2023-07-18 04:48:25 ET
Summary
- AB Volvo is a leading global manufacturer of trucks, buses, construction equipment, and marine and industrial engines. The company is successfully transitioning to EVs.
- The company has grown well in the last decade, owing to its strong brand, deep industry expertise and innovation, and global presence.
- There is a concern with slowing demand and threats from China, however, thus far, its diversified model has allowed the business to remain resilient.
- Relative to peers, the business performs extremely well while trading at a discount, implying value even in a downside scenario where performance declines.
Investment thesis
Our current investment thesis is:
- Volvo is a highly attractive business, owing to strong innovation, a global footprint, and a highly regarded brand.
- The business is successfully transitioning into the EV market while investing in its autonomous capabilities. We are slightly worried about the long-term competitive position of the business but currently, we remain bullish.
- The company's diversified revenue stream is softening the impact of slowing demand, keeping the business on a positive trajectory.
- Compared to peers, Volvo outperforms while trading at a lower valuation, implying upside.
Company description
AB Volvo ( OTCPK:VLVLY ) is a leading global manufacturer of trucks, buses, construction equipment, and marine and industrial engines. Headquartered in Gothenburg, Sweden, the company operates through various business segments, including Trucks, Construction Equipment, Buses, Volvo Penta, and Financial Services.
This business is not to be confused with the Volvo Car company, which is owned by Geely ( OTCPK:GELYF ). Also, AB Volvo owns Renault Trucks.
Share price
Volvo's share price has performed well in the last decade, especially when considering total returns. This is a reflection of its solid financial development during this period, quietly performing well.
Financial analysis
Presented above is Volvo's financial performance for the last decade.
Revenue & Commercial Factors
Volvo's revenue has grown at a healthy CAGR of 7% in the last 10 years, with a strong growth trajectory throughout the period. The business has occasionally experienced a decline but the trajectory is broadly positive and wholly recovered from the pandemic.
Business Model
AB Volvo designs, manufactures, and sells a wide range of commercial vehicles, including trucks and buses, as well as construction equipment and industrial engines. The company utilizes its deep expertise in manufacturing and design to produce related products while achieving diversification by industry. This contributes to a higher-quality revenue profile as the business is less reliant on a single industry's growth. Volvo operates a global distribution network to reach customers in different markets.
Further, Volvo provides extensive aftermarket services, including spare parts, maintenance, repairs, and fleet management solutions. These services contribute a recurring revenue profile, softening the volatility of annual demand for vehicles.
Finally, the company offers financing, leasing, insurance, and other financial solutions to facilitate the purchase and operation of its vehicles and equipment. With higher rates, we are seeing activities slow and spreads compress.
Volvo maintains its market-leading position by consistently investing in research and development to drive innovation and technological advancements. Volvo has consistently spent 4-6% of revenue on both Capex and R&D, illustrating its financial commitment. This is a critical requirement as customers seek continued value development in efficiency. This has allowed Volvo to develop a reputation for safety, quality, and environmental sustainability.
In the most recent quarter, Volvo has achieved healthy delivery growth YoY, yet continues to see issues QoQ. This is a reflection of the current economic condition, posing several issues for Volvo. With elevated rates and high inflation, we are seeing global demand soften, with fears of a recession. This discourages large financial expenditures as businesses fear the demand will not be there to justify it. Further, with the cost of capital higher, it is now more expensive to both finance Volvo's products, as well the projects they are used for. This is likely the reason for the noticeable slowdown in Construction deliveries.
These factors have been partially offset by the ability to raise prices, contributing to top-line stability, although the business is seeing its costs rise. Further, Penta and Service sales continue on their upward trajectory, illustrating why its diversified revenue model is so lucrative for achieving a healthy long-term trajectory.
Although this is concerning in the near term, the business is seeing resilient orders in Trucks, the largest segment of the business, implying a complete drop-off is not on the cards. We are positive that the global strength of deliveries implies near-term resilience.
Competitive Positioning
Volvo's competitive position is based on the following factors:
- Strong Brand. The Volvo brand is widely recognized and associated with high quality, reliability, and safety.
- Technological Development. The company's commitment to innovation and research enables it to remain at the forefront of technological capabilities.
- Global Presence / Scale. Volvo has a strong global footprint with manufacturing facilities, sales networks, and service centers in various regions, allowing it to serve customers effectively.
Truck and Manufacturing Industries
AB Volvo operates in a competitive landscape with several key competitors, including Daimler AG ( OTCPK:DTRUY ), CNH Industrial NV ( CNHI ), Scania AB ( OTCPK:VWAGY ), Cummins ( CMI ), PACCAR ( PCAR ), Komatsu ( OTCPK:KMTUY ), and Nikola ( NKLA ).
The Truck market environment has been overarchingly positive, as expected, given the economic development experienced globally. The industry is somewhat cyclical, although currently looks to be in an upswing. The forecast is for further gains, although it must be said there is a risk of this softening. Barring India and potentially China, no region looks to be clearly on an upward trajectory.
The construction industry is far less volatile in developed nations, with growth coming from developing nations as they build out their infrastructure. The weakness in South America is disappointing but the real issue is that China is forecast to decline. This is potentially linked to changing conditions in the country, as the Government encourages investment in society improving growth rather than meaningless construction.
The shift towards cleaner and more sustainable transportation is driving the adoption of electric and hybrid vehicles, as well as alternative fuels such as natural gas and hydrogen. This is the biggest trend impacting the truck (and wider vehicle) market, as consumer beliefs and legislation drives change. Volvo's innovative approach has garnered a rapid response to this, with the business a leader in the European market and delivering in growing numbers.
We believe, as supported by the data below, the market will achieve strong growth in the coming years, with a full transition to the technology at some stage. Early development and market share growth are critical to being a leader in the new iteration of the market.
The development of autonomous vehicle technology has the potential to revolutionize the transportation industry, enhancing safety, efficiency, and productivity. This is a technology that will likely follow the EV transition, although is being developed in conjunction with it. Volvo is developing heavily in this area and is expanding its global footprint to prepare for hub-to-hub transport once online.
Margins
Volvo has achieved strong margin improvement during the last decade, driven by pricing, scale economies, change in product mix, and operational excellence. The recent bump has been achieved through shrewd management of the supply-chain issues with semiconductors, allowing the business to increase prices while demand has remained strong.
Our expectation is for margins to normalize at these elevated levels, although further improvement in the near term may be difficult due to softening demand.
With Penta and Trucks continