Brief Summary

1. Market Position and Challenges: Stellantis struggles with innovation in the electric vehicle sector, lagging behind leaders like Tesla and BYD. High interest rates further strain the automotive market, complicating consumer financing and impacting vehicle sales.
2. Brand Perception and Quality Issues: Significant brand perception challenges, especially in the American market, are exacerbated by multiple recalls affecting key models like the Jeep Grand Cherokees and Citroen, DS, Opel, and Peugeot brands, leading to potential safety concerns and eroding consumer trust.
3. Financial Performance: Stellantis has experienced a notable decline in revenue, with a reported 12% drop in net revenues year-over-year in the Q1 2024 and an inventory buildup indicating ongoing sales difficulties despite modest gains in electric and low-emission vehicle segments.
4. Investment Potential and Valuation: Despite current challenges, a deeper financial analysis reveals potential undervaluation. Stellantis maintains strong financial resilience with $19.5 billion in net positive cash and a sustainable dividend yield of 7.5%, suggesting investment potential under a conservative valuation approach.
5. Value Investing Perspective: Stellantis presents a compelling buy for value investors due to its undervaluation relative to intrinsic metrics, bolstered by substantial cash reserves and a robust dividend yield. Applying conservative value investing principles, including Greenwald’s EPV model, suggests a potential for significant upside despite the broader market’s pessimism and operational challenges. This aligns with a value investment strategy, emphasizing potential gains from a recovery or normalization in market conditions.

Market Dynamics and Industry Challenges

The auto sector is notorious for its competitive margins, and with the evolution towards electric vehicles (EVs), companies lagging in innovation are finding it particularly tough. Stellantis, despite its efforts, is among those caught behind, which is especially evident in the struggle to compete with industry leaders like Tesla and BYD. This struggle is compounded by high interest rates, which depress the automotive market further since most consumers rely on financing to purchase vehicles.

Currently, Stellantis is facing significant brand perception issues, particularly outside of Europe, in the American market, where the quality of its cars is frequently questioned. This sentiment is reflected in several recalls, which have not only impacted sales but also the brand’s reputation:

1. Plug-in Hybrid Electric Vehicles (PHEVs) Recall: Stellantis has recalled over 90,000 vehicles across brands like Citroen, DS, Opel, and Peugeot due to fire risks associated with the drive battery support potentially leading to water damage and rust.
2. Jeep Grand Cherokees Recall: This recall involves more than 354,000 vehicles globally due to improperly installed rear coil springs that could detach while driving, posing serious crash risks.
3. Chrysler-Fiat Airbag Issue: In Canada, over 10,000 Chrysler 300 and Dodge Charger models from 2018 to 2021 have been recalled due to a defect in the side curtain airbag inflators, which could unexpectedly rupture and send metal fragments towards occupants.
   These safety issues necessitate urgent attention and action from Stellantis, affecting consumer trust and potentially future sales.

Recent Performance and Market Reaction

The inventory levels reflect ongoing struggles, with unsold cars accumulating:

• Share Price Drop: Stellantis’ stock has plummeted by more than 24% in just over a month.
• Quarterly Financial Report: The Q1 report showed a 12% drop in net revenues year-over-year, shipments decreased by 10% to 1.3 million units, and a total new vehicle inventory rising to 1.39 million units.
• BEV and LEV Sales: There has been some positive movement, with battery electric vehicles (BEVs) and low-emission vehicles (LEVs) sales up by 8% and 13%, respectively., but not enough to spark any optimism.

Valuation and Investment Potential

As a value investor, my focus is on areas the majority might overlook, especially when they abandon quantitative evaluations. I aim to delve into the numbers to gauge the market’s level of pessimism and to determine if the prevailing nervousness has led to unrealistically low valuations. This could signal a potential buying opportunity for me. I’m aware that I’m not investing in a top-tier business; rather, I’m betting on a mediocre business priced too low to ignore, despite the challenges it faces

Despite the pervasive pessimism, which has led many traders and funds to steer clear of the sector, a deeper dive into Stellantis’ numbers suggests potential undervaluation:

• Financial Resilience: Stellantis boasts $19.5 billion in net positive cash and has increased its dividend to $1.65, yielding about 7.5% at the current stock price. This dividend is sustainable, supported by a robust balance sheet valuing the company at $65 billion with earnings of $20.5 billion.
• Investment Strategy: The company’s commitment to reinvestment is evident from its billions of capital expenditure in the past three years, aiming for a return to be competitive.

