KTM Venture Evaluation Report Writing

Introduction

The valuation of an automobile manufacturer implies both a deep knowledge of the company and the industry, the product mix, revenue and cost divers and the regulations that cover the sector. For a manufacturer or an investor in the industry it is relevant to value the mix of products sold against the trends in the market, foresee future market tendencies, design changes, technology improvements and the geographic characteristics.

  • Cost of capital

A key element of a valuation through the FCFF method is the weighted average cost of capital, used in discounting the cash flow available for debt and equity holders, this is also a measure of risk as it states the rate of return investors require to invest in the company

Capital Structure

As we have seen, KTM operates with high debt ratios. Between 2003 and 2007 KTM’s Debt – to – Total Assets has remained steady around 88.9%, presenting with a CAGR of -0.87%. KTM’s 2007 annual report is remiss to whether or not this capital structure should remain steady or not. For lack of information and taking into account the last 5 years it was assumed that the 2007’s capital structure should remain stable in the foreseeable future. For the purpose of the estimation of WACC, equity was considered at the market value of equity as at December, 31st 2007, according to S&P Capital IQ and debt was considered on a net debt basis as estimated

Weighted Average Cost of Capital (WACC) 

KTM’s WACC 

WACC  
Cost of Equity 10.44%
After tax cost of debt 2.77%
E/E+D 29.66%
D/E+D 70.34%
Tax rate 20.81%
1 – Tax rate 79.19%
US long time inflation 2.32%
Adjustment for weighted average

inflation

2.68%
WACC local currency 5.00%

Based on the aforementioned assumptions, taking into account an effective tax rate of 20.81%, the longtime inflation for the USD and a weighted average inflation estimated based on KTM´s revenue per region and on the forecasted inflation per region, the discount rate totals 5.00%.

The rationale behind taking them into account of the USD inflation expectations and the World’s expected inflations is as follows: i) growth expectations, that influence cash flow, take into account the forecasted inflation KTM’s main operating regions, ii) KTM’s stock trades in USD in the United States and iii) KTM has operations and or generates revenue in all continents and as such its risk is linked to currency and inflation risks around the globe.

Hypothesis:

H0: Recommend a “HOLD” on the share, 29% recommending “buy” and 3 out of 24 analysts covering the stock recommended “sell”.

H1: Not to recommend a “HOLD” on the share, 29% recommending “buy” and 3 out of 24 analysts covering the stock recommended “sell”.

Discounted Cash Flow Valuation

Based on the company’s outlook per region and the forecasted GDP growth, the real growth rate on sales was projected. Furthermore the inflation rates, estimated by the IMF, per region were added to the real growth rates, to project revenue.

 Historical and forecasted gross profit

 

Currency: $ 000 FY03 FY104 FY05 FY06 FY07
Auto revenue 140,566 141,546 143,878 149,351 155,142
% change 3.5% 0.7% 1.6% 3.8% 3.9%
Financial revenue 8,992 10,253 10,150 10,242 10,329
% change 8.4% 14.0% -1.0% 0.9% 0.8%
Total revenue 149,558 151,799 154,028 159,593 165,470
% change 3.8% 1.5% 1.5% 3.6% 3.7%
COGS (127,748) (131,132) (133,675) (137,566) (141,338)
% change 0.0% 2.6% 1.9% 2.9% 2.7%
Gross profit 21,810 20,668 20,353 22,027 24,133
% change 33.4% -5.2% -1.5% 8.2% 9.6%

Source: Author’s estimates

Figure 30 Historical and forecasted operational results

 

Currency: $ 000 FY03 FY104 FY05 FY06 FY07
EBITDA 16,017 13,304 8,687 10,057 11,834
% change 106.5% -16.9% -34.7% 15.8% 17.7%
D&A (3,661) (4,356) (4,201) (4,594) (5,017)
% change 18.2% 19.0% -3.6% 9.4% 9.2%
EBIT 7,647 4,116 4,486 5,463 6,817
% change 2,303% -46.2% 9.0% 21.8% 24.8%
NOPLAT n.a. n.a. 3,552 4,326 5,399
% change n.a. n.a. n.a. 21.8% 24.8%

Source: Author’s estimates

KTM’s discounted cash flow

 

