2023-11-08 14:53:19 ET
Summary
- Plastic Omnium is a global automotive supplier, providing innovative solutions for the mobility industry.
- The company focuses on developing and producing intelligent exterior systems, customized complex modules, lighting systems, and clean energy systems.
- Going forward, the company also aims to be the global leader in hydrogen by 2030, with EUR 3 billion in annual sales.
- Overall, the business environment has been very challenging for a number of years, but we believe that the prospect for margin expansion makes Plastic Omnium's shares undervalued at present.
Note: Plastic Omnium's ( OTCPK:PASTF ) primary listing is on Euronext Paris, where it is trading with POM as its ticker symbol . There are 53.4 million shares freely-floated, and an average daily liquidity of approximately EUR 1.5 million. There are risks related to the liquidity of U.S. listing: investors that consider making an investment in the company should focus on the primary listing rather than the very illiquid U.S. listing.
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Company description
With roots stretching back to 1875, Plastic Omnium is one of the largest automotive suppliers in the world.
The company describes itself as a 'world-leading provider of innovative solutions for the mobility industry – developing and producing intelligent exterior systems, customized complex modules, lighting systems, clean energy systems, and electrification solutions for all mobility players'.
The company organizes itself along two main segments:
1. Plastic Omnium Industries , which includes Intelligent Exterior Systems (IES), Clean Energy Systems (CES), New Energies ((NE)) and PO Lighting activities:
- Intelligent Exterior Systems (IES) is dedicated to lightweight and intelligent bodywork. Complex body part assemblies are made of injected polypropylene or composite materials: bumpers, energy absorption systems, tailgate modules, spoilers, fender supports and rocker panels. These systems enhance passenger safety and are designed with the objective of helping to reduce greenhouse gases emissions from vehicles through aerodynamics improvement and weight reduction. The activity of IES in its 66 plants represented 42% of the Group’s economic revenue in 2022. With 22 million bumpers produced in 2022, IES equips one in six vehicles worldwide .
- Clean Energy Systems (CES) specializes in energy storage and depollution systems. CES manufactures blown polyethylene energy systems (fuel tanks for internal combustion or hybrid vehicles) and depollution systems for diesel engines. The acquisition of ACTIA Power - an expert in battery systems for heavy mobility - resulted in the creation of the E?Power business, marking a new step forward in electrified mobility. The activity of CES in its 42 plants represented 28% of the Group’s economic revenue in 2022. CES produced 18 million fuel tanks and emission reduction systems in 2022, equipping one in five vehicles worldwide.
- New Energies ((NE)) is dedicated to the development of new energies including hydrogen and associated technologies such as high?pressure storage in fuel tanks with carbon fiber reinforcement, as well as fuel cells. At the end of 3Q22, the New Energies’ order book amounted to approximately EUR 4 billion.
- PO Lighting specializes in interior and exterior lighting components, projection systems and complete headlights. Present across the entire lighting value chain thanks to the combination of Varroc Lighting Systems (VLS) and Automotive Lighting Systems GmbH (AMLS) – both acquired throughout 2022 – Plastic Omnium is now able to offer a differentiating range of connected solutions to meet the growing demand from manufacturers for integrated exterior systems and thus increase content and value per vehicle. The PO Lighting activity, in its nine plants, represented 3% of the Group’s economic revenue in 2022 (percentage of revenue for the fourth quarter of 2022)
2. Plastic Omnium Modules , which corresponds to the HBPO activity:
- HBPO is specialized in the development, assembly and logistics of front?end modules and extends its product offering to other parts of the vehicle such as the cockpit and the center console. The activity of HBPO in its 30 plants represented 27% of the Group’s economic revenue in 2022. HBPO delivered nearly 5 million front?end modules, equipping one in five vehicles worldwide produced in 2022.
Plastic Omnium has also launched OP'n Soft in 2022, a new Group activity dedicated to the development of software for its products and services. OP'n Soft has 120 employees in 2023, and will have more than 250 by 2025, supporting mobility that is more electric, connected, autonomous and shared.
