1 28 Mar 2007 EQUITY RESEARCH DOGUS OTOMOTIV AUTOMOTIVE BUY Adding value via differentiation! We initiate coverage of DOAS with a BUY rating. Our DCF driven price target is TRY8.1 per share, implying 31% upside potential. DOAS is a vehicle to invest on domestic automotive demand. Yet, developments such as new business lines and expected finalization of a privatization deal will enable the company to benefit from all automotive related activities (not just distribution), making DOAS longer term prospects stronger and less volatile. We also expect improvements in operating margins going forward, which dropped to an all time low of 2.4% in 2006 due to currency volatility ( average operating margin of the company is 6.0%). We do not expect such adverse movements in exchange rates this year (1q07 is being favorable with TRY appreciating 1% against Euro since the beginning of the year). In general, DOAS benefits from Euro depreciation against TRY. New business lines include regional expansion and production. DOAS will start selling VW LCVs in Egypt starting in In addition the company will start producing and exporting Krone brand trailers starting from These new initiatives will help diversify the business risk of DOAS. Stock Data Date 28/03/2007 Company Ticker DOAS Share price TRY: 6.2 Target price TRY: 8.1 Target Mcap $ mn: 647 Market Indicators # of shares - mn: 110 Free Float: 34% Mcap mn TRY: 682 Mcap mn $: 493 Beta: 1.34 Relative Price Performance / TRY Daily -0.5% 1 Month -10.1% Y to D -1.0% 3 Months -0.9% 1 Year -27.4% % Motor Vehicle Inspection Stations privatization (a 20 year license to build and operate motor inspection stations that was privatized in 04), in which DOAS has 33% stake in the winning consortium is expected to reach a happy ending. Privatization Administration awaits High Court Danistay s written declaration (for a formal approval of the privatization tender) in order to finalize the process and to transfer the inspection rights to the consortium. We foresee MVIS Net Present Value contribution to DOAS at $159mn (24% of our target value), which we did not include in our fair value estimate for sake of conservatism. Any positive news on this deal should propel the stock price in our view. RATIOS 2005/ / /12e 2008/12e 2009/12e 2010/12e 2011/12e P/E 5.9x 32.1x 11.8x 8.2x 7.4x 6.8x 6.3x Adj P/E 4.1x 22.4x 8.2x 5.7x 5.1x 4.8x 4.4x EV/EBITDA 3.4x 8.7x 5.5x 4.2x 3.8x 3.6x 3.3x Adj EV/EBITDA 2.3x 5.8x 3.7x 2.8x 2.6x 2.4x 2.2x EV/Sales 0.2x 0.3x 0.3x 0.2x 0.2x 0.2x 0.2x P/BV 1.4x 1.4x 1.3x 1.2x 1.1x 1.0x 0.9x Dividend Yield 7.3% 1.0% 4.2% 6.1% 6.8% 7.3% 7.9% FCF Yield 9.7% 9.7% 8.8% 10.4% 12.9% 13.8% 14.8% ROE 29.0% 4.3% 11.3% 15.2% 15.6% 15.6% 15.5% * Adj P/E and Adj EV/EBITDA: Mcap adjusted for 3.9% Dogus Holding stake FORECASTS - $ mn 2005/ / /12e 2008/12e 2009/12e 2010/12e 2011/12e Revenues 1,827 1,765 1,780 2,100 2,335 2,528 2,700 EBITDA Net Income Shareholders Equity Growth Ratios 2005/ / /12e 2008/12e 2009/12e 2010/12e 2011/12e Revenues - adj 6% -3% 1% 18% 11% 8% 7% EBITDA 25% -61% 59% 30% 10% 8% 6% Net Income 54% -82% 172% 45% 11% 8% Source: Tera estimates 8% Ayse Colak, CFA
2 Favorable exchange rate movement is yet to be priced in Mark up on auto sales is the main driver of profitability for DOAS. In general the company aims 5% mark-up on imports and 7% mark-up on distribution, achieving 12% gross margin. Yet, mark ups are exposed to the cyclicality on domestic automotive market and exchange rate movements (therefore volatile). The stronger the local currency, the higher DOAS profit margins on auto sales. Euro depreciation against TRY is generally working in favor of DOAS since 80% of sales are TRY based and even with constant sales prices, mark-ups tend to increase. In the last few years, stable prices for quality cars resulted in increasing market share for DOAS in the domestic market. As can be seen in the chart below, DOAS EBIT margin is negatively correlated with TRY/ trend. For instance DOAS EBIT margin fell from 5.6% level in 1q06 to 0.9% in 2q06 after 23% TRY devaluation against Euro. Although the company uses partial hedging, the significance of TRY movements on margins cannot be ignored. All in all, we think that as long as remains stable or declines, DOAS s operating margin will increase once again to its