Tire Industry Valuation

[ Rubber- Tire Industry, Basic Materials Sector]

[pic 1]The Southern Rubber Industry Joint Stock Company (CASUMINA)

Date: 10/12/2013

Ticker: CSM

Current Price: VND 35,200

VND/ USD: 21,036

Recommendation: HOLD

Target Price: VND 36,401(2.6% upside)

Source: Team estimates, Bloomberg

Highlights

We ground our initial HOLD rating for The Southern Rubber Join Stock Company (CSM) on its both potential-development environment and expected as well as risky radial project. We arrive at a price target price of 36,401 VND, a 2.6% upside from its current share price. CSM is currently one of the biggest blue-chips on HOSE, which have largest volume of share transaction in its industry. The company has the biggest proportion, accounting for 33% in the total rubber & tires industry, with the weighted main volume units’ product coming from motor bicycle.

Casumina is benefiting from the fall of rubber prices. Therefore, gross margin of CSM in 2012 increase significantly to 23.23% as compared with only 9% in 2011.

Net income of CSM is forecast to increase rapidly in the 2014-2018 period because of the potentially high profit of new radial tires which will be first sold in 2014.

Estimated increasing amount of Cash Flow from Operation in contrast with decreasing Cash flow from financing. This is due to the accelerating net income along with rising debt payment, especially the debt of Radial project.

Main risks of CSM includes: interest risk, exchange rate risk and long-term solvency risk derived from investing in Radial project. Tough competition in foreign markets makes it difficult for CSM to raise income, reducing the production and exports than expected plans of the company.

CSM daily stock prices (VND)

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Source: Bloomberg, team estimates.

Business Description

Casumina is the largest tires and rubber product manufacturer in Vietnam. Casumina was initially listed on Ho Chi Minh Stock Exchange in August, 2009. Currently, Vinachem makes up 51% of the total Charter capital.

PRODUCT

Tires are the major products of Casumina. Tire products of Casumina are highly diversified, including: bicycle tires, motorbike tires, automobile tires, industry tires, rubber pipes … More specifically, there were 23.389 million motorbike tires, 9.044 million bicycle tires along with 1.204 million automobile tires produced by Casumina in 2012. Regarding automobile tire products, Casumina has focused on truck-related products.

Rubber accounts for the large proportion of input expense. The components of input for Casumina’s products include natural rubber, synthetic rubber, cord fabric, black carbon, blade steel and some other chemicals. Natural and synthetic rubber constitutes 58% of input expense. CSM suppliers’ choice depends on 2 main factors: Price base and material characteristics. CSM contacts the suppliers directly, not through intermediaries. The majority of such materials are imported, except for natural rubber. Others input materials (synthetic rubber, black carbon, chemicals …) have been imported from Taiwan, China, Korea, Japan, Thailand …

REVENUE

Casumina accounts for the large proportion compared to other company in the tire and rubber industry. CSM is a highly brand, highly credible and long-lasting company in producing tire and rubber products for truck, motorbike as well as bicycle. According to 2012 statistical data, CSM made up 33% of the domestic tire and rubber market, which was higher than other two big companies (DRC- 25%, SRC- 10%). However, in 2013, Casumina plans to grow at the growth rate of 5- 10% for the domestic market whereas the major expanding plan is from exporting.

CSM is outstanding in the automobile and motorbike tire & rubber segment. These are also the two main product lines of Casumina. Considering automobile and motorbike tires separately, CSM constitutes 25% and 35% of the automobile and motorbike tires respectively of Vietnam. Also, these two types of products bring the highest revenue and margin revenue. In 2012, sales of automobile and motorbike accounted for 45% and 41% of CSM’s total revenue respectively.

Increasing exporting is the major strategy for CSM’s development. Currently, revenue from exports constitutes around 25% of total revenue. Casumina products are sold in almost 40 countries globally and Southeast Asia (especially Thailand, Indonesia, and Malaysia) is the main exporting market, bringing 60% of total export revenue. CSM aims to raise exporting revenue to account for 35% total revenue in 2015 and 50% in 2020. The main (core) products will be Radial tire, “type and tubeless” motorbike tire..

ADVANTAGES

High quality and credibility products: The prominent products of CSM are motorbike and truck tires because of high quality and meeting the demand of consumers. At present, the company is maintaining the system of quality management ISO 9001: 2000. Moreover, warranty policy is executed strongly.