As of the end of last fiscal year (ending December 2022), the company operated 150 manufacturing plants and 43 R&D centers in 28 countries across all continents, employing 40,500 employees. Approximately half of economic sales came from Europe, slightly less than one-third from North America, and about 20% from China and other Asian countries, as shown below:
market evolution
Before turning to Plastic Omnium’s financial performance, it is important to appreciate the context in which automotive suppliers have been operating over recent years.
The graph below displays the evolution of global passenger car production, as well as the split by powertrain type:
As can be seen, global automotive production had already been in decline for two consecutive years prior to the pandemic of 2020. Then, the temporary shutdown of the world economy prompted a sharp decline of over 16% in global production to 72 million vehicles, down from 86 million in 2019.
The speedy recovery that was expected to take place in 2021 also did not materialize, as other issues such as semiconductor shortages, supply chain disruptions, and inflationary pressures started to surface. Global vehicle production somewhat rebounded throughout 2022, despite a very rapid rise in interest rates, but as we progressed through this year, higher interest rates have started to pressure consumer demand and overall economic activity, including automotive production. According to estimates by S&P Global, the total production of passenger vehicles is not expected to surpass its prior 2017-peak of 92 million vehicles before 2028.
Moreover, according to the same estimates, the mix in powertrain type of vehicles produced is expected to change at an accelerating rate going forward. Internal combustion engines ((ICE)) are forecasted to decline from 58% of total production in 2022 to only 32% by 2027, while plug-in hybrid electric vehicles’ (PHEV) share is expected to increase from 13% to 30%, and zero-emission vehicles (ZEV) from 8% to 28% of total vehicle production.
One might also note that the structure of the industry’s value chain has also gradually changed, with an increasing level of consolidation amongst OEMs, which has arguably increased their bargaining power relative to their suppliers.
Overall, this has made for a very challenging operating environment for automotive components suppliers. As the consultant aptly summarizes in its recent 2023 Deloitte Automotive Supplier Study :
The global automotive industry has held up remarkably well in spite of enormous challenges over the past three years. It has survived crisis after crisis—from semiconductor shortages and inventory challenges to supply chain disruptions and raw material price swings.
Suppliers, in particular, have endured a seemingly permanent state of triage , while maintaining the business, meeting customer demand, and finding opportunities to grow. At the same time, manufacturers and dealers have uncovered some unexpected benefits from stronger price positioning and increased profitability. Underpinning all of this turmoil, the global mobility sector is transforming at a rapid rate, as governments and consumers around the world spark a shift to electric vehicles.
The pressure to innovate grows every day, and suppliers increasingly find themselves on the front lines as vehicle manufacturers push the responsibility to develop new technologies back through the value chain. However, some suppliers have struggled to keep up with the cost and pace of change, leaving them vulnerable with more change on the horizon.
Moving forward with hydrogen
Beyond its leadership position in Intelligent Exterior Systems and Modules, as well as its growing presence in Lighting components, Plastic Omnium also aims to maintain its leading market position in Clean Energy Systems by betting heavily on hydrogen.
The company aims to be the global leader in hydrogen by 2030, with a market share of over 25% in high pressure systems, approximately 10% in integrated hydrogen systems, and approximately 10% in fuel cell stacks.
To do so, Plastic Omnium has already invested a cumulative EUR 376 million since 2015, and is expected to invest a further EUR 100 million per year in developing its production capacity to achieve EUR 3 billion in annual sales by 2030. As shown below, the order book for the hydrogen business has grown rapidly this past year, and currently stood at approximately EUR 4 billion.
Financial performance
Let us now briefly go over a number of graphs that illustrate the firm's financial performance over the past couple of decades, before focusing on more recent developments.
