. I will assume a 700k increase in operational profit (0.02€/share).

Auto services and renting, Industrial equipment and international commerce (Cape Verde)

Auto services sales, in the long term, should benefit from increased auto sales. However in the short term I do not expect much change. I have no new data to add here, neither on the auto renting unit. However, it is interesting to look at Q1 data:

-auto services operational loss was 80k on 3786k sales

-auto renting unit operational loss was 24k on 1587k sales

- industrial equipment operational profit was 940k on 4183k sales

As long as the economic environment keeps increasing the industrial equipment sales and profit should also continue increasing. The increase in profit should exceed the increase in sales due to the unused capacity (just like in the remaining divisions of Toyota Caetano)

Segmental data are subject to eliminations (since there is much integration between units global profit change should be much lower than the sum of the individual parts). However, after a 1411k Q1 operational profit (721k net income to shareholders), the results should see a reasonable increase in Q2. In fact, I would expect (on a very light and maybe optimistic analysis) a near double of both operational profit and net income, which would mean 0.06€/share net income in the first semester (0.12€/share annualized, slightly above my projection some months ago).

BONUS:

July Toyota+Lexus auto sales were 944 units, a 56% increase YoY  (606 units), equivalent to 62% of Q1 sales in a single month. This is especially important because auto sales were already in recovery mode in July 2013 (the company's operational profit in 3Q 2013 was about 130k, translating to a 30k net income). However August and September are typically weak months. The August effect is probably also true for the industrial unit, although I have no data on that. However, with this information maybe we can expect a 3Q2014 similar to 1Q2014 in what comes to results.

In conclusion, Toyota Caetano sales seem to be recovering faster than I expected. If the increase continues, maybe de 0.10€/share net income I wrote about some months ago will be too conservative. Since the shares are trading at 1.20€, a 0.12€/share net income (which should translate to a 0.12€/share dividend) would represent a 10% (dividend) yield. Not bad for a still subnormal year.

2Q2014 results should be out by the end of the month and by then I will be able to check if I am modeling the results properly.

Disclaimer: I own shares off Toyota Caetano. I have added to my position at current price and at higher prices, but my average price is still below current price. This is no investment recommendation. I might (and will be) wrong in some instances. Do your own diligence. Always read the introduction post.

Banco Espirito Santo - risk, reward, circle of competence and coattailing

For a day last week the international markets went crazy on the reported falling of the a main portuguese bank. The problem was that some people didn't understand the difference between Banco (bank) Espirito Santo -BES- and Grupo (group) Espirito Santo - GES.

Today that has already become reasonably clear to everybody: GES belongs (partially) to the Espirito Santo family and GES owned 25% of BES (through Espirito Santo financial group, ESFG, this is quite an holding cascade). However, if look deeper we might notice that today GES owns (most likely) only 0,1% of BES. In fact Nomura  margin called them and aquired 4.9% (or 5%, I'm not exactly sure) of BES. Additionally, ESFG sold some debt which it can elect to pay with shares equivalent to 20% of BES valued at a price of €1.3129 (it currently trades at 0.38€). If ESFG bankrupts it is likely that those 20% will automatically settle the loan. So they actually own 20.1% of BES but are highly likely to soon own only 0.1%.

So we have the difference reasonably settled: the espirito santo family owns a holding that holds a holding that holds a holding (...) that holds 40 something% of a holding that owns 20.1% of BES, that actually are likely to be 0.1% in the future (maybe a not so distant one). In addition the management of BES change yesterday and the new managers not only aren't related to the Espirito Santo family, but actually are unlikely to be very sympathetic to them (they have a good reputation and most likely want to keep it clean, in fact they wanted to wait until the results are out to enter the group so that they wouldn't launch results they didn't have the opportunity to check). So basically GES and BES are almost totally independent right? Not so fast.

The problem is that only some months ago they were in charge of the bank:
- it has already been disclosed a significant direct exposition of BES to GES: since it is quite complicated I leave the link http://web3.cmvm.pt/sdi2004/emitentes/docs/FR51236.pdf
- there are fears that there might be further exposition either direct or indirect
- there are fears that the quality of management that led to the current GES situation might show up also in BES
- in a related note it seems that BES Angola (which belongs to BES) is in a distressed position. That would imply no further problem if BES couldn't be called to cover a part of the hole there (it is said that BES might have to put up to 2000-3000 million there). This is one of the big question marks. Actual exposition doesn't seem clear, but it is worth noting that the Angola government warrants about 4000 million of the about 6000 million credits there and it is said that BES Angola might be nationalized there. Here I can had no insight, I haven't studied this situation.

