1. 1. Corporate Finance Final Project Automotive Industry Toyota (covered by Robert Petts) Tesla (covered by Charles Efthimion) Ford (covered by Nic Greer)
2. 2. Automotive Industry Overview The automotive companies we covered focus their operations in automotive manufacturing, production and sales. Although Toyota and Ford own subsidiary companies that focus on automotive financing, we have chosen to focus on the automotive business. Given the nature of automotive sales, these companies are exposed to macroeconomic risks such as the prices of raw materials, the prevailing rate of interest and overall consumer purchase of durable goods. In addition, these automotive companies have high indirect bankruptcy costs as sales would be negatively affected upon a companys bankruptcy. Ford reports revenues generated in North America, South America, Europe and Asia Pacific Africa. Roughly 58% of revenues are generated from the United States; roughly 21% of revenues are generated from sales in Germany, Mexico, Canada and the United Kingdom; the remaining 21% are attributed to sales in all other countries. Toyota reports 25.7% of its revenues from Japan, 27.8% of its revenues in North America, 9% of its revenues from Europe, 19% of its revenues from other Asian countries besides Japan, and 18.5% of its revenues from other, unspecified regions. Tesla reports revenue in the United States. There are cars sold around the world however at this poit all revenues are reported in America.
3. 3. Corporate Governance Ford is governed by its board of directors which includes at least a handful of insiders, including the current president and CEO, Alan Mulally; former COO, Edsel B. Ford II; and former CEO, William Clay Ford Jr. Toyota uses a board of directors which consists of few insiders, which interact directly with the Senior Managing Officers and Managing Officers. These Managing Officers then interact with the Chief Officers who are in charge of each division. Toyota also recently instated an auditing system to ensure that Management was making good investment decisions and reporting honest financial information. Toyota puts out an annual 20-F form and other financial information as well as information about the company as a whole on its website, toyota-global.com. Toyota holds social responsibility as one of its core beliefs, and takes part in as well as organizes many various social contribution activities. Tesla Motors is a company that is held majority by institutional and mutual fund owners. Insiders only own around 35% of the company. The founder and CEO, Elon Musk, directly owns only 75 shares in Tesla. For most companies this is a frightening sign, showing that the insiders do not have faith. In fact, Musk owns the most amount of stock, just not directly. Currently the board of directors consists of 7 men, none of which would be considered insiders. Some have close relationships with Elon Musk but they have never been executives at Tesla. Tesla is considered a ground-breaking company with regards to corporate governance. Based on the corporate governance styles of Toyota, and Tesla, one would expect to see in a typical automotive firm a board of directors with few insiders which have a large amount of control over management. However, Ford has a large amount of insider influence in its board, and both Ford and Teslas CEOs sit on their boards. Using these three firms as representative of the automotive industry as a whole shows that there is really no corporate governance style that is specific to the automotive industry.
4. 4. Stockholder Analysis While all board members are invested in Ford, only .49% of shares are held by insiders. Compare this small percentage to the 56.88% owned by institutions and 24.06% owned by funds.1 Major institutional holders include Evercore Trust Company, Vanguard Group Inc., BlackRock Fund Advisors and State Street Corp. Vanguard Group manages five of the largest six mutual fund positions in Ford Motor Company. Out of the 3.447 billion shares Toyota has outstanding, Toyota owns 280,568,800 shares (8.137%). Large institutional investors hold 2,677,872,300 shares (77.665%) which make them the average investor in Toyota. Individuals/ small institutional investors hold 463,110,800 shares (13.431%), and 26,445,592 shares (.767%) are held by unspecified investors. Major institutional shareholders include Japan Trustee Services Bank, Ltd., The Master Trust Bank of Japan, Ltd., State Street Bank and Trust Company, and Nippon Life Insurance Company. The marginal investor in Toyota would be Japan Trustee Services Bank, Ltd., as it holds the most shares of any investor in Toyota at 328,913,000 shares. However, there would be insider influence, as Toyota itself is the second largest shareholder with 218,515,000 shares. Tesla currently has around 124.09 million shares outstanding. Around 35.30% are held by institutions. The largest institutional holder is Elon Musk the CEO of Tesla, who owns 28.3 million shares but only 75 as an insider. This does however make Elon Musk the marginal investor. According to Yahoo finance Elon Musk only owns 75 shares and owns none as an institution. Yet, Thomson Reuters reports Musk as the largest institutional owner. 1 http://investors.morningstar.com/ownership/shareholders-overview.html?t=F&region=usa&culture=en- US&ownerCountry=USA
5. 5. Recently, Tesla has net insider shares of -99.211. These shares were sold by Kimbal Musk and Antonio Gracias. This represents insiders disposing of stock suggesting it is trading high or there is some doubt. The average investors in all three firms are large institutional investors, and the marginal investors are the institutional investors with the largest holdings. In addition, many individual investors also have stakes in Ford, Tesla and Toyota.
