“Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper.” – Warren Buffett
For most of us that are used to investing in relatively efficient markets, the following may seem too good to be true.
I have to thank one of our analysts in the Copenhagen Investment Club, Jon for bringing this opportunity to the attention of the group.
Hyundai Motors: The Common Stock
Hyundai Motors was originally part of Hyundai Group, a multinational chaebol headquarted in Seoul, South Korea. The group was founded in 1947 as a construction firm, but expanded into a diverse array of over 60 different subsidiaries that spanned everything from ship building to financial services. However following the 1997 East Asian Financial Crisis the group underwent a major restructuring and split off in to several different companies that each focused on one business area such as heavy industry or property development. Hyundai Motor Group was one of these entities. Although it was initially painful, the split has been good for Hyundai, as it forced the firm to stand on its own two feet. In 2012 Hyundai Motor Group sold 4.41m vehicles. This makes up just over 5% of the global total of 81.8m units. However it is a very fragmented market, and the market leader, Toyota, only produced 9.75m units in the same period.
Since 2009 Hyundai has grown its international sales at a compounded rate of 16% per year compared with 7% for the global market.
Hyundai’s management has made a lot of being named the ‘fastest growing automobile brand since 2005’ by Interbrand. But it does underscore the impressive transformation that the company undertaken from the ‘low-quality affordable’ positioning of the 1990s to the ‘high quality affordable’ segment that it operates in today. Management focus a lot on elevating the brand and consumer perception of the company as a means to continue its international growth.
Perhaps even more impressive is the company’s operating performance throughout this growth. While its major competitors (Ford, Toyota, Nissan, GM etc.) all report operating margins of in the range of 5-6%, Hyundai has over the past few years reported operating margins that are consistently around 10%. Likewise the company’s net profit margins have clocked in at 8-9%, around 3% above its major rivals.
A quick DuPont analysis illustrates how the company has pulled itself up since the global financial crisis and improved margins while paring back leverage.
- So, here we have a company from an emerging economy that:
- has transformed itself by moving up value chain,
- is growing faster than its peers,
- is more profitable than its peers,
- and whose management is focused on elevating the company to be the top global auto brand.
If this story sounds familiar then it is for good reason. Hyundai have very clearly sought to emulate the success of Toyota by adopting the ‘Toyota Production System’ but tweaking it to focus relentlessly on speed to market.
Yet with all that it has going for it Hyundai currently trades at a PE of only 8.31 compared with a market cap weighted average for the industry of 13.92.
But I know what you are thinking, this is still an auto company. So lets assume for the sake of argument that the common stock of Hyundai Motors is completely fairly priced as its current 8.31 PE multiple, which is a price per common share of 257,500 Korean Won. http://www.reuters.com/finance/stocks/financialHighlights?symbol=005380.KS
The Preferred Stock: A 52% Discount
So why do the 1st Class Preferred Shares currently trade at only 124,000 Korean Won? http://www.reuters.com/finance/stocks/financialHighlights?symbol=005385.KS
This is where it gets interesting. Hyundai Motor company currently has 220m common shares and 65m preferred shares on issue.
The characteristics of the preferred shares are as follows:
The only point I would clarify from the above is that the 1st class preferred shares guarantee a dividend higher than the common of +1%. Whereas the 2nd and 3rd Class preferred shares don’t guarantee a specific value of the extra dividend. From what I can read they instead just guarantee that the extra dividend will be no less than 2% of the par value of the preferred. However in practice it seems that they do apply exactly as listed above e.g. +1% or +2%.
From the Investor relations section of the Hyundai Motors website:
The series 1 preferred shares pay dividends in cash in the amount which is the sum of 1% per annum of par value which is KRW5,000 and the amount of dividends declared on the common shares. The series 2 preferred share pay dividends as declared by the Board of Directors which may not be less than 2% per annum of par value. The series 3 preferred shares pay dividends as declared by the Board of Directors which may not be less than 1% per annum of par value. The option for conversion of preferred share to common share is not included in the series 1, 2 and 3 preferred share.
But in any case, one thing is clear, the preferred shares participate in normal dividends just like their common counterparts and they receive an extra dividend on top.
The dividend calculation for last year is below. Clearly the preferred shares receive a higher dividend. But because the extra % relates to the face value of the shares at issue its important to note that this is not the same as boosting your current yield by 1% since it is now 12 years after issue and they trade well above face value. In 2012 the value of the +1% bonus on Tier 1 Preferred is that the dividend cheque you receive in the mail would be 3% bigger per share held than a common shareholder got (1950KRW compared with 1900KRW).
So we have established that the preferred shares have higher dividends, what else do we know about them?
The preferred shares are:
In other words, they have the same right to profits as a common share and are in substance the same as a normal common share with the added bonus that they pay an extra dividend. The only downside is that they are non-voting.
In a family controlled company such as Hyundai, how much value should we really put on voting rights? In the US non-voting vs. voting preferreds can trade at a discount of around 10%. However with the added bonus of a higher dividend it is also common for these types of preferred shares to trade at a premium to the common stock. We can see an example with the Volkswagen preferred shares.
To conclude, the Tier 1 Preferred Shares pay an extra dividend and are currently trading at a 52% discount to the common. This works out to a PE ratio of only 3.98.
You could easily argue that the common stock of Hyundai Motors is already trading at a discount of around 33% just to bring it in line with the multiples of its less profitable, slower growing peers.
Yet here is an opportunity to buy a profitable well managed company that is outperforming its peers, at a 52% discount to an already cheap price.
In the next update I will talk about:
- Some theories on why this could be so cheap (e.g. liquidity, war fears, fund restrictions, is there anything I could be missing?)
- What catalysts are there to narrow the valuation gap over time? (& what has happened in other similar situations elsewhere)
- Who else is talking about this now (there is not much public discussion available out there on this, but some highly respected value investors have started talking about the issue – and taking action – earlier this year)
- How you actually buy the preferred shares (it is not straightforward or transparent for a normal investor – but it is possible for most)