Andrew Burton
Utilizing Return on Invested Capital (ROIC) as a guiding metric, Stellantis (NYSE:STLA) efficiently allocates its resources for profitability. Despite potential risks from the electric vehicle revolution, the company currently presents a compelling investment opportunity, trading at remarkably cheap multiples to enterprise value. Embracing a “cigar butt” philosophy like Benjamin Graham’s, investors may find sensible long-term value in Stellantis’ stock.
Stellantis Achieves Record-Breaking Results in H1 2023: Strong Growth and Profitability Amidst Challenges
During the presentation of Stellantis’ first-half 2023 results, CEO Carlos Tavares highlighted that the company has achieved outstanding performance during this period. Net revenues increased by 12%, adjusted operating income by 11%, net profit by 37%, and international free cash flow by 63%. These record numbers demonstrate the success of their strategic Dare Forward 2030 plan.
Tavares emphasized that Stellantis is not only growing its business, but also preparing for a profitable future. The company achieved an impressive €14 billion of adjusted operating income with a high AOI margin of 14.4%. Furthermore, they generated a rewarding free cash flow of €8.7 billion, a 63% increase compared to the previous year, indicating the company’s efficiency and effectiveness.
Overall, Stellantis’ H1 2023 financial results showcase their commitment to executing their strategic plan and building a strong and successful company for the future.
ROIC – Understanding How Companies Allocate Capital for Profits
Return on Invested Capital (ROIC) serves as a crucial metric in evaluating a company’s ability to efficiently allocate its capital towards profitable ventures and investments. To calculate ROIC, one divides the net operating profit after tax (NOPAT) by the invested capital.
Determining the invested capital involves summing the net debt, obtained by subtracting excess cash and cash equivalents from the gross debt amount, with the equity values from the balance sheet. However, a more accurate representation of invested capital should exclude intangible assets. These intangible assets, once developed or acquired, require no further capital expenditure for replacement.
By incorporating intangibles into the invested capital formula, we find that STLA derives a value of 25% for its ROIC ( ROIC= NPOAT/Invested Capital; H1 NOPAT of $11 billion ->$22 billion annualized; Invested Capital of $88 billion). However, when excluding goodwill and intangibles (total of ~ $50 billion of these two on the Balance Sheet) the ROIC surges to an impressive 64%. Some might say that excluding intangible and goodwill is good practice in computing ROIC since these two assets don’t require replacement (i.e.: capex expenditure).
Expected Returns – The Link Between ROIC and Shareholder Gains
Businesses capable of achieving higher-than-average returns on invested capital are likely to generate above-average returns for their shareholders in the long run. The excess cash generated by STL can be reinvested into the business, bolstering net worth, or distributed to shareholders.
As an illustration, consider the past six months’ performance of Stellantis, where $4.2 (Page 37 on the 10-Q link below), cash flow statement) billion was paid out to shareholders as an annual dividend, and the total equity (net worth) increased by over $4.5 billion. This indicates a total value creation of ~ $8.7 billion within the six-month timeframe (which matches the industrial cash flow production of the firm, page 6 in the 10-Q link provided below).
Drawing from the wisdom of Aesop’s ancient saying, “A bird in the hand is worth two in the bush,” Warren Buffett has repeatedly referenced this phrase to explain his investment philosophy on valuation. Investors must consider factors like the number of opportunities available (“birds in the bush”), the timing of their realization, and their certainty. While Stellantis is expected to generate around $19 billion in hard cash for shareholders in 2023, uncertainties persist regarding future prospects.
Assuming Stellantis sustains its $19 billion cash flow into the foreseeable future, determining a fair valuation becomes critical. If treating it like a bond that pays $19 billion annually for ten years and then redeems at net worth, the calculation would involve discounting these future cash flows to their present value using a 25% internal rate of return (IRR). The convergence of the IRR with the ROIC figure is no coincidence, as in the long term, stock returns tend to align with return on capital figures.
Via organic growth and acquisitions and mergers the company has more than 10X’ed EBITDA of the past decade:
Growth Metrics (SA)
EV/EBIT multiple in the “cigar butt” zone:
EV/EBIT multiple (SA)
Risks – Electric Vehicle Challenges for Incumbent OEMs
One cannot overlook the looming threat posed by the electric vehicle (EV) revolution for established Original Equipment Manufacturers (OEMs). With EV adoption increasing from 14% to an expected 60% by 2030, traditional OEMs like Stellantis must adapt to retain their earnings amidst the shift. While Stellantis currently generates nearly $20 billion in free cash flow, this figure accounts for an annualized capex of $8 billion.
Should the company decide to transition its power plant and equipment for all six million units produced annually, the capex expenditure would soar, exemplifying the innovator’s dilemma. Moreover, OEMs face pressure to innovate and cannibalize their own operations; otherwise, companies like BYD (OTCPK:BYDDF) or Tesla (TSLA) are poised to capitalize on the opportunity.
Conclusion:
In conclusion, Return on Invested Capital (ROIC) stands as a vital gauge for a company’s capital allocation efficiency, and Stellantis has showcased promising figures with a 64% ROIC when excluding goodwill and intangible assets. Higher-than-average ROIC suggests the potential for above-average returns for shareholders, as evidenced by the company’s ability to generate substantial value. Despite the looming risks of the electric vehicle revolution for incumbent OEMs, Stellantis remains an attractive investment option, trading at extremely cheap multiples to enterprise value. Embracing a “cigar butt” philosophy akin to Benjamin Graham’s approach, investors may find a sensible opportunity in Stellantis’ stock.
