2023-09-27 13:33:28 ET
Summary
- The UAW strike raises serious issues for the Detroit Big Three.
- Stellantis seems to have the best balance sheet to face the inevitable higher costs it will have to sustain once an agreement is reached.
- In this article, we stress-test Stellantis' bull case to see if it can withstand one of the first turmoiled times in its short history.
Introduction
Trouble is in sight for the Detroit Big Three. General Motors ( GM ), Stellantis ( STLA ) and Ford ( F ) are dealing with the United Auto Workers - UAW - strike begun on Sept. 15 and still going on.
Now, having a big position in Stellantis, as I have shared several times on Seeking Alpha, I want to go over what's happening to understand what impact it could have on the company. Can the strike undermine the auto giant?
The strike
In the U.S., strikes are less frequent than in Europe. However, when they take place, they're usually harsher and longer, as we have seen with the actor strike.
Regarding US automakers, after some unsuccessful rounds of negotiation, the strike ratcheted up a level adding 38 General Motors and Stellantis parts distribution centers, while Ford was spared because of " significant progress during negotiations."
Much is being said and reported by the media about this issue, with politicians of all sorts, up to the U.S. president joining members of the UAW on the picket line.
At the time I'm writing, General Motors seems to be the one company that's more at odds with the UAW, after its president Mark Reuss wrote an editorial on the Detroit Free Press calling against the "flow of misinformation," explaining how the company offered a 20% wage increase and isn't fueling corporate greed - even before 2022 net income of $9.9 billion, the company needs capital spending of at least $11 billion in 2023.
Stellantis has tried to use softer tones, highlighting its willingness to meet worker demands. However, it pointed out it offered a 21.4% compound wage increase, including an immediate 10% increase, inflation protection measures and $1 billion in retirement security benefits.
The union is seeking a 40% pay increase over four years, saying company leaders see their pay grow at this pace. In addition, other demands include a four-day working week, pay increases linked to inflation, stricter limits on temporary staffing, and more holiday days.
Estimates see a cost of $1 billion for every 10 days of strike by all 140,000 workers, who would lose around $900 million in wages. The total hit to the economy could be around $5 billion, considering the Big Three account for about 40% of US car sales.
Where can an agreement be found? It's hard to forecast, since we don't know what made the UAW say it had made significant progress with Ford.
A forecast on a possible agreement
I believe we will see an agreement around a 33%-35% wage increase with some other measures tied to this.
Why do I think this could be the target?
We're talking about a four-year contract. Usually, automakers should improve their cost structure by 5% per year, leading to 20% savings over the time-span of the contract. By improving efficiency, the company would automatically finance its wage increase.
The union knows this and, therefore, it rejected the 20% wage increase offered by GM and Stellantis. In other words, it wants these companies to do something out of the ordinary.
I believe a 33%-35% wage increase could be reached because automakers will surely take into account that, over the next four years, the electrification process will pick up speed. BEVs are still sold at higher margins. In addition, there are plenty of subsidies to incentivize purchases.
General impact of the strike
Assuming the Big Three will find a deal with the UAW at the same time, we can consider the general impact of the strike on them.
The first result is a delay in production. This leads to delayed deliveries.
Once again, just when the supply chain was easing and auto deliveries were increasing (one of the few business lines that is holding railroads up this year), we have a situation creating another shortage.
For sure, U.S. sales will be a bit lower than anticipated for The Big Three, depending on how long the strike lasts. For Stellantis, this can be meaningful, as North America is its higher-margin market. At the same time, Stellantis is more diversified than General Motors and, to a lower extent, Ford. In other words, it could either shift production to Europe and Mexico to keep up with its North American order backlog.
Another consequence will be a market share loss. In the overall market, there will be less cars sold manufactured by The Big Three. There will surely be some customers who need to buy a car within a certain delivery time and the Big Three won't be able to meet this demand. Toyota ( TM ), Honda ( HMC ), Nissan ( NSANY ) and Mazda ( MZDAY ) are set to benefit from this.
Once some market share is lost, it's not that easy to gain it back. In fact, cars are discretionary items and before a customer changes it, some years go by. In the meantime, many things may happen, including customer satisfaction with the new vehicle. In addition, automakers work hard to retain customers through financing and leasing plans aiming at incentivizing car replacement within the same brand.
If the strike doesn't last long, the impact on market share may be insignificant. But if it lasts longer, then it could add up even to a couple of percentage points. Right now it's too soon to say, but it's something to keep a close eye on.
Third, costs. There's no way around it. The Big Three will have to pay more. However, since they will all have to do so, this equalizes the situation for them. It could, however, advantage their non-unionized competitors that won't have to face the same cost increase.
As I said, a 20% wage increase over four years is not big deal if an automaker is managed correctly. What's above this threshold will inevitably be an additional cost. However, North America is a high-margin market where these companies have higher pricing power than elsewhere. Stellantis, in particular, owns brands such as Jeep and Ram, whose customers are willing to pay a premium in order to own one of the products. However, Cox Automotive has warned that "the prospect of higher prices down the road due to labor wage increases a potential headwind for demand from the Detroit players." So, as far as the situation is unfolding, the Big Three can't just simply raise wages and then push up car prices accordingly, making the final customer pay for wage hike.
