Monthly Archives: February, 2013

Navios Maritime nm

Navios Maritime Holdings (NM) Moderate Financial

February 20th, 2013 Posted by Company Research Report No Comment yet

Balance Sheet

Financial Liquidity 

For NM’s liquidity, the following is their results from 2007 to 2011 operations.

  • Current ratio was 1.88, 1.86, 2.18, 1.73 and 1.47. Average of 1.83, which shows that in five years period it is fluctuating, its highest ratio was in 2010.
  • The quick ratio was 1.88, 1.82, 2.11, 1.64 and 1.38. Its average was 1.77 which is also up and downtrend and high in 2010 while the lowest was in 2012 at 1.38.
  • Working capital ratio average was .09, which shows positive result throughout its five years of operation, trending down with the highest ratio in 2008 at .20. Its lowest was 2011 and 2012 at .04.

As long as the company’s current asset could meet its current liabilities when due, the company is considered liquid. Therefore, NM is a liquid company; its current resources can meet its current obligations when becoming due. However, it did not meet the standard ratio of 2.

Asset Management/Efficiency

Laid below are the data gathered by Rio for Navios Maritime Holdings Inc.’s efficiency ratios from 2007 to 2011:

  • The average inventory turnover ratio was 34.96 times and it takes 11 days to sell its stocks.
  • The receivable turnover ratio was 7.64 times average which is equivalent to 52 days for its receivable to collect.
  • While payable turnover ratio was 12.19 times and 33 days for the company to pay its suppliers.
  • Asset turnover ratio average was .31 times. This ratio indicates the productivity of total assets in generating revenues.

Cash Conversion Period

Let’s see NM’s cash conversion cycle through the table and graph below:

Cash conversion cycle of Navios Maritime Holdings Inc. was 30 days average. In 2007, it was negative 1 since the inventory balance was 0. However, thereafter until 2011, it went high. This tells the owner the number of days that cash or capital stays tied up in the business processes of the firm.

 Leverage

Debt ratio, debt to equity ratio and the solvency ratio of NM from 2007 to 2011 are as follows:

  • Debt ratio was .61, .64, .68, .71 and .64. Its average was .66 which means that total liabilities of the company was 66 percent against total assets.
  • Debt to equity was 1.56, 1.80, 2.17, 2.47 and 1.75, an average of 1.95. It tells us that total liability was 195 percent of the owners’ equity.
  • Average solvency ratio was .12 which means that the company did not meet the standard percentage of 20.

By looking at the above data, NM’s total debt was more than 50 percent of its total asset, more so with total equity which was 195 percent average. It indicates that the company expanded its assets through borrowings. Thus, it contributed to a lower solvency ratio of 12 percent.

Let’s get to find out now who has the majority claimants of the company based on total assets.

  • Current liabilities to the total asset has an average of .11 which means that the company’s creditors have only 11 percent claim.
  • While long-term liabilities to the total asset was .47 which tells us that the banks and bondholders have only 47 percent claim.
  • And, stockholders’ equity to the total asset was .34 which means that its stockholders have only 34 percent claims on the total assets of NM.

“Therefore, it shows that the majority claimants of the total assets of the company are the banks and bondholders which have a percentage of 47,” Rio said.

Property, Plant & Equipment

Investment in the Navios Maritime Holdings Inc. in property, plant, and equipment from 2007 to 2011 are the following:

  • The gross property, plant, and equipment have an average of 1,487 in five years period. It shows that its expansion had increased which started in 2010 doubling it’s 2009.  Yearly percentage of growth was 75, 109, 44 and -17 percent.
  • Accumulated depreciation was 135 average which is equivalent to 9 percent only.
  • The cost of PPE was 1,352 average in five years or 91 percent of the total cost of the fixed asset.

Therefore,  if the estimated life of the property was 5 years, its used life was the only half year, so, the property could still be usable for 4 and a half years more.

Income Statement

Income

  • Revenue was 758, 1246, 599, 680 and 689 with trailing twelve months of 656. It was trending up and down which has a growth rate of 64, -52, 14 and 1 in 2011.
  • Gross profit was 731, 153, 213, 296 and 299 with ttm of 258. Its percentage growth was -79, 39, 39 and 1.
  • Operating income was 676, 53, 95, 132 and 138. It is the result after deducting operating expenses from gross profit.
  • Income before tax was 275, 64, 69, 146 and 41 with a growth rate of -77, 8, 112 and -72 percent.
  • And income after tax was 271, 119, 68, 146 and 41, with ttm of 41.  This is the result of applying the provision for income tax.

