AOMFF - Alstom: Remain Neutral After Cash Warning

2023-10-28 08:43:07 ET

Summary

• Alstom issued a cash warning and cut its full-year FCF guidance to negative €500-750 million.
• Moody's changed Alstom's credit outlook to negative, but maintained its investment-grade rating.
• The updated valuation suggests a 33% upside for Alstom shares, but concerns about cash generation capabilities and balance sheet health remain.
• We would avoid buying Alstom shares now, given the looming concerns.

We have previously published a note on Alstom (ALSMY) with a Hold rating, highlighting major tailwinds as well as various issues including a problematic acquisition, poor cash generation, and the risk of a potential credit downgrade and a dilutive equity raise. The bear thesis has largely played out in the last couple of weeks as Alstom issued a cash warning and the credit outlook was changed to negative, causing the shares to plummet. We will provide a brief overview of the latest developments, analyze key data and news, value the shares in the light of recent changes, and provide an updated investment recommendation.

Pre-release and cash warning

Alstom pre-released its H1 results and had a conference call afterwards most notably announcing a cut in its full-year FCF guidance to negative €500-750 million vs the previous positive FCF guidance. Revenue and net profit guidance remain unchanged. H1 results came in poor with orders below consensus and EBIT 10% below consensus, while FCF was significantly negative at -€1.15 billion, vs. consensus expectations of around -€150 million. The cash burn is caused mainly by the increase in inventories and contract assets, lower down payments, and the delay of a major UK program. The inventories and down payments trends are expected to improve in the second half of the fiscal year, while the delay in the Aventra program in the UK, will only be partly recovered in H2.

We are aware of Alstom's track record of big cash flow swings however we find such an unexpected major negative move worrying, especially combined with contract execution issues and questions over the strength of the balance sheet and the need for a capital increase. Moreover, the situation casts doubt on Alstom's contract risks and operating performance, as well as Alstom's long-term cash generation capabilities.

Credit outlook to negative - Remains investment grade

Moody's changed Alstom's credit outlook to negative while maintaining its Baa3 rating. This provides some relief as a credit downgrade to sub-investment grade would have been significantly costly for Alstom and severely impacted other aspects discussed in our previous note. The negative outlook however means more scrutiny and highlights Alstom's need to improve credit metrics enforce better cash control and likely deleveraging through divestments. We would like to note again that the maintenance of investment-grade rating is key to Alstom's future performance.

Valuation update and investment recommendation

After the poor H1 results and cash warning, we update our assumptions and estimates, as well as update our price target materially. As in our previous note, we value Alstom using EV/EBIT multiples given the sector, and FCF yields due to the market's focus on Alstom's cash generation capabilities.

We forecast 4% sales growth until FY2026 and a 7% exit adjusted EBIT margin, slightly lower than the guidance. We are in line with the new consensus on top-line growth and on EBIT margins. We then arrive at FY 2026e adjusted EBIT of ca. €1.3 billion. We value Alstom at a lower exit EV/EBIT multiple that more accurately reflects Alstom's fundamentals and is in line with the lower ranges historically: at 9x EBIT'26e or at an EV of €11.7 billion. We discount this EV to the present at a cost of capital of 8% (3% risk-free rate, beta of 1, and 5% Equity Risk Premium), and we arrive at an EV of €9.3 billion. We subtract €3.3 billion of net debt and other EV adjustments and obtain an equity value of €6 billion, and a share price of €16 or ca. $17. This implies a 33% upside which we do not deem satisfactory. Alternatively, we value Alstom at an exit 5% FCF yield in 2026e (similar to our previous estimate). We lower our FCF forecast to €600 million - although this number reflects an "exit" number rather than a fair estimate for 2026e. We then obtain an EV of €12 billion in 2026. We discount that to the present and get an enterprise value of €9.5 billion, and an equity value of €6.2 billion, which is in line with the valuation obtained from the EV/EBIT ratio methodology.

While our views on rail tailwinds and Alstom's long-term potential remain unchanged and there is a sizeable gap between our target price and the current share price, we are concerned about the firm's cash generation capabilities, balance sheet health, etc., and would prefer to stay neutral and avoid buying the stock until there is more clarity. At the current share price, multiple other European capital goods offer more attractive risk / reward.

Risks

Downside risks include but are not limited to lower than expected rail demand, increased competition including from Chinese peers, cost inflation leading to a decline in operating margins, delivery and quality issues / poor operating performance, higher than expected contract losses, and higher cash burn, contract cancellations, a liquidity crunch, higher cost of borrowing, dilution from an equity raise, capital misallocation and destruction of shareholder value (similar to the BT deal), unsustainable leverage, technology risk, legal and reputational risk, corporate governance risks, etc.

Upside risks to our thesis include but are not limited to higher organic sales growth driven by the shift to rail, better than expected cash generation and deleveraging, upside from the arbitration case with Bombardier, speculative appeal from strategic players, etc.

Conclusion

We are Neutral on Alstom and would avoid buying the shares at this price. We will keep a close eye on the name and provide additional follow-ups in case of major changes.

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