Economists around the world are now quite unified in their judgement, namely that the only possible solution to this immediate crisis is for the ECB to bring out the big guns and intervene massively in the bond market.

In difficult situations like these, one shall always bear in mind that the best investments are made when everyone is pessimistic about the future and running away from the stock market. So is this a good time to buy shares? No. We are not there yet. The two most fundamental reasons why:

1) Stock markets are up since the beginning of October. Markets have edged on good performing quarterly reports and hopes for a Greek solution. And even if some stocks seem like good buys in the long run, it’s always better to buy even cheaper. Things will quite certainly get worse before they get better.

2) The ECB and European leaders can not keep up with the pace of global markets. And if the ECB won’t save Italy, no-one will. In this way Italy will default  simply because it will be cut off from the credit markets. If Italy defaults - the end of the Euro zone?

You can expect a lot of market turmoil in the next few weeks, so instead of waiting for those big guns to come out - drop your shares and stay back for a while.

We start our analysis by looking back at Scania’s performance in the midst of the 2008-2009 financial crisis which hit the automobile and truck industry extremely hard.

Looking at the quarterly reports, we note that Q3 2009 was worst in terms of Sales decline (-34% year-on-year) and Q2 was worst in terms of operating income (+/-0). The first half of 2009 displayed a record low operating margin of 1,7%. The company only reported negative EPS during one single quarter, the EPS plunge was as swift as the recovery (see picture 1 below).

Using this past data and the current share price for SCV B in our Stretch Target Regression Model (STRM), we can produce the future EPS and growth rates currently reflected in the share price.

Picture1

Main assumptions:

- the 2009 EPS of 1,41 SEK is set as worst case in the next downturn

- the next EPS decline will start in Q3 2011 (now) and last longer than the previous one

- The risk-free interest rate is now as low as 2,2% for a 10 year Swedish government bond. However, this change is offset by the increase in market risk premium

- SCV B closed today at 100,00 SEK.

The result is quite astonishing. The EPS for 2011 is set as low as 9,57 (analyst estimates at Scania’s homepage is still as high as 12,68) which corresponds to Scania having a good Q3 in line with the previous quarters but that Q4 coming out at worst case lows. This will be followed by a worst case 2012, a recovery during 2013 and consolidation at 2011 level in 2014 (see picture 2 to the left). However a long term growth rate of 3% will mean that EPS will reach 2010 levels in 2022!

Picture 2

It’s up to the reader to decide if such scenario is realistic or not. At Stretch Target we deem this to be too pessimistic. Looking at how well prepared Scania is for a coming downturn, we observe that the Equity/Assets ratio increased impressively from 20,9% after Q2 2008 to 30,3% after Q2 2011. We conclude the analysis by noting that

i) Scania is at present even better prepared for an economic downturn than in 2008

ii) Even if we accept the fairly pessimistic scenario above, a long term growth rate of 3% is too pessimistic. Increasing that to 4% yields a 10% upside on the share price.

]]> http://www.stretchtarget.se/2011/08/22/the-scenario-reflected-in-current-share-prices-analysis-of-scania-ab/feed/ http://www.stretchtarget.se/2010/10/29/qe2-is-coming-time-to-withdraw-from-the-us-stock-market/ http://www.stretchtarget.se/2010/10/29/qe2-is-coming-time-to-withdraw-from-the-us-stock-market/#comments Fri, 29 Oct 2010 20:26:28 +0000 Peter Tjernström http://www.stretchtarget.se/?p=572 In a previous article I argued that the Fed, due to the high stakes involved, would act very carefully when withdrawing from the unconventional monetary policy of near-zero interest rates and massive Quantitative Easing (QE). I took this as a reason to stay in the stock market despite the obvious risk that this type of policy can create asset bubbles. Nine months later the amount of securities held by the Fed is still around $2 trilion and there’s no sign of interest rate increases. Au contraire the minutes from the Fed’s meeting held on September 21st have given rise to speculations about the emergence of a second stimulus package commonly dubbed QE2.

