Valeo reported results for 2018; we reduced our stance from a Buy to a Hold and reduced our price target from €40 to €33.
Our reduction in stance and price target was brought about for the following reasons:
EBIT margins - The company reported an EBIT margin of 6.3% for 2018 (we were factoring in 6%). However, it is also true that the 6.3% was a significant drop from the 8% and 7.7% margins achieved in 2H17 and 1H18. We revised our margins lower for 2019 (5.5% from 6%) and 2020 (6% from 6.5%) due to;
- Higher costs weighing on the Valeo’s performance as they adapt to new emission requirements (Increased cost to adjust for new emission targets set in September 2018). We expect these costs to remain high in 2019;
- The Valeo Siemens eAutomotive JV loss is weighing negatively on performance and we do not expect any improvement in the short term as the company continues to invest in this new business (The share of the loss recorded by Valeo Siemens eAutomotive was €147m in FY18 vs €53m in FY17)
Management’s EBIT target for 2019 – The company’s EBIT guidance for 2019 is 6.2%-6.5% (before JV losses) depending on the trends in automotive production and in the price of raw materials and electronic components. We are assuming margins will come in at the lower end of guidance (and include a further reduction of 0.7% for potential losses from the JV) as we expect higher raw material prices in 2019.
Managements longer term targets – These have become harder to obtain in the current environment - The significant drop in EBIT margin also puts into question managements’ target of an operating margin of 9% by 2021. We saw a change in trend in 2018, which put into question these longer term targets. If we do not see a strong uptrend in performance, these targets would have to be revised downwards. We need to start getting positive data from the company in order for us to feel comfortable and improve our assumptions in our model. For the time being we remain defensive
Sales – What also concerned us was the 1.5pp outperformance of global sales when Faurecia had reported just three days earlier that it had outperformed global auto production by 8.1pp in FY18. Also the weakness we have seen in China was larger than we were expecting (16% decline in sales). Increased competition and global growth concerns weight on Valeo’s sales target and we do not expect large upswings anytime soon. We reduced our sales growth assumptions for 2019 and 2020 (from 5% to 3%).
Discount rate – We increased the discount rate in our valuation model from 11% to 12%
Given that 1H19 is expected to continue to be challenging for the company and the Company’s long term objectives have become questionable, the coming months will be very critical for management. The Group’s CEO said that FY18 margin was heavily disrupted at 6.3% (due to 2H18s margin of 4.8%). Rather, he urged investors to consider the 8% and 7.7% margins achieved in 2H17 and 1H18 as evidence of the group’s potential. If management can prove that 2018 was a one off, the shares are very attractive at these levels. However, it is too premature to make this call, hence our hold recommendation.
Disclaimer: This article was issued by Kristian Camenzuli, investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.