level in EBIT Margin vs Change in TRY/ EBIT Margin 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 25% 23% 20% 15% 10% 5% 3% 2% 0% 0% -1% -3% -2% -1% -2% -5% -5% -9% -10% -15% 3q04 4q04 1q05 2q05 3q05 4q05 1q06 2q06 3q06 4q06 today Chg in TRY/ EBIT Margin Chg in TRY/ Source: Tera estimates Not a mere local distributor anymore DOAS will start distributing VW brand LCVs in Egypt this year and produce Krone brand trailers in Turkey starting from Until the end of 06, the company was purely an importer of high end vehicles. Penetration into a new market and the launch of a production line will help the company diversify its domestic market risk to some extent. Note that DOAS seeks distributorships in other markets as well. DOAS will sell VW brand LCVs in Egypt starting from Even though this business line will be relatively insignificant in the immediate term, we think Egypt sales might reach around 5% of domestic LCV sales in two years. VW did not have presence in Egypt LCV market previously. Total annual LCV sales in Egypt are estimated at 20k per year. DOAS aims to reach 3,000 annual units in Egypt in few years. DOAS will produce Krone brand trailers starting from Total capacity will be 10k with an estimated capex of 30mn. DOAS has been Krone brand s Turkey distributor since DOAS and Krone will set up a new company (for manufacturing) where DOAS has 49% stake. We assumed 49% of related capex to be financed by DOAS (in two years). Following the commencement of the production, DOAS will use equity method to account for Krone (meaning we will not be seeing sales figures at the top line).
3 Motor inspection stations (MVIS) will be a significant asset if DOAS is part of the consortium with 33.33% that won 20 year license to operate auto inspection stations in Turkey (a business that was under state control previously). The tender took place at the end of 2004 and the consortium won the tender with a bid of $613.5mn (10% discount applicable if paid in cash). High Court Danistay already announced its positive decision (in favor of the winning consortium) verbally and now is expected to declare this decision to Privatization Administration in written format so that PA can proceed with the actual transfer of inspection rights to the consortium (recall that Privatization High Council decision is still pending, which is contingent on the final verdict from the courts). There are media reports that MVIS will be approved by authorities very soon. Note that the consortium is also planning to subcontract the business on a regional basis. Revenues generated by the operations will be shared with the State. MVIS will pay 30% of revenues to the State for the first three years, 40% between 3-10 years and 50% thereafter. Therefore we find the plans for subcontracting on regional basis very reasonable. As of 2006YE, there are 12.2mn registered vehicles in Turkey; LCV and PVs comprising 68% of the total. The percentage of the vehicles that went through an inspection was 29% of all registered vehicles in 2006 yet the ratio should have been 47% given the age structure of Turkish vehicle fleet. We estimate MVIS business NPV to DOAS at $160mn which we did not include in our fair value estimate. Subcontracting would increase the NPV in our view (lower capex requirement, lower operating costs). Our assumptions are as follows: Growth rate of registered vehicles: 6% between , 3% between and 2% thereafter % of inspected vehicles: 31% of between , 36% between and 45% thereafter Operational costs: 40% of gross revenues Tax rate: 20% Initial capex: $105mn (in first 2 years), $10mn thereafter Average inspection price: $65 DOAS in brief DOAS is the exclusive distributor of Audi, Porsche, Volkswagen, Scania and Krone in Turkey. It also has 50% joint venture in Skoda and SEAT (DOAS acquired full stake at SEAT at the end of 2006). DOAS will also start selling Bentley, Lamborghini, Meiller and VW Marine Engine brands in Currently Import and Distribution segment accounts for c.70% of sales and Retail and After-sales services account for c.30% of sales. The company enjoys 11.5% market share in PVs (distributed by DOAS) as of 2006YE. Additionally, VW brand LCVs secured a 13% market share in LCV market (up from 8% in 2003); a very good performance! Note that DOAS does not fully