UNITY MAKES STRENGTH

STOCK MARKET ANALYSIS

The European automotive sector has massively underperformed the market since the beginning of the year, down 28.6%. Most manufacturers are even showing a correction of around -30%, with the Stoxx Europe 600 Automotive index being offset by Renault's remarkable performance of +0%. Despite the sector headwinds,Volkswagen has raised funds through the IPO of its Porsche subsidiary. Can changes in scope and alliances bolster an industry in turmoil?

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Porsche enters the race against Ferrari as a luxury brand

Following Porsche's IPO, the luxury car sector now has one more listed player. What are Porsche's chances of joining Ferrari in pole position or the risk of a near miss like Aston Martin? This niche sector shows divergence in terms of valuation and stock market performance (see Fig.2). Ferrari is down 30% and Aston Martin is down 82% year-to-date (-98%since its IPO in October 2018!). Porsche is trading at 15x 2023 PE compared to over 34x for Ferrari. In terms of EV/EBITDA, the gap is even wider with multiples for 2023 of 5.8x for Aston Martin, 7.9x for Porsche and 17.6x for Ferrari.

The luxury car sector, like the rest of the industry,is moving towards greater sustainability and the production of electric vehicles, which requires heavy investment. Porsche and Ferrari have committed to investing in electric models, while keeping their beloved combustion engine models for as long as possible. Part of the cash generated by the Porsche IPO will be used to finance Volkswagen's transition to electric vehicles. The rest will be returned to shareholders in the form of a special dividend.

These transformations are costly and this is what is currently weighing on Aston Martin's share price, which is burning cash month after month. In addition to the transition to electric cars, thebrands are facing an exceptionally difficult context following the Covid-19 pandemic, supply issues and pressure on margins due to raw material and wage inflation.

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Fig. 2 - The post-IPO pathway may diverge within the same sector

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The brands have very different marketing strategies. Ferrari has focused exclusively on expensive sports cars, raising prices and limiting supply, a hallmark of the luxury business. Porsche, on the other hand, has expanded into the more affordable market and embarked on a major expansion of sports utility vehicles (SUVs), pushing sales above 300,000 units sold per year, close to Jaguar and Land Rover. Sales of its Taycan electric sports car alone are four times Ferrari's total annual deliveries.

These differences have implications for the profitability of the companies. Porsche is aiming for a profit margin of 20% in the long term (16% in 2021), which is much lower than Ferrari's 25% in 2021. The Italian manufacturer claims to increase this margin even further by 2030.

In terms of governance, the Porsche group remains closely linked to Volkswagen, sharing the same CEO and relying on the Volkswagen group for certain projects. For example, Porsche already had to postpone the launch of the electric version of its Macan SUV due to delays in software development, but separating from Volkswagen would mean paying compensation and starting from scratch. Ferrari is completely independent of Fiat and the Agnelli family and is developing in a Hermes-like fashion, justifying high valuation multiples.

Alliances between manufacturers help to avoid stalling in the face of multiple challenges

In the 1980s and 1990s, the automotive industry evolved from a multitude of independent companies to a handful of global consortia. The intensification of the price war led manufacturers to ally with each other to gain access to technology, global markets and to achieve economies of scale. In this context, capital-intensive and risky mergers and acquisitions have given way to strategic alliances. These have focused primarily on building common platforms to reduce costs. Indeed, of the most expensive elements to design, the platform is certainly the most pricey. The platform, the basic structure of the car, is composed of a chassis (a rigid structure to which all the components of a vehicle are attached) and some non-visible parts. Platforms vary according to the type of energy that powers the car (see Fig. 3).

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‍A car model with an internal combustion engine, an electric motor or a hybrid does not share the same platform but three distinct platforms.The cost is therefore considerable for manufacturers who choose to make the energy transition. It is therefore easy to understand why some manufacturers, such as Toyota, have concentrated, perhaps wrongly, on hybrid models, ignoring the all-electric model, which requires an even different platform.

Competition between brands is intense, but working together allows them to take on larger projects and shorten their timelines. The aim is therefore often to share costs, innovate and strengthen the companies' balance sheets. Examples of major alliances include Renault/Nissan, Fiat/Chrystel, Hyundai/Kia and Toyota/Tesla (see Fig. 4).

Fig. 4 - Table of selected alliances

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 There are many motivations: cost reductions, innovation and sustainability

Companies are striving to stay on top of the latest technology trends through a range of ecosystems, alliances and collaborations. These new combinations often involve players from outside the automotive world, such as Silicon Valley start-ups or semiconductor companies, who bring new skills. They allow car manufacturers to accelerate the development of autonomous driving, electrification and mobility as a service - and to share the huge financial burden that this entails (see Fig. 5).

Fig. 5 - Top 10 trends and innovations in 2022

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Unusual relationships are being created such as BMW/Spotify playing music in vehicles,Jaguar/PayPal/Shell partnering to offer in-car fuel payments, or Audi China, through its FAW-Volkswagen joint venture, cooperating with Alibaba, Baidu and Tencent in the areas of data analytics, vehicle internet platforms and intelligent urban transport.

The consumer trend to view mobility more and more as a service makes it even more difficult for manufacturers to differentiate themselves. Today, if car ownership is still a mode of identity expression, tomorrow the vehicle on demand as a service will become more of a commodity.

Finally,the industry's commitment to sustainability involves the entire value chain: manufacturers, dealers, suppliers, services and aftermarket retailers. This is why networks of automotive suppliers and technology companies are coming together to address challenges such as supply chain issues, secure data transfer and management, industry electrification including vehicles and charging stations, battery life cycle management and sustainable business practices that reduce carbon footprints. Companies cannot manage the whole cycle alone; they need industry collaboration to develop effective long-term solutions.

Is the sector ready for the next crisis?

With the risk of recession increasing, investors have shifted away from cyclical sectors such as automobiles. Stocks are already trading at deepdiscounts to their historical valuation multiples (see chart of the week).

The industry is engaged in a costly energy transition while maintaining an obsolete production system of internal combustion engine cars. Surprisingly,this transition and the shortage of electronic components has allowed many brands to change their product mix and sell more higher value cars, such as electric cars, pick-ups and SUVs(see Fig.6). Sales volumes have declined but margins have increased. It is likely that the sector will continue to play on this picture to mitigate the effects of the crisis. The sector remains sensitive to both demand and cost pressures, particularly raw materials and energy.

Consumers are beginning to suffer from inflation and rising interest rates. If inflationary pressure becomes too strong, repayment of car loans or the writing of new loans could dwindle, putting pressure on finance services companies owned by the automobile manufacturers.

 Fig. 6 - Distribution of US vehicle sales by price range

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‍Conclusion

The sector remains sensitive to economic downturns as competition from China intensifies. Valuations already seem to reflect the most alarmist outlook, with historically low multiples. Adapting, investing in the future and joining forces is the way forward to a sustainable automotive industry - for the climate, workers and investors too.

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