Kia Motors Is an Incredibly Cheap Stock with Masking Issues

Over the last year, Kia's stock price has decreased over 23% because of numerous operational issues. In July 2012, unionized workers at Hyundai and Kia in South Korea voted to strike, which ended in September and cost Kia ~63k units in lost output.

Compounding these events, in November 2012, Kia announced that it would restate the fuel economy of certain cars and compensate customers in the United States after the EPA determined the Company's mileage testing methodology was flawed and aggressive. Other factors that weigh on the stock: (1) fears of a stengthening won over the next year, decreasing profitability and (2) fear that capacity will not grow in the next two years (current capacity utilization is ~100% globally). All of these factors have caused Kia to trade at 3.3x LTM EBITDA, 6.4x FY13E earnings and at EBITDA less Capex / EV yield of 16%.

Investment Merits

Incredibly Cheap Stock On An Absolute and Relative Basis With Masking Issues:
-Kia trades at a 1 year forward P/E of 6.4x, at an EV / LTM EBITDA of 3.3x and at only a 26% premium to its liquidation value
-Kia is easily the cheapest large OEM auto stock on a P/E basis in the world and the cheapest on an EV / EBITDA basis excl. GM
-43% of Kia's market capitalization is composed of cash and long-term investments in associates, net of debt
-It appears that Kia trades primarily on a P/E basis and investors are wary to assign a high multiple for the above reasons
-Given this reluctance, the enterprise value of the core Auto business relative to its EBITDA is extremely low, indicating the equity could be over-sold

Great Company - Strong Cash Flow, Balance Sheet and High Historical ROEs
-Generates in excess of 2 trillion won each year in free cash flow
-Net-cash balance sheet, both including and excluding investment portfolio, with minimal intangibles
-Historical ROEs between 20% and 30%

Well-Positioned for Emerging Market Growth
-China: In FY 2012, Kia sold 481,000 units and saw unit sales in 1Q13 up 26% YoY, with capacity and the dealer network in the country set to increase when Kia's new factory comes online next year
-Brazil: New import taxes in Brazil have resulted in a 2.2% decrease in sales in 1Q13 to 38k units, but this is mitigated by news that Kia intends to build a factory in Brazil, making the Company eligible for more attractive tax treatment going forward
-Rest of World sales up 10.3% in FY12 and increased traction in 1Q13 seen in the Middle East and Africa (69k units, +4.6%), Russa (42k units, +6.1%) and Eastern Europe (+19.9%)

Share Gainer in U.S. and E.U.
-In FY12, Kia commanded 3.8% and 2.6% of the U.S. and European automarkets, respectively
-Kia has focused on selling strategic models custom built for European, Russian and Chinese consumers
-Kia has also built a substantial marketing foot print and brand value in these countries (Super Bowl, UEFA advertising)

Investment Risks
*Mileage Restatement Hampers Company's Credibility and Strains Company's Financials
*Labor Contract Renegotiation / Strike Risk This Summer
*Capacity Constraints Hamper Forward Growth Outlook
*Anticipated Won Strength Dampens Forward Profit Expectations

Catalysts
1. 1H Earnings in July - Stub imapct of new product introductions
2. Formal announcement of capacity expansion within the next year
3. Incremental impact of new model launches in USA, Korea and Europe in 2H13 (K5, Sportage and Soul in USA; Soul, Sportage, K3 Coupe and K7 Hybrid in Korea; K5, Soul and Sportage in Europe)
4. Impact of increased productivity at existing plants due to new capex in the next year

Conclusion

Investors are forgetting that Kia is a fantastic company that has grown share consistently all over the world since its founding by making stylish and high quality vehicles. I don't expect issues with its Union to be substantial this year given the major union victory in and huge cost of last year's strike. Most importantly, because Kia aspires to continue to increase share, new capacity will eventually come online, and this will most likely happen in a jurisdiction outside of Korea to mitigate the strengthening Won. I anticipate that this will be announced within the next 12 months. Once this announcement is made, coupled with increased traction of new product rollouts and increases in productivity due to new capital projects over the next year, I believe Kia's earnings will surprise on the upside of investor expectations.

This is currently reflected in analyst recommendations but not in current multiples. Assuming Kia trades at 9x P/E (at a 25% discount to global peers) in 2014 or 5.5x 2014 EBITDA (~30% discount to global peers), each Kia share will be worth ~92,000 Won, a 57% premium to today's price. This is especially attractive relative to Kia's liquidation value of ~46,700 Won, a 20% discount to today's price. I believe this to be the lowest rational market price for Kia's equity and highly unlikely to be seen in this market absent a major negative externality (e.g., a recall).