Multinational automotive company Stellantis NV (STLA, Financial) has faced bearish momentum since reaching its all-time high at the end of March. Shares plummeted following a drop in production and revenue, as revealed in the company's most recent quarterly results, halting a strong rally that had been building up since last year.
One of the key reasons behind the market's bearish outlook is skepticism about the company's next product cycle stage, given its plans to invest billions of euros in developing its BEVs and PHEVs.
While I acknowledge these risks associated with Stellantis' journey into electrification, I believe that considering the company's robust fundamentals and the experienced and competent management at its helm, the market's reaction to its recent challenges may be exaggerated, particularly in pricing the stock based on transient headwinds.
Further, given the company trades at a significant discount compared to its peers, I maintain a bullish outlook on Stellantis. In my view, investors stand to benefit in the long term from the recent developments surrounding its stock at current valuations.
Why the rally was paused
Stellantis had a record year in 2023, with net revenue, net profit and free cash flow all reaching new highs. The Dutch company continued to post improving profitability quarter after quarter, supported by solid and healthy financials.
However, the recent drop in its rally has been attributed to specific headwinds:
- First-quarter 2024 results were disappointing regarding volumes. Recent data shows dealer inventory has risen to approximately 100 days in the U.S., indicating potential excess supply and a challenging sales environment.
- Management expects first-half adjusted operating income margins of 10% to 11%, below the previous year's consensus estimates, signaling a downturn in profitability.
- Wall Street lowered its target prices for the company based on revised estimates, reflecting a more cautious outlook on the stock's future performance.
Product cycle transition
In the automotive industry, how well a company performs often depends more on the skills and decisions of its management team than on having unique technologies or advantages over competitors.
CEO Carlos Tavares played a pivotal role in Stellantis' success. He steered PSA Group from the brink of insolvency to profitability through astute cost-cutting measures and strategic acquisitions. Later, the merger with Fiat Chrysler transformed it into one of the world's largest automakers.
The company performed exceptionally well over the past few years, especially during the early pandemic when competitors faced severe supply issues. However, now that supply has normalized and competition has increased, Stellantis has been losing its appeal among Wall Street investors. This is particularly evident in the company's most recent earnings results, which revealed a significant decline in revenue and shipments.
In North America, shipments fell by 20%, and revenues decreased by 15%. In markets like China, India and Asia, shipments declined by 42% and revenues were halved.
As is common in the automotive industry, domestic product cycles often have a more significant impact than macroeconomic cycles, and this may be the case here. Stellantis' shipments are down because the company is destocking and halting some production in preparation for a new product rollout scheduled for the second half of the year.
Tavares said Stellantis will introduce eight electric vehicles to the U.S. market alone. By the end of the year, 48 EV models will be available, representing almost half of the company's total portfolio.
As communicated during the earnings report, volumes in North America fell by 50,000 units, impacted by the discontinuation of the Chrysler 300, the Dodge Charger and the Dodge Challenger. The company has been preparing to ramp up the next generation of the Charger in the third quarter.
The Sterling Heights assembly plant also transitioned to producing the updated Ram 1500 light-duty truck, reducing production by almost 20,000 units year over year. They also idled 12,000 Jeep Cherokee units to prepare for electrification initiatives.
Should investors buy this dip?
I believe the company's most recent earnings release caused some stress in the market as shipments and revenue fell amid a transitional period in the product cycle.
Stellantis guided investors that it will spend $50 billion over the next 10 years to fund investments in BEVs and PHEVs, an average of $8.30 billion annually. Even so, if the company continues to report cash operations above $20 billion, as it has for the last three years, it would still have half of that left in free cash flow, ensuring robust dividend distribution as Stellantis' earnings yield has been at 7.70% average in the past five years.
Moreover, two metrics make me confident the current momentum could be an excellent buying opportunity at a discounted valuation that should continue to pay off handsomely.
The first is Stellantis' ability to invest its capital well, as evidenced by a very solid return on invested capital of 16.60%, compared to the automotive industry average of 6%. The company achieves this great percentage through a combination of factors, including streamlined operations and a strategic product mix featuring high-margin vehicles.
The second metric is its earnings yield, representing the ratio between earnings per share and share price. Stellantis boasts an earnings yield of 29%, one of the most attractive in the market for a stock with such a high ROIC.
Source: Data from company's filings.
The combination of a strong ROIC and a high earnings yield indicates the company is generating profits efficiently and offering solid returns for shareholders relative to the market price of its shares. It suggests the market has probably overreacted to recent events.
To provide further clarity on the significant valuation disparity, Stellantis shares are trading at a mere 2.20 times enterprise value/Ebitda compared to an industry average of 10 and a price-cash flow ratio of 3.50 versus an industry average of 9, indicating the company appears severely discounted.
What could go wrong?
While Stellantis' recent weaker results were anticipated due to its preparation for a new product cycle focused on electrification, there is an inherent risk associated with the success of its upcoming EV lineup.
Questions arise regarding whether the Jeep family of 4xe vehicles can effectively compete with Tesla's (TSLA, Financial) Cybertruck and Rivian (RIVN, Financial) and whether models like the Peugeot e-2008 and the new Fiat 500e will emerge as top contenders in the EV market.
Moreover, the broader question remains: can Stellantis translate its $50 billion investment plan into electric vehicles that achieve significant sales success in a reasonable time frame? Only time will provide the answers, but initial market reactions suggest a lack of confidence in absolute success.
The bottom line
The momentum in Stellantis' stock has hit a snag as investors struggle to digest the headwinds associated with the company's internal product cycle transition.
Given the company's fundamentals remain robust and its investment returns are above average, the extremely attractive valuation suggests investors who take advantage of the current dip should reap good rewards in the long term.