The income of NM was up and down. Its revenue almost doubled in 2008 but decreased by 52 percent in 2009, rose back by 14 percent in 2010 and 1 percent in 2011. However, its income after tax showed a decrease of 56 percent in 2008, 43 percent in 2009 but recovered in 2010 by an increase of 115 percent but dropped in 2011 by 72 percent.

“Overall result was positive although there were an up and downtrend,” Rio explained.

Expense

Expense refers to any deduction from the company’s earnings in a given period.  Details of NM’s expense from 2007 to 2011 are as follows:

  • The cost of revenue was 28, 1093, 385, 384 and 391, ttm of 398 which is equivalent to 4, 88, 64, 56 and 57 of revenue.
  • Operating expense was 54, 100, 119, 164 and 160 with ttm of 153, equivalent to 7, 8, 20, 24 and 23 percent of revenue.
  • And total expense was 459, 149, 183, 256 and 267 whose average was equivalent to 36 percent of the total revenue.

NM’s expense percentage to revenue was the cost of revenue average of 54 percent, operating expense 16 percent and other expense 19 percent of a total of 36 percent.

Margin

Margin refers to the company’s total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. From 2007-2011, here are the margin of Navios Maritime Holdings Inc.

  • Gross margin was .96, .12, .36, .44 and .43, ttm was .46. This is the percentage result of the gross profit over revenue.
  • Operating margin was .89, .04, .16, .19 and .20, ttm of .30. This is the operating income over revenue in percent.
  • Pretax margin  was .36, .05, .12, .21 and .06. with ttm of .16
  • And net profit margin was .36, .10, .11, .21 and .06, ttm was .17. This is the bottom line express in percentage.

Above data shows the percentage result of NM’s profit over its revenue. The average gross margin was 46 percent, operating margin was 30 percent after deducting the operating expenses and net profit margin was 17 percent.

Profitability

Profitability ratios help users of a company’s financial statements determine the overall effectiveness of management regarding returns generated on sales and investments. Let’s see what Rio got in NM’s profitability ratios from 2007 to 2011.

  • Net margin of NM was .36, .10, .11 .21 and .06 average of .17. It is the bottom line of the income statement expressed in percent. As noted, it was high in 2007 at 36 percent and very low in 2011 at 6 percent.
  • Asset turnover ratio has an average of .31 times.
  • Return on asset was .14, .03, .02, .04 and .01 with an average of .05.
  • Financial Leverage was 2.56, 2.80, 3.17, 3.47 and 2.75. Average was 2.95.
  • Return on Invested capital was .07 average in five years period.
  • Return on equity of NM was 15 percent using the DuPont method; if debt-free is only 5 percent.

Return on Equity using the DuPont Method

There are three components in the calculation of return on equity using the traditional DuPont model. They are the net margin, asset turnover, and equity multiplier. By examining each input individually, we can discover the sources of a company’s return on equity and compare it to its competitors.

The net profit margin is simply the after-tax profit that a company generated for each dollar of revenue. While asset turnover is a measure of how effectively a company converts its assets into sales. And the equity multiplier, a measure of financial leverage, allows the investor to see what portion of the return on equity is the result of debt.

To calculate the return on equity using the DuPont model, simply multiply the three components (net profit margin, asset turnover, and equity multiplier.) or follow this formula:

Return on Equity = (Net Profit Margin) (Asset Turnover) (Equity Multiplier).

“Through this method, we could determine what is the real ROE of the company if debt-free and what portion was the returns of the company earned on the debt at work in the business”, Rio said.

Modified Income

Rio really wanted us to understand things further so she made a graph which comprised the three areas of the income statement. So let’s get to know the graph better.

  

The data above shows that:

  • Revenue of NM from 2007 to 2011 was 758, 1246, 599, 680 and 689 with trailing twelve months of 656.
  • Total expenses were 487, 1127, 531, 534 and 648. ttm of 625 which include the cost of revenue, operating and others.
  • And net income was 271, 119, 68, 146 and 41, trailing twelve months of 31.

