I love buying household stuffs in Ace Hardware. It’s a helpful place. It’s a great company as I will shortly demonstrate as well with EVA. But, is it a good investment at current price?
I will be brief here in examining ACES true performance, because the major point as far as I’m concerned is not in its actual performance.
ACES is a consistent value creator, and it is keep increasing its value since 2015
And, sure enough the market follows...
MVA is the franchise value of the company. It is the added value above invested capital. The major part of MVA is the share price. An increase in MVA means an increase in share price most of the time. Why MVA? Because EVA is directly tied to MVA.
Now look at the following graph to see why I often don’t need to bother switching my chart to share price when I already have MVA...
Let’s give credit to where its due. Usually, I make an example of how bad net income is in explaining share price. But some companies do have net income that is pretty reliable that you actually don’t need EVA to get the right big picture. ACES is one such company. Yes, that means net income tracks EVA well in ACES case. Unfortunately, this is not usually the case, which is why I don’t make my opinion based on net income.
Net Income tracks EVA well in ACES case. That means, there is a good chance in the future that we could look straight to net income for quick and reliable indicator of changes in value creation.
The major reason ACES could grow its EVA from IDR 280 Billion in 2015 to IDR 433 Billion in 2018 is because of sales growth. ACES cumulative sales growth was 52% during those 3 years.
Alright. That’s it for performance analysis. All good and dandy. EVA is growing strong and there is a good reason to believe that it could continue its trajectory by the end of this year (just look at EVA graph for Q2 2019 in the first graph). The market also seems going where EVA goes as well. I would bet that overwhelming majority analysis out there (fundamentally) would give this stock a strong buy.
But I say, wait a minute. How about the expectation that is embedded in its share price? How optimistic it is? I know that ACES share price moves higher when EVA goes higher as well. But I would really hate it if I’m buying shares that already has tremendous expectation in place, even if the company is doing well.
Well...I have bad news for you.
The expectation from investors in ACES is very, very, unrealistically high. Now...how to best show you...this will be a bit mouthful. I will give you the EVA projection that justifies ACES share prices from time to time and I will show you ACES actual EVA side-by-side.
The following graphs show actual EVA vs expected EVA derived from its share price at that time. The horizontal axis is the projection period. Period 0 is starting point and I use five years projection period before terminal calculation in my model. Let’s use period 2013 as an example (the first graph below). There are numbers 0-6 in the horizontal axis. Point zero in 2013 5-years projection is year 2013. Point 1 is the first projected year from 2013, which is to say year 2014, and so on. (In 2018, the year 1 EVA uses LTM Q2 2019 result as an approximation for Q4 2019 EVA).
At least, focus on the labels (reality vs expectation). I believe you can figure out the rest yourselves.
Note that the the graph makes more sense in 2015. And what happened in 2015? Actual EVA declined. So, from the way I see it, it took a modest decline in EVA for the market to become.....rational. But after that? Optimists run the show. Note that the scaling in Y axis keeps increasing year by year after 2015. It’s scary, son!
ACES is one particular case where I need to reconsider adding EVA growth period in the model assumptions. So far, I do not see the need to extend the growth period beyond 5 years, but the expected EVA growth is just too much. So, I extended the growth period to 10 years before going terminal. Well, as it turns out, it does not change the message at all!
Let’s put this in another way. I will now speak in terms that everyone can understand which is in terms of sales growth. How much sales growth is needed to justify its current share price?
First, let’s assume that EVA margin stays at the most recent period (which is too high already in my opinion). This is a very good assumption if you take a look at this chart.
With the exception in 2014, ACES’ EVA Margin has been pretty much flat in 6%.
Now, with that critical assumption in place, this is what sales level needs to be to justify its current share price (1,790/share).
How much expectation is too much?
I don’t think the show is over yet, at least not in this year. If the past repeats itself, the music would only stop after ACES could no longer run. One thing I believe is that the mechanism is already in place that ensures sharp decline when the music stops.
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