Michelin ML FP
December 30, 2007 - 10:44pm EST by
compass868
2007 2008
Price: 79.25 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 11,406 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Michelin earnings potential should be 60%+ above 2007 levels in 2009 due to 3 key factors: (i) significantly higher margin potential due to 07-09 restructuring efforts, natural attrition of high cost European labor and a production shift to low cost countries (ii) Michelin’s dominant position in an extremely strong European truck tires market and (iii) strong profit upside potential in specialty tires due to strong demand in earthmovers (mining), agricultural and aircraft equipment.  Generally speaking, global tire manufacturers are experiencing extremely healthy margins this year due to modest raw materials increases, firm pricing and strong volume growth.  As a tire pure-play, Michelin stands out as the most obvious beneficiary.  With Truck Tires and Specialty Tires red hot (demand exceeds supply) and representing 50% of profits and the rest of the passenger tire business experiencing positive fundamentals, Michelin has the most leverage to these trends. 
If Michelin trades at 12x 2009E EPS in 2008, Michelin offers 50%-65%+ upside.  The global tire average 2008 P/E multiple is currently 10.5x after a significant de-rating since July 2007.  Tire manufacturers have been grouped as a consumer discretionary end market which has contributed to the sell off.  Although 70% of volumes and a greater percentage of EBIT come from stable replacement tire business, the public markets are indicating this business is indeed cyclical.  To the extent this business proves to be resilient, I believe Michelin’s multiple will increase to its long term average multiple of 12x.  In addition, given the favorable dynamics in the European Truck market and in specialty tires, Michelin should surprise to the upside on EPS and the opportunity could be even greater.
 
BUSINESS DESCRIPTION
Michelin is the world’s 2nd largest tire manufacturer with 18% market share.  Michelin’s passenger tire division consists of (i) the largest European passenger tire operation (ii) a significant position in the US and (iii) a significant position in Asia (#1 in China).    Michelin also ranks as the world leader in truck tires (with a dominant position in Europe).  The company’s third division consists of Michelin’s distribution operations, specialty tires (earthmovers, agricultural equipment, aircraft, etc).  
 
Revenue                                 CY07E               Mix                 CY08E                 Mix     07-08E % growth
Passenger & Light Truck Tires  €9,216               54.0%                 €9,525             53.9%               3.3%
Truck Tires                                 5,662              33.2%                   5,875              33.1%              3.8%
Specialty Tires                            2,182              12.8%                    2,300           13.0%              5.4%
Total Michelin Revenue        €17,060            100.0%               €17,770          100.0%            3.3%
 
 
EBIT                                       CY07E             Mix                 CY08E                        Mix             07-08E % growth
Passenger & Light Truck Tires     €897              49.7%                    €957                        47.5%               6.6%
Truck Tires                                    562              31.2%                      644                        32.0%               14.5%
Specialty Tires                               345              19.1%                      414                       20.5%               20.0%
Total Michelin EBIT              €1,804             100.0%                  €2,015                   100.0%               11.6%
 
 
Geographic Mix
 
 
Sales
Europe
49.0%
North America
35.0%
Rest of World
16.0%
Total
100.0%
 
INVESTMENT CONSIDERATIONS
 
  • #1 European mkt share in Truck Tires which has very strong volume & pricing growth (15% sales, 15% profit)
 
    • Demand for Trucks shows no sign of slowing and the European replacement truck tire market should have a multi-year phase where volumes can grow 5%+ per annum.
 
    • Replacement truck tire demand in Europe is just off cyclically low levels.  In 2005, the European truck replacement market hit 10.9MM truck tires which was similar to 1998 volumes.  However, the European commercial vehicle market had increased 18% since 1998 to 29MM units.  In 2006 volumes grew 2.9% and in 2007 volumes are expected to be 5%
 
    • The growth of the new truck volume over the past few years has enlarged the size of the total truck population increasing the addressable market for truck tires. Replacement volume is at a secular low % of total truck tire volume in Europe (although part of this is tires last longer than previously).
 