Since 2000, the company has grown from EUR 1.2 billion in economic revenue [1] to an estimated EUR 10 billion in fiscal 2023, approximately half of which was generated via organic growth, and the other half via acquisitions and joint ventures. Over the past decade, sales have grown at a compounded annual growth rate ((CAGR)) of 7.8%:
On the other hand, profitability levels have been consistently trending downward, and have yet to recover to their pre-pandemic levels. For example, EBITDA margins (which is arguably one of the most relevant metrics to assess profitability, given the company's large depreciation and amortization expenses) have declined from approximately 10-15% historically and currently remain in single-digit territory:
The difficulty in improving profitability margins back to pre-pandemic levels is due to the current inflationary environment, and the rather weak bargaining power that automotive suppliers have to pass on price increases to OEMs. While raw material price increases can generally be passed on to OEMs (with a time lag), wage inflation eats directly into margins, and suppliers are also required to deliver yearly productivity gains, which nullify some of the price increases.
As a result of a fairly high level of capital intensity and modest profitability, returns on investment are typically acceptable but far from spectacular. Under normal operating conditions, the level of return on invested capital ((ROIC)) can be expected to be in the low teens, slightly in excess of the firm's capital costs. With adequate levels of financial leverage, return on equity ((ROE)) typically surpasses 20%. However, since the 2020 recession, ROIC and ROE have stagnated at significantly lower levels, 5% and 9% respectively as of fiscal 2022.
Let's now look at cash flows. As expected, the company generates cash from operating activities well in excess of net income, due to sizable non-cash depreciation and amortization expenses. Between 2020 and 2022, Plastic Omnium generated an average of nearly EUR 500 million in cash from operations, despite the deterioration in financial performance described above.
However, as the company continues to win orders at a fast pace, it must undertake sizable investments in new production capacity. In fiscal 2022, nearly EUR 400 million was spent in capital expenditures, and the company guides that going forward, capex should represent approximately 5% of sales, or about EUR 500 million.
Thus, free cash flow generation has only averaged approximately 2% of sales over the long-term, and is expected to remain around these levels while the company is on a fast growth trajectory that requires sizable capital investments.
Financial position
Over time, Plastic Omnium has generally maintained an adequate level of financial strength, with a net debt to EBITDA ratio of approximately 1x. Having said that, leverage ratios have spiked more recently due to increased debt levels from recent acquisitions and investments, coupled with subdued EBITDA growth.
As of the end of June 2023, Plastic Omnium has a net debt of EUR 1.5 billion, representing a net debt to adjusted EBITDA ratio of 1.7x [2]
The company has EUR 2.3 billion in available liquidity including cash and undrawn and confirmed credit lines.
In its capital allocation framework, the company indicates that it intends to keep leverage below 2x net debt to adjusted EBITDA.
Dividend
Plastic Omnium has historically paid out a dividend to shareholders representing about 20% of net income. As such, when earnings decline during economic downturns, the dividend has historically been cut by 30% to 50%.
Between 2003 and 2020, the dividend has grown at a CAGR of 7.6%. In 2022, Plastic Omnium distributed EUR 41 million in dividends, equivalent to a dividend of EUR 0.28 per share and a payout ratio of 32.1% of net income.
According to consensus estimates, the expected dividend payment on 2023 results (to be paid out in March 2024) will be between EUR 0.30 and 0.45 per share. At the mid-point, this represents a dividend yield of approximately 3.0% at today's share price.
Note: Dividend payments from public French companies are subject to a 30% withholding tax. Having said that, under the double taxation treaty between the U.S. and France, U.S. investors are only subject to a 15% withholding tax. This does however require some paperwork.
Ownership & management
As of today, Plastic Omnium remains a family-owned business, majority owned and controlled by the Burelle family. As of the end of 2022, Burelle SA owned 60% of Plastic Omnium's capital, and controlled over 74% of voting rights:
Regarding the company's management, Pierre Burelle founded the company over 75 years ago, and ran it until his two sons succeeded him in the 1980s. In 2001, Laurent Burelle became CEO, and retained that post until 2020, when a change in corporate governance was announced: the role of CEO and Chairman of the Board were to be separated, and while Laurent Burelle remained Chairman, the company decided to bring in a new CEO from outside the family.
