2023-04-17 11:52:41 ET
Summary
- AB Volvo saw good delivery numbers as semiconductor issues let up from last year.
- Orders are down signaling a downturn in trucks and other consumer durables, with China hitting the construction segment especially hard. Still flat volume forecast for 2023.
- 1.7x service margins over unit sale margins is downside protection with countercyclical mix growth. Also there are some temporary cost effects that could dissipate on the labour side.
- While some overall pressure on earnings is to be expected, a 9% earnings yield here is defensible and signals undervaluation.
- It also helps that buses aren't detracting from profits anymore. Note that the dividend is not at a committed 7% yield level, and of course consumer durables risks apply.
AB Volvo ( OTCPK:VOLAF )( OTCPK:VLVLY ) saw some delivery increases in the last quarter, but order developments signal that we should see the beginning of slower deliveries as backlogs get smaller. Volvo investors shouldn't be too worried thanks to the importance of service revenues in the mix and that service revenues should grow in the mix and help preserve some of the profitability. Also, there are some costs that should come down, including the obvious ones, but also some specific labour considerations that Volvo have been priotising in 2022. Finally, non-macro related trends are pushing buses into profitability which is helpful. The yield is discretionary in dividends at almost 7%, and the earnings yield is 9%, and these figures look reasonably defensible, but it will be hard to get around those falling order figures. Undersupply does mean the outlook is still flattish into 2023 and the coming quarterly report shouldn't see serious declines yet. We are passing on the stock despite a decent value case here on poor economic direction.
Looking back at FY 2022
Let's detail some of the key thoughts, beginning with the more obscure dynamics. Volvo management indicated that they are overstaffed in order to respond effectively, albeit inefficiently, to the receipt of parts and to building their vehicles and getting them to customers. The idea is that customers will value the Volvo relationship if they are getting their vehicles quicker than competitors.
It is also overmanning, because we have been firm, and we still think this is the right thing to do short term to support our customers, they need their equipment. And as long as we are not disturbing the underlying quality, it is the right time -- it is the right thing to do.
It makes sense, and it also leaves the door open for workforce reductions. This is desirable considering that in addition to higher costs and continued supply chain issues, margins are coming down meaningfully from labour effects as well, since volumes have gone up and even operating leverage wasn't enough to expand margins .
As was just said, the outlook is actually flat with Volvo anticipating as many units delivered next year as this year, indicating pent-up demand effects are still in action. This may not be something you can extrapolate to cars but it is notable. When prompted about how a flat volume development squares with macro conditions, the CEO had this to say:
So, we feel confident about the forecast that we have said. And still early days, obviously, things can happen. So, flexibility is key. I don't know…
We must stress that orders are collapsing meaningfully , and not just from China. So yes, there's demand for the units in the pipeline, but not more. Backlogs are going to fall even if 2023 still isn't seeing the impacts.
China, if anything, will recover a little, although automotive companies reference price competition in these markets. Construction equipment was more hit by the China impact, and the lessened orders there show that consumer durables and construction are all pretty linked to the rate forces at play. Deliveries are nice to see, but these backlogs matter a lot, especially in an economy that could move sideways for years, especially if we don't see a deep recession.
Assuming backlogs don't regenerate, there are still backstops. Service revenues remain an important revenue source, but have fallen in the mix. Service revenues have about 1.7x the margin of the straight delivery business. They have fallen in the mix but would increase in representation if the installed base started to age a little more.
The bus business is also experiencing a non-macro related tailwind associated with reopening. This should burn for a while, and turns the segment from a profit detractor to a contributor with revenues being driven by a BRICS country, which is optimistic considering they are less exposed to some of the more dangerous global macro dynamics.
What's Next
The dividend is almost 7%, but don't count on it. It looks consistent because the company has been doing consistent special dividends, but they could draw back hard and there's not much of a yield off just the ordinary dividend. This is common in European companies; not having a committed dividend.
Earnings yield is good at around 9%, battling well against risk-free rates. The earnings are defensible considering the expectations for 2023, starting with the upcoming Q1, to see still strong deliveries and backlogs liquidated at better prices as supply chain issues ease. Finally, there are backstops in secular buses coming up in the mix and services.
Overall, AB Volvo looks like a decent deal, but there could easily be some pressure on consumer durables' stock prices and stress coming from shattered backlogs given the macro direction. It's not super safe, and we therefore pass.
For further details see:
Semiconductor Let-Up Signals Sustained 2023 AB Volvo Deliveries Despite Order Drop