Value Trap
A market in downtrend does not necessarily mean it is cheap. A price to book ratio (PBV) less than one does not necessarily mean it is undervalued. Without a measure that could link between real performance and value, we would not know which is which.
I really looked at GJTL in February because it looked very attractive technically. If you use technical analysis, be honest, you would want to have a piece of this after seeing this chart: a clear breakout from a trading range from a long downtrend.
If you fancy PBV, GJTL has a ratio of 0,46 as of now. It is less than one. What is more, GJTL has lost nearly 87% of its value from its top in 2016 to its lowest point so far in 2018. Putting it all together, you will likely conclude this is a bargain. I beg to differ. By focusing on a real value measure, I conclude that GJTL has a PBV less than one because it deserves to be so: it’s got low valuation (PBV) because GJTL has been destroying shareholders’ wealth and it keeps getting worse. It is what I call, a value trap. By focusing on EVA (Economic Value Added), I will show you how it is so.
EVA in brief is a profit measure after deducting revenue from its operating expenses and capital charge. This is a profit measure that puts cost of opportunity of its capital providers in consideration. If EVA is negative, it is a clear indication that the business could not make profit to its owners. On the contrary, negative EVA means the business destroys owners’ wealth. Importantly, a business that destroys owners’ wealth will have value below its net assets (money that has been invested by investors, both shareholders and lenders). In other words, a company generating negative EVA persistently is worth less than its net asset (book value). Put another way, investors rightly give value PBV less than one because the company destroys value (negative EVA). If you understand this paragraph, you are on the right path on the quest of understanding value. Time to move on to GJTL case.
GJTL Case
GJTL has been a persistent wealth waster since 2014. It was so bad in 2017 that GJTL scored EVA IDR -1 T. It got better somehow during Q1-Q3 2018. The chart below is showing this downward EVA trend for GJTL. The golden line shows total value created by GJTL from investors perspective. This line is called MVA (Market Value Added) or NPV (that’s right - Net Present Value). It is a measure derived from stock price and follows closely with the change in stock price. MVA is calculated by substracting total market value (debt and equity) with its total capital invested (from both lenders and shareholders). It is the total cash that investors could expect to take out from the company as an ongoing entity. As is usually the case, MVA follows EVA. That is because MVA is the discounted EVA from current assets and future investments. MVA, which is measured from investors expectation, follows EVA, which is a real performance measure. Far from being a gambling spot, stock market follows fundamentals if you know what to look for. If you know EVA, you will not be surprised when GJTL kept going lower in 2018.
Let’s take a look deeper. Even after cutting prices, investors are still holding expectation that GJTL will eventually grow its EVA although not too optimistic. MVA at current price of IDR715/share is IDR -2 T. Like I said, MVA is discounted EVA. If we assume GJTL could not increase its EVA and just be able to keep it steady (EVA is IDR -693B), which is business as before scenario, it has MVA of IDR -6,3 T at the cost of capital rate of 11% (IDR -693B/11%). That means investors are, at current price, expecting that management could add another positive NPV, whether by new projects or simply environment improvement, or both, which would worth IDR 4,3T. Even with such improvement expectation, MVA is still negative and consequently, GJTL adjusted PBV (Market Value/Invested Capital) is 0,85. Investors are still generous enough even with current price. Investors are not being too pessimistic, they are adjusting downward their expectations to better match reality, which is a sad EVA reality. Without such generous expectation, market value (both debt and equity value) would fall by 37%. Which part of it is being undervalued?
Even with just this big picture, we know some pretty useful insights. We know that GJTL is not a safe company to invest because its EVA has been negatively persistent for the past 5 years. We know that at current price, investors still have to put a-better-than-before EVA scenario. From here, if we still want to invest in GJTL, we must have a basis which basically says our expectation is greater than other investors, and it would turn out to be correct or even better. That would require some sophisticated techniques which I highly doubt I could explain (or want) in articles. But even without that, I would argue that further useful analysis could be done by searching the critical factors of the company which affect EVA materially and importantly, its constraint.
After running some numbers (how else would we know?), I have found that both improvements in margin and asset turnover have almost the same impact on EVA. This means GJTL has a lot of channels to better its EVA. That is the good news. The bad news is a material asset turnover requires a lot of demand for tires, that is because its plants that produce tires could not find enough buyers. GJTL is hard pressed to find more buyers now because management has made a big blunder in the past that they must still to atone: they invest a lot (most likely in plants and production equipment) in 2014, just when things start to fall. They invested a lot near the peak of commodity cycle, just as many companies that rely on commodities did. Even worse, that investment was still going strong even in 2015. Only in 2016 they started to realise it was a mistake and started to pull back investment. Had the management focused on EVA, they would know that something was terribly wrong in 2014 and would cut back sooner.
Therefore, as an investor, if you want to have GJTL in your portfolio, it is your job to find reasonable basis on growing tires demand, and it should better be some significant growth, big enough and persistent that eventually could lift GJTL EVA in green again just as before 2014. It is not a good idea to choose an investment where at best you just expect EVA improvement in the future, but still negative. You would be just wasting your money if you invest in negative NPV prospect(s).
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