The five years period profit and loss statement of NM company tells us that its total expense reached as high as 83 percent average resulting in a net income of 17 percent. Its high figures were in 2007 and 2010 and the lowest in 2011 but all positive result. What can we say to this company then? “Good enough to this company,” Rio answered.

Cash Flow

Presented below is Navios Maritime Holdings Inc Cash Flow. But as mentioned there are three categories. Why don’t we tackle each? Let’s go.

Cash Flow from Operating Activities

Net cash provided by operating activities of NM from 2007 to 2011 was 128, -28, 216, 182 and 107. ttm was 110.  All results are positive, except in 2008 which was negative 28, but immediately recovered in 2009 to 2011. It means that the company has available funds for investing.

Cash Flow from Investing Activities

For Navios Maritime Holdings Inc., investing transactions from 2007 to 2011 were:

  • Total cash inflows were 353, 75, 67, 552 and 120 which came from PPE reductions and other investing activities, while
  • Cash outflows were  -369, -527, -868, -682 and -295 which are an investment in PPE, acquisitions, purchase of investment and other investing activities.

Investing cash flow of NM showed a negative balance throughout its five years period because cash outflows were more than its cash inflows on investing activities.

Cash Flow from Financing Activities

Total cash inflow was 382, 322, 1016, 901 and 621 which came from debt issued and common stock issued. Cash outflow, on the other hand, was -165, -135, -390, -920 and -588 which were debt payment, repurchase of treasury stock, cash dividends and other financing activities.

The financing cash flow of NM results was positive in 2007 to 2009 and 2011 because its cash inflows exceed cash outflow while in 2010 cash outflow was -920.  Its cash inflow was 901 resulting in a negative balance of 19.

 Free Cash Flow

The free cash flow of Navios Maritime Holdings Inc. was 83, -446, -562, -400 and -87.  Cash flow shows a negative balance because of high capital expenditure starting 2008 to 2011. It indicates that financing is needed to support current operations and programs.

It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run. Thanks to Rio for that wonderful explanation.

Cash Flow Ratios

For NM, cash flow ratios used from 2007 to 2011 are:

  • Cash flow margin average was .17. It shows that the company is able to create $0.17 of cash out of $1 dollar in revenue.
  • Average operating cash flow ratio was .52 which is not good at all.  The company is not generating enough cash to pay off its short-term debt which is a serious situation. It is possible that the firm may not be able to continue to operate.
  • Free cash flow ratio was .17 ttm.  It is a measure of the financial strength of the company.
  • Capital expenditure was -.78 which tells us that the company has no financial ability to invest in itself through capital expenditure.
  • And total debt ratio was .06 which indicates NM’s ability to cover the total debt with its yearly cash flow from operations.

The overall cash flow of NM is not impressive as shown through its cash flow ratio results.  Cash flow margin was .17, operating cash flow was.52, capital expenditure was -.78 and total debt ratio was .06; insufficient to cover its total debt.

Alright, probably this is my favorite part of the article. Not that it was close to ending but this is where I can see the perspective of the reader. So with this, I want to know what Rio can say to the overall of Navios Maritime Holdings Inc.

Conclusion:

As to the financial strength of the company, its liquidity is at a moderate level with average cash conversion cycle of 30 days, leverage not so high however solvency is below normal. For the company’s margin and returns, net margin average in five years was 17 percent and returns on equity which include debt was 15 percent, however, if debt-free was only 5 percent. And for its cash flow, average cash flow margin was 17 percent and cash flow ratios showed that it is not impressive, did not meet the standard level.

Taking into consideration all the things mentioned above, therefore, my stand on this company is HOLD.

Written by Rio
Edited by Cris

Tencent Holdings Limited (0700 HKG) Investment Valuation

February 19th, 2013 Posted by Investment Valuation No Comment yet

Tencent Holdings Limited is a Chinese multinational investment holding conglomerate founded in 1998. The subsidiaries specialize in various Internet-related services and products, entertainment, artificial intelligence, and technology. 

