Special Situations: PSA PEUGEOT CITROËN (UG: FP) - Is the Race Over?
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PSA stock rallied 80% since the beginning of the year. The company, which suffered in the last few years from shrinking market share and declining profits is now going through a reconstruction plan, and has managed to show operating profitability in 2014 for the first time since 2010. We believe that further improvement in the operational performance together with a continued recovery of the European Auto sector (which was seen year to date), can lead to further share gains. However, at the current stock level we prefer to wait for a better entry point that will reflect a more attractive risk-reward ratio.
Valuation & Investments strategy
We identify two potential catalysts which we recommend investors to follow: 1) PSA reconstruction plan - in April 2014 Carlos Tavares, Chairman of the PSA and former Renault executive, announced the 2014-2018 “back in the race” business plan, with a clear focus on returning the group to profitability. The plan includes three main financial metrics - recurring positive group operating free cash flow by 2016 at the latest, €2 billion in total Group operating free cash flow over the 2015-2017 period (this was lately updated by management from 2016-2018); and a 2% operating margin in the Automotive Division by 2018 with a long term target of 5%. The company aims to achieve these goals by reducing overall models numbers, improving capacity utilization through restructuring, and SG&A cost reduction. We believe that strong execution can continue to drive the stock up especially if the recovery in the Auto sector continues through 2015. 2) Potential M&A candidate - we see PSA as a natural candidate for M&A deals given the fact that it is one of the smallest OEM’S in Europe and could be acquired by a bigger OEM which could drive scale out of it. We point out that this could be a major catalyst.
We value PSA at €19 per share using a sum of the parts analysis based on the following assumptions and adjustments: 1) The automotive segment was valued at 0.2x EV/SALES on FY16 estimated revenues in order to reflect a certain level of improvement in the operational performance. 2) Faurecia stake (51.1%) was taken at market value based on a share price of €40.7 (the closing price as of June 4, 2015). 3) BANQUE PSA finance was taken at 20% discount to book value. 4) PSA China was taken at 0.55x EV/SALES on the FY14 revenue which we believe is quite conservative given the good performance of PSA in China together with its local partner DPCA (this valuation is also supported by the DDM method based on 2014 dividend). 5) PSA net debt and pension liabilities were taken excluding Faurecia. 6) We accounted the dilutive effect from the equity warrants issued in April 2014 by adding 120 million shares and €770 million to assets.
We note that PSA management stated in 1Q15 revenue release that the Group is ahead of schedule with its "Back in the Race" recovery plan and is benefiting from a favorable economic environment. We ran a sensitivity analysis for PSA share value in order to reflect a number of potential scenarios for the automotive segment and for PCA China. We took a 0.10-0.35x EV/SALES multiple range for the automotive segment and 0.55-0.70x range for China PSA. We believe the appropriate range of the share value is @ a €16-€21 range (an average of €18.5). Therefore, at current market price of €18 we see PSA as Natural but we recommend to follow the stock and the company’s operational progress and take advantage of a potential pull back.
Key risks
Main risks include: (1) unexpected drop in European and global vehicle demand; (2) poor execution of PSA restructuring plan and lack of management’s ability to improve profitability and become cash flow positive in the short term; (3) market share declines in Europe and globally which will lead to declining revenues. (4) Strengthening of the euro particularly relative to sterling or emerging market currencies.