Thus, in January 2020, Plastic Omnium announced its new CEO: Laurent Favre, a graduate engineer from the École Supérieure des Techniques Aéronautiques et de Construction Automobile (ESTACA), with professional experience in the automotive industry in Germany including at ThyssenKrupp (steering systems), ZF (transmissions an steering columns) and Benteler (structural parts).
Also in 2020, Félicie Burelle - daughter of Laurent Burelle - who started her career at the company in 2001, was promoted to Managing Director. A new CFO, Kathleen Wantz-O'Rourke, was also appointed in 2021.
Valuation
Valuing Plastic Omnium isn't a particularly easy exercise, due to the fairly high level of uncertainty about the future development of key value drivers (i.e. sales growth, profit margins, and free cash flow conversion, ...), as well as due to the high level of fair value ((FV)) sensitivity to the main value drivers listed above.
Our base case assumes sales to grow to slightly over EUR 10 billion in 2023, and approximately 3% p.a. thereafter. We expect operating margins to expand modestly to nearly 5% in the coming years, but to remain below long-term historical averages. Finally, with a fairly high level of depreciation & amortization, as well as capital expenditures (both representing about 5% of sales), we expect free cash flow to represent about 90% of net income.
Discounting these future cash flows (with a terminal growth rate of 2% p.a.) at a rate of 9%, we reach a FV of EUR 15 per share, nearly 30% above the current stock price.
Having said that, it should be clearly noted that should profitability levels remain at depressed levels, or fall further into low-single-digit territory, than not only are investors looking at further downside potential, one might argue that the viability of the entire business model comes into question.
And yet, Plastic Omnium is very much needed by the auto manufacturers it serves, which leads us to believe that the most likely scenario going forward is that margins will not deteriorate further, but rather stabilize in the mid-single-digit territory, which is what is required for most automotive suppliers to earn their cost of capital and thrive long-term.
On the other hand, a return to operating margins in the high-single-digit, or even into the double-digits (which appears very unlikely in the short- to mid-term) would imply the stock price to be severely undervalued, by a factor of 2-4x.
Risks & red flags
No analysis should fail to highlight some of the key risks related to a given investment. For Plastic Omnium, such risks include the ones listed below, among others:
- Automotive program risk: Each automotive program has risks which could reduce its profitability from that initially expected. The risk relates particularly to programs that incorporate product innovations or which implement new industrial processes. This risk is increased for programs whose launch coincides with the start of a new plant. These uncertainties may require Plastic Omnium to invest and/or spend more than initially forecast in order to reach the rates and quality levels required by the customer. In addition, each automotive program is subject to risks in terms of manufacturing volumes, which depend on a wide range of factors, some of which are regional in nature, such as economic activity, carmaker production strategy, consumer access to credit and the regulatory environment, but also on factors specific to each vehicle, such as the attractiveness of their design.
- Shortage of raw materials or components: The global automotive industry may be impacted by a long?term shortage of certain raw materials or components that are widely used for the production of sub?assemblies required for vehicle assembly by carmakers. Such shortages, like that affecting semiconductors in 2021, may lead to a significant and lasting decline in the activity of carmakers on a large number of vehicle models, and consequently, in the activity of equipment manufacturers.
- Quality of products and services sold: Plastic Omnium is exposed to the risk of warranty and liability claims from customers in respect of the products it sells and services it provides. This is particularly the case for the Clean Energy Systems activity, where the majority of products sold to carmakers belong in the 'safety equipment' category. The company is also exposed to the risk of third?party product liability claims.
- Customer credit risk: Due to its business as an automotive supplier, Plastic Omnium has a limited number of customers and cannot rule out the possibility that one of its customers might find itself in financial difficulty, thus preventing it from respecting certain commitments.