Tencent Value Investing Approach   

This method of valuation approach for Tencent Holdings Ltd was based on the Discounted Model.  The historical data was calculated. And then we come up with the projected financial data and ratios to come up with the net present value of the 6th year period. Net present value is one way to decide if an investment is worthwhile by looking at the projected cash inflows and outflows.

 

Tencent Discounted Cash Flow Approach  

The formula for the discounted cash flow is:

  Discounted Cash Flow

Where:

  • Vo is the value of the equity of a business today.
  • CF1 to CFn represent the expected cash flows (or benefits) to be derived for periods 1 to n.  The discounted cash flow model is based on time periods of time of equal length.
  • r is the discount rate that converts future dollars of CF into present dollars of value.

The equation above is the basic discounted cash flow (DCF) model.

Discounted Cash Flow Spreadsheet

Tencent Combined DCF

Explanation

The Discounted Cash Flow spreadsheet shows the historical income and expense plus the equity data in the total amount and per share.  The present value of equity was $26.35 at a rate of 29.80 percent.  The future value of $96.94 is equal to the present value of $26.35. This means, leaving you a choice of having $26.35 today or wait for the 6 time periods to have $96.94 per share. If you take the $26.35 today, you will have a chance to reinvest the money at 29.80 percent at the same equal time periods which will end up having more than $26.35.  Moreover, the projected net income for year 5 was $32.05 per share a total value of $59.62 billion, while the present value was $25.7 billion.

On the other hand, the capital rate that was used was 15 percent. The future value of equity was $312.9 billion at a future price of $168.25 per share. While the present value of Tencent Holdings Ltd was $135 billion at $72.74 per share. The return on investment that was used was 33.07 percent. While the price to earnings that were used in the calculation was $5 and it’s earning per share was $8.71.  The current market price, February 13, 2013, was $35.10 per share.

Tencent Investment in Enterprise Value   

The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value (EV) is the present value of the entire company. Market capitalization, on the other hand, is the total value of the company’s equity shares. In essence, EV is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt while pocketing any remaining cash. This gives the buyer solid grounds for making its offer.

Tencent EV

Explanation

The market capitalization for Tencent Holdings Ltd was increasing except in 2011 where it experienced a drop of 8 percent. The total debt represents 6 percent average, while the cash and cash equivalent represent a 78 percent average. As a result, the enterprise value was lesser by 72 percent against the market capitalization. If an investor decides to buy the entire business of Tencent Holdings Ltd, then he/she will be paying 100 percent of its equity, no debt, because cash was greater than the total debt.

The purchase price to date February 13, 2013, in buying the entire business of Tencent Holding Ltd was $42.9 billion at $23.07 per share. The market price to date was $35.10 per share.

Benjamin Graham’s Stock Test    

Net Current Asset Value (NCAV) Approach     

Graham developed and tested the net current asset value (NCAV) approach between 1930 and 1932. Graham reported that the average return, over a 30-year period, on diversified portfolios of net current asset stocks was about 20 percent. An outside study showed that from 1970 to 1983, an investor could have earned an average return of 29.4 percent by purchasing stocks that fulfilled Graham’s requirement and holding them for one year.

Net Current Asset Value (NCAV) Method  

Studies have all shown that the Net Current Asset Value (NCAV) method of selecting stocks has outperformed the market significantly.

Graham was looking for firms trading so cheap that there was little danger of falling further.  His strategy calls for selling when a firm’s share price trades up to its net current asset value. The reason for this according to Graham is when a stock is trading below the Net Current Asset Value Per Share, they are essentially trading below the company’s liquidation value and therefore, the stock was trading at a bargain, and it is worth buying.

The concept of this method is to identify stocks trading at a discount to the company’s Net Current Asset Value per Share, specifically two-thirds or 66percent of net current asset value.

Tencent MC NCAV

Explanation

The net current asset value approach of Benjamin Graham indicates that the stock price was overvalued from 2007 to 2012. Because the market value was greater than the 66 percent ratio. The 66 percent ratio represents only 18 percent of the market value. Thus, the stock was trading above the liquidation value of Tencent Holdings Inc.

It tells us that the stock of Tencent did not pass the stock test of Benjamin Graham because the price was expensive.

Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation  

By calculating market capitalization over the net current asset value of the company, we will know if the stocks are trading over or undervalued. The result should be less than 1.2 ratios. Graham would only buy if the ratio does not exceed 1.2 ratios.