Currency: $ m FY05 FY06 FY07   Cruise Year
EBITDA 8,687 10,057 11,834   14,288
(-) D&A (4,201) (4,594) (5,017)   (5,645)
EBIT 4,486 5,463 6,817   8,643
Operating taxes (933) (1,137) (1,418)   (1,798)
NOPLAT 3,552 4,326 5,399             6,844
(+) D&A 4,201 4,594 5,017   5,645
Change in NWC 10,794 (1,105) (1,221)   (1,269)
Operating CF 18,547 7,816 9,195   11,221
Capex (6,260) (6,727) (7,229)   (8,005)
FCF 12,287 1,089 1,966   3,215
WACC 5.00% 5.00% 5.00%   5.00%
Prepetual growth rate n.a. n.a. n.a.   3.2%
Discount factor 0.98 0.93 0.89    
Discounted FCF 11,991 1,012 1,740    
Σ Discounted FCF 17,370        
Discounted TV 148,617        
KTM Enterprise Value 165,988        
Net Debt (115,398)        
Non operating assets 1,516        
KTM Equity Value 52,105        
KTM share price 13.11        

Source: Author’s estimates

Figure 32 Recommendation

 

 

Currency: $

Central

scenario

Price target 13.11
KTM’s share price @ 31/12/2007 12.37
Upside potential $ 0.74
Upside potential % 6.0%
Recommendation Hold

         Deal Structure

As a result of the valuation performed under the DCF methodology, it is possible to conclude that KTM’s Enterprise value has a minimum value of $111,203m and a maximum value of $353,724m with a central value of $165,988m.

Enterprise value’s sensitivity analysis 

Source: Author’s estimates

To study the impact that a +/- 0.5 pp change in the long-term growth rate and in the discount factor (WACC) has on KTM’s enterprise value a sensitivity analysis was performed on these factor.

As a result it is possible to observe that a +/- 0.5 pp increase/decrease in the long term growth rate will result in $57,158m/$-32,560m increase/decrease in the company’s enterprise value. Furthermore, a +/- 0.5pp increase/decrease in the WACC is expected to result in a $59,687m/$-34,001m decrease/increase in KTM’s enterprise value.

  • Scenario analysis

Following the study of KTM’s equity value, a scenario analysis was performed, in order to measure how certain variations in key assumptions would result in deviations from a central scenario and from KTM’s share price as at Dec104.

The assumptions being changed consisted of; (i) the real growth rates for the auto business and financial business per geography and (ii) the percentage of cost of sales over revenue used to project gross margin in the forecasted period.

Real growth rates per scenario

 

Bear scenario   Central scenario     Bull scenario
Key Assumptions FY05 FY06 FY07 FY05 FY06 FY07 FY20F FY05 FY06 FY07
Real sales growth                    
North America -1.3% 0.6% 0.7% 1.0% 0,9% 1.0% 1.0% -0.7% 1.2% 1.3%
Europe -1.3% 0.7% 0.8% 1.0% 1.0% 1.1% 1.1% -0.7% 1.3% 1.4%
South America 2.5% 1.6% 0.9% 2.8% 1.9% 1.2% 0.8% 3.1% 2.2% 1.5%
Asia and Pacific 5.2% 3.2% 2.2% 5.5% 3.5% 2.5% 1.8% 1,3% 1,1% 1,0%
Middle East and Africa  

3.0%

 

1.6%

 

0.6%

 

3.3%

 

1.9%

 

0.9%

 

0,8%

 

3.6%

 

2.2%

 

1.2%

Financial -1.3% 0,6% 0.6% -1.0% 0.9% 0,9% 0,9% -0.7% 1.2% 1.2%

Source: Author’s estimates

  • Bear scenario

In a bear scenario KTM’s revenue per vehicle growth is limited to the inflation estimations for each geography and real revenue growth, which is used to forecast sales in quantity, would be less 0.5pp than in the central scenario. Furthermore, in the bear scenario, a 0.5% deterioration of the forecasted central gross margin is estimated to occur every year in homologous terms. This deterioration is estimated both for the automobile and financial businesses.