  • Specialty Tires segment is fastest growing segment and is supply constrained (13% of revenue, 20% of profit) 
 
    • Earthmoving Tires and other specialty tires are in an incredibly tight supply situation and the top line will grow as fast as Michelin can add capacity.  Michelin is expanding 2 of 4 existing earthmoving tire plants (20% capacity increase in each) and adding a facility in Campo Grande, Brazil this November
 
    • Mining capital expenditures drive the purchase of earthmoving tires (5% of mining capex for tires)
 
    • 40% of the world’s agricultural tires are sold as original equipment and high crop prices are creating strong demand for agricultural equipment and tires.
 
    • Michelin is #1 in radial aircraft tires with 60% market share (military, regional, general aviation and commercial aircraft tires)
 
  • Large restructuring and cost reduction opportunity with targeted cumulative savings of €1.5Bn-€1.7Bn by 2010
 
    • 07-09E EPS doesn’t incorporate all of the savings which provides an upside opportunity. 
 
    • €4.7Bn is total labor cost for Michelin and the company is targeting €700MM in savings.  The company is trying to reduce labor cost from 29% of sales to 20%-21% in line with competitors.  A combination of high cost employee attrition (4,000 employees/year) and plant closures in high cost regions and automation will be used to reduce 80,000 manufacturing employee headcount by 30%.
 
  • Current environment for Tire pricing is strong with all players increasing prices 3-7% this year and more price increases already scheduled for early 2008
 
RISKS
 
  • Raw material pricing has been a headwind for the past few years.  Prices have been stable YTD and the industry is benefiting from price increases which should return profit margins to historical levels.
 
    • With natural rubber representing 31% of tire raw materials, increases in natural rubber prices will impact daily trading.  Price increases in oil and oil derivatives impact natural rubber. 
 
    • Government efforts to cool economic growth in China should ease demand pressure on pricing
 
  • Low cost imports are 15% of North American passenger tire market and 10% of the European passenger market.  5 years ago imports were only 2-3%. 
 
    • Low cost Imports are lower quality and are expected to  remain in the lower end of the market. 
 
  • Execution risk of Michelin’s restructuring.  While all of the benefits are not in the stock, at least 1/3-1/2 could be baked into the stock price currently
 
  • Excess capacity in the tire industry could lead to lower prices going forward. 
 
    • Current capacity plans assume worldwide tire production capacity increases from 1.5Bn units in 2006 to 1.6Bn units in 2010 which represents a 1.6% CAGR from 2006-2010
 
  • Michelin wants to increase rest of world volume from 16% of sales to 33% of sales eventually.  Acquisitions in Asia may be required.
MICHELIN VALUATION
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock Price
€ 79.25
 
 
 
 
Shares Outstanding
143.9
 
 
 
 
Market Capitalization
11,406
 
 
 
 
Net Debt
4,320
 
 
 
 
Minority Interest
24
 
 
 
 
Enterprise Value
€ 15,750
 
 
 
 
 
 
 
 
 
 
Based on Consensus Estimates
 
 
 
 
 
 
 
 
 
 
2007E EBITDA
€ 2,631
 
2007E EV/EBITDA
6.0x
2008E EBITDA
2,956
 
2008E EV/EBITDA
5.3x
2009E EBITDA
3,284
 
2009E EV/EBITDA
4.8x
 
 
 
 
 
 
2007E EPS
€ 6.33
 
2007E P/E
 
12.5x
2008E EPS
7.64
 
2008E P/E
 
10.4x
2009E EPS
8.82
 
2009E P/E
 
9.0x
 
 
 
 
 
 
2007E FCF
€ 747
 
2007E FCF Yield
6.5%
2008E FCF
932
 
2008E FCF Yield
8.2%
2009E FCF
1,178
 
2009E FCF Yield
10.3%
 
 
 
Comprable Company Comparison
 
 
 
 
 
 
 
 
USD ($)
 
 
 
 
 
 
 
 
 
 
 
 
Market
 
P/E
 
EV/EBITDA
 
 
Capitalization
 
07E
08E
09E
 
07E
08E
09E
 
 
 
 
 
 
 
 
 
 
 