consolidate Skoda sales (uses equity method). Free cash Flow Period Lump-sum payment - mn $ NPV of FCF at 15% - mn $ DOAS' share DOAS' share - mn $ Source: Tera estimates % 159 Sales - units 2003/ / / /12 AUDI 2,551 4,297 4,705 4,956 VOLKSWAGEN PV 21,123 33,094 32,049 27,619 PORSCHE SEAT 5,092 5,546 6,570 4,572 SKODA 5,002 7,002 8,026 5,489 VOLKSWAGEN LCV 10,891 26,984 33,163 31,947 SCANIA 1,515 1,837 2,073 2,099 KRONE hand car sales n.a. n.a. 4,881 7,735 Market Share 2003/ / / /12 AUDI 1.1% 1.0% 1.1% 1.3% VOLKSWAGEN PV 9.3% 7.3% 7.3% 7.4% PORSCHE 0.0% 0.0% 0.0% 0.1% SEAT 2.2% 1.2% 1.5% 1.2% SKODA 2.2% 1.6% 1.8% 1.5% VOLKSWAGEN LCV 7.9% 10.9% 12.2% 13.1% SCANIA 5.0% 4.9% 4.9% 5.0% TOTAL 11.7% 10.7% 11.5% 11.7% TOTAL PV 14.9% 11.1% 11.7% 11.5% TOTAL PV + LCV 12.3% 11.0% 11.9% 12.1% KRONE n.a. n.a. 11.0% 15.0% Source: Company reports, Automotive Manufacturers Association, Tera estimates
4 DOAS is also involved in various automotive-related services such as supply and distribution of parts, logistics, used car sales as well as consumer finance, and fleet rental through its affiliates. Consumer finance is carried out by the company s 48% subsidiary VDTF Consumer Finance. Revenues from subsidiaries reached $10mn in Yet in 2006, DOAS only incurred $1.4mn income from subsidiaries. The subsidiary list and their accounting methods are outlined below: Company Stake Accounting method Dogus Oto Marketing 87% Full consolidation Katalonya (SEAT) 100% Full consolidation TUVTurk North 33% Equity method TUVTurk South 33% Equity Method Yuce Auto (Skoda) 50% Equity Method Dogus Insurance 42% Equity Method VDF Holding 38% Equity Method VDTF (Consumer Finance) 48% Equity Method Dogus Holding 3.9% Available for sale securities Source: Company reports VDF Holding (shareholders: Volkswagen Financial Services AG 51%, DOAS 38% and Dogus Group 11%) Currently there are two companies under the management of VDF Holding: VDF Auto Service and VDF Insurance Services. Volkswagen Financial Services plans to sell its stake in fleet rental business i.e., VDF Auto Service to Leaseplan (one of Europe s largest fleet rental company). Therefore if the deal goes through, Leaseplan will hold 51% stake in VDF Auto Service. This deal is important because Leaseplan aims expanding in Turkey (in fleet rental business which is at early stages) and fleet expansion implies more VW car sales for DOAS as well as higher after-sale services and 2.hand car sales business going forward (in fleet rental average life span of vehicles are two years). VDTF (Consumer Finance) VDTF is a consumer financing specialized in motor vehicles. As of 2006/12, the company has $850mn loan portfolio (down 3% y/y mainly due to depreciation of TRY; total increase in number of vehicles in the portfolio is 23% y/y in 2006) with 14% market share in auto loans. Bursa land is also a prospect Group company GRGYO (Garanti REIT) agreed to construct a commercial center (auto showrooms, service stations, hotel, sports center, shopping center etc) on DOAS s land in Bursa in Accordingly DOAS would have received 29% of the revenues in return for the land s ownership transfer to GRGYO. It was a large project over 37k sqm land, however it was cancelled (later GRGYO was sold to Dogus/General Electric Real Estate Europe). At the moment the company is considering its options for possible projects on Bursa land. Any related development might provide a support for the share price. Conservative Sales Forecasts for Local Automotive Market Historically speaking, Turkish PV and LCV market displayed a rather erratic sales performance, mainly in line with economic cyclicality. In the last ten years, domestic PV and LVC markets showed 4.5% and 14.4% CAGR respectively. LCV tax rates are more favorable compared to PVs. As a result, some multipurpose LCVs currently play an imperfect substitute role for PVs as well. HCV market has experienced a transition period in the last few years. Namely smaller transportation companies have turned into professional logistics companies due to strong competition. As international and domestic transportation grows (Turkey s strategic location as a bridge between Asia and Europe as well as increasing economic activity supports the growth), HCV market poised to experience decent growth rates going forward.
