The core Renault Stub (CarCo + FinCo) is trading at a negative EV. While this is not a new or rare phenomenon, the Renault Stub is experiencing its best financial position with the lowest amount of CarCo net debt ever. Renault CarCo is expected to reach a net cash position at FY2012.
Today, sellers of RNO are paying buyers to own a debt-free auto manufacturer that is marginally profitable today and shifting the direction of its business towards more attactive profitable markets and models.
I recommend letting the market pay you ~€5bn to own the equity in an auto company that (a) is FCF positive, (b) whose FCF should grow as it outearns over the next several years due to improvements in near-term fundamentals, and (c) is supported by FinCo tangible book value of ~€2.5bn.
To paraphrase Charles Barkley, anything less than recommending the Renault Stub today would be uncivilized.
RNO is a leading French-based auto company. RNO owns public stakes in Nissan, Volvo, and Daimler. The value at market of RNO's stakes in Nissan and Volvo alone comprise ~150% of RNO's market cap.
Long RNO FP
Short 7201 JP
Short VOLVA SS
Short DAI GR
Short AVAZ RM
... will result in you being long the Renault Stub, comprised of the economics underlying Renault CarCo and Renault FinCo.
RNO is a better business than people think. Since 2004, the core Renault Stub has had operating cash conversion of EBITDA averaging 107%, generated over €4bn of FCF (excl. dividends from equity interests), and improved its sales exposure to attractive markets outside of Western Europe.
Improving Profitability at Renault CarCo
In an interview earlier this year, Carlos Ghosn said that he expected international sales could represent 50% of total unit sales as soon as this year. YTD Sep 2012, RNO has had 49% of total unit sales outside of Europe.
|Total Car Volumes
|% of Total
RNO's focus on increasing its sales mix outside of Europe is economically beneficial for three reasons:
- Lower labor costs - It is expected that all non-European sales will be locally sourced, with over 60% of RNO's manufacturing capacity located outside of Western Europe. Hourly labor costs in Western Europe are ~2-4.5x higher in Romania and ~8-9.5x higher than in Morocco.
- Higher capacity utilization -
Capacity utilization rates are estimated to be running close to 100% in Romania and Morocco, in contrast to below 50% in some French and Spanish facilities.
- Higher entry-level growth - Barclays research expects RNO's entry-level production to grow ~20% in 2013 outside of W. Europe while staying float in W. Europe, helping to make RNO's entry-level cars a growing portion of the sales mix.
The last point is important because RNO's entry-level cars are profitable sales. This segment is profitable due to lower operating costs because (a) stripped down entry-level vehicles require less R&D and (b) growth is occurring in markets with lower labor costs with localized production. Some sell-side estimates expect these models to produce €1 billion in EBIT by 2013. Carlos Ghosn has confirmed that the entry-level platform is currently comprising more than 100% of Auto EBIT. The entry-level platform produce 812,000 units in 2011 and is projected to produce 1.4 million units in 2015. It doesn't take heroic assumptions for Renault CarCo to do €1-2bn in EBIT within the next several years.
Potential Structural Cost Savings at Renault CarCo
Carlos Ghosn joined Renault in 1996 and Nissan in 1999. He became CEO of Nissan in 2001 and Renault in 2005, becoming the first person to run two Fortune Global 500 companies simultaneously. RNO's alliance with Nissan saved the car makers €1.75bn in 2011 and is expected to save them €2bn this year. Recent news reports disclosing RNO's internal goals indicated a target of doubling annual cost savings to €4bn in 2016. Although Nissan obtains a majority of the savings due to its higher relative production levels, RNO is expected to obtain a sizable share of these savings. Right now, RNO's SG&A costs as a % of Revenues is ~11% while Nissan's are ~7%.
Better Balance Sheet at Renault CarCo
The Renault Stub was negative at ~-€4bn in 2001-2003 (see old VIC writeup). Back then RNO CarCo had ~€2.5bn of net debt. The Renault Stub was valued at ~€15bn in 2007 with ~€2bn of net debt and valued at ~€15bn in 2008 while having ~€5bn of net debt.
Today RNO has ~€472mm in net debt and is expected to go net cash at FY2012. Carlos Ghosn has said that RNO will continue to pay down debt and that he wants the business to have a net cash position. "As you know, the first priority was to take care of the debt, but we made a good step in 2011 in difficult conditions. We're going to continue to do that. I want the Company to be cash. I want the Company to be significantly cash."
We've all heard the arguments for negative stub equity when the balance sheet is loaded with debt, but the world is simply not right when a FCF positive company with (soon to be in a ~month) a net cash position is trading at a negative valuation. Although the Renault Stub has been negative in the past, I believe todays' negative-ness is less risky than in the past.
I believe that Renault FinCo is worth book value, as it has been earning high teens ROEs with decreasing leverage. RNO earned an attractive ROE through the downturn and has continued to do so with lower levels of leverage. Assets/Equity = 11x
Valuation - Equity Stakes
Right now, RNO's stakes in Nissan, Volvo, Daimler, and AvtoVaz are worth ~€55/share. Nissan and Volvo alone are worth ~€52/share.
Valuation - FinCo
Renault FinCo's book value is ~€2.5bn or ~€9/share.
Valuation - CarCo
Renault CarCo's invested capital (Net PP&E + NWC) is ~€11bn. Financial debt is ~€9.4bn, but if you want to be really conservative, then gross debt including off-balance sheet commitments and the underfunded pension is ~€12.8bn gross cash. With cash of ~€9bn, this puts net debt at ~€4bn. This puts the net capital of Renault CarCo at €7bn or ~€24/share. Renault CarCo FCF positive with significant potential earnings power sometime over the next several years.
Potential (Gross) Upside
€55 + €9 + €24 = €88/share
Current price of €37/share
Upside of ~138%
Another way of looking at: You suffer from the limitations of your cognitive apparatus and are biased against European auto companies, so you're reluctant to give ANY value to Renault CarCo but you feel safe about auto finance. In that case, €55 + €9 = €64/share. If the Renault Stub can trade to ONLY the value of Renault FinCo (with no increase in or return on existing FinCo book value) in three years, then you make a 19% IRR over three years.
Potential (Net) Upside
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.