Michelin
 
15,284
 
12.5x
10.4x
9.0x
 
6.0x
5.3x
4.8x
Continental
 
21,011
 
11.4x
10.5x
9.4x
 
7.6x
6.5x
5.8x
Goodyear
 
6,119
 
22.5x
9.6x
9.3x
 
5.2x
4.4x
3.9x
Cooper Tire
 
1,060
 
13.6x
10.6x
10.0x
 
4.9x
4.3x
4.3x
Bridgestone
 
14,305
 
12.2x
11.6x
9.8x
 
5.5x
5.2x
4.8x
 
 
 
 
 
 
 
 
 
 
 
 
 
Average:
 
14.4x
10.5x
9.5x
 
5.8x
5.2x
4.7x
 

MICHELIN UPSIDE +20-50% / DOWNSIDE (15%)
 
 
Michelin Valuation Sensitivity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Michelin Stock Price (1 Year From Now)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2009E EPS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
€ 8.00
 
€ 9.00
 
€ 10.00
 
€ 11.00
 
€ 12.00
 
% above (below) consensus
(9.3%)
 
2.1%
 
13.4%
 
24.7%
 
36.1%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2009E P/E
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
10.0x
 
 
€ 80.00
 
€ 90.00
 
€ 100.00
 
€ 110.00
 
€ 120.00
 
11.0x
 
 
€ 88.00
 
€ 99.00
 
€ 110.00
 
€ 121.00
 
€ 132.00
 
12.0x
 
 
96.00
 
108.00
 
120.00
 
132.00
 
144.00
 
13.0x
 
 
104.00
 
117.00
 
130.00
 
143.00
 
156.00
 
14.0x
 
 
112.00
 
126.00
 
140.00
 
154.00
 
168.00
 
15.0x
 
 
120.00
 
135.00
 
150.00
 
165.00
 
180.00
 
 
 
My view is the most likely scenario will be a 12x P/E valuation and 2009E EPS will be revised from €8.82 to €10-€11 over time.  Therefore €120-€130 is the target range.  There are analysts that have modeled €11.00 in EPS for 2009 in anticipation of the strong multi-year story with Michelin. 
 
From a downside perspective, I think it is unlikely earnings are revised downward but in that event, Michelin could trade at a slightly lower P/E multiple (9.0x) and 2009E EPS could be €8.00.  This is limited downside in my opinion as €72.00 is 10% below today’s trading price.  
 

07-09 EARNINGS PROJECTIONS CONSERVATIVE – SIGNIFICANT UPSIDE TO ESTIMATES
Michelin Projected Income Statement
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2007E
2008E
2009E
2010E
 
Commentary
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales
 
17,050
17,700
18,378
19,000
 
modest top line growth is included in current estimates
 
 
 
4.1%
3.8%
3.8%
3.4%
 
 
 
 
 
 
 
 
Change In EBIT
 
 
 
 
 
 
 
 
 
 
 
 
 
  Volume
 
219
215
150
125
 
 
 
 
 
 
 
 
    % Increase
 
3.6%
3.6%
2.5%
2.0%
 
2008 based on current trends; modest growth after (2.0%-2.5%)
    Gross Margin Impact
 
37.0%
35.0%
34.0%
34.0%
 
Company GM used for EBIT contribution for Volume
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Price
 
406
341
0
0
 
 
 
 
 
 
 
 
    % Increase
 
2.5%
2.0%
0.0%
0.0%
 
After 2008 assumes 2.0% price reduction/year
 
 
    Gross Margin Impact
 
100.0%
100.0%
100.0%
100.0%
 
All price increases fall 100% to EBIT
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Mix
 
213
171
133
92
 
 
 
 
 
 
 
 
    % Increase in Margin
 
1.3%
1.0%
0.8%
0.5%
 
Gross margin expansion/year from Mix
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Raw Material/Energy Price
 
(74)
(250)
(50)
0
 
No raw material inc. consistent with price declines above
 
  Depreciation/FX/Other
 
(229)
(200)
(150)
(150)
 
FX main driver
 
 
 
 
 
 
  Productivity/Other (50% Credit)
 
(135)
175
230
258
 
Productivity according to management plan
 
 
Change In EBIT
 
401
451
313
324
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Year Before EBIT
 