However, it is not all bad news:
Banco de Portugal (the regulator) has been all over this situation for months. They have been trying to insulate BES from the group:
- As you can read on the link, ESFG has had to establish an"unconditional and irrevocable guarantee of EUR 700 million". Whatever that is it might mean that part of the problem might be covered (as long as ESFG can cover it, they say they can)
- BES exposition to GES was already known by BP and as such BES had to make a capital increase of over 1000M€ last month at 0.65€, after which the bank traded around 1€
- the new independent management most likely was chosen under pressure from Banco de Portugal and they had to start their work there before their chosen date
-the new management is said to have asked today an audit to the company numbers
-today the previous CFO (if I'm not mistaken), who the family had initially proposed to CEO instead of the current management seems to have left the BES management.
- Seth Klarman, through Baupost, disclosed a position in BES last week, when the bank was trading around 0.5-0.6€ (today closed at 0.38€).


So what should I do?
1- Banking is out of my circle of competence. I could try to learn it but I doubt it would be useful in this particular case.
2- Distressed investing is out of my circle of competence. It isn't however outside Seth Klarman's circle and I believe I read/heard some years ago that Klarman was at the time the only fund manager he recomended (from those he could promptly remember).
3- I like coattailing but only to get ideas, I don't coattail blindly
4- I am not an high risk/high reward type of investor. Taking my circle of competence into account this is a very high risk situation for me

As such, I'm out and I won't regret not getting rich with this one. But if Klarman paid much more than you could pay today it might be worth your attention

disclosure: no position. I might have got something wrong on the info above. I believe it to be reasonably accurate but ALWAYS do your own due diligence.

The Oi PT merger and the price collapse

This merger is getting much more interesting than I expected in the beggining.

As mentioned on precious posts, I never entered the arbitrage situation but I did point out to the price gap getting thinner on the following week suggesting a closing of the arbitrage. But this is also a case to remind us that the most unexpected sometimes happens. The good news is that the arbitrage implied going short PT and long Oi common ADR and that the gap actually reduced a lot and might even invert (if it hasn't yet, I'm not going to the the calculation here - it is fairly easy to do and was already exemplified on the initial post). But let's go back a little:

So we had a situation of a merger where the terms had been settled and there seemed to be no way it was going to be canceled. A price gap of 18% allowed a decent arbitrage situation. But some months latter we find out that previously to the settlement PT administration decided to lend 897M€ to a shareholder (or related parties to that shareholder, it isn't important) in financial distress. It was a short term loan but (as it happens when you are in financial distress-- Don't go into debt) it is currently seeming likely that those shareholders will not be able to pay back on time (and even to pay back the full amount ever).

Since 897M€ is a decent amount of money to PT this might be a gamechanger. It seems likely that the merger will happen anyway but it also seems likely that (if PT isn't paid back in full in due time) the terms will be changed and maybe PT shareholders will receive a worse ratio than expected. Oi shareholders would get less diluted, PT's management image gets a "little" burned (and so easier to substitute), Corpco would have "some" millions less (and would have to find a way around it, which is hard for a leveraged company), but still the merger will probably go through. All this led to a price collapse of both PT and Oi, bigger on the PT side.

Anyway, the arbitrage situation, despite having been profitable should be turned off until new information arrives even if the gap re-opens. It could happen that everything stayed the same and this was just a lump but it seems wise to recalculate the odds.

Disclaimer: no positions for the moment, I have no idea if I will do something about this all situation at the moment. Most of the things  I write on this post are just a rationalization attempt and it is perfectly possible that I am wrong - do your own research. This isn't an investment advice (it never is - read the introduction post).

Toyota caetano update

Both the auto data for May as well as the Toyota Caetano’s interin report are out.

First of all I have no insights as to why light vehicle sales were so off base in May. I would add however that both Lexus sales and commercial vehicle sales continued growing pretty fast. Taking everything into account the volume decrease of 7 units is negligible in terms of sales. However, it still is a totally off-base month. On the other hand an off-base month on the negative side after an off-base month on the positive side makes me think that maybe both were "sample errors" and the baseline sales should be somewhere in the middle. Sitting and waiting is the most important job for an investor and as such here I wait for June's results.

Market share loss is the most preoccupying factor that is implicit on the results. On a rising sales market it could mean that mindshare might have been lost. On the positive side what I like in Toyota Caetano are both the balance sheet and I would be happy with the cashflows even if they stayed flat yoy.

First three months results are out and in line with expectations.