Formula: Market Capitalization / NCAV = Result (must be lesser than 1.2)    

Let’s go over with the result from the table below:

Tencent NCAVPS

The MC/NCAV valuation tells us that the stock price of Tencent was overvalued from 2007 to 2012. Because it exceeded the 1.2 ratios. It did not pass the stock test of Graham because the stock was expensive. 

Benjamin Graham’s Margin of Safety (MOS)     

The margin of Safety requires knowing when the buying price is low in absolute terms, rather than merely relative to the market as a whole. This formula is used to identify the difference between company value and price.Graham called it the intrinsic value.

This is the concept taught by Benjamin Graham and still referred to by Warren Buffett. Value investing is buying with a sufficient margin of safety. Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. Because enterprise value takes into account the balance sheet and a much more accurate measure of the company’s true value compared to market capitalization,

To arrive at the results below for Tencent Holdings Ltd, we used the formula Margin of Safety = Enterprise Value – Intrinsic Value.

Tencent MOS

Explanation

Benjamin Graham’s margin of safety indicates a 96 percent average for Tencent Holdings Ltd. The margin of safety was at $282 average. The enterprise value was average $10 representing only 3 percent of the intrinsic value, while on the other hand, the intrinsic value was average $292 representing 3041 percent of the enterprise value.

Intrinsic Value

Intrinsic Value = Current Earnings x (9 + 2 x Sustainable  Growth Rate)   

The explanation in the calculation of intrinsic value was as follows:

EPS or the company’s last 12-month earnings per share; G as the company’s long-  term (five years) sustainable growth estimate; 9 is the constant that represents the appropriate P-E ratio for a no-growth company; and 2 for the average yield of high-grade corporate bonds.

Tencent IV

Explanation

What factors intrinsic value? In our calculation, using the formula of Benjamin Graham for intrinsic value, the earning per share and the growth plays an important role in the calculations. The earning per share was $3 average, while the sustainable growth rate was 39 average. On the other hand, the annual growth rate was 86 average.

Earnings per Share (EPS)

The formula for earning per share was:

          EPS

Sustainable growth rate (SGR), on the other hand, shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its blowback ratio, which is equal to 1 minus the dividend payout ratio.

Sustainable Growth Rate

Sustainable growth rate = ROE x (1 – dividend-payout ratio)
Tencent SGR

The table above shows that the return on equity was average 42 percent while the payout ratio was 8 percent average.

Let’s move on with Return on Equity or ROE. This is used as an indicator of a company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. In other words, the return on equity shows how many dollars of earnings result from each dollar of equity. The formula for the return on equity was:

 ROE

Relative and Average Approach

The summary of the two approaches is in the table below.

Tencent Relative

Let us walk farther and see how is the real value of the stock of Tencent Holdings Ltd and the market price of the stock significant in the margin of safety.

  Tencent Graph

Explanation

The intrinsic value line soared up very high at a rate of 2969 percent average from 2007 to the trailing twelve months 2012. This is the true value of the stock of Tencent Holdings Ltd. This means that the true value of the stock is soaring high, but in the trailing twelve months of 2012, it falls down at -9 percent. The price was stable at an average of $10, trending at 13 percent average.  The graph shows a 96 percent average margin of safety from 2007. Overall, this is what Benjamin Graham meant, when he said, purchasing at a discount to its underlying intrinsic value.

IV is the true value of the stock and EV is the market price and the difference between the two lines is what we called the margin of safety.

Tencent Relative Valuation Methods       

The main purpose of these relative valuation methods for valuing a stock is to compare market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock. 

Price to Earnings/Earning Per Share (P/E*EPS)  

This valuation will determine the status of the stock price. Stocks may be undervalued or overvalued.  One way to do this is by simply multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share.

Tencent PE EPS

Explanation

The P/E*EPS valuation shows that the price was undervalued from 2007 to the trailing twelve months 2012. The enterprise value represents only 8 percent of the P/E*EPS ratio, therefore, the price was cheap.

The price was undervalued because the stock price was lesser than the result of the P/E*EPS ratio. Another way of calculating this valuation is by using the average price to earnings ratio.