1,338
1,739
2,190
2,503
 
 
 
 
 
 
 
 
Change
 
401
451
313
324
 
 
 
 
 
 
 
 
EBIT
 
1,739
2,190
2,503
2,828
 
 
 
 
 
 
 
 
EBIT Margin
 
10.2%
12.4%
13.6%
14.9%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
D&A
 
954
1,045
1,136
1,178
 
 
 
 
 
 
 
 
EBITDA
 
2,693
3,235
3,639
4,006
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Interest
 
(285)
(250)
(200)
(175)
 
 
 
 
 
 
 
 
EBT
 
1,454
1,940
2,303
2,653
 
 
 
 
 
 
 
 
Taxes
 
(480)
(640)
(760)
(875)
 
 
 
 
 
 
 
 
Tax Rate
 
33%
33%
33%
33%
 
 
 
 
 
 
 
 
Minorities
 
(7)
(12)
(23)
(23)
 
 
 
 
 
 
 
 
Net Income
 
967
1,288
1,520
1,754
 
 
 
 
 
 
 
 
Shares Outstanding
 
143.9
143.9
143.9
143.9
 
 
 
 
 
 
 
 
EPS
 
€ 6.72
€ 8.95
€ 10.56
€ 12.19
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Median EPS Estimate
 
€ 6.33
€ 7.64
€ 8.82
€ 9.32
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
% Upside To Cons EPS Estimates
 
6.2%
17.1%
19.8%
30.8%
 
 
 
 
 
 
 
 
 
 
 

FINANCIAL SUMMARY OF MANAGEMENT COST SAVINGS & RESTRUCTURING PLAN
 
Management Restructuring/Cost Savings Plan
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cumulative
 
 
 
 
2007
2008
2009
2010
 
2007-2010
 
Target
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SG&A / R&D / Logistics
 
50
75
85
90
 
300
 
300
Purchasing
 
25
100
175
200
 
500
 
500
Industrial Costs
 
100
175
200
225
 
700
 
700
Total Productivity/Cost Savings
 
175
350
460
515
 
1,500
 
1,500
% of Sales
 
1.0%
2.0%
2.5%
2.7%
 
 
 
 
 
 
EUROPEAN TRUCK TIRE MARKET IS EXPECTED TO HAVE STRONG VOLUMES IN 07-09
 
 
2000A
2001A
2002A
2003A
2004A
2005A
2006A
2007E
2008E
2009E
 
 
 
 
 
 
 
 
 
 
 
 
European Truck Tire Market
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Original Equipment
 
4.3
4
3.8
4
4.5
4.7
4.9
5.2
5.4
5.6
  % growth
 
12.1%
(7.1%)
(2.9%)
2.8%
15.0%
4.0%
4.6%
6.0%
4.0%
3.0%
  Replacement
 
11.6
11.4
11.3
11.5
11.5
10.9
11.2
11.8
12.5
13.1
  % growth
 
0.0%
(2.0%)
(0.9%)
2.3%
(0.5%)
(4.7%)
2.9%
5.0%
6.0%
5.0%
Truck Total
 
15.9
15.4
15.1
15.5
16.0
15.6
16.1
17.0
17.9
18.7
 
 
 
 
 
 
 
 
 
 
 
 
Replacement/Total (%)
 
73%
74%
75%
74%
72%
70%
69%
69%
70%
70%
 
 
MICHELIN IS #2 IN WORLDWIDE MARKET SHARE AND HAS SCALE AND STRONG MARGINS
 
Global Tire Market
 
 
 
 
 
 
 
 
Global
 
07E Operating
 
Market Share
 
Margin
 
 
 
 
Bridgestone
18%
 
6.2%
Michelin
18%
 
9.8%
Goodyear
17%
 
6.0%
Continental
6%
 
11.8%
Pirelli
5%
 
NA
Sumitomo
4%
 
6.1%
Yokohama
3%
 
5.4%
Hankook
3%
 
3.0%
Cooper
2%
 
3.8%
Others
24%
 
NA
Total
100%
 
6.5%
 

Catalyst

Earnings beats and upward revisions of consensus estimates
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