There are many analysts stating that OEMs and suppliers are trading at a discount to their target prices. For that reason, I decided to cover Gestamp and check if this company is really trading below its intrinsic value.
Gestamp Automoción S.A. is a Spanish firm that develops and produces components for the automotive industry mainly through stamping, assembly and welding technologies.
It has two different lines of business: Body-in-White & Chassis and Mechanisms and operates in several markets. The main ones are the following:
In order to better know Gestamp, it is crucial to know who it competes against. Reading financial statements and several publications, I identified the main competitors for both lines of business:
Taking 2018 sales figures as a reference, I have graphically represented the biggest players in a Pareto chart. The right axis represents the individual market share of each competitor whereas the left one represents the accumulative market share. As it can be seen in the following graph, the first four companies represent 75% of total sales:
Having four big players that represent three quarters of the pie lead to think that there are barriers to entry due to high investments required in order to operate profitably. What is more, there is a relevant difference between Voestalpine and Unipres in terms of revenue.
Beyond identifying main competitors, it is important to see the evolution of their sales figures. In the following graph we can see the evolution of revenue of the four main companies: Magna Cosma, Gestamp, Benteler and Voestalpine.
As we can see in the previous graph, aggregated sales of the four main competitors have grown at a 3,4% CAGR during the last six years. In addition, we can see how different sales growth rates have been among the four companies. While Benteler, Magna Cosma and Voestalpine had decreasing sales, Gestamp’s turnover grew at a 4% CAGR.
Thus, Gestamp is a company that has increased its sales while the rest of competitors have earned less. Nevertheless, Gestamp’s business is based on economies of scale, so a deeper view through EBITDA margin can complement this fact. In the following graph we can see this metric for Gestamp and key competitors.
We see how Voestalpine has the highest EBITDA margin. Operationally speaking, it could resist a higher price cut an remain competitive. Regarding Gestamp, is quite similar to the biggest competitor while Benteler has the lowest margin.
A second conclusion can be extracted: margins have improved for the group as a whole, but Benteler, Magna Cosma and Voestalpine did it better than Gestamp. In the following table, evolution of EBITDA margin has been calculated:
Beyond improving margins, it seems unlikely that a single company could corner the market. In the one hand, from the supplier side, there is a strong incentive in increasing capacity and trying to exclude competitors. In the other hand, OEMs are the ones that decide to outsource their activities and who they work with. If OEMs spread their activities among several suppliers, it easier for them to keep their negotiation power and cut prices.
As a consequence, suppliers need to increase their portfolio of clients in order not to rely on very few customers. Thus, future evolution of customer base should be taken into consideration.
Key industry drivers must be identified in order to anticipate future earnings and growth rates. Thus, at least four factors must be taken into account:
- Car demand. According to OECD database, car demand has moved between 6% and -6%, with a negative trend from 2012 to 2018. For that reason, we cannot expect the car demand to grow dramatically in the foreseeable future. In fact, car-sharing platforms can keep car demand growth below past rates.
- Increase in outsourced activity. A second key driver is the fact that OEMs have been historically less profitable than suppliers. This fact can be observed in the following graph:
Average EBIT margin for suppliers has been systematically above OEMs. Thus, in order to improve their operating performance, they are expected to outsource some components and services to more efficient suppliers.
- Increasing number of electric cars, can be seen as an opportunity for Gestamp. Hot stamping allows a reduction in cars weight and an increase in cars autonomy. Furthermore, they are also developing new specific components for electric cars.
- Emissions. There is an increasing concern about emissions and environmental issues. Thus, more and more governments are setting restrictions to contaminant emissions. In this scenario, there is an interest in making cars lighter.
- New added-value features. In the future, software will account for almost 70% of what we currently know as car. In the following excerpt we can see some of the characteristics:
It is reasonable to think that OEMs will search new joint ventures and investment opportunities in order to include those new features in their cars. This fact will probably pressure other components price in order to keep cars cost as low as possible.