Developing products: Currently, products of CSM have been exported to over 40 countries all over the world. Revenue from exporting accounts for almost ¼ of total revenue from operating. Casumina supplies products for a large number of goods markets; fulfilling demand of different customers enables CSM to develop new products.

DISADVANTAGES

Casumina is facing throat- cutting competition with multinational and domestic firms in the tire and rubber industry. In domestic market, there are 3 major tire and rubber firms, namely: CSM, DRC and SRC. Furthermore, Casumina is facing rigorous competition with foreign leading brands. Products of Michelin, Yokohama, Cheng Shin have been widely distributed to agents, even Bridgestone company has been constructing a plant in Vietnam and intends to make the operation in 2014. In addition, low-price firms of China and Korea also create certain barriers to the sales of Casumina.

Marketing approach is weak and motorbike-related product is considered to be in the middle class. Motorbike tires are the focusing products of CSM, however, not being assessed well. In fact, Casumina products are new and high quality but has not yet been well known.

Counterfeits problem has not yet been tackled. Casumina is one of the leading brands in domestic market, therefore, a relatively large number of anonymous firms have supplied the fake products which are based on CSM’s products, which has not only had detrimental effects on CSM sales, profit but also lowered the credibility of CSM. In the long term, such counterfeit goods could impact negatively on the sustainable development of CSM.

MARKETING STATEGY

The distribution system is large. CSM owns the largest distribution system with more than 200 level-one resellers across 64 provinces of Vietnam. Moreover, CSM has been taking advantage of level-two agents in order to save transportation cost and seeking for level-three agents which are qualified to collaborate with company to make the market. Recently, CSM has executed 50% of the bicycle and motorbike tires’ modern distribution system and plans to apply for automobile tires to complete at the end of 2014.

Selling expense is increasing considerably. The reason is, in 2012, CSM has implemented trading-promotion campaigns.

Industry Overview

Small market, slow growth for total unit sales in the near future

• In the Tire market report, the total revenue of the market in 2012 only reached 16.8 trillion VND (equivalent to 800 million USD) and accounted for only 0.34% of the global tire market (235 billion USD – Tire Business, Bridgestone). In which, the product generating the highest revenue, car tires, had the total sales of 4.3 million units /year, equivalent to 0.33% of the total global figure 1.3 billion units /year.
• The bicycle tires market is nearly saturated, the compound annual growth rates (CAGR) of the period 2005 – 2011 of bicycle tires and bicycle tubes are 0.7% and 1.3% respectively, even the sales of bicycle tires experienced a gradual decline from 24.5 million units in 2008 to 21.3 million units in 2011. Regarding motorcycle tires and tubes, CAGRs of the period 2005 – 2011 are 8.9% and 10.2% respectively, but the growth is slow down for the upcoming period due to the stable demand for motorcycles in Vietnam. Regarding car tires and tubes, while tires followed a relatively quick growth of about 20.8%/year, car tubes fluctuated in the range of 6.3 – 9.5 million units (Ministry of Industry and Trade).

Competition

• In general, the level of competition is relatively complicated. Despite the appearance of many (both domestic and foreign) companies, there is only an insignificant competition between the domestic group (CSM, DRC and SRC) and foreign group (Bridgestone, Michellin, Kumho, Yokohama…). FDI group is holding almost all the passenger car tire market, while domestic companies only focus on bicycle, motorcycle and truck tires, and this situation will not change even after the introduction of domestic radial products (still mainly for trucks). However, in fact that domestic group still has to compete with some Chinese producers and fake products, but this does not affect much due to the customer behavior toward Chinese products.

• Regarding the competition among domestic companies, CSM holds the first position in total sales of all products with about 33%, followed by 25% of DRC and 15% of SRC (CSM annual report). For each product, CSM is leading motorbike tires, DRC is leading truck tires and SRC is leading bicycle tires. The biggest competition is experienced in truck tires; in particular, DRC is leading in heavy duty trucks and light trucks for 35% of market share, while CSM holds 25%. SRC lags far behind both competitors and only gains a little advantage in bicycle tires. Besides, the geographic factor also exists that CSM has the advantage in the South, DRC has in the middle and SRC has in the North.