S&P 500 1 year

So what’s happened on the stock market during these nine months? The S&P500 is up 8% from 1097 to 1184 overcoming a 15% slump as the European sovereign debt crisis unveiled in April-May. The USD is at 0,72 EUR, which is roughly unchanged compared with nine months ago. Meanwhile, the broad index on our home market, the OMX_Stockholm_PI, is up by 14%. During this time the Swedish Riksbank has increased its interest rate in three steps from 0,25% to 1,00%. Many large companies, both US and Swedish ones, are publishing record profits and accumulating cash. I general, demand and sales have some way to go before reaching the top levels of spring 2008, but profit margins are very high due to massive and swift cost cutting during 2009.

So it seems like staying on the stock market for the discussed period was a good choice, but what about the nine months to come? The Fed’s policy isn’t the only input to that analysis of course but the U.S. still play a major role in the global economy and companies everywhere are either directly or indirectly dependent on the U.S. and the value of the USD.

My reasoning goes like this: Profit margins can’t get much higher, if share prices are to rise it needs to be through expected sales growth. In the U.S. this cannot, as in previous upturns, depend on domestic private consumption. The U.S. households simply have to pay back debt, and so does the government. Domestic demand is sluggish, the current GDP growth rate  is 2%; way lower that during previous recession recoveries. I doubt that the intention with QE2 would be to lower interest rates further in order to stimulate domestic investment and spending. The main intention would be to increase inflation and thereby (lowering real interest rates and) depreciating the USD. A cheaper USD would stimulate U.S. exports, improve the current account balance and create growth for U.S.-based global companies. Increased inflation will also ease the burden for heavily indebted households.

This strategy may or may not work. But if it is executed and fails to spur growth, the Fed may be stuck in a liquidity trap from which it can’t get out without severely hurting demand. Hence, QE2 will be a very dangerous route to take. As an investor outside the U.S., I will stay away from the U.S. stock market and from companies with high U.S. exposure, large sales or pricing in USD, until it has been proven that the U.S. economy can grow at an annual rate above 3%.

In a previous article I argued that the Fed, due to the high stakes involved, would act very carefully when withdrawing from the unconventional monetary policy of near-zero interest rates and massive Quantitative Easing (QE). I took this as a reason to stay in the stock market despite the obvious risk that this type of policy can create asset bubbles. Nine months later the amount of securities held by the Fed is still around $2 trilion and there’s no sign of interest rate increases. Au contraire the minutes from the Fed’s meeting held on September 21st have given rise to speculations about the emergence of a second stimulus package commonly dubbed QE2.

S&P 500 1 year

So what’s happened on the stock market during these nine months? The S&P500 is up 8% from 1097 to 1184 overcoming a 15% slump as the European sovereign debt crisis unveiled in April-May. The USD is at 0,72 EUR, which is roughly unchanged compared with nine months ago. Meanwhile, the broad index on our home market, the OMX_Stockholm_PI, is up by 14%. During this time the Swedish Riksbank has increased its interest rate in three steps from 0,25% to 1,00%. Many large companies, both US and Swedish ones, are publishing record profits and accumulating cash. I general, demand and sales have some way to go before reaching the top levels of spring 2008, but profit margins are very high due to massive and swift cost cutting during 2009.

So it seems like staying on the stock market for the discussed period was a good choice, but what about the nine months to come? The Fed’s policy isn’t the only input to that analysis of course but the U.S. still play a major role in the global economy and companies everywhere are either directly or indirectly dependent on the U.S. and the value of the USD.

My reasoning goes like this: Profit margins can’t get much higher, if share prices are to rise it needs to be through expected sales growth. In the U.S. this cannot, as in previous upturns, depend on domestic private consumption. The U.S. households simply have to pay back debt, and so does the government. Domestic demand is sluggish, the current GDP growth rate  is 2%; way lower that during previous recession recoveries. I doubt that the intention with QE2 would be to lower interest rates further in order to stimulate domestic investment and spending. The main intention would be to increase inflation and thereby (lowering real interest rates and) depreciating the USD. A cheaper USD would stimulate U.S. exports, improve the current account balance and create growth for U.S.-based global companies. Increased inflation will also ease the burden for heavily indebted households.