Tencent Relative PE

Price to earnings ratio using the average approach has greater results because it takes into consideration the past performance of the company, in which the P/E ratio for 2006 was 5000 percent. 

The Enterprise Value (EV)/Earning Per Share (EPS) or (EV/EPS)    

The use of this ratio is to separate price and earnings in the enterprise value. By dividing the enterprise value of projected earnings (EPS). The result represents the price (P/E) and the difference represents the earnings (EPS).  If the analysts think that the appropriate ratio is greater or lower than the result.

  Tencent EV EPS

Explanation

The EV/EPS valuation indicates that the price (P/E) that was separated represents 36 percent average. While the earnings (EPS) a were 64 percent average. This might indicate that the price was cheap because the price represents only one-third of the enterprise value.

Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)        

This metric is used in estimating business valuation. It compares the value of the company inclusive of debt to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries.

Tencent EV EBITDA

Explanation

The EV/EBITDA valuation tells us that it will take three years to cover the cost of buying the entire business. In other words, it will take three times the cash earnings to cover the cost of the purchase price. This valuation also shows the profitability wherein, it has a 74 percent average gross profit margin. Likewise, its net margin was 38 percent average.

Conclusion: 

In the Discounted Cash Flow spreadsheet, the capital rate that was used was 15 percent.  The present value of equity per share was $26.35 at the rate of 33.07 percent. While the future value was $96.94 per share discounted today at present value. Taking the amount of $96.94 today, you will be able to reinvest at the same 33.07 percent for the same equal 6 time period. Also, end up getting a higher amount. Moreover, the future value of equity was $312.9 billion at a future price of $168.25 per share. While the present value of Tencent was $135 billion at $72.74 per share. In addition, the projected income at year 5 was $32.05 per share discounted at present value.

Enterprise Value

The enterprise value valuation, total debt represents 6 percent and the cash and cash equivalent represent 78 percent. Thus the enterprise value was lesser by 72 percent against the market value. Buying the entire business to date, December 26, 2012, will cost $37.5 billion at 20.16 per share.

Net Current Asset

The net current asset value approach of Benjamin Graham indicates that the stock price of Tencent was overvalued. For the reason, the stock was trading above the liquidation value of the company. MC/NCAV valuation, on the other hand, shows that the stock price was expensive because the ratio exceeded the 1.2 ratios. Further, the margin of safety for Tencent Holdings Ltd was 96 percent average. While the intrinsic value was $292 average. In addition, the sustainable growth rate was $39 and ROE was $42 average.

Relative Valuation

Taking consideration of the relative valuation, it shows that the stock price was undervalued. Because the price (P/E) represents 36 percent. While the earnings (EPS) was 64 percent average in the EV/EPS valuation.  Moreover, the P/E EPS valuation shows that the price was undervalued because the price represents only 8 percent average.

EV/EBITDA

Furthermore, the EV/EBITDA valuation tells us that it will take 3 years to cover the costs of buying the business. In other words, it will take 3 times the earnings of the company to cover the costs of buying. The gross and net margins were 74 and 38 percent average.

Overall, the stock price was cheap and the margin of safety was 96 percent average. Moreover, the company has an impressive gross and net margins at 74 and 38 percent, respectively. Moreover, the return on equity was 42 percent average. Therefore I recommend a BUY in the stock of Tencent Holdings Ltd.

Research and written by Cris

This investment valuation is a bit different from our previous report.

BHP Billiton plc

What’s Up with BHP Billiton Plc (ADR) BBL

February 14th, 2013 Posted by Investment Valuation No Comment yet

BHP, formerly known as BHP Billiton Plc (ADR), is the trading entity of BHP Group Limited and BHP Group plc, Anglo-Australian multinational mining, metals, and petroleum dual-listed public company headquartered in Melbourne, Victoria, Australia. From Wikipedia

BHP Value Investing Approach   

This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. The essence is that any investment should be purchased at a discount. In other words, the true value should be more than the market value. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.

BHP Investment in Enterprise Value  

The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise  Value (EV) is the present value of the entire company.  Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash. 

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)
BBL EV
The market capitalization was erratic in movement. Total debt was 9.5 percent, while cash and cash equivalent were 4 percent of the enterprise value, thus enterprise value was 5.5 percent over against the market capitalization. Buying the entire business of BHP is paying 5.5 percent of its total debt and 94.5 percent of its equity. The cash per share was $2.88 average.

