My intrinsic valuation of MTS is $2.87 per share assuming that MTS current EBIT margin (2.6%) remains unchanged.
MTS has begun a 3-year capital investment program to build a new distribution warehouse and to refurbish its retail outlets.
Assuming a modest improvement in MTS EBIT margin (3.0%) due to MTS capital investment and strategic initiatives, my intrinsic valuation increases to $3.62.
The risks to MTS are:
- Further stagnation in sales.
- Failure of strategic initiatives: price cuts, revised product mix, store refurbishment, new distribution centre.
- Cost over-runs on capital investments.
- Lower food price inflation.
- Increased competition from Woolworths, Coles and ALDI.
As of 3rd of October 2014, MTS shares were trading at $2.59, representing a:
- 9.27% discount to intrinsic value (operating margins remain at 2.6%)
- 28.41% discount to intrinsic value (operating margins improve to 3.0%)
Why value MTS? MTS is an interesting company with the following attributes:
- Trading at a discount to intrinsic value
- Stable earnings
- Modest debt
- Sustainable yield
So how does MTS measure up? Here are a few key facts:
- Revenue growth has plateaued since 2011 and there have been several significant items due to impairments, strategic review costs and acquisition costs.
- MTS has announced a $500-$600 million in capital investment over the next 3-4 years as part of a transformation project in March 2014. It also announced that it was reducing its dividend payout ratio to 60% to help fund the transformation project.
- This announcement took MTS to its 10-year lows. The stock has traded sideways ever since.
- It appears that most of the bad news about the company is already reflected in the price.
- MTS trailing 12m dividend yield is 7.14% (Thompson Reuters). Even with the reduction in the DPR, the expected dividend yield is still above the yield of the market and its peers.
- MTS operates in a defensive industry – food and grocery retailing. The business has fairly stable margins.
- Debt levels (even after brining operating leases onto the balance sheet) are modest and the interest coverage ratio of 4.84x is healthy.
Why might this be an opportunity? Because most investors in the stock market generally don’t have the patience to wait 2-3 years. Investors who can be patient may have the opportunity earn an attractive return from a defensive, high-yielding stock (that’s cheap compared to most high yield stocks) with some potential for upside if margins improve.
- This is my first ever intrinsic valuation using a free cash flow to firm model. I welcome your feedback and constructive criticism.
- I have used Professor Aswath Damodaran’s free cash flow to firm (FCFF) valuation model to prepare my intrinsic valuation.
- I currently do not own any shares in MTS. The stock is on my watch list.
- This blog post is not investment advice. Please see my disclaimer.