A value investor might argue that this is not growth capex but essential spending, because not investing in EVs means falling behind. I can agree with this viewpoint, which is why I do not include the growth capex. Historically, this company achieved an ROIC of nearly 20% and, by reinvesting 50%, should theoretically generate 10% growth. This is evidenced by their new acquisitions and the 25 new models coming this year, so ignoring the impact of this substantial capex is still quite a conservative stance, to say the least.”

Valuation and Financial Analysis

I’ve put together a rough valuation model, somewhat similar to the one I use for Meta, acknowledging that Stellantis doesn’t match the same quality level of business. I’ve assumed a revenue decline of roughly 15% from the last year levels and a margin contraction to 9%, although the CFO recently reiterated that they expect to maintain double digit margins. But, for a conservative approach, let’s stick with the more pessimistic margin.

Earning Power Value (EPV) Assessment

The EPV model, developed by Professor Bruce Greenwald at Columbia University, is a staple in my value investing toolkit. It’s designed to calculate sustainable earnings without growth. As per book I should add to the sustainable earnings calculation to the side the money spent on growth that are not maintenance, because on the long-term those capex will eventually stop however in a twist to adopt a very conservative stance, I hypothesized that all growth capex, which is significant, is completely lost—like throwing money in the bin.

Despite such a severe assumption that the reinvestment rate at 20% ROIC would generally suggest a 10% EBIT growth, the market doesn’t see this as feasible, and neither do I. I prefer to err on the side of market wisdom and stay pessimistic. Using a leveraged beta of 1.41, I’ve calculated an equity premium of 7.8% over a WACC of 12%. Given the risks involved I have added an extra layer of 3% discount over my cost of capital, bringing the total to 15%. Even with these conservative figures, I still see over a 50% upside potential.

An Intrinsic Valuation Perspective

As a value investor, I typically avoid using DCF models because the number of assumptions required could create a false sense of security with seemingly complex outputs. However, it’s useful to understand the potential numbers that could appear in a DCF analysis, especially with assumptions that align with those used in Earning Power Value (EPV) models, and to identify the drivers that could influence the valuation.
Market analysis indicates a clear reduction in EBIT and an absolute lack of growth. Initially, I thought the WACC might have been inaccurately calculated. As Stellantis operates internationally, it’s crucial to consider the risks associated with global operations, sometimes even if the cost of capital isn’t a predominant consideration for some investors.

In past analyses, I have discerned how different assumptions about the WACC can significantly alter stock valuations, impacting the attributed equity premium or beta. This is not the case, but it is why I wanted to have a thorough analysis of the beta and WACC and, therefore, I have written a session only for approach these elements which you will find below in the report.
So far, the WACC is not the issue, I believe the market is currently overstating the impact of growth reduction on the stock; only a 14% loss would justify the current market valuation.

I am presenting the first DCF model in which I’ve maintained some assumptions similar to those in my EPV analysis. These include management projections up to 2028, after which I’ve aligned with the consensus for the terminal margin. I’ve considered a minimal growth of 1.5% up to 2028 and no growth beyond that date. For both cases, the WACC used is 12%. Please refer to my paragraph discussion on WACC for more details.

We are again very close to the Earning Power Value (EPV) and also to the stock value before the last earnings call. However, the current market price implies a substantial 14% drop in revenue, which seems at odds with the company’s high reinvestment rate. Stellantis’s strategy involves reinvesting heavily—more than 11 billion annually, representing a 50% reinvestment rate. Such a significant commitment to reinvestment typically does not align with the narrative of a steep decline in growth prospects. If this revenue drop persists, it may compel the company to reassess its reinvestment strategy. They might either reallocate these funds more effectively or adopt new measures to enhance value distribution to shareholders and implement cost-cutting strategies to improve long-term EBIT. Under the leadership of Carlos Tavares, an expert manager, Stellantis is equipped with top-tier, highly reliable management that is well-prepared to navigate these challenges

Weighted Average Cost of Capital at 12%

Value investors traditionally dislike using beta and calculating the WACC. I understand their perspective but also think that when performing an intrinsic valuation of a stock, it’s crucial to carefully reflect on the value of risk to accurately assess the premium. Using an equity premium that might distort the intrinsic valuation of the stock is risky; it could be too high or too low for the specific stock, potentially rendering the intrinsic valuation impractical. Additionally, when deriving an Earning Power Value (EPV) by capitalizing the cost of capital, it’s essential to have a defendable, objective cost of capital; otherwise, the EPV lacks credibility.

You might disagree with defining risk as volatility based on standard deviation from historical movements, in that case you could use other approaches, like bottom up beta or others that allows for a baseline beta valuation or alternative methods.