- Inflation: Plastic Omnium's business requires the purchase of large quantities of raw materials (plastics and paints), the purchase of energy (electricity and gas) and the purchase of logistics services (often indexed to the price of petroleum). These purchases are subject to market price fluctuations and could impact the company’s operating margin and cash flow. Plastic Omnium’s production activity requires a high level of industrial labor in its plants and could face significant wage increases in countries where wages are indexed to inflation.
- Impact of climate change on the business model: As an industrial group operating in the automotive sector, Plastic Omnium is strongly impacted by the challenges of climate change. This requires the company to constantly adapt and innovate to ensure that its products remain in demand for the type of vehicles that will be produced in the future, including an increasing share of non-ICE vehicles.
- External growth: Plastic Omnium periodically carries out external growth operations through acquisitions or partnerships that may be of a significant size. These transactions are decided on the basis of assumptions, notably, objectives of market growth, synergies and future results, which may not be achieved in the timescales or to the extent initially expected. For instance, in 2022 Plastic Omnium completed four external growth transactions: AMLS Osram, ACTIA Power, Varoc Lighting Systems, and HBPO (purchase of Hella's 33.3% stake). Plastic Omnium may encounter difficulties in integrating the companies acquired, their technologies and product ranges, as well as the integration and retention of their employees. It may also be unable to retain or develop strategic clients of the acquired companies.
- Interest rate risk: Plastic Omnium typically operates with a certain level of financial leverage, making it exposed to changes in interest rates. As of the end of June 2023, Plastic Omnium has a net debt of EUR 1.5 billion, a large portion of which will need to be refinanced in the next 24 months.
Initial conclusions
As described throughout this article, Plastic Omnium is one of the world's leading automotive suppliers. Constantly adapting to a fast-changing operating environment via innovation and external transactions, the current focus of its strategy centers on developing intelligent exterior systems, customized complex modules, lighting systems, clean energy systems, and electrification solutions - for the vehicles of tomorrow.
As should be plainly obvious to anyone who has ever researched an automotive supplier before, being in the business of supplying automotive OEMs is not an easy gig. It is typically a very capital intensive business, for which winning new business results in the necessity to undertake large capex investments. Profitability levels are generally fairly low, and suppliers don't have a great bargaining position towards the increasingly consolidated segment of OEMs. Thus, inflation can pressure profitability levels until some price increases can be passed on, as has been the case over the past two years.
On a more positive note, these suppliers are absolutely indispensable to the industry, and consolidation amongst them has also been ongoing in order to mirror what's been happening at the level of the OEMs. Over time, this should result in a more balanced level of bargaining power between suppliers and OEMs, and should stabilize operating margins at levels that make it possible for suppliers to earn a return on investment slightly above their capital costs. For a company like Plastic Omnium, with a global market share of close to 20% for many of the products it supplies, and an order intake of close to EUR 20 billion thus far in fiscal 2023, we have little doubt that it will not only continue to endure - but also thrive in the automotive industry of tomorrow.
For investors, the prospect of margin recovery - should it materialize - implies a severe level of undervaluation at the current stock price. There is, however, a fairly high level of uncertainty, which should be factored in by investors in their decision to potentially invest in the company, and/or in position sizing within their portfolio.
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Appendix
Breakdown of revenue by customer (2022)
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[1] Corresponds to consolidated revenue, plus revenue from the Group’s joint ventures, consolidated at their percentage of ownership:
Yanfeng Plastic Omnium (50%) Chinese leader in exterior body parts, SHB Automotive modules (33.33% then 50% from December 2022), Korean company leader in front?end modules, BPO (50%), major player in the Turkish exterior equipment market, and EKPO Fuel Cell Technologies (40%), specializing in the development and mass production of fuel cells for hydrogen mobility.
[2] Plastic Omnium defines its own measure of EBITDA, which we’ll refer to as adjusted EBITDA, as: the operating margin, which includes the share of profit of associates and joint ventures before allowances for depreciation and operating provisions.
For further details see:
Plastic Omnium: Risky, But Huge Upside Potential On Uncertain Future Margin Expansion