This strategy may or may not work. But if it is executed and fails to spur growth, the Fed may be stuck in a liquidity trap from which it can’t get out without severely hurting demand. Hence, QE2 will be a very dangerous route to take. As an investor outside the U.S., I will stay away from the U.S. stock market and from companies with high U.S. exposure, large sales or pricing in USD, until it has been proven that the U.S. economy can grow at an annual rate above 3%.

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When contemplating these $1000bn and the low interest rate, it is easy to see that demand is manipulated and that the stock market has been on steroids for the last 10 months. Owning shares right now feels a bit like being in a chicken race. When all the fiscal stimulus around the world is being pulled back from the markets, share prices are going to be shaky for some time. If this exit isn’t handled with extra care, it can also severely hurt real demand in the economy and pull some countries back into a recession. But this is actually a good reason for staying in the chicken race for some time. Who wants to end the stimulus sooner rather than later if the stakes are so high? If you move slowly and save the world economy, who cares if you create a few asset bubbles along the way?

When looking at analysts’ estimates for Q4 and 2010 after the report, we find that most analysts have lowered their estimates slightly. Handelsbanken has cut their EPS estimates for 2010 to 0.65 EUR.  Piper Jaffray increased  their 2010 estimate (with one cent)  to 0.70 EUR, although recently reducing it.

Nokia reported a non-IFRS result of 0.17 EUR for Q3, a pro-forma result thought to give an accurate view of the core performance excluding one-time effects.

Valuation: Using a conservative 0.15 EUR for Q4 and 0.65 EUR EPS for the full year 2010, a DCF analysis yields a fair value of 10.5 EUR. This shows that the immediate reaction after the report was exaggerated, and that now is a good time to take a position prior to the Q4 report.

Summary of investment bank’s comments on the Nokia report (Swedish).

Back in 2000, Infineon Technologies was the world market leader in chip-sets for Cordless Phones, also known to many as DECT Phones. Infineon had reached that position thanks to fruitful combined efforts with its one time owner, Siemens, which then had the no 1 position in the market for these consumer products. At this time, the Vice Presidents at Infineon’s Business Group for wireless communication (WS) decided to stop all new product development in the Cordless segment in order to be able to invest in future technologies with higher growth and profitability prospects such as Bluetooth and Wireless LAN.
In the beginning of 2005 the WS Business Group was in trouble. Its most important segment, that for cellular communication (GSM, UMTS, EDGE, etc), was still very dependent on one customer: Siemens. And Siemens was losing market share. Fast. In this environment, the newly appointed Head of the Business Group, Kin Wah Loh, decided to prioritize serving customers in segments where significant revenue and profits were generated and where Infineon in the short term could grow with its customers. This meant, amongst other things, a restart of product development efforts within the Cordless segment in order to send a very clear signal to the customers who by now were at the limits of their own imagination and engineering skill when it came to develop new phones based on Infineon´s old chip-sets. Why, you may ask, were these customers still using archaic Infineon products when there were plenty of others to choose from? The answer is twofold: Firstly, the Cordless Phone market (especially in the low-cost segment) is volume driven and margins are low. Since Infineon had decided to stop investment in the product segment, it could of course offer an attractive price and still be profitable. Secondly, the customers had developed software based on Infineon´s HW architecture that could not easily be ported to other platforms without significant effort. This effort comes at a price too high for a producer of low-cost phones were feature sets anyway were only slightly more advanced than they were four years ago.

The Assignment

Once the decision to restart the Cordless programme was made, a Programme Manager was announced to take care of the current business, strategy, etc. Shortly after that I was, as the second person in the programme, assigned to head up the development of the new platform for cordless phones.