I aim not to bore the reader with different WACC calculations and their methodologies in this research, but rather to present the information I’ve collected. We start with the assumption that the 10-year Treasury rate is not risk free and depurated the embedded default risk, that’s why we have used 4% rather than the actual rate of the 10-year. We then compile the revenue information and assign a weighted average premium to each region. This step is crucial, especially for a company operating globally including potentially volatile and emerging markets, where a lower WACC could significantly impact the valuation. Historical discrepancies in risk perception have sometimes caused dramatic drops in stock prices when the market adjusts.
For the unleveraged beta, I’ve used the industry average, and then adjusted for Stellantis’s debt-to-equity ratio. You can find the formula below for reference.

WACC calculation using Damoran model

Liquidation Value Considerations:

Rather than tediously examining each asset, I opted for a quicker, yet quite realistic approach to estimate the liquidation value. If Stellantis were to liquidate today, here’s how the numbers would look:

• Tangible Book Value: $15.76 per share.
• Goodwill and Intangible Assets: I looked into the $30 billion of goodwill and intangible assets and identified that only $15 billion is directly related to the brand value. These brands would hold value even if Stellantis were to liquidate; other automotive manufacturers could potentially purchase these brands.
• Inventory Valuation: With $22 billion in inventory, applying a 30% discount for quick sales gives us a rough current market value.

Therefore, I don’t see Stellantis facing bankruptcy within the next three years. To justify the current valuation at 3.74 times earnings, revenues would have to significantly decline over 30% annually, which seems unlikely. Even at the existing capex levels, which would no longer make sense if growth stalls, Stellantis could still generate 50% of the current market cap in free cash flow in the next 3 years and maintain a residual liquidation value at today’s prices.

Market Sentiment and Investment Perspective

I’m not counting on Stellantis to suddenly turn around and fulfill its ambitious plans for 2030 under CEO Carlos Tavares. If it does, the stock might hit $60, but that’s not where I’m placing my bets. I’m interested in the company’s real worth, which seems overlooked. I am going to use a simple value formula to derive the value.

Rate of Return
Formula = R t,t+1 = Dt/Vt + gt,t+1 + (1+gt,t+1) * ht,t+1

Where
Dt = share repurchase + Dividend + Net debt repayment + Interest rate
Gt,t+1 = Marginal ROIC * Reinvestment rate
Reinvestment rate = Growth Capex / Adj. NOPAT
ht,t+1 = Multiples Expansion/Compression

For this instance I am going to assume a zero growth and not debt repayment
• Dividend Yield: 7.5%
• Buyback Yield: 3.5%
• Growth (gt): 0% (assumption of no growth)
• Initial P/E Ratio: 3.3
• Target P/E Ratio: 5.0

Where
• Dt (Total returns from dividends and buybacks): 7.5% + 3.5% = 11%
• Gt,t+1 (Growth rate): 0%
• ℎ+1ht,t+1 (Multiples expansion): (53.3−1)=51.52%(3.35−1)=51.52%
Plugging these into the formula, the expected rate of return, considering the multiple expansion, is approximately 62.52%.

To calculate the annualized return:
Annualized Return=(1+Total Return)(Number of Years1)−1

The annualized return over a 3-year period, based on the initial single-year return estimate of approximately 62.52%, is about 17.57% per year.

In understanding this valuation, it’s important to note that it includes an assumption of multiple expansion, which might seem too optimistic. However, we’re in a high-interest rate environment, and it’s reasonable to expect rates to drop over the next three years. If you set aside the multiple expansion, the stock could still offer an annual return of 11%. This is not bad, considering it also gives you a free shot at additional gains if CEO Carlos Tavares even partially achieves his goals. It’s a situation where if things go well, you win; and if they don’t, you don’t really lose much — tail you win, head you don’t lose that much.”

Conclusion

Stellantis, despite its current challenges, presents a value buy opportunity. The potential for significant upside and a robust dividend yield makes it a compelling investment in a market that may be undervaluing its fundamentals.

I then rate Stellantis a Strong Buy.

Risks

The prevailing high-interest rate environment is elevating financing costs for consumers, potentially suppressing automotive sales. Should interest rates persist at these elevated levels, or if anticipated rate reductions fail to materialize, Stellantis could see a significant impact on both sales volume and stock performance. Particularly, if the so-called ‘Fed put’—an expectation of Federal Reserve intervention during economic downturns—does not provide the anticipated market support, there could be further downside risks. If sales decline exceeds our projected 15% and profit margins deteriorate beyond current forecasts, Stellantis’ stock may experience substantial valuation pressures.