The Impact on Stellantis
Let's now focus on Stellantis. We will use euro currency because Stellantis is headquartered in The Netherlands for fiscal reasons. Therefore, it reports in €.
The general impact outlined above will, of course, hit the company, too. This translates in higher-than-expected costs down the road.
First of all, let's examine how Stellantis is doing as the strike crisis hits. I have pointed out more than once how Stellantis has an outstanding balance sheet and it's literally swimming in cash. As of June 30, 2023, it had €49 billion in cash while carrying only €29.5 billion of debt. Its net financial position is € 24.5 billion, while its industrial net financial position is even better at €29.8 billion.
Comparing it the other two, we see Ford carrying $29.8 billion in cash and a total debt of $144.9 billion and GM having $27.4 billion in cash with a total debt of $120.9 billion. Clearly, Stellantis has much more financial strength than the other two, enabling it to face higher costs with greater ease.
Another important aspect is that Stellantis has been able to improve its profitability way above its two North American competitors. Currently, its operating income margin is 12.4% (adjusted 14.2%), Ford is at 4.3%, while GM is at 6.6%. The difference is even more staggering when we consider that Stellantis generated €8.7 billion of industrial free cash flow only in the first half of this year from revenue of €98.4 billion. GM expects its automotive free cash flow to be in the range of $7-$9 billion for the whole year coming from a revenue estimated to be around $171.2 billion. Ford expects free cash flow of $6.5-$7 billion for the whole year with revenues that should come close to $175 billion . The numbers speak for themselves and are in favor of Stellantis' bull case alongside the fact it can easily become a reliable dividend player down the road, with its juicy 7.84% yield, not to mention its recently instated share buyback program covering up to €1.5 billion (2.6% of the current market cap).
The fourth point to keep in mind when considering Stellantis is its big and underestimated role as a BEV player . As a matter of fact, Stellantis is third in EU30 BEV sales and second in the US. If we consider PHEV sales, Stellantis is the U.S. market leader with 66k units sold in the first half of this year. This is important because I expect electric vehicles to be subsidized for a while. The more an automaker will be able to catch market share, the more its margins will benefit, offsetting the impact of higher costs.
Finally, Stellantis owns a premium luxury brand such as Maserati. It's a hidden gem that has struggled in the past. Under the new leadership, it's quickly gaining ground both in sales and in margins. Sometimes, rumors go around about a future spin-off, creating value both for Stellantis and for Maserati. If this will be the case, I estimated Stellantis could easily raise an extra €10 billion or so, depending and what percentage of its shares it wants to sell publicly. We have seen spin-off in the past with the aim of raising cash and funding the new electrification process (Volkswagen spun off Traton, Mercedes spun off Daimler Truck). It could happen again with a highly valuable brand.
All of the above reasons make me consider Stellantis a strong company even in case of a recession. True, with automakers we must be cautious. The industry is highly competitive and tough. There are new players coming from China that will cause margin pressure on Western manufacturers. There's no real player, as far as I see, with a real moat, apart from Ferrari ( RACE ) which actually plays in a separate league.
Nonetheless, Stellantis keeps on being highly undervalued compared to its peers.
What could happen to Stellantis due to the strike? We said higher costs down the road are granted. Stellantis should have around 10,000 employees in Detroit, out of 272,367 of its global workforce. This means around 3.7% of its headcount is in Detroit. Of course, these are workers with higher pay compared to the ones in other countries. This can be even be seen by what other unions have asked around the world. For example, last year Italian union delegates asked Stellantis for a wage rise of 8.4% . In France , unions asked for a similar pay rise. Peanuts compared to what the UAW asks for. In Italy, where Stellantis runs several factories coming from Fiat and Alfa Romeo, a worker in production earns on average €28k-30k per year. In the U.S. the cost of living is higher and production workers earn on average $45k-50k per year. This means workers in Detroit have a higher cost for Stellantis compared to other workers in the Western world.
We can thus assume that if these workers will get a 35% pay rise, the impact on Stellantis' cost structure will be at least $675 million in four years, as a result of this calculation: Average production salary *wage raise* Detroit employees (50,000*1,35*10,000=675 million). I say "at least" because there are probably higher paid employees whose raise will be more meaningful on Stellantis' financials. If we divide equally the extra cost over the next four years, we have around $170 million per year of extra costs. Considering Stellantis' TTM total operating expenses are $16.3 billion, we're talking about a 1% increase, which I believe is acceptable, especially considering Stellantis' healthy balance sheet.
Conclusion
The UAW strike must be watched carefully as it can unwind in many ways. However, as far as I can see, it won't be as menacing to Stellantis as the news suggests. The company will end up just fine and, hopefully, the workers will find a deal that will satisfy them, too. As an investor, in fact, I want the workers of a company I own to be happy and work well. Given the rough calculations I shared in the article, I don't see any meaningful impact on Stellantis' financials. Therefore, I stick to my buy rating with a target price in the $35-$40 range.
For further details see:
Stellantis: The UAW Strike Will Prove Its Resilience