UK cover version

In a nation where the idea of the American Dream still prevails, this book has ignited some heated discussions. It often seems like readers have interpreted Gladwell as giving the social factors too much weight. My interpretation of Gladwell’s point of view is that while there are many who possess the intellect, skills (not always the ones we think of) and devotion to become true outliers, not everyone can become one. These are necessary but not sufficient criteria. The circumstances and timing also have to be such that the skill set and devotion pays off. A person with Bill Gates’ skills and build wouldn’t have particularly successful if born in a medieval village in Scandinavia when the Viking leaders were raiding and fighting for power.

Read the book, it’s full of insight and can alter your view of the world. Here are some comments from Malcom Gladwell himslef and from others.

Scania posted a Q2 loss, all results worse than expected and management expects a tough Q3

After competitor AB Volvo reported lower than expected sales due to a weak market, we lowered our estimates for Scania Q2 and the FY2009 in an analysis (Swedish only) one day prior to the report. Expectations were reduced in all areas: sales, gross margin, operational and financial result. However, the report still came in lower than expected.

Net Sales were 14429 MSEK (1331 MEUR), 12% lower than our estimates, the gross margin came in at 19% (we: 21,9%), and Scania recored a 150 milion SEK loss after tax where we expected a 420 milion SEK profit. The difference was majorly due to weaker market conditions (i.e. lower sales). ,

In terms of outlook, the management team was adding to the pain when it concluded that

“The demand in Q3 is likely to be on the same level as Q2. Come September, we’ll know better where the market is heading.” (Leif Östling, CEO)

and regarding credit losses in financial services Jan Ytterberg (CFO) commented that

“We haven’t seen the worst yet. I believe that Q3 will be difficult for the transportation industry.”

Two different ways to assess the company value

In order to figure out if Scania is traded at a fair value, we have carried out a DCF analysis based on two different scenarios.

1) Using the median value of analyst estimates

Scania AB publishes an overview of analyst estimates on its company homepage. For each year of the years 2009, 2010 and 2011, we have used the median EPS estimate in our DCF analysis. These predict that Scania will earn 1,88 SEK per share this year, increase it (by 104%)to 3,8 in 2010 and (by 51%) to 5,8 in 2011. For the years 2012 and onwards, we have used an average growth rate of 5%. This DCF analysis yields a Fair Value (FV) of 69 SEK.

2) Using the past to predict the future

Scania has been through downturns before, (although this one is tougher and more sudden than any of the downturns after 1945), the last one in 2001. We have used past sales and operating margin growth data from the four years after the 2001 downturn in order to predict the EPS for 2010-2013. We have also compensated for the fact that this dip is bigger than the 2001 one, by exaggerating the EPS growth for 2010 compared to the historical data. This analysis predicts an 2010 EPS of 3,76 SEK and growing by 27%, 17% and 12% for the three years thereafter before turning to the long term growth estimate of 5%. This DCF analysis produces a FV of 66 SEK.

It should be mentioned that these EPS estimates are by no means conservative. Given the current market situation, it is very doubtful that Scania will reach 1,88 SEK this year, not to mention a 100% EPS growth in 2010. I believe it  is fair to say that these levels suggest a quite rapid market recovery during 2010. In this context we also note that CA Cheuvreux today increased its recommendation for Scania from underperform to outperform (target level 106 SEK from 60 SEK earlier), in an analysis entirely based on the assumtion that Volkswagen will sell its part of Scania to MAN and thus triggering a mandatory public offer. The Scania share rose 4,6% to 85 SEK on these speculations.

Conclusion

It may be tempting to speculate on a mandatory offer from MAN and buy the Scania share on the basis of such speculation. However, even on the basis of aggressive EPS estimates (as above) the Scania share trades above its fair value and so is fundamentally overvalued. Based on the current company performance and the market developments, Scania is a clear cut sell case. We took at short position at 85 SEK in todays closing trade.