- Sustitutive product: there are different materials that also can be used to produce car chassis and parts: carbon fiber & composites. These materials can help cars to reduce their total weight and, as a consequence, increase their autonomy. In a research report conducted by Roland Berger (2017), I found the differences between both materials:
As we can see in the previous excerpt, composite materials can have a stronger impact on weight reduction as well as on cost whereas stamped products add more safety and recyclability per additional cost unit.
Regarding returns, there are several metrics that measure profitability. Nevertheless, the theoretical return that an investor would obtain is measured by the return on equity. This metric ignores the financial leverage of the company. Thus, comparing several firms thourgh ROE with different levels of leverage can lead to misleading conclusions.
Here, we only analyze Gestamp returns. However, I have decomposed ROE into its different components in order to better understand the source of ROE evolution.
In the previous table, we see that Gestamp has decreased its return on equity from a 14% to 11,4% in the last three years. However, the reasons are found in two factors:
- The first one is the net financial leverage. The company has slightly unlevered its balance sheet by reducing the amount of debt compared to equity.
- A second factor is the spread. This metric measures the difference between operating return on assets and the effective interest rate after tax. As we can see, since operating ROA has remained almost constant, we can deduct that the cost of debt has increased over these three years.
As a consequence, a lower return on equity has not been driven by a lower return on operating assets. In fact, a lower financial leverage is good since the company becomes less sensitive to interest rates movements and can retain more of the cash it generates. By the contrary, the second factor, spread, is not fully controlled by Gestamp.
Accounting principles give managers a certain degree of discretion to record financial facts. For that reason, I have checked the footnotes of both Balance sheet and Income statement for the last four years (2018-2015).
I found a very interesting fact on revenue footnotes. In the following screenshot, it can be seen several revenue components that are not directly related to the business:
- “Other expenses”: the company states that such revenues are not related with Gestamp core activities.
- “Subsidies incorporated to Income Statement”: portions of subsidies that are recorded on Equity but transferred to Income Statement on a yearly basis.
- “Excess of provisions”: provisions that were overstated in previous years or whose associated risk has disappeared or reduced.
- “Assets disposals”: revenue earned by selling part of its assets.
- Work carried out by the Company on its fixed assets.
Since those concepts are not directly related to Gestamp daily operations, I decided to extract them for valuation purposes. In addition, I capitalized development expenses, with a minor impact on earnings.
For years 2016 and 2015 I have used outstanding shares from 2018 and 2017 in order to neutralize the effect that a share capital increase can have on earnings per share metrics. The results of recasting are the following:
There are several valuation techniques that can be used. Some of them are complex and involve assumptions about future earnings. Such techniques are very sensitive to changes in key inputs (earnings growth, terminal values, etc). Here, I have tried not to rely on future assumptions a follow a technique consisting in averaging profits and multiplying the resulting earning by a multiple.
The following table shows the details:
If we use adjusted earnings, the intrinsic value that we obtain is 2,12€, which is far below the current market price and other analysts’ estimations. Repeating the same calculation, but using reported earnings instead of recasted ones, the intrinsic value provided would be 8€.
Valuation is more art than science. Thus, more than an exact figure, the Intrinsic value should range between 2.12€ and 4€ per share.
We have seen that the autoparts have both opportunities and threats. In order not to repeat industry trends, here I summarize them with the impact on Gestamp future performance:
As we can see, there are more factors with a positive impact on Gestamp than those affecting negatively.
Regarding competition, Gestamp should maintain or increase EBITDA margin in order to maintain its competitive position. It also should be mentioned that the company has four big customers: Daimler, BMW, Renault and Volkswagen. Thus, an expansion on its customer base would not only give Gestamp more revenue, but also more negotiating power and less dependence on existing clients.
Price paid is important. For that reason, I would prefer not to buy Gestamp stocks at the moment. Instead, I would analyse Cie Automotive with a current P/E ratio around 6x.
By no means this is an investment recommendation (none of my articles are), so each one should conduct a deep analysis or pay for professional advice.