Tuesday, October 4, 2011

6201: Toyota Industries

OK, this is one of the oldest stub trades ever and hasn't really been an exciting one.  Marty Whitman of the Third Avenue Value fund has owned it forever.  For those interested in actionable ideas right now, look at some of the financials.  You can skip this post.  Also, I'm sure many value investors have heard this idea many times over the years.  It is true there is no real 'catalyst' here to realize the value in the near or far future.  So those value investors can skip this too.  I don't think there is anything new here.

You may be interested, however, if you are interested in Japanese stocks and Toyota in particular.  If you're going to own Toyota, why not get it at a discount or in a package that is a bargain? 

I took a quick look at it recently so I just thought I'd jot down some notes; let's see if there's a good deal here.

The basic idea is that Toyota Industries owns a bunch of Toyota Motor Corp. and other stocks and the stock market often doesn't reflect the value of the holdings and the value of Toyota Industries' operating business.

Here are the basic facts:
Toyota Industries owns 215,640,000 shares of Toyota Motors Corporation and other stocks.

Value of stock holdings:
Toyota Motors Corp at 2568 yen/share:      567 billion yen
Other stockholdings:                                    325 billion yen
Bond investment trusts:                                 60 billion yen
Transferable deposits:                                    72 billion yen

Total value of portfolio:                            1,025 billion yen

Shares of Toyota Industries outstanding:    325.8 million shares

Total portfolio per share:                           3146 yen per share

Closing price of Toyota Industries:          2175 yen per share

So the total holdings exceeds the current share price of the stock.   This is not the whole story, though, as there is a tax liability to the above stock holdings.  Assuming a 40% tax rate and applied to the stock holdings, that would value the total portfolio at:

Total value of portfolio net of taxes:            668 billion yen

Total portfolio per share net of taxes:      2050 yen per share

So net of taxes, the market is valuing the operating business of Toyota Industries at 125 yen.

But what is the business worth?

The company expects to generate sales of 1.57 trillion yen for the full year ended March 2012 and operating earnings of 70 billion yen.  Net income includes interest and dividend income from the above investments, so we'll just start with the 70 billion yen operating income, deduct interest expense on the debt and then apply a 40% tax rate to see what the operating business net earnings will be:

70 billion yen minus interest expense of 16 billion yen (same as last year) = 54 billion yen in pretax income x (1 - 40% tax rate) = net income of 32.4 billion in net income.

With 326 million shares outstanding, the operating business eps would be: around 99 yen per share.

So Mr. Market is valuing Toyota Industries' operating business at 1.3x p/e.  Yes, that's not a typo.  1.3x p/e. 

If we think the business is worth 10x p/e, then the operating business is worth 1,000 yen per share, and adding the portfolio per share would give a fair value for Toyota Industries of around 3,000 yen per share versus the current 2175 yen per share price, 40% higher.

An important assumption here is that we assume that the debt Toyota Industries carries of 473 billion yen (including current portion of long term debt) will be able to be carried even without the investments on the balance sheet (which may or may not be true: Surely, the lenders are comforted by the large investment holdings).

With a 70 billion operating income and a 16 billion yen interest expense, this is not completely unreasonable.

But just to be sure, let's look at the same with an Enterprise Value (EV) / EBITDA ratio (EV includes debt).

The total market cap of Toyota Industries is currently 709 billion yen and total debt is 473 billion for a total enterprise value of 1.2 trillion yen.  Excluding the after-tax value of invesment holdings, currently around 670 billion yen, that would give us an adjusted EV of 530 billion yen.

EBITDA (this excludes interest and dividend income from investments) last year was 150 billion yen, so under this scenario the market values Toyota Industries at 3.5x EV/EBITDA.

Many value investors like to look at net cash, or net portfolio value after all debt is paid back. 

If we do the same with this one, then you would take the after tax value of the investment portfolio of  670 billion yen, deduct long term debt of 473 billion for net investments of 197 billion.   On a per share basis, this comes to around 600 yen per share.

Deduct this from the current share price of 2175, you get 1575 yen per share value for the operating business AFTER long term debt has been paid back.

So what would the operating business EPS be without interest expense (since debt is paid back)?  The company estimates operating earnings this year of 70 billion.  On an after tax basis, this becomes 70 billion x (1 - 40%) = 42 billion yen.  With 326 million shares outstanding, that comes to around 130 yen per share in EPS, leaving the operating business valued at 12x p/e.

With the current price relationships, Toyota Industries only looks really cheap when you assume the total debt can be carried by the operating business and the investment holdings can be spun off.  If not and the debt has to be paid off in a breakup scenario, then it doesn't look that particularly cheap. 

In any case, the possibility of a spin off or any sort of realization of value is very remote; activists have for years have tried to realize value in companies with very little success.

Does this work as a pair trade?
The other thing to think about is whether this would make a good long short trade.  Since the value of the investment holdings is so large relative to the market capitalization of the company, that's certainly something to think about.

I did a really quick check on the historical prices of Toyota Motor and Toyota Industries.  Assuming the shares outstanding of Toyota Industries haven't changed over the years, and the number of shares owned of Toyota Motor also hasn't changed, I looked at the percentage of market cap of Toyota Industries is made up of Toyota Motor stock holdings.

As of last night, that ratio was 0.79x; around 79% of the market capitalization of Toyota Industries is accounted for by the market value of Toyota Motor Corp stock it owns (on a pretax basis; this excludes deferred taxes).    This figure has averaged 0.9x since 1988.  It has been as low as 0.43x (in 1989) and high as 1.53 times (in 1999)).

That seems pretty wide and we seem to be right in mid-range.   Not so interesting as a pair trade at this point on a historical basis.

Without a clear endgame or catalyst, this trade is unlikely to work out as a long/short.

Is Toyota Motor Cheap?
Just as a footnote, I should mention that one factor in the appeal of this trade is the attractiveness of Toyota Motor stock.  Obviously, this is going to be a big driver in the value of Toyota Industries.

Toyota is interesting due to the bad news over the past few years and the bad news in general in Japan.  That's usually a good reason to take a look at something.

Anyway, I haven't taken a really close look at Toyota recently (auto industry seems increasingly crowded to me) but there was a nice table in Barron's last week with a few auto stocks and their valuations.  Judging from that, Toyota doesn't look particularly interesting at this point.

                                                 2012 estimated:
                                                 P/E                EV/EBITDA
Volkswagen (VLKAY):          5.2                 2.52
Volkswagen (VLKPY):           5.5                 3.32
BMW:                                      7.3                 2.25
Daimler:                                   5.6                 2.47
Honda:                                    12.9                8.21
Toyota:                                    18.1                8.13     <-- not so cheap?
GM:                                           4.6                2.16


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