6. 6. Cost of Capital and Risk Profile Company Rating Default Spread Cost of Debt (pretax) Tax Rate Cost of debt Toyota Aa3 .600% 3.23%2 37.6%3 2.015% Ford Baa3 2.00% 4.599%4 35.1% 2.985% Tesla B-5 0% 2.59% 35.1% 1.68% Company Reg. Beta ERP Cost of Equity Jensens Alpha Toyota .716 6.877%7 7.51% -.7672 Ford 1.34 6.027%8 10.817% .2459 Tesla 1.37 3.33% 7.15% .6186 Toyota has an R-Squared of .304 on a regression of Toyotas monthly returns against monthly returns of the S&P 500 over the past 5 years, meaning that 30.4% of Toyotas risk is from market sources, and that 69.6% is firm specific and thus diversifiable, meaning that it is unrewarded under the CAPM. Toyota has a beta of .71 (with a standard error of 4.4%, showing that the regression beta is quite accurate), meaning that Toyotas returns should move with the market, but to a slightly smaller 2 Assumes a 2.63% risk free rate (based on US 10yr T-bond rate as of 6/24/2014). Toyotas bond rating is Aa3 (Moodys, .6% default spread) 3 Japanese Statutory Tax rate, accounts for Toyotas incomes from different regions with different tax rates 4 Assumes a 2.599%. Based on US 10yr T-bond. 5 According to Standard and Poors rating. N/A for Moodys. 6 Calculated by running a regression of Toyotas monthly returns against S&P 500 monthly returns from May 2007-March 2013 (Standard Error= 4.4%) 7 Weights Toyota sales in Japan (5.9%), North America (5%). Assumes a conservative 8.5% ERP for Toyota sales in Europe, Asia, and other unspecified regions. 8 Weights Ford sales in USA, MEX, DE, CA and UK with their respective equity risk premia. Assumes a conservative 8.500% ERP for the remainder of Ford sales in Europe, Africa, South America and Asia. 9 http://www.macroaxis.com/invest/technicalIndicator/F--Jensen-Alpha
7. 7. magnitude. However, Toyota has a Jensens Alpha of -.7672, meaning that Toyota did .7672% worse than predicted by the CAPM between May 2007 and March 2013. Fords beta is 1.34, which means the companys returns react moresentitively to changes in market returns compared to Toyota. Ford also has a .245 Jensen s Alpha, suggesting Ford outperformed the the CAPM prediction. Fords high beta (compared to Toyota) is likely due to its high degree of financial leverage. Very similar to Ford, Tesla has a beta of 1.37 which makes it more sensitive to to market changes than Toyota. Being a high growth company, Tesla s Jensens Alpha is higher than Toyota and Ford and out performes CAPM expectations. Tesla has the highest beta of the three companies most likely because of its high debt levels. Company Debt/Capita l Cost of Debt Equity/Capi tal Cost of Equity WACC Toyota 46.56% 2.015% 53.44% 7.51% 4.96% Ford 58% 2.985% 42% 10.817% 6.238% Tesla 46.76% 1.68% 53.23% 7.15% 4.59% As mentioned earlier, the automotive industry, especially for companies operating internationally, is subject to a variety of industry, market, political, and other macroeconomic risks which make the automotive industry highly volatile. Another trend within the automotive industry is the use of debt financing among mature, stable companies - such as Toyota and Ford - which tends to lower the cost of capital.
