ARGGY - Aston Martin Lagonda: Dilution May Eat Up Future Potential

2023-11-20 07:13:07 ET

Summary

• Aston Martin's presence in Formula One has measurably raised the brand's profile.
• The company's financials, on the other hand, are less impressive, as profitability remains elusive and debt levels high.
• The shareholder structure, with multiple major shareholders seeking to supply EV technology, may complicate the company's direction and slow down technological transformation.
• There is the potential of business growth and eventual profitability, but dilution through further capital increases in order to fund necessary investments could put pressure on the share price.

At the time of writing, the Formula One Group’s (FWONA) (FWONB) (FWONK) much anticipated Las Vegas Grand Prix has just finished. Two of the twenty cars on the grid – recognizable by their British Racing Green paint scheme – raced under the Aston Martin name. Well, the Aston Martin Aramco Cognizant name, technically speaking, but outside press releases and official documents the team is known as “Aston Martin”. Both cars finished in the points, despite Fernando Alonso temporarily dropping to the back of the grid following a first lap collision. Competing in Formula One has measurably raised the brand’s profile. There is an uptick in website and configurator traffic on race weekends compared to non-race weekends. More importantly, 60 percent of luxury car buyers are more likely to buy an Aston Martin due to its association with the series, according to market research .

Nonetheless, the performance of Aston Martin Lagonda Global Holdings plc’s ( AMGDF ; ARGGY ) share price is much less impressive than the eponymous team’s on track results. In this article, I aim to take a look into the company’s business and assess whether there is a compelling investment case to be made at the current share price.

Financials

The Aston Martin brand may be strong, but its financials are less so. Unlike listed competitors such as Ferrari N.V. ( RACE ) or Porsche AG ( DRPRF ; DRPRY ), the company continues to bleed money at a fast, albeit recently slowing, pace. The company reported a loss of GBP260 million for the nine months period ended September 30 ^th . Even after certain adjustments (see appendix of the report ), a loss of GBP221.3 million remains. In fairness, that figure all but halved YoY. Yet, in absolute terms, it is still massive.

Operating loss only minimally improved to GBP145.3 (2 percent improvement YoY) while adjusted operating losses even increased by 5 percent YoY to GPB135.1 million. Given nine month revenues of a little over GBP1 billion, these numbers are unsustainably high. Continued cash outflows may lead to further capital increases, in my opinion. Through 2027, Aston Martin plans with investments of around GBP2 billion. It is hard to imagine it being able to finance this from cash flows exclusively. At the same time, the company is already indebted considerably. Gross debt stood at just shy of 1.3 billion as of September 30 ^th . Net debt only decreased (to GBP749.9 million; -10 percent YoY as of Q3 ) due to additional capital in the amount of GBP234 million being provided by Geely Automobile Holdings Ltd. ( GELYF ). Otherwise, it would have climbed by around 18 percent. One should keep in mind, that this follows a 2022 capital raise of more than GBP650 million from the Saudi Public Investment Fund ((PIF)). Still, in August, the company conducted a further placement of shares in the amount of GBP210 million in order to reduce leverage by way of early redemptions of outstanding notes.

Shareholder Structure May Complicate Things

For the time being, Aston Martin is being kept afloat by cash injections from its largest shareholders. Obviously, these entities demand additional equity in return. Chinese carmaker Geely increased its stake in May and now owns around 16.66 percent of Aston Martin. The Saudi PIF, meanwhile, holds more than 20 percent both directly and through Lucid Group ( LCID ) in which it has a majority interest. Lucid acquired an equity position as part of a deal to supply access to its electric powertrains. I would like to point out, that this access comes at a considerable price, all things considered. In total, this agreement will cost Aston Martin $ 450 million (albeit close to half of it consisting of equity). Nonetheless, it is significant cost given the company’s annual revenues well below the equivalent of $2 billion.

Also, there are now two major shareholders who explicitly seek to supply EV technology in Geely and Lucid. Arguably, at least one of those partnerships is redundant. It may be lack of imagination on my part, but I do not see Aston Martin relying on two different electric powertrain infrastructures going forward. And, at least in theory, Mercedes-Benz Group AG ( MBGAF ), another major shareholder with an equity stake just shy of 10 percent currently supplying combustion engines and technology, also has EV know-how. Following the Lucid deal, Mercedes Benz Group will be compensated in cash rather than stock options for engines and other technology. Given the fact that all current V8 models use Mercedes-AMG engines and even the 12 cylinder variants rely on Mercedes electronics, that may add financial strain in the near term – after all, the shift towards electric mobility will not happen overnight, if at all, for a company like Aston Martin.

At worst, the competing interests of core shareholders may even slow a technological transformation down. The PIF has a vital interest in Lucid being favored as a supplier, as has Geely, for obvious financial reasons.

There is also a potential conflict of interest regarding the commercial relationship with the Formula One team on the part of executive chairman Lawrence Stroll. Despite my expectations to the contrary, Aston Martin has not acquired a significant equity stake in the team. Mr. Stroll and members of the Yew Tree consortium (which remains the largest shareholder at currently a little over 26 percent) directly profit from any payments made to the team. That includes fees for naming right and sponsoring. Notably, while not identical, there are similarities between the Yew Tree consortium and the team’s ownership structure in terms of the individuals involved. It is noteworthy in this regard, that the Formula One team was valued at a reported GBP1 billion in a recent transaction. Arctos Partners acquired a 25 percent stake. The remaining 75 percent of the team have a higher value than Yew Tree’s equity stake in Aston Martin itself.

Back in 2020, I believed a takeover to be an interesting option. This perspective has become increasingly unlikely, I believe, given the current shareholder structure. Then again, there had never been concrete indications of an imminent takeover being considered at any time, so this is more of a side note anyway.

Other Risk Factors

There are also risks to be considered beyond the potentially negative impact of Aston Martin’s shareholder structure. The current CEO, Amedeo Felisa, is 77 years old. Thus, he is unlikely to remain in charge for years or decades to come. The rest of Aston Martin’s executive suite are younger and I presume that there are already succession plans, so I would not expect chaos following Mr. Felisa’s eventual retirement. Nonetheless, leadership changes, especially during challenging times, always come with the risk of distractions.

Also, I am not sure if Aston Martin will be able to successfully transition to EVs. As I have pointed out before, I do believe that there will always be a market for ICE powered cars, sports cars in particular. I like to compare this to what happened with horses: no one seriously uses them as a means of transportation anymore, but more than enough affluent individuals (and their daughters) continue to ride for fun and spend handsomely on that hobby. Aston Martin and its direct competitors sell a few thousand units to an even smaller number of customers (as many of these own multiple such cars). So, in terms of global emissions, it is virtually irrelevant if Aston Martin produces gas-guzzlers or eco-friendly BEVs. So, as long as no ideologically driven political measures are imposed, I suppose Aston Martin could just stick to the kind of vehicle it is offering right now. However, the company has, by now, committed to its electrification push. Investments have been made and contracts entered into. Hence, there is no way back, at least not without significant financial pain and write-offs.

In so far, an investment in Aston Martin is also a bet on Lucid proving to be the technological leader that it claims to be. For the time being, I am at least somewhat skeptical in that regard given Lucid’s performance so far. At least, there is always Geely as a fall-back option. Regardless of actual performance, Chinese technology “under the hood” may, however, be detrimental to a luxury image (although, in fairness, there is also the chance of this becoming a selling point in China going forward). The kind of cars that Aston Martin builds are inherently an emotional product category. The engine is an important part of that emotionality. Admittedly, the current lineup overwhelmingly is powered by third party power units. But there is an important emotional gap between a Mercedes-AMG V8 engine (which is itself a somewhat exclusive brand, though not as exclusive as Aston Martin) and a powertrain that is essentially available at scale to middle class buyers in China.

There may also be some reputational risk due to the PIF’s involvement as a shareholder. Personally, I believe Saudi Arabia to be on a rather promising path with regard to its societal and economic modernization. Sure, the human rights situation is not comparable to a Western democracy. But when applying realistic expectations, the country’s society is opening up at a pace unimaginable just a decade ago. But I am aware that there are many who do not share my perspective on the country and may, therefore, be reluctant to purchase a (strictly speaking unnecessary) product from a company in which the kingdom has a significant financial interest. Even worse, activists may try to exercise social pressure on (potential) customers. The boycott of Brunei owned luxury hotels over the country’s criminalization of homosexual acts a few years back may serve as a cautionary tale in that regard.

Valuation and Conclusion

All in all, I think that Aston Martin remains in a tough spot business wise. Based on competitors results, the last few quarters should have been a relatively benign environment for a carmaker, especially one in the luxury segment. Still, the company continues to rake in losses and the share count has been massively diluted by capital increases every few months. The immediate future, meanwhile, appears likely to be more challenging on a macro scale.

I will not rule out that there is potential. The company’s target is to post around GBP2.5 billion in revenue by 2028. If it could achieve an EBITDA margin of 12.5 percent – which is about half of what Porsche AG generates – that would add up to GBP312 million. At these levels, it could easily afford its debt load. These levels of profitability are moderately ambitious, I believe. However, getting there may very well require additional funds, thus additional capital increases, thus further dilution. So, while I think that an overall equity valuation of GBP5 billion (a relatively conservative 2 times targeted 2028 sales) may well be in the cards, I am less convinced that this makes Aston Martin’s stock a good investment. On an undiluted basis, this would represent upside of around 150 percent or a share price of slightly above 560 pence (currently around $7 per share). But given the current market capitalization of around GBP2 billion and factoring in the foreseeable demand for further spending, the significant debt load and recent history of with regard to capital increases, I would expect significant dilution going forward. The share count net of any splits or reverse splits may easily double or more by 2028, thus reducing the upside in terms of Aston Martin’s stock price, even under the assumption of an improving business.

Therefore, I do not consider Aston Martin a buy by any means. But it is not a hopeless case either. On account of its upside potential if targets are met and visible improvements in terms of at least reducing losses, I view Aston Martin as a hold (although I should probably add that I have been proven wrong in this view once before , mainly due to the aforementioned issue of dilution).

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