Introduction
I am a fan of Warren Buffett, and I intend to get rich through investment like him (who doesn't). The Investment methodology is called Buffettology. In the following series of exercises, I would like to examine Airasia and different companies using Buffettology. Its beneficial to answer these questions on your own, maybe you can get different answers.
A. BUSINESS TENETS
1. Is the business simple and understandable?
Yes and No. The core airline business is easily understandable. Management also consistently provides very detail operational and financial information.
Other businesses such as BIGPAY, Rokki, eWallet are more complicated.
Basically Warren dislikes companies diversify, only investors do. This is also the consensus of the academic world.
2. Does the business have a consistent operating history?
Yes. Since listed in 2004, the company has been making increasing profits except the year 2008. Revenue is growing at an amazing 23.7% compounded between 2005-2018. Net Operating Income has been increasing at 25% p.a. compounded.
3. Does the business have favorable long-term prospects?
Yes. If Airasia can repeat the success in Malaysia in other ASEAN countries as well as ASIA countries, Airasia can grow 20 times larger than today.
B. MANAGEMENT TENETS
1. Is management rational?
The most important management act is allocation of the company's capital. It is the most important because allocation of the capital, over time, determines shareholder value. Deciding what to do with the company's earnings--reinvest in the business or return money to shareholders--in Buffett's mind, an exercise in logic and rationality.
Yes, Since listing in 2004 at RM1.40, Airasia has since distributed RM1.19 as dividend and special dividend. Management also said to distribute special dividend every two years.
2. Is management candid with the shareholders?
There are two parts in this, 1) Does Airasia hide their problems in numbers? Probably no. 2) Does Airasia admit their mistakes? Probably never. 3) Does Airasia achieve what is promised? Yes.
3. Does management resist the institutional imperative?
Does management imitate illogical behaviours of other managers? No.
(As an example, in the early years of Public Bank, it went into real estate too for a short period of time. If Public Bank didn't stop, probably you won't s see it exist today. )
C. FINANCIAL TENETS
1. "Focus on return on equity, not earnings per share. "
ROE is 24.4 for 2016, 23.4 for 2017, Maybe 29.38 for 9M2018.
8 is normal, 12 is good, more than that is amazing.
Note to say Airasia create another figure "Return on Capital Employed" which just means they take account of debts loaded to examine the real performance. The figure is lower and meaningful.
2. Calculate "Owner's Earning" to get a true reflection of value.
Warren Buffett says companies which are capital intensive needs to replace their asset (aircrafts) to stay competitive. When he did his calculations on airline businesses years ago, he found out the Owner's Earning of Airlines businesses is negative (hence a zero sum game). This just mean at that time airlines cannot get back their investments at the end of the aircraft's life cycle. Few years ago, that number turns positive and Berkshire did invest in Airline businesses big time.
Although Airasia has very high aircraft utilisation rate (increasing from 12 to 15 hours) and bought the aircrafts much cheaper (because of its size of the order), Airasia is not much different in comparison. Fortunately Airasia is selling its aircrafts and change into asset light mode.
Basically, Owner's Earning = Net Profit + Depreciation - Capital Expenditure.
3. Look for companies with high profit margin.
The average gross margin for Airasia is around 21% over the period of 2005-2017. Nothing spectacular. However, Warren Buffett's concern is the managers of high-cost operations tend to find ways to continually add to overhead, whereas managers of low-cost operations are always finding ways to cut expenses. Well, saving money is in Airasia's DNA. In this regards, Airasia pass this tenet.
4. The One-Dollar Premise
This is a quick test that can be used to judge not only the economic attractiveness of a business but how well management has accomplished its goal of creating shareholder value.
Say if a company makes RM1M, then the manager of the company will consider to distribute that RM1M as dividend or to repay debt or make new investment.
Too often in Bursa we see companies which makes lots of money but eventually the profit went into drain as management has wasted it.
Airasia on the other hand, has been increasing shareholder's fund from 952.9M in 2005 to 6710M in 2017 (Note: 1000M from TF and MK private placement). That is slightly less than 18% growth per year. Remarkable!
D. MARKET TENETS
After Warren Buffett studied all of the above, if the company pass the test, then he starts to value the business. As we know, Warren likes to use Dividend Discount Model (DDM), and Discounted Cash Flow (DCF). Theoretically in the longer-term, both methods equalises. Warren uses long-term government bond rate as the discount rate. Here, we use 3.5% only.
"Risk comes from not knowing what you do. " Therefore, in Buffettology, no risk premium is applied.
1. What is the value of the business?
If I use Owner's Earning to calculate Present Value, then most years between 2005-2017 is making losses, but 2018 will be making 5 billion or so (because Airasia sold a lot of planes). So, I will stick to the audited net income.
Let's assume Tony Fernandes continue to work very hard, grows 15% profit a year (vs 25% historical), 10 years later finally Airasia is bigger than SIA in market cap, Tony retires. Airasia grows slower for 10 years @ 5%, then after another 10 years Flying vehicles takes over and Airasia stop to exist.
Present Value = RM28.92.
2. Can the business be purchased at a significant discount to its value.
Buy at attrative price!!!! Warren Buffett is only willing to pay 20% of the Present Value calculated above. The remaining 80% is his "margin of safety".
Yes.
SO, its a YES.
Conclusion: You will find most companies in Bursa cannot get through the test, if you think there are good companies which has a chance, let me know.
https://klse.i3investor.com/blogs/Buffettology/193719.jsp
