Delivery of another large beat in 1H 2016 is laudable, but we note the cyclicality of Peugeot's market, earnings, cash flows and valuation; and, given signs that the up-cycle is slowing, now does not seem the right time to own a European mass OEM. Remain Underweight.
Great 1H execution, huge improvement in returns: Peugeot reported 1H Auto
EBIT of €1.3bn, a record high 6.8% EBIT margin, driven by positive market
demand, lower production costs and lower SG&A. Cash flow was also very
strong with FCF at €1.85bn. Peugeot again highlighted its net cash, now at €6bn
(obviously a large proportion of its market cap), although we continue to treat its
"negative working capital" of €3.5bn as more akin to debt than actual Peugeot
cash. We update our forecasts, and our price target rises from €11 to €12.
Cyclicality – how sustainable are Peugeot's improved returns? The market rarely
forecasts cycle downturns before they happen. In the case of autos, we think it is
a crucial debate. We do not believe the market should (or will) extrapolate (close
to) cyclical peak earnings, or value them on through-cycle multiples. We show
how Peugeot's key markets have always been very cyclical (e.g. China in FY16),
how its historical EBIT margins and cash flows have been very cyclical and,
maybe most importantly, how investors' views of investments such as Peugeot
have also been very cyclical. While acknowledging the very significant
improvements that CEO Tavares has made, we reiterate our view that in mass
autos, when it comes to share price returns, auto markets have the upper hand
over management action. Thus, we note that the key upside risk to our call is
better-than-expected EU auto demand.
Conclusion: excellent results, but it is very hard to see how this is not the peak:
Whilst Peugeot has again surprised on the upside, we continue to believe its
current performance should not be extrapolated. European market growth looks
set to slow as most country sales approach previous peaks and 2H comps get
much tougher. Historically, Peugeot auto EBIT margins have proved very
vulnerable going into such a European slowdown. Whilst guidance on margins –
"an average of 4% 2016-2018" – now looks conservative, we cannot forecast
much upside from the 1H 16 performance. The question is, with the higher base
1H 2016 earnings, how will investors value the shares? We believe they will
continue to discount peak earnings, and remain Underweight.