8. 8. Measuring Investment Returns A typical project for a firm in the automotive industry would be to develop plans for, manufacture, and sell a vehicle. The timeline of cash flows for a typical project in the auto industry would be a long initial period of negative cash flows in the firms native currency as the firm pays for research & development as well as facilities and equipment needed for manufacturing, and then a long period of steady, positive cash flows in multiple different currencies as the firm sells the vehicle internationally. Cost of Equity Return on Equity10 Cost of Capital Return on Capital11 Toyota 7.51% 9.089% 4.96% 2.49% Ford 10.817% 33.81% 6.238% 5.46% Tesla 7.15% -21.84%12 4.59% -4.40%13 Toyota has a higher Return on Equity than Cost of Equity, but a lower Return on Capital than Cost of Capital. This could be for a variety of reasons, but is most likely because Toyota has many investments in various other enterprises that are making it a lot of money. However, the relationship between the Return on Capital and Cost of Capital is a better indicator of whether a company is taking good investments or not, and as such, having a lower Return on Capital than Cost of Capital implies that Toyota did not make good investment decisions in the 2012-2013 fiscal year. Tesla has lower returns than costs for equity and capital. This is much different than the other two companies. This is due to the fact that Tesla is a new automotive company while Toyota and Ford have been well established for years. From analyzing Tesla, we can see that there may be many project that should not be taken. There are incredible negative returns. However, as previously stated, Tesla is a new company and is attempting to create an international network of charging stations, all electric vehicles, and worlds first giga factory. All of these projects require an immense amount of resources and it is important to note that Tesla is in an upward trend, income is increasing while expenses are decreasing. 10 Most recent years Net Income/ Average Book Value of Equity over the past 2 years 11 (EBIT(1-tax rate))/ Average Book Value of Debt & Average Book Value of Equity over the past 2 years 12 As of Quarter ending March 2014. 13 As of Quarter ending March 2014.
9. 9. Ford currently has a return on equity of 33.81% which is substantially higher than its 10.817% cost of equity. This suggests Ford is making good investment decisions. However, Fords subsidiary Ford Motor Credit Company contributes to the 33.81% RoE. It is atypical of an automaker to have RoE numbers this high.14 In addition, Fords return on capital - a better indicator of investment decisions - is lower than its cost of capital at 5.46% and 6.238% respectively. Ford should focus on improving its return on capital by investing wisely and taking on positive NPV projects. Toyota and Ford both have lower returns on capital than costs of capital, but higher returns on equity than costs of equity. Leaving Tesla as an outlier (being a new company and not as established as Toyota and Ford), this is indicative of the fact that automotive firms have a lot of holdings in other companies that they make a lot of income from. 14 Compared to Honda, Daimler and GM. www.marketwatch.com data.