The purchase price to date, February 11, 2013, would be $202 billion at $75.54 per share.  The market price to date was $68.08 per share.

Stock Test by Benjamin Graham

Net Current Asset Value (NCAV) Method

Studies have all shown that the Net Current Asset Value (NCAV) method of selecting stocks has outperformed the market significantly.

The reason for this is when a stock is trading below the Net Current Asset Value Per Share, they are essentially trading below the company’s liquidation value and therefore, the stock was trading at a bargain, and it is worth buying.

Primarily, the concept of this method is to identify stocks trading at a discount to the company’s Net Current Asset Value per Share, specifically two-thirds or 66 percent of net current asset value. 

BBL NCAVPS

Explanation

The net current asset value approach tells us that the stock of BBL was trading at an overvalued price from 2008 to the trailing twelve months. The 66 percent ratio represents only 2 percent of the market value per share. The net current asset value was negative during 2012 and the trailing twelve months.

It shows that the stock of BHP did not pass the stock test because the price was expensive and was trading above the liquidation value of the company.

Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation    

By calculating market capitalization over the net current asset value of the company, we will know if the stock is trading over or undervalued. The result should be less than 1.2 ratios.

Formula: Market Capitalization / NCAV = Result (must be lesser than 1.2)  

BBL MC NCAV

The MC/NCAV valuation shows that the stock of BHP was trading at an overvalued price from 2008 to the trailing twelve months because the ratio was more than 1.2 ratios.

The margin of Safety (MOS)  

 In my calculation, I used the enterprise value because it takes into account the balance sheet so it is a much more accurate measure of the company’s true market value than market capitalization.

BBL MOS

Explanation

The margin of safety for BHP was 63 percent average which is equivalent to $246. The enterprise value was 21 percent of the intrinsic value.  There was the margin of safety from 2008 to the trailing twelve months except in 2009 where there was zero margin of safety.  The formula for intrinsic value was:

Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)    

The explanation in the calculation of intrinsic value was as follows:

EPS or the company’s last 12-month earnings per share; G as the company’s long-term (five years) sustainable growth estimate;  9 is the constant that represents the appropriate P-E ratio for a no-growth company as proposed, and 2 for the average yield of high-grade corporate bonds.

BBL IV

Explanation

BHP Billiton plc (ADR) marked an intrinsic value averaging to $306, decreased by 93 percent in 2009 and went up by 530 percent the following year. While the sustainable growth rate was 20.69 percent and the annual growth rate was 50.38 percent average. The earning per share was $5.39 average.

The formula for earning per share was:

    EPS

Sustainable Growth Rate (SGR)

Sustainable growth rate (SGR), on the other hand, shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio. Sustainable growth rate = ROE x (1 – dividend payout ratio)

BBL SGR

Explanation

The average return on equity was 31 percent from 2008 for BHP, while the payout ratio was 38.68 percent average. ROE was low at 15.01 percent during 2009 but the payout ratio was high at 77.8 percent.

Moving forward, Return on Equity (ROE) is an indicator of company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. For us to calculate for ROE, we would use this formula:

      ROE

Return on Equity also shows how many dollars of earnings result from each dollar of equity.

Relative and Average Approach

BBL Relative

Relative and Average approach produced almost the same results. For the return on equity, the average result is greater by 2 percent because it took into account the previous period’s performance.

BBL Graph

Explanation

As we can see, the line of intrinsic value in 2009 slope downward by 93 percent from 2008, then it dropped down below zero, for margin of safety. Then it slowly rose up by 530 percent the following period of 2010, until it reached its peak of $684 at 228 percent trend, then sloping downward again in 2012 at -66 percent. What does this mean?

The intrinsic value is the true value of the stocks of BHP. The line shows how the true value of the stock trends in the market. On the other hand, the enterprise value is the market value of the stock. I have used the enterprise value rather than the market value because, in my own discretion, it is more accurate to use because it factors the total debt and cash of the company, in which buying the whole company, you have to acquire also its debt and pocket the cash. Enterprise value was stable below $100.

The margin of safety is the space between the two lines. If we have to calculate the margin of safety we get the difference between the enterprise value and the intrinsic value.  For BHP, the average margin of safety from 2008 was 63 percent.