Market driver: Radial products and the growth of car market

• As the trend of tire products in the world that changes from BIAS tires to Radial tires most of market, two biggest Vietnamese tire companies CSM and DRC have implemented Radial projects and will gradually substitute for the current Bias tires. SRC also stated that the company would consider changing to Radial in the next 10 years. Radial tires have a much higher price and get a better interest of consumers, so it will be the future drive of the industry.
• Another market drive is the development of car market. Car tires bring the much higher revenue than other types of products. Currently, due to the high price (because of high taxation), economic stagnation and under-developed infrastructure, the total cars sales and active cars are quite low, but there are many evidences for the future of car market: the reduction of taxation from economic agreements, the rapid economic growth of Vietnam, the improvement in roads and infrastructure, etc.

Major indirect factors: Rubber price and economy growth

• Cost of raw materials (mainly natural rubber and synthetic rubber) accounted for approximately 70% of the cost structure (58% for natural rubber and synthetic rubber) of the tire industry businesses(Rubber World Report). Thus, the increase or decrease in the price of rubber has a great impact on the profitability of companies in the industry. All of reports in 2013 (CSM, DRC, SRC) said that the reason of the strong gain in net income was the big decline in rubber price, and according to some external reports, rubber price will not either increase or decrease significantly in the near future, so we do not expect any major change in profitability due to rubber price.
• Economic growth is also a major factor driving the tire market, not only in Vietnam but the world market (Rubber World Report). In general, economic situation affects the tire market mostly through vehicle consumption (better economy leads to higher ability and willing to buy vehicles) and vehicle usage (the more usage, the more replacement).

Investment Summary

Fundamentals and valuation suggest a HOLD position.

The analysis on a ground basis of the company, along with the estimated valuation of several methods, confirms the attractiveness of CSM stock. The target price of VND 36,400 at the end of 2013 indicates a slight 5% absolute upside. Despite the difference of current and target price of CSM is not high, the operation characteristics, dividend policy as well as the positive effects of Radial projects imply the sufficient interest of CSM investment.

CSM has a sustainable business model to support its growth.

CSM corporate governance is rated to be more than the industry average.The company is long-lasting and the majority of board of management has served the company for years, hence, they have valuable experiences in managing company as well as have deep knowledge of typical features of company.

Strong financial position and high dividends

• Accelerating forecast Cash Flow from Operation: CFO of CSM is estimated to increase rapidly because of high profit from Radial products. However, as the company is constructing plant and factory for the first period of Radial Project while the project is divided into three periods, making the CFF to rise and the CFI to decrease significantly in several forthcoming years.

• The company is able to pay principal debt before planned (within 10 years) because of high income from Radial tires. In addition, dividend is going to increase as the company tends to raise the charter capital as well as using high Cash Flow to pay cash dividend.

Possible investment risks:

      CSM is likely to cope with risks from exchange rate, rubber price, interest changes and macroeconomic factors. Since the company is investing in the Radial Project, CSM needs to borrow a large amount from banks; hence, the changes in interest rate have direct effect on CSM expense.

      Additionally, total amount of synthetic rubber is imported; therefore, the cost of input materials not only depends on rubber price but also depends on the value of exchange rate.

      The 0% of export taxation on tires and the ability of Vietnam to join TPP in the near future would make the industry fiercer with more competitors taking advantages of such macroeconomic conditions to join Vietnam goods market. Therefore, CSM’s profit may be negatively affected.

Valuation

We have considered two standard approaches to value CSM- Discounted Cash Flow (DCF) model and comparable company multiple pricing.

DCF valuation

We used Discounted Cash Flow Model: Free Cash Flow to Firm (FCFF) which is suitable for CSM because company’s capital structure includes a relatively large proportion of debt. According to our detailed DCF analysis, we anticipate the target price of VND 36,101.

Four major components of FCFF: Cash Flow from Operation (CFO), Fixed Capital Investment, WACC, residual growth rate.