10. 10. Capital Structure Analysis: Current v. Optimal Current Debt/Capit al Optimal Debt/ Capital15 Current Cost of Capital Optimal Cost of Capital16 Current Share Price Optimal Share Price17 Toyota 46.5% 40% 4.96% 5.312% $118.8418 $97.63 Ford 64.94% 10.00% 5.80% 6.21% 17.2519 $11.09 Tesla 99.65% 90.00% 4.59% 14.56% 239.06 $228.46 Toyota uses a large amount of debt in its capital structure for a variety of reasons. First, using a large amount of debt provides a tax benefit by subtracting interest expenses from taxable income, and by providing added discipline to managerial decisions. However, Toyotas Debt to Capital is higher than its optimal ratio, so it is overlevered, and would benefit from paying off some of its debt. Toyota has high expected bankruptcy costs, especially since people wont buy cars from a firm if they dont think that they will be able to get parts for it in the future (if there is a decent chance that the firm will go bankrupt). Toyota also has high agency costs, since lenders have little control over how their money is being used, and Toyota can use their money in a large number of ways. Likewise, Ford makes use of debt financing in its capital structure. Debt financing is popular in the automotive industry as it is cheaper than equity and provides tax benefits. However, Ford is currently overlevered as its debt to capital ratio is roughly 64.94%20 (54.32% long-term debt to total capital according to www.marketwatch.com) compared to the 10.00% optimal debt to capital ratio. Ford shares the same high implicit bankruptcy costs as Toyota; in 2006 Ford narrowly dodged bankruptcy while competitors such as General Motors felt the effects of a slowing economy and filed for Chapter 11 bankruptcy. Fords highly levered capital structure caused solvency and liquidity problems for the company and led to Fords suspending dividend payments during the years 2007-2012. 15 Computed using the spreadsheet found in the capitalstructure.xl file in NYU Classes 16 17 18 As of 6/27/2014 19 As of 6/28/2014 20 Computed using the spreadsheet found in the capitalstructure.xl file in NYU Classes
11. 11. Tesla would fall under the category of a Stage 3 High Growth company. Its IPO was around 4 years ago so it is safe to assume it is no longer in rapid expansion yet, no where near mature growth or decline. As we can see in the table above Tesla is tapping many capital markets in order to finance their projects. The results were acquired from the given Excel spread sheet so accuracy is questioned, yet it is clear that Tesla, a young company trying to penetrate a saturated automotive market, needs debt in order to compete with well established companies (i.e Ford and Toyota).21 As we have discussed, debt financing is common in the automotive industry. However, Tesla, Toyota and Ford are overlevered. In the current interest rate environment with spreads so tight, debt is a cheap way for companies to raise funds; but Tesla, Toyota and Ford should take on new projects with equity funding or aim to retire debt and move towards their optimal debt to capital ratios. 21 Computed using the spreadsheet found in the capitalstructure.xl file in NYU Classes
12. 12. Mechanisms of Moving to the Optimal Toyotas optimal Debt to Capital ratio is lower than its current, which implies that Toyota is overlevered. Toyota is also not currently under a lot of bankruptcy threat, now that it is receiving cash inflows. Since Toyota is currently close to its optimal Debt to Capital ratio, it is not imperative that it drops its ratio immediately, although it has the ability to do so. Since, as mentioned before, Toyotas Return on Capital is less than its Cost of Capital, in order drop to its optimal Debt to Capital ratio, Toyota should pay off some of its debt with retained earnings. This would be the best choice, as opposed to reducing dividends or issuing new equity to pay off debt, as Toyota wont have to deal with the lashback from bondholders for getting rid of its cash on hand if its paying them back with that cash, and will not affect shareholders. Ford is currently overlevered and should reduce its debt to capital ratio. The firm is no longer under bankruptcy threat after the improvements in the economy and declining long-term debt interest expenses: Ford is moving away from the leverage that gave it trouble in the past. I would suggest Ford take on good, positive NPV projects using retained earnings or using newly issued equity funding. Ford could also retire outstanding debt using retained earnings in order to move towards its optimal debt to capital ratio; however, I would not recommend Ford cut or reduce in any way its dividend to do so. According to the results from the optimal capital structure, Tesla need to lower the amount of debt it currently has. This is the natural movement for a company of this nature. Debit is not always a bad thing especially when there are high cost like the automotive industry, however it should not be as high as Teslas. It is important to be very careful when choosing projects especially when in reality the CEO had the most say and does not always take the input of the company. Looking at the current growth of Tesla, the company will naturally move to their optimal capital structure because they are currently building their infrastructure and that is a sunk cost. After the giga factory is created and the charging stations are perfected, Tesla will be able to save capital and reduce debt. After analyzing each companys optimal capital structure, we can see that each company needs to raise their current cost of capital and lower their current debt. This could be because current interest rates are so low that it is cheap for major corporations to take on debt. Each company also have stock prices that are trading on the higher side. In order to reach the optimal capital structure each company needs reduce their stock prices. This seems to be the common trend for automotive companies.