Price to Earnings/Earning Per Share (P/E*EPS)      

This valuation will determine whether the stock is undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share. From there, we can determine the status of the stock price.

BBL PE EPS

Explanation

The relative valuation for P/E*EPS shows an overvalued price from 2008 except in 2011. The stock was trading at an overvalued price because the price was greater than the P/E*EPS ratio.

The enterprise value was 116 percent of the P/E*EPS ratio, therefore, overall, the stock price was overvalued by 16 percent, thus the price was considered expensive.

In my computation above I have used the relative approach in the P/E*EPS ratio. There is another way of computing this valuation and that is the average approach. In the relative approach, we consider the prior year performance of the company and that is the 2007 performance in the price to earnings ratio. In the table below, you will find out the difference between doing these two approaches.

BBL Relative PE

The table shows that using the average approach produced a higher result of P/E*EPS ratio.

The Enterprise value (EV)/Earning Per Share (EPS) or (EV/EPS) 

The use of this ratio is to separate price and earnings in the enterprise value dividing the enterprise value of projected earnings (EPS).  The result represents the price (P/E) and the difference represents the earnings (EPS).

BBL EV EPS

The relative valuation for EV/EPS tells us that the price (P/E) was 23 percent average from 2008. While the remaining 77 percent represents the earnings (EPS). But as mentioned, this valuation depends on the analyst’s own discretion.

Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA).   

This metric is used in estimating business valuation.  It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries.  It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.

BBL EV EBITDA

Explanation

The EV/EBITDA tells us that it will take 7 years to wait to cover the costs of buying the entire business of BHP.  In other words, it tells us that it will take 7 times of the cash earnings of BBL to completely cover the costs of purchasing the entire business of the company. This valuation shows the cash earnings of the company in relation to the enterprise value or market value. The EBITDA represents 15 percent of the enterprise value.

The EV/EBITDA shows the profitability of the company with regards to its cash earnings compared to the market price. It shows how long will the buyer is willing to wait to cover the costs of buying the entire business.

In conclusion,

The market capitalization of BHP is trending erratic. The total debt represents 9.5 percent of the enterprise value, while cash and cash equivalent represent 4 percent, thus buying the entire business would be paying 5.5 percent of total debt and 94.5 percent of equity. The total cash per share was $2.88 average.

The purchase price to date, February 11, 2013, would be $202 billion at $75.54 per share. The market price to date was $68.08 per share.

Net Current Asset Value

On the other hand, the net current asset value approach shows an overvalued price from 2008 to the trailing twelve months. Since the stock was trading above the liquidation value of the company.  While the MC/NCAV approach shows an overvalued price since the ratio exceeded the 1.2 ratios. 

Further, the margin of safety tells us that the average margin of safety was 63 percent. Looking at the growth of the company, it shows that the sustainable growth rate of BBL was 20.69 percent average, and the annual growth rate was 50.78 percent average.  While the return on equity shows a 30.71 percent average from 2008.  The intrinsic value was $306 average.

P/E*EPS Valuation

Furthermore, the price was overvalued. Since the average price was 116 percent against the P/E*EPS ratio. This price is overvalued by a 16 percent average. While the EV/EPS shows that the price (P/E) was 23 percent and the earnings (EPS) was 77 percent average. Although the result of this valuation depends upon the analyst’s own discretion.

EV/EBITDA Valuation

The EV/EBITDA valuation tells us that it will take 7 years to cover the cost of buying the entire business. In other words, it will take 7 years for the cash earnings to cover the purchase price for the entire company. The EBITDA represents 15 percent of the enterprise value.

There was a margin of safety of an average 63 percent, it tells us that there is safety in buying. In addition, BHP has a fair return on equity of 30.71 percent average. Moreover, a fair net margin of 23 percent average. Therefore, I recommend a BUY in the stock of BHP Billiton plc ADR.

A note to the reader: These calculations were made on February 11, 2013. These ratios and recommendations are good only until there are changes in the market price. Thank you for reading.

Research and Written by Cris
Interested to learn more about the company? Here’s investment guide for a quick view, company research to know more of its background and history; and value investing guide for the financial status.

Note:

Research Reports can be found under the company tab.