In order to calculate and forecast the above components, the following estimated factors are highly important:

• Sales: The estimate of sales is based on the sales of new products- Radial tires and available-before products (bias tires, rubber tubes…). Because the radial tires’ sales constitutes for the large proportion of total revenue, and in 2014, the first radial products will be sold, increasing the revenue significantly (23.5%). However, the radial project will have the substitute effect on the sales of previous products, diminishing their revenue. According to the plan and strategy of company to focus on radial products as well as the forecast about the growth rate of motorbike and automobile, we estimates that the sale for bias products will rise by 1- 2% each year since 2013.
• Residual growth rate is based on: (1) the expected rising GDP growth rate, (2) the average annual growth rate of other big and long-lasting tire &rubber companies (used as the benchmark for the Perpetuity period of CSM), (3) the strategy of CSM, (4) high expected cost of equity (median value of 19.6%). Taking into account the aforementioned factors, we establish the residual growth rate of 5% since 2022 when the radial manufacture reaches the highest and stable capacity and the debt for radial project is fully paid.
• Dividend policy: CSM plans to pay at least dividend of 12% per year (CSM prospectus) but 30% is preferred in case the profit is high. In addition, dividend will be paid both in cash and securities because the company aims to increase the charter capital considerably next years. Therefore, according to team estimate of CSM’s accelerating net income, the company will pay total dividend of 30- 50% annually, including 12% of dividend securities (see appendix).
• Capex: Owing to the construction of the first-period radial project which is estimated to complete in 2013, the future capital expenditure will be substantial. CSM plans to invest in radial project in three periods (period 1: 1,327 bln VND, period 2: 620 bln VND, period 3: 850 bln VND) of which the greatest amount of investment is in the first period (2012-2014), after that, the depreciation will be significant.
• WACC: The cost of equity was calculated using CAPM model. We utilized 10-year government bond risk-free rate of 8.89%, the adjusted beta, which is changing from 1.295 in 2013 (CSM price in VND regressed against VNIndex) to 1.030 in residual value calculation. The sum of market and country risk premium id equal to 14% (based on A. Damodaran estimations). The after-tax cost of debt was calculated using value of 10.41% in 2013, increasing to 11.10% since 2016 due to the changing of tax policy. For more details about components of WACC and its assumptions, please refer to appendix 5.

Multiples Valuation

We consider P/E in association with ROE, ROC and ROS to choose peers and evaluate target price of CSM. We believe that this method can support for the DCF method to be more precise at evaluating intrinsic value of CSM.

Peer group selection

We consider companies in Asian emerging countries for having the relatively the similar risk and profitability ratios (ROE, ROC, ROS). Then we select companies which have the large proportion of revenue coming from the core business of rubber and tires. Hence, we choose six other companies, two companies from Malaysia (SKP RESOURCES BHD & WELLCALL HOLDINGS BHD), two from Thailand (INOUE RUBBER (THAILAND) PCL & SRI TRANG ARGO - INDUSTRY PCL), one from Indonesia (GAJAH TUNGGAL TBK PT) and one from Vietnam (DANANG RUBBER JSC).

Seven companies chosen are from South East Asia; therefore, they have similar business efficiency as well as country risk.

Because the available data for CSM is only from 2009, therefore, we use the average numbers instead of medians to calculate the benchmark ratios. Seven companies considered have the ROC and ROE of at least 10%. Moreover, the least ROS of seven firms is 3%.

P/E methodology

Having previously chosen appropriate peer group, we conducted multipliers pricing using benchmark P/E ratio which is based on two-year forward averages.

We collect the current P/E of these companies, the market P/E in each country and the market capital of each enterprise. Then we calculate the average weighted P/E considering the difference of the country P/E and the proportion of market capitals. Consequently, the final P/E to be applied is 7.584x. We see this P/E is relevant because it shows the target CSM security’ price of VND 36,700 which is close to the target price calculated by FCFF approach.

Weighting of the model

As calculating the target price in the FCFF model is based on the forecast of company’s financial statements with several assumptions about the radial project which will have great effect on the price result. The Radial project’s data is estimated according to the plan, strategy of CSM (CSM’s prospectus) as well as the consideration of the expected consumers’ demand. Meanwhile, P/E methodology considers the comparable companies in the same industry and the companies have similar geographic characteristics. Moreover, the target prices reached by using these methods are relatively similar. Therefore, we choose the weighting of 50/50 to calculate the final price for CSM security at the end of 2013.

Conclusion

By combining both valuation methods to account for the company’s intrinsic value as well as factoring in the growth potential, the fair price of CSM is VND 36,401. In comparison to the current price of VND 34,700, there is still not a clear opportunity to buy CSM because of the potential upside gain of only 4.8% by the end of 2013. Hence, we only suggest the HOLD position of CSM at present.

Risk to target price

The FCFF model relies mostly on the terminal value, which is determined largely by the assumed perpetual growth rate. The target price may be altered substantially should there be any changes to the terminal value, which represents a large lump sum amount of the discounted cash.