The European automotive OEM sector has witnessed continuous improvement in recent years. However, markets are looking through higher returns and cash flows, and are pricing in a mean-reversion to pre-pandemic years. Bernstein acknowledges the significant advancements made by the sector during the pandemic but believes that such a negative outlook would require a global recession of significant scale in the coming year.
Analysts there take a more optimistic view, pointing out that pent-up demand could partially offset macroeconomic challenges and affordability concerns. This could result in a free cash flow upside of more than 25%, aiding OEMs in financing the transition to electric vehicles while improving shareholder distributions.
They wrote of the EU sector: "This year will mark a turning point for European OEMs. Fundamental trends will align with cyclical tailwinds, creating significant cash opportunities for established OEMs. We expect the industry to gradually escape the overhang of the electric revolution, generating more room to discuss shareholder-friendly capital allocation policies."
The 5 key European OEMs under Bernstein's coverage, namely Volkswagen (ETR:VOWG_p), Mercedes Benz (OTC:MBGAF), BMW (OTC:BMWYY), Stellantis NV (NYSE:STLA), and Renault (EPA:RENA), have made remarkable strides in their free cash flow performance over the past four years. They have successfully doubled their average annual free cash flow from €15 billion between 2015 and 2019 to over €30B (€1 = $1.1134) post-2020.
The analysts strategically favor Mercedes-Benz and tactically prefer mass-market OEM Renault. Renault stands out as the first OEM to upgrade its guidance for FY23, with Bernstein expecting other OEMs to follow suit during the Q3 earnings cycle. On the other hand, Mercedes-Benz, which had the highest capital expenditure and research and development intensity in the sector, faced challenges in financing its dividend with free cash flows.
In 2019, a new management team led by CEO Ola Källenius and CFO Harald Wilhelm took charge at Mercedes with the aim of bringing the company back on track. Their strategy involves a focus on luxury products while also implementing a comprehensive overhaul of the business, including a 20% reduction in capex and R&D costs compared to 2019 levels. The COVID-19 pandemic provided Mercedes-Benz with an opportunity to expedite its strategy, leading to a 12% reduction in its workforce since 2019.
Bernstein's research indicates that Stellantis has a free cash flow yield of 19% for FY+2, ranking second among Bernstein's coverage, only trailing Renault with 21.7%. The higher cash flow position of Stellantis will enable the company to fund increased dividends and share buybacks.
The Fiat-parent was recently upgraded by Bank of America to a Buy rating as analysts see the limitations on supply chains becoming less strict and predicting the probability of returning to normalcy for the automaker. Consensus expects a sharp decline in 2H23 for Stellantis. However, Bank of America believes the trajectory may prove more gradual.
While sector valuations have been declining and price-to-free cash flow (P/FCF) valuations are trending down, the analysts believe that strong companies like BMW will continue to execute their proven path of delivering shareholder returns. With a market cap of $76.5B and 2.4 million cars sold, BMW's volumes and revenue continue to grow, positioning the company to meet or exceed its FY23 guidance.
Volkswagen, with an electric vehicle sector valuation exceeding $288B, has sold 8.3M vehicles, surpassing the combined sales of Mercedes, BMW, and Renault. With a free cash flow yield of 14.3% and a 15% increase in revenues, Bernstein anticipates a solid performance from Volkswagen in FY23.