Last three months 2013 volume was about 1730 Toyota light vehicles, 31 heavy commercial vehicles (so 1761 Toyota vehicles) and 61 Lexus. First three months 2014:“ Toyota sales increased from 1063 to 1515 (42.5%). Lexus sales increased from 37 to 62 (67.6%).”

Since the volumes are not comparable due to seasonality, the useful comparison here is to search for profits evolution. So (on a rolling base) a 13.5% decrease in volume resulted in an EBITDA decrease to 4139k€ from 4479k€ (7.5%). Net income decreased from 954k€ to 721k€ (24.5%), which is expectable since despite lower debt depreciation is a fixed expense. For that motive, and knowing that sales are not comparable, I believe the EBITDA evolution to be the most important on the comparison and would be above expectations IF the only profit driver where Portuguese car sales, which actually is not the case. As such, I would not go as far as saying that the results were above what should expected but instead they seem to be roughly in line with expectations

Both mensal sales and interim reports are more important to value trends than results meaning nothing if not into context. For example, investment in the auto renting unit from January through March was 1177K€. At 15k€ per unit that would amount to 78 units. If we imagine that the company wanted to increased their auto renting fleet for the Summer and decided that May was too near and June too late it would be perfectly logical that the company decided to buy themselves 100 units in April and none in May, which averaged out would mean that maybe normalized sales should have risen without such effect. This example, despite plausible, comes straight from fantasy land, but shows how little this results mean in an isolated way. With that said, I would rather have seen rising sales and higher profits but it changes very little in my thesis.

Disclaimer: I own Toyota Caetano shares. I WILL buy and/or sell shares without prior notice if I believe appropriate. Always do your own research. See my other disclaimers.

Toyota Caetano: an update on sales and what will determine investment success

In my post about Toyota Caetano I rambled a lot around what I think is important but I might not have stated it appropriately.

In my opinion what truly can make the investment an homerun (or not) is:

1-The evolution of the portuguese economy in the form of car sales (more specifically Toyota an Lexus car sales) and, to a lesser extent, real estate market (because the company as both directly and indirectly a significant real estate position)

2-Toyota Motor Corporation long term resiliency (basically, if they stopped manufacturing cars or if their cars lost interest this investment would have little if any upside)

So, I must monitor these factors closely. Factor number two is both unlikely and very long term, meaning that monitoring has little use. The portuguese real estate market is less meaningful for the company and less objective to monitor. However car sales are easy to monitor.

And April (provisory) car sales are out:
-In April 2014, total national car sales were up 54.2% year over year, totaling a January to April increase of 46.4% yoy.
-In April, Toyota light vehicles sales increased 68.5% yoy totaling a 49.9% yoy 4 month increase.
-In April, Lexus light vehicles sales increased 475% yoy (only 4 units sold in April 2013) totaling a 107.3% yoy 4 month increase.
-In April, Toyota heavy commercial vehicles sales increased 500% yoy (only 2 units in April 2013) totaling a 83.3% yoy 4 month increase.

These data seem great but are less meaningful than they seem at first sight. The truth is that the first 4-5 months last year were very weak and April was one of the worst months (if we adjust for seasonality). Since the economy slowly improved throughout 2013 yoy growth should also decrease through 2014. However, it is likely that the pace continues for some months and, since car sales are still very low in comparison to historical levels, that could mean that this increase might be on the worst case a new normal but likely still below normal.

More importantly, what do current numbers mean in comparison to company projections?

In 2013 Toyota sold 5876 units and Lexus sold 156 units. They propose an increase of 16% in Toyota sales and 80% increase in Lexus sales. This would imply an increase of 940 Toyota units and 125 Lexus units. Until April 2014 the increase has been of 749 Toyota units and 44 Lexus units.

As such, it seems that very little growth is required to hit the full year objective for Toyota vehicles and Lexus objective is still on track. A flat second semester would probably be enough to reach Toyota sales objectives. Second semester last year represented about 1 million in net income (which is what they usually translate into dividends). Lower leverage however would most likely add a bit to that income and, in that case, the first semester would most likely be better than the second.

Taking everything into account I would not be surprised if, conservatively speaking, 2014 net income neared 3.5 million (0.10€/share) and if the company ended the year with little or no net debt (depending on the evolution of investment cashflows).

Also interesting will be comparing 2011 to 2014. Up to now sales have been inferior but it does not seem impossible that either in June or in September unit sales will be similar. That would allow us to confirm if the company's efficiency truly increased and to quantify the increase (however, special workforce reduction costs in 2011 will have to be taken into account in the comparison). I am looking forward to that exercise and hope it is reached already in the first semester.

disclosure: read previous posts disclosures and the introduction post. I own Toyota Caetano shares