VLEEF - Valeo: The 2025 Targets Look Juicy But Markets Are Still Challenging

Summary

• Valeo is a French manufacturer of car parts.
• The net income and free cash flow results were okay in 2022 but certainly not impressive.
• The company's long-term targets for 2025 are appealing as the EPS should increase to in excess of 3 EUR.
• There's an execution risk, and I'm on the sidelines to see how Valeo deals with increasing costs and pressured margins.

Introduction

Car parts suppliers are tough to invest in. I thought Faurecia (now Forvia) was cheap when I invested, but the stock continued to go down before finally catching a bid at the end of last year. Valeo ( OTCPK:VLEEF ) ( OTCPK:VLEEY ), another French company active in the car parts supply chain, optically looks cheap, but there are no real catalysts to push the share price higher. As Valeo dropped by almost 10% on its earnings report (and was trading at a loss of in excess of 10% during the trading day), I wanted to have a quick look under the hood to see if the market is overreacting or if a short-term hiccup is creating a long-term opportunity. Valeo focuses on the powertrain systems, comfort and driving assistance systems (with for instance the LiDAR systems detecting crossing pedestrians or cyclists) and the thermal and visibility systems.

Valeo’s primary listing in France has FR as ticker symbol . The volume on Euronext Paris is substantially higher (almost 1 million shares) than anywhere else so I would strongly recommend to trade in Valeo’s shares using its Paris listing. There also are options available.

A healthy amount of free cash flow was generated in 2022 - thanks to a working capital release

2022 wasn’t a bad year for Valeo. The total revenue increased to in excess of 20B EUR but the company clearly experienced pressure on its margins as the operating margin decreased from 4% to just 3.2%.

That being said, the contribution from equity-accounted companies improved dramatically: whereas Valeo had to confess a 243M EUR loss in 2021, this was converted into a 115M EUR contribution in 2022 which helped to boost the operating income including the contribution from these equity-accounted companies by almost 2/3rds. The net income came in at 295M EUR of which 230M EUR was attributable to the shareholders of Valeo and 65M EUR was attributable to non-controlling interests. This means the EPS was 0.95 EUR, an increase from the 0.73 EUR in FY 2021 despite the operating margin pressure and the higher finance expenses (131M EUR versus just 60M EUR).

As Valeo has a relatively high net debt level (see later), I'm more interested in seeing if the company is actually generating a positive free cash flow, which will help to keep the debt levels under control.

The company reported an operating cash flow of 1.91B EUR in FY 2022 but this includes a nice contribution of 231M EUR from working capital changes which would have to be deduct again. I also see the company paid 291M in cash taxes but only owed 214M EUR based on the income statement. We should also deduct the 59M EUR in dividends paid to non-controlling interests and the net interest payments of 100M EUR.

This means the adjusted operating cash flow in FY 2022 was approximately 1.6B EUR.

We also see the total capex was 1.5B EUR, resulting in an underlying free cash flow of just 100M EUR. That’s hardly worth talking about but let’s not forget Valeo is in an "investment modus" as it has ambitious growth plans for 2025. Valeo expects to reach a total revenue of 24B EUR in 2025 , and this should be combined with higher margins.

It wants to achieve a 14.5% EBITDA margin (which basically means Valeo is implying the 2025 EBITDA result will reach 3.5B EUR). But even more important is the guidance for a 6.5% EBIT margin.

Based on a revenue of 24B EUR, Valeo’s 2025 guidance implies an EBIT result of approximately 1.55B EUR. But while Valeo was guiding for an 800M-1B EUR free cash flow result, I’m a bit more cautious. The 2022-2025 projections were published in Q1 2022, before interest rates started to increase pretty dramatically.

And with in excess of 6B EUR in gross debt (see below), increasing interest rates will become an important factor. Earlier this year, a 500M EUR bond with a 0.625% coupon matured and later this year another (much smaller) debt issue of 115M EUR with a 0.95% coupon has to be refinanced as well.

If I would assume an average interest rate of 4.25% on the 6B EUR in gross debt, the interest expenses will increase to almost 260M EUR. Deducting this from the 1.55B EUR EBIT guidance would result in a pre-tax income of 1.3B EUR and a net income of approximately 950M EUR of which I estimate about 100-125M EUR would be attributable to non-controlling interests. The net income attributable to the Valeo shareholders would then be around 825-850M EUR. This represents an EPS of approximately 3.5 EUR per share.

Investment thesis

I’m only lukewarm when I see Valeo’s financial results for 2022 and although the guidance for 2023 looks encouraging with an anticipated 10% revenue increase and slight EBITDA margin increase I remain on the sidelines here until I see Valeo has indeed turned a corner.

The 2025 targets are very enticing so I will keep an eye on Valeo as it works toward those targets but it's clear this now is an execution story. And Valeo will for sure have to keep an eye on its debt level and interest expenses while advancing its strategic plan.

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