13. 13. Dividend Policy Toyota strives to pay a stable and continuous payment of dividends twice a year (an interim dividend and a dividend at the end of the year) of 30%, while giving consideration to factors like business results for each term, investment plans, and Toyotas cash reserves22. In the past three years (after Toyota recovered from the financial crisis and returned to having typical cash inflows), Toyotas average payout ratio was 30.14%, and they paid out an average of 10.19% of their FCFE. Toyota has continuously paid cash dividends, even when they had cash outflows during and in the years immediately following the financial crisis. Year-end dividends are a matter that Toyota resolves at the General Shareholders Meeting, even though Toyota may distribute retained earnings as dividends pursuant to the resolution of the board of directors. Toyota prefers to pay cash dividends out to its shareholders as opposed to doing stock buybacks, as can be seen in the charts below. Ford resumed paying a dividend to shareholders in 2012 when it began paying a $.05 dividend per share. Ford had previously halted dividend payments in 2006 as a result of being near insolvency; Ford escaped the bankruptcy fate of General Motors.23 Between 2006 and 2012, Ford sold the Volvo and Mercury brands as well as closed factories and developed new products.24 Ford resumed paying a sustainable dividend upon seeing strong liquidity and balance sheet improvements.25 Ford paid a $.10 dividend in 2013 and has paid a $.125 dividend in the first two quarters of 2014; Ford pays dividends quarterly. Tesla has never declared dividends on our common stock. We intend on retaining all future earning to finance future growth and therefore, do not anticipate paying any cash dividends in the foreseeable future.26 22 http://www.toyota-global.com/investors/stock_information_ratings/dividends.html 23 http://www.forbes.com/sites/steveschaefer/2011/12/08/ford-brings-back-dividend-will-pay-5-cents-a- share/ 24 http://www.syracuse.com/news/index.ssf/2011/12/ford_to_resume_paying_dividend.html 25 http://www.forbes.com/sites/steveschaefer/2011/12/08/ford-brings-back-dividend-will-pay-5-cents-a- share/ 26 From Tesla Motors http://ir.teslamotors.com/faq.cfm
14. 14. Cash Dividends Paid27: 2013 Cash Dividends Paid: 2012 Cash Dividends Paid: 2011 Cash Dividends Paid: 2010 Cash Dividends Paid: 2009 Toyota $2,020 $1,908 $1,697 $1,854 $4,479 Ford $1,570 $763 $0 $0 $0 Tesla $0 $0 $0 $0 $0 Stock Buybacks28: 2013 Stock Buybacks: 2012 Stock Buybacks: 2011 Stock Buybacks: 2010 Stock Buybacks: 2009 Toyota $23.75 $0 ($12) ($5) $697 Ford ($213) ($125) $0 $0 $0 Tesla $0 $0 $0 $0 $0 FCFE29: 2013 FCFE: 2012 FCFE: 2011 FCFE: 2010 FCFE: 2009 Toyota $17,475 $14,304 $30,476 ($13,421) ($7,146) Ford $2,270 $2,790 $5,490 $7,390 $11,480 Tesla $(748.6) $(398.8) $(447.46) $(279.03) $(148.51) After analyzing each companys dividend policy we can see that Ford and Toyota are very similar to each other. Tesla on the other hand is in its growth phase and can not afford to pay out dividends. Toyota has been very consistent with its payments while Ford had to stop them and continue dividend payments in 2012. With regards to cash buy backs, Toyota has issued the most while Ford just began offering them in 2012. 27 In Millions of $ 28 In Millions of $ 29 In Millions of $
15. 15. Closing Remarks The auto industry has seen a turbulent start to the 21st century. The rise of energy prices and scarcity of fuel-efficient cars in the early 2000s left the industry vulnerable to the credit crunch and its effect on the prices of materials. The cyclical nature of the industry further hurt companies, such as Chrysler and GM which filed for chapter 11 bankruptcy. However, new projects such as increases in marketing fuel efficient, compact cars, and adjustments to the capital structure of large automakers have led the industrys recent upward trends.