5 Unit Sales Domestic Market 2002/ / / / /12 PV 90, , , , ,219 LCV 66, , , , ,543 HCV 15,028 30,096 37,205 41,982 42,071 TOTAL 172, , , , ,833 % PV -31% 151% 99% -3% -15% % LCV 28% 105% 80% 10% -10% % HCV 128% 100% 24% 13% 0% % PV+LCV -14% 131% 92% 2% Source: Automotive Manufacturers Association -13% 2006 was not a good year in terms of unit sale performance; the underlying reason was the short-term economic turbulence in Turkey caused by a combination of global and domestic factors. As a result of the turbulence, exchange rates climbed putting a cap on imported car sales and auto loans have frozen due to poor consumer confidence (auto loans play an important role in domestic sale performance, percentage of vehicles purchased through bank loans hovers around 65% of total PV and LCV sales). We assumed 2007 sales to recover modestly (in line with sector estimations) and assumed above the real GDP growth for 2008 and Unit Sales Domestic Market 2005/ / /12e 2008/12e 2009/12e 2010/12e 2011/12e PV 438, , , , , , ,000 LCV 271, , , , , , ,000 HCV 41,982 42,071 30,000 44,000 47,080 49,905 52,899 TOTAL 752, , , , , , ,899 % PV -3% -15% 3% 9% 8% 5% 4% % LCV 10% -10% 2% 16% 6% 4% 3% % HCV 13% 0% -29% 47% 7% 6% 6% % PV+LCV 2% -13% 3% 12% 7% 5% Source: Automotive Manufacturers Association, Tera estimates 4% Financial Performance DOAS reported a weak performance in 2006 in line with expectations. Revenues (including revenues from subsidiaries) declined by 4% YOY in dollar terms. Note that we adjust total revenues for income from subsidiaries consolidated using equity method (mainly because these operations are also company s core businesses). Operating margin and net income margins have shrunk by 410 bps and 360 bps respectively compared to Net income was under pressure of shrinking operating margins and exchange rates losses. Still in a very bad year for importers and domestic auto market, DOAS was able to post 11.5% gross margin and eliminated all excess inventory. $ mn 2004/ / /12 Revenues 1,727 1,827 1,765 Revenues from subsidiaries Total revenues 1,727 1,837 1,766 EBIT - adjusted Other Income/Expenses Minority&Monetary Income before tax Tax Net Income EBITDA EBIT Margin (adj) 5.4% 6.6% 2.5% EBITDA Margin 6.1% 7.1% 2.9% Pre-tax Margin 4.8% 6.4% 1.1% Net Income Margin 3.1% 4.5% Source: Company, Tera estimates 0.9%
6 Despite much lower EBITDA, DOAS basically improved its free cash flow by reducing its inventory and extending its trade payables as can be seen below in the free cash flow table. The ability to raise cash flow through better working capital terms demonstrates how flexible DOAS can be; an investor friendly argument. Free Cash Flow Table $ mn 2004/ / /12e EBITDA Capex (-) Inv in affiliates (-) Taxes (-) in WC Free Cash Flow Source: Company, Tera estimates Our price target is TRY8.1 per share, implying 31% upside potential We employed DCF valuation (at 16.3% WACC and 1% terminal growth rate in dollar terms) to arrive at a fair value for DOAS. There are few listed distributors to compare with DOAS in emerging markets; we could only find Hotai in Taiwan, Delek in Israel and MBM in Malaysia. On the other hand, we do not think comparison with automotive manufacturers would offer a good assessment due to different risk profiles. We present the global peer comparison later in the report, yet we mainly rely on our DCF driven fair value due to inadequacy of alternative methods. Our assumptions for WACC calculations are: - Risk free rate: 7.5% (Turkey Eurobond rates) - Equity premium: 7% (higher than our standard 5%) - Beta: Tax: 20% Based on DCF valuation (see Exhibit I), our fair value estimate is $5.9 (~TRY8.1) per share, implying the company is trading at 24% below our estimated fair value. Note that 23% of our total fair value estimate comes from 3.9% stake at Dogus Holding (Dogus Holding holds 35% stake at DOAS, we adjusted Dogus Holding value for cross shareholding accordingly). Dogus Holding (unlisted) is among largest conglomerates in Turkey active in various industries such as banking, construction, media, automotive and tourism. 