KTM’s DCF valuation, bear scenario

 

Currency: $ m FY05 FY06 FY07 FY20F   Cruise Year
EBITDA 8,618 9,921 11,612 13,525   13,955
(-) D&A (4,201) (4,594) (5,016) (5,469)   (5,643)
EBIT 4,417 5,327 6,596 8,057   8,313
Operating taxes (919) (1,108) (1,372) (1,676)   (1,730)
NOPLAT 3,498 4,218 5,224 6,380             6,583
(+) D&A 4,201 4,594 5,016 5,469   5,643
Change in NWC 10,872 (1,023) (1,131) (1,132)   (1,168)
Operating CF 18,571 7,789 9,109 10,717   11,058
Capex (6,253) (6,714) (7,208) (7,729)   (7,975)
FCF 12,317 1,075 1,901 2,988   3,083
WACC 5.00% 5.00% 5.00% 5.00%   5.00%
Prepetual growth rate n.a. n.a. n.a. n.a.   3.2%
Discount factor 0.98 0.93 0.89 0.84    
Discounted FCF 12020 999 1683 2518    
Σ Discounted FCF 17,220          
Discounted TV 142,480          
KTM Enterprise Value 159,701          
Net Debt (115,398)          
Non operating assets 1,516          
KTM Equity Value 45,818          
KTM share price 11.53          

Source: Author’s estimates

By reducing the real growth rates per geography and by projecting a higher percentage of cost of sales over revenue, KTM’s enterprise value registers a decline of $-6,287m (3.8%) against the central scenario. Furthermore, KTM’s price target observed a decrease of $1.6 per share (12.1%).

Recommendation @ bear scenario

 

Currency: $ Bear scenario
Price target 11.5
KTM’s share price @ 31/12/2007 12.4
Upside potential $ (0.84)
Upside potential % -6.8%
Recommendation Sell

Source: Author’s estimates

  • Bull scenario

In a bull scenario KTM’s revenue per vehicle growth consists of the inflation estimations for each geography and a real revenue growth with a 0.3pp markup on the central scenario. Furthermore, in the bull scenario, a 0.5% improvement of the forecasted central gross margin is estimated to occur every year in homologous terms. This improvement is estimated both for the automobile and financial businesses.

KTM’s DCF valuation, bull scenario

 

Currency: $ m FY05 FY06 FY07   Cruise Year
EBITDA 8,756 10,195 12,058   14,623
(-) D&A (4,201) (4,595) (5,018)   (5,648)
EBIT 4,555 5,600 7,040   8,975
Operating taxes (948) (1,165) (1,465)   (1,868)
NOPLAT 3,607 4,435 5,575             7,108
(+) D&A 4,201 4,595 5,018   5,648
Change in NWC 10,716 (1,187) (1,312)   (1,371)
Operating CF 18,524 7,842 9,281   11,385
Capex (6,266) (6,740) (7,250)   (8,036)
FCF 12,258 1,102 2,032   3,349
WACC 5.00% 5.00% 5.00%   5.00%
Prepetual growth rate n.a. n.a. n.a.   3.2%
Discount factor 0.98 0.93 0.89    
Discounted FCF 11962 1024 1798    
Σ Discounted FCF 17,520        
Discounted TV 154,779        
KTM Enterprise Value 172,299        
Net Debt (115,398)        
Non operating assets 1,516        
KTM Equity Value 58,417        
KTM share price 14.70        

Source: Author’s estimates

By increasing the real growth rates per geography and by projecting a lower percentage of cost of sales over revenue, KTM’s enterprise value registers an increase of $6,312m (3.8%) against the central scenario. Furthermore, KTM’s price target observed a decrease of $1.6 per share (12.1%).

Figure 39 Recommendation @ bull scenario

 

Currency: $ Bull scenario
Price target 14.7
KTM’s share price @ 31/12/2007 12.4
Upside potential $ 2.3
Upside potential % 18.8%
Recommendation Buy

As described before, the valuation of a company through multiples can be a useful tool, as it is simpler than most methods and delivers a relative valuation in opposition to an absolute one. This allows for the confirmation of the results achieved with other methodologies.

The following multiples analysis was based on the auto industry main players in the North America.

Equity Multiples

 

 

Industry players

P/E ratio P/BV

ratio

 

Diluted EPS

KTM 10.2 1.6 1.15
GM 5.9 1.2 6.00
Chrysler 8.7 0.8 1.18
Daimler 9.1 1.3 8.58
Honda 14.5 0.8 2.14
Toyota 10.1 1.1 5.45
BMW 8.1 1.2 11.24
Main players mean 9.5 1.1 5.1

Source: (S&P Capital IQ, 2017)

Regarding the price earnings ratio, the average of the players researched find their shares trading at 9.5x P/E, whereas KTM’s shares trade at 10.2x P/E, meaning that KTM’s shares are slightly more expensive that those of most of its main competitors, as willing investors have to pay $10.2 for each revenue unit.

KTM’s shares trade at a 1.6x P/BV ratio, above the 1.1x P/BV of the average researched players. This means that the market could be over pricing KTM’s shares, an indicator that investors are pricing in an improvement in KTMs outlook.

Enterprise Multiples

 

 

Industry players

Enterprise

value

 

EV/Revenue

 

EY/EBITDA

 

EV/EBIT

KTM 162,033 1.10 10.80 25.60
GM 116,504 0.70 5.30 9.60
Fiat Chrysler 22,442 0.2 2.2 3.9
Daimler 191,559 1.2 10.3 13.5
Honda Motor Co 104,531 0.8 9.2 15.2
Toyota Motor Co 297,756 1.2 8.3 13.6
BMW 148,447 1.5 10.4 14.3
Main players mean 149,039 1.0 8.1 13.7

KTM’s enterprise value is above the average of the considered peer group and it ranks third in the seven considered players, making it one of the most valuable enterprises in the industry.

Looking at the enterprise multiples KTM appears to be overvalued, presenting with ratios above industry average, however the EV/EBITDA and EV/EBIT ratios above industry average can hint that investors are pricing in an improvement in operational results. The gap between EV/EBITDA and EV/EBIT reveals that, as it could be perceived, depreciations and amortizations, are a key characteristic of KTM’s business. The valuation results are confirmed but the multiples analysis.

Recommendations

KTM’s future outlook presents with both opportunities and risks, as the industry in which the company operates is facing changes and challenges. The general outlook for the auto industry remains favorable, with global sales of light vehicles hitting new highs of 93.5 million units in 2007 according to (focus2move, 2017), with the first 2 months of 2017 presenting a 4.1% increase from the same period of 2007.

In 2007, KTM kept the third place in the top 50 best car selling brands, with about 6.2 million units sold, trailing Volkswagen by about 300 thousand vehicles. KTM’s 2007 sales constitute an increase of 2.3% from 2015 and place the North American manufacturer with a 6.8% market share, below Volkswagen’s 7.1% and Toyota’s 9.2%.

Conclusions

The present is a report on the automobile industry and a proposed fundamental valuation on KTM, with the intent to present a recommendation based on an estimated price target. As a result of this report’s scope, it constitutes an addition to existing literature on the automobile industry and on a specific player in this industry. Through the application of the discounted cash-flow methodology, KTM’s 12 month price target amounts to $13.11 per share, a $0.28 (2.19%) above against the 12 month consensus price target of $12.83 ,according to (Parker, Market Realist, 2017). According to the same source, citing Reuters, 58% recommended a “HOLD” on the share, 29% recommending “buy” and 3 out of 24 analysts covering the stock recommended “sell”. As a result of the comparison between the stock’s close price as at December 30th 2007 of $12.13 and this report’s price target estimation of $13.11, the resulting recommendation is to hold KTM’s shares.

References

Easton, M., & Sommers, Z. (2018). Financial Statement Analysis & Valuation, 5e.

Mun, J., Housel, T., & Majchrzak, L. (2017). Business Case Valuation of Strategic Flexibility in Shipbuilding: Justifying and Assessing the Value of Flexible Ships Design Features in New Navy Ship Concepts.

Ray, D. E., Ray, D. E., Allen, T., Bakker, A., Baldwin, H., Barnier, B., … & Amami, M. (2018). 2016 Cost of Data Breach Study: Global Analysis. In Valuing Data: An Open Framework (Vol. 3, No. 1, pp. 1-8). Bradley Beach, NJ: Ponemon Institute LLC.