In terms of valuations, one of the most effective techniques is the owner earnings model as described by Warren Buffett. These are the true earnings that are attributable to the owners of an enterprise and take care of things like finance cost and maintenance capex that a company must undertake to maintain its current competitive position.
Let’s apply this model to one of the largest transport logistics companies in India – VRL Logistics.
VRL operates a fleet of about 5100 trucks and buses. Preliminary newsflow suggest that new scrappage policy will fix the commercial vehicle age to about 15 years. This means that on average, VRL has to scrap about 1/15th of its fleet every year (Note that we are taking average here but a precise calculation can be done by taking the average age data that the company provides in company’s investor presentations).
This means that the company will have to buy about 340 new vehicles ( 5100/15 ) every year just to maintain their current fleet, without any growth.
Based on the information in public domain and from industry experts, (for the vehicle profile of VRL) a new vehicle minus the scrapped value of old vehicle would translate into an expense of about 35 Lakhs per vehicle. For 340 such transactions, the total amount comes out to be ₹ 119 cr.
Thus we can use this ₹ 119 cr as the maintenance capex that the company must do to ward off the red queen effect and keep its current competitive position in place.
With these assumptions, we can calculate the owner earnings as below:
Cash from Operations (250 Cr) – Interest Expense (40 Cr) – Maintenance Capex (119 Cr) = 91 Cr
A genuine question arises here. What about repairs and maintenance that the company would be paying to maintain their existing fleet?
If we look at the PnL Statements of the company, this is already charged by the company as an expense every year and isn’t capitalised. Therefore, there is no need to subtract this from the cash generated from the operations in order to calculate the total owner earnings for the company.
The current valuation of about 1500 cr gives a multiple of 15-16 times its normalized owner earnings (current earning are severely affected due to Corona pandemic).
VRL is a fully integrated business model with lots of operating leverage built-in due to its fleet ownership, owned supporting infrastructure (like petrol pumps and warehouses), no-contracted employees and pan India reach. Sales growth CAGR is around 5% for the past 5 years, which is due to the sluggish economy and due to competition from private equity backed loss making new age players. In the past, the company was able to operate at a 15% operating margin level which is down to about 10% now.