22% of Garanti Bank (GARAN) belongs to Dogus Holding. Based on global peer comparison (see below), DOAS is trading at significant discount based on EV/EBITDA 07e and EV/Sales 07e valuation multiples (its peers trades at 10.8x EV/EBITDA 07e versus DOAS s 5.5x EV/EBITDA 07e). However DOAS is not trading cheap based on P/E multiples. Company Currency Mcap - mn EV EV/ EBITDA07 P/E07 EV/ SALES07 Hotai Motor TWD 42,384 37, x 11.1x 0.5x Delek Automotive ILS 2,972 3,604 n.a. 8.9x 0.8x MBM Resources BHD MYR x 7.3x 0.6x Median 10.8x 8.9x 0.6x DOAS - Tera estimates $ x 11.8x 0.3x Source: Bloomberg, Tera estimates Risks Sharp currency movements present the most important risk for the company since it heavily weighs on profit margins. We assumed 7% equity premium for DOAS (as opposed to our standard 5% equity premium) in our cost of equity calculation. In addition, the Beta (1.34) that we used already reflects the risk level of the company. Turkey has always been susceptible to the risk of tax increase on autos (the tax regime for the Turkish automotive industry has never been stable over the years). Government s decision to increase already
7 high excise tax or general tax rates on cars would lead to lower than estimated domestic market sales and would negatively impact our valuation. We do not expect such a decision this year. Possible deterioration in current macro conditions would have a toll on automakers as well but we think automotive market already made a dip due to uncertainties last year; therefore we think the downside is quite limited. Any termination in distributor agreements with existing brands (especially VW Group Companies) would seriously harm the company s business. DOAS commercial relationships with VW Group Companies are strong (they even will start distributing VW LCVs in Egypt). Therefore we attribute this risk a very low probability. Block Exemption Rule (BER) is effective as of January 1 st, 2007, meaning dealers will be free to sell multiple brands, therefore independent dealership mechanism will get stronger as this rule is absorbed by the market, leading to more competition and possibly to lower margins. Note that the impact of BER in EU countries has not been very dramatic. Major effects can be summarized as follows (-source: DOAS): - the number of distributors and their average size increased - service-repair prices increased - maintenance-repair expenditures declined - number of authorized repairers has fallen - almost one fifth of independent repairers became contractual partners of the manufacturer - stand-alone repairers became part of large repairer groups Our EBIT assumptions for DOAS incorporate this effect. We assumed 4.0% EBIT margin in 2007 and 4.5% going forward despite the company s average EBIT margin in the last years is 6%.
8 Exhibit I: Valuation Model $ mn 2005/ / /12e 2008/12e 2009/12e 2010/12e 2011/12e Revenues 1,827 1,765 1,780 2,100 2,335 2,528 2,700 Revenues from subsidiaries Total revenues 1,837 1,766 1,782 2,102 2,338 2,531 2,703 EBIT - adjusted Other Income/Expenses Minority&Monetary Income before tax Tax Net Income EBITDA EBIT Margin (adj) 6.6% 2.5% 4.1% 4.6% 4.6% 4.6% 4.6% EBITDA Margin 7.1% 2.9% 4.6% 5.1% 5.0% 5.0% 5.0% Pre-tax Margin 6.4% 1.1% 2.9% 3.6% 3.6% 3.6% 3.6% Net Income Margin 4.5% 0.9% 2.3% 2.9% 2.9% 2.9% 2.9% Free Cash Flow Table $ mn 2005/ / /12e 2008/12e 2009/12e 2010/12e 2011/12e EBITDA Capex (-) Inv in affiliates (-) Taxes (-) in WC Free Cash Flow Period Months Present Value Factor PV of FCF Discount Rate 16.3% Terminal growth rate 1% Valuation Sensitivity Sum of FCF / mn $ 202 terminal growth rate Terminal Value mn $ 254 Share price 0.0% 1.0% 2.0% 3.0% EV % TRY 8.8 TRY 9.0 TRY 9.4 TRY % TRY 8.3 TRY 8.6 TRY 8.8 TRY 9.1 Total Debt % TRY 7.9 TRY 8.1 TRY 8.4 TRY 8.6 Cash % TRY 7.6 TRY 7.8 TRY 8.0 TRY 8.2 Net Debt - mn $ % TRY 7.3 TRY 7.5 TRY 7.6 TRY 7.8 Estimated Fair Value - mn $ 498 Terminal Value Calculation 3.9% stake at Dogus Holding (BV) - adj 149 Total Fair Value - mn $ 647 EBITDA after tax 115 x (1+ Long-term growth ) 1.01 Current Mcap $ mn 493 Equals:Terminal Net Oper. Profit 116 Current Price TRY 6.2 Less:Normalized CapEx 12 Target price $ 5.9 Minus: Incremental WC 27 $/TRY exchange rate 1.38 Equals: Terminal Cash Flow 77 Target price TRY 8.1 x (1/(r-g)) 6.5 Upside potential 31% x PV factor 0.51 Equals: Terminal value 254 Source: Tera estimates discount rate
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