EVA Brief: ITMG (Indo Tambangraya Megah)

Let's get some facts first. ITMG has been a consistent value creator and that has been reflected by its market value (MVA).

ITMG has been a consistent value creator

And so does what the market thinks

Its EVA growth has been spectacular in the last 3 years from 2015 to 2018 (especially in 2017-2018) as you have seen.

EVA momentum in those 3 years averaged an outstanding 3.7% per annum, more than tripled EVA from nearly IDR 894 Billion in 2015 to IDR 3,240 Billion just three years later. Consequently, investors' wealth as measured by MVA also changed from negative IDR 6,072 Billion to positive IDR 21,223 Billion. It was a truly marvelous time.

Both growth and productivity gain contributed to the growth of EVA during those times, with a heavier emphasis on productivity gain (a.k.a an increase in EVA margin or ROIC) (averaged per annum).

This improvement in EVA margin (productivity) is mostly attributed to the increase in operating margin (averaged per annum).

As you might expect, that is due to what happened to coal prices during those times.

That was a tour of how much effect coal price has on ITMG real performance, and you can be sure that the market follows through.

As you now just saw, coal price has been declining throughout this year, which is why EVA suffers as well.

Now, it is one thing the market follows the changes in EVA (which I call direction), and quite another how much the recent EVA performance is being discounted by the market into the share price (which I call magnitude), which is why it is vital that not only EVA has high correlation with market value (specifically, MVA), EVA also needs to have direct relationship with discounted value of the company.

Well, EVA passes both tests which is why I could compute how much the market expects EVA to grow through the share price at any point in time. This is the key piece to answer the magnitude problem which is a very helpful guide to identify potential mispricing.

It should be noted firsthand, that currently, MVA is barely positive. In hindsight, the easiest time to invest in ITMG was in 2015 when the market effectively valued ITMG as a value destroyer. One only needs to believe that this company is a value creator (as demonstrated by positive EVA in that year) to reap huge gains.

Market expectation is not excessively pessimistic now compared to what it was in 2015. But, let me tell you straight. The market being pessimistic is the norm here. And to make it saltier, eventually..they were right, except in 2015. After this FGR chart, I will tell you more.

FGR (future growth reliance) is a number that tells us the portion of market value that is due to expected future EVA growth. In 2015, that number is -700%! I have never seen an FGR number like this! The market literally expected ITMG to go bonker from its recent real EVA performance.

So, here's what I did. I just computed how much share price would be if the market turns its head to adjust their expectation to ‘just assuming that future EVA would be just the same as it was in 2015, without any growth." Are you ready? That number is IDR 17.150/share. Its share price would go flying from a depressed level of IDR 4,600/share in 2015 to IDR 17,150/share IF the market looks at the recent reality and expect no more. They did. In 2016, share price soared to IDR 16,500/share. Of course, at that time, ITMG actually managed to increase its EVA, which is why the market continuously adjusting its expectation by lifting share prices further.

As I keep telling and will keep telling, the market discounts EVA and adjust themselves quickly. It is no longer a dreamy response ‘till kingdom come' (there are some few exceptions where unrealistic expectation persists for a long time, see for example UNVR). EVA is the most single important fundamental number there is when it comes to measuring up the value of a company.

In general, I have never seen FGR numbers as pessimistic as this one, especially in 2015. Pessimism is the norm here.

Now we know from FGR graph above that the market is generally a skeptic bunch, and I did tell you that their precaution is eventually justified. What did I mean by that?

Well, the big rally in coal price could not continue. It fell, and so did EVA in Q2 2019. But the market never once did expect that happy time could go on forever, and they were right. This is evident if we take a look at the difference between the expected EVA growth from the market and actual EVA growth (MIM and EVA momentum, subsequently).

When the gap is minus, that means the actual performance (EVA momentum) beats the expected number (MIM). This is what I call ‘beating the market expectation', and it is the key to big share price appreciation.

The gap was so large in 2017, that one could make a reasonable stock purchase there. In hindsight, ITMG could continue to increase its EVA until 2018, which is why the stock investment made in 2017 was so profitable. Unfortunately, that is no longer the case in 2018. If you bought the stock back then because you believe there is an opportunity created by the gap between expectation and reality there, you are getting a harsh lesson here.

The market, as I have shown you earlier, adjusts quickly to new developments.

Coal price has been declining since late 2018, and it is deep and persistent that it is bound to happen that by the end of the year, EVA would contract by a lot (I suspect still positive though.

A huge contraction in recent EVA performance makes the pessimistic outlook from the market looks not so extreme anymore...in fact, one could say that at the current price the market is being a bit more optimistic than what reality tells them.

Bottom Line

It is hard for me to call the shot at the current price. The gap between real EVA momentum recently with the market expectation hardly tells that the market is being pessimistic. If any, they were being a bit optimistic. From the findings, I know that investors in ITMG generally are a skeptic bunch. It is almost a guarantee that by the end of the year, EVA would contract by a lot, but I expected ITMG to keep its position as a wealth creator. Investors, being a pessimistic lot, are then likely to drive share prices lower to the point that they see ITMG as a value destroyer. At present, they already see ITMG as a value-neutral company.