Here is how the fundamental numbers work:
In recent performance (Q3 2019), SRIL EVA was IDR 387 Billion for the past 12 months. A positive economic profit as it has always been, and just as important, a huge improvement from Q4 2018, and it got better from its Q2 2019 performance.
And that performance improvement is after taking a hit from fires in the warehouse which is estimated at around IDR 0.5 Billion worth of damage. That number goes to capital account in my calculation which is dutifully charged at the cost of capital. Without the fire incident, EVA would be 8% higher. However, most of the damage is insured. Because of that, there is a good reason that my EVA calculation is lower than it should be.
Most of the improvement in EVA comes from a normalization of gross margin and lower selling expenses. With the depreciation of the dollar, I would expect gross margin to be around 20% in the near future. And that means there is a potential of 2% EVA momentum left in the table.
Let's suppose EVA remains constant. IDR 387 Billion forever. Future sales growth does not add to value. In this scenario, the NPV (Net Present Value) of SRIL business would be IDR 3,500 Billion (EVA of 387 Billion divided by cost of capital around 11%). What this means is investors could expect to take out IDR 3,500 Billion cash into their pockets. That's the amount of added value from SRIL business. This NPV is also called MVA when we talk NPV from investors' perspective which is reflected from the share price.
The company overall value is that added value plus cash that has been invested to SRIL business. In Q3 2019, SRIL invested capital (minus cash) is IDR 17,400 Billion. Add them together, (3,500 + 17,400) and the value of SRIL business is around IDR 21,000 Billion. From there, it is a simple process to calculate its supposed-to-be share price assuming constant EVA (add back cash because it is excluded from invested capital calculation, and subtract debts, then divide it with shares outstanding).
What do you think about the market assessment of SRIL NPV right now? It is not IDR 3,500 Billion as calculated above, it is minus IDR 3,300 Billion. Completely in the opposite direction!
Dividing market value into invested capital and NPV gives a tremendous insight into the dividing line between value creators and value destroyers. In the case of SRIL, it is a consistent value creator because its EVA has always been positive. But right now, its share price is at IDR 220/share, which translates that investors view SRIL's NPV minus IDR 3,300 Billion, in other words, a value destroyer.
SRIL business is not that great. EVA margin is only 2.6% at its peak in 2016-2017. Very low compared to a big fish like UNVR whose EVA margin is near 16%. But it certainly is a value creator, not value destroyer. The market has taken its pessimistic view too far, and that presents a great opportunity.
But, who knows? Maybe the market is right. Maybe the future is bleak for SRIL. So, here is what I do. I consult the market and ask what it thinks. I reverse-engineer its share price to know what EVA future growth would look like*, so that SRIL NPV would become minus IDR 3,300 Billion. And here is what the market tells me:
That is the EVA projection that would justify its current share price at 220/share. I bet the market is wrong.
*The reverse-valuation process assumes perpetuity without any EVA growth after year 5.
Climate Awareness
US is approaching new election. Why should we care? Martin Wolf from Financial Times put it nicely, I'll quote him:
"Perhaps the most important issue (if one leaves aside avoiding nuclear war) is management of the global commons – above all, the atmosphere and oceans. Crucial concerns are climate and biodiversity. Little time is left to act against threats to both. A renewed Trump administration, hostile to these causes and the very concept of global co-operation, would make needed action impossible."
If you have access to Financial Times, you could read what Martin Wolf writes fully here.
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