Hello guys,
This is my first post here, and i’m looking for some practical ideas on how to evaluate a cyclical company. To be more accurate, the company is based in Brazil and all of its revenues come from domestic market. They produce vehicles and trailers (focused on towed vehicles for the agriculture market).
The company business is highly cyclical and dependent on credit supply, it doesn’t have a very big barrier to entry as the products are not high in technology, but they do have a considerable economy of scale and brand recognition. In the last 10 years the ROIC has been fluctuating from as low as 15% to as high as 60% (their WACC is something around 13%). They have been losing market share to smaller competitors, but not profitability.
The manager has a very long and succesfull track record in the business.
Their current P/E is 7,3 and P/TBV is 1,4. There are no comparable companies listed.
Problem: If we try to use DCF, the assumptions for the next 5 years will vary widely and the perpetuity will have a huge impact depending on the FCFF of the last year.
The P/E appears to be attractive compared to other industries in Brazil, but it could be due to the market forecasting terrible years to come (the question is whether it’s being “too pessimistic”).
The P/TBV is on its lowest point ever, but a mean reversion may not happened if company loses its pricing power (ROIC dropping as there are no barriers to entry).
My idea so far: i’m looking for the “normal” year of the company. Even though the company was able to generate a lot of excess value in prior years, i don’t think it will be able to keep that up. For that, I’m setting a “normalized” ROIC of 20% and considering the Invested Capital I get to the “normalized” NOPAT.
From here, I have assumed that the company is maintaning its market share, thus growing the same thing as the country conomy in perpetuity. And now i consider that in perpetuity the EV should be:
EV = (Normalized NOPAT)*(1-Reinvestment Rate)/(WACC-growth)
With the reinvestment rate being calculated as:
Reinvestment Rate = (growth)*(1-efective tax rate)/(Normalized ROIC)
From this, I’ll get the EV subtract the Net Debt and arrive on the Market Cap.
I would like to hear ideas and sugestions from other researchers.