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.