NSANF - Nissan Accelerates Towards Recovery With Promising Q3 Results

Summary

• Nissan's Q3 earnings for fiscal year 2022 showed significant improvement, with revenue increasing by 40% to JPY 2.84 trillion, operating profit increasing by 155% and automotive free cash flow turning.
• Nissan is facing challenges due to strong currency fluctuations, raw material price increases, and lower sales volumes caused by the semiconductor supply shortage and a resurgence of COVID-19 infections.
• Nissan has reduced overhead, revamped its product strategy, and cut sales to daily rental car companies to reverse the previous strategy of pursuing market share at any cost.
• My fair value for Nissan’s shares is $15 per share offering a 100% upside.

Nissan ( NSANY )( NSANF ) sells approximately 4 million vehicles, but as part of the Renault-Nissan-Mitsubishi alliance, it's the third largest automotive group worldwide, trailing only Toyota (TM) and Volkswagen (VWAGY). Nissan's financial services subsidiary offers auto loans and leases to consumers, as well as financing sales to its dealerships. Renault owns 43.4% of Nissan (that will be reduced to 15%), and in turn, Nissan owns 15% of Renault. Furthermore, Nissan has a controlling 34% stake in Mitsubishi Motors.

Q3 Earning Results

Nissan's Q3 earnings for fiscal year 2022 showed a significant improvement compared to the same period a year ago, which was during the peak of the chip crisis. Although consolidated volume decreased by 7%, revenue increased by 40% to JPY 2.84 trillion due to the average revenue per unit soaring.

However, the chip shortage and China COVID-19 resurgence partially offset the revenue gain. Despite these challenges, consolidated adjusted operating profit increased by 155% to JPY 133.1 billion, and automotive free cash flow turned positive from burning JPY -1.2 billion last year to generating JPY 119.0 billion. Despite turnaround efforts, higher costs, including energy, logistics, and inflationary pressures, offset some of the gains.

Nissan faced a challenging business environment in Q3, with strong currency fluctuations, increases in raw material prices, and lower sales volumes compared to the previous year due to the prolonged semiconductor supply shortage and a resurgence of COVID-19 infections affecting production. However, Nissan is making steady progress with its Nissan NEXT business transformation plan. The company is enhancing the quality of sales and optimizing costs to improve net revenue per unit of major models. During the quarter, Renault and Nissan renegotiated their agreement, resulting in Renault eventually reducing its stake in Nissan from 43.1% to 15%. The official release can be found here , but for a summary of the main points, you can read the article by Mare Evidence Lab.

Nissan's Recovery Efforts Under CEO Uchida Include Revamping Product Strategy and Cutting Sales to Rental Car Companies

The cross-ownership between Nissan and Renault has been regarded as a rare success story in the automotive industry, but this relationship was strained after the removal of Carlos Ghosn on allegations of misconduct in 2018 (his escape story is very entertaining, in case you are curious, read here ). Nissan's recent performance has been subpar but improving, and the company faced challenges even before the Ghosn scandal. In 2017, Japanese regulators discovered that Nissan had falsified final inspection certification documents, which led to the recall of 1.2 million vehicles in Japan. Nissan's CEO has been replaced several times since dismissing Ghosn, with the current CEO, Makoto Uchida, appointed in October 2019. Under Uchida's leadership, Nissan has reduced overhead, revamped its product strategy, and cut sales to daily rental car companies to reverse the previous strategy of pursuing market share at any cost. In the Q3 earnings call, Ashawi Gupta spoke about the mix of sales to rental cars and implied continuing the same strategy going forward.

And we are strictly controlling the mix between rental and the retails and especially when I look at not only the quarter three, but when I even look at January we are doing so. There is one thing which are changing – which is changing is the product mix.

Nissan's Lack of Competitive Advantage Heightened by Stiff Competition and High Investment Costs for Electric Vehicles

It is challenging for mass-market auto manufacturers to have a sustainable competitive advantage. Nissan faces stiff competition and is unable to command significant pricing power relative to rivals. Nissan lacks a competitive advantage as customers can easily switch to competitors. Nissan's early investment in mass-market electric vehicle technology could have provided a temporary competitive advantage, but the investment cost is high, especially in lithium-ion battery manufacturing capacity. Co-investment by alliance partners Renault and Mitsubishi in all-electric vehicle capacity helps reduce Nissan's risk.

Valuation

Nissan lowered its volume guidance for fiscal year 2022 due to ongoing chip shortage and logistics disruption from 3.7 million units to 3.4 million units. However, the company's revenue, operating income, and net income remained the same. The estimated consolidated revenue for 2022 is JPY 10.9 trillion, with operating profit of JPY 360 billion and net income of JPY 160 billion.

My assumptions are in line with management’s guidance. However, I expect operating margins to be 300 bps lower as I expect the current headwinds to persist longer than management’s expectations.

Based on these assumptions, my fair value is $15 per share. The cost of capital is 8.5% based on an unlevered beta corrected for cash of 1.08.

Risk and Uncertainties

Nissan operates in a highly competitive and capital-intensive industry that experiences fluctuations in demand. The company's high fixed costs result in significant operating leverage, which makes profits highly susceptible to even minor changes in demand. Unfortunately, the COVID-19 pandemic and the microchip shortage have heavily impacted Nissan's operations in 2020 and 2021. Other potential risks include fluctuating commodity costs and the need for revamping the infrastructure for the company's mass-market battery electric vehicles. Additionally, the current battery technology limits the demand for battery electric vehicles due to their slow recharge time. In this industry, swings in volume and volatile input costs can substantially impact profitability, and overcapacity in the global auto industry increases pricing pressure, thereby limiting the potential for economic profits. Nissan's primary joint venture with Dongfeng allows it to sell more than 1 million vehicles per year in China, which could be at risk if China-Japan relations deteriorate.

Conclusion

Despite facing multiple headwinds, including the chip shortage, China COVID-19 lockdowns, and inflationary pressures, I believe Nissan will emerge from its turnaround as a more efficient and closer ally of Renault. Also, Nissan's alliance with Renault and ownership in Mitsubishi provides the company with significant economies of scale and cost-sharing arrangements, allowing it to benefit from lower production costs. Additionally, Nissan is currently ahead of other automakers in terms of all-electric powertrain vehicle technology, providing the firm with a minor but temporary competitive advantage. To further improve its competitiveness, Nissan is cutting sales volume to daily rental fleets, which should help the company improve its average pricing and expand its margins. At the current share price, the upside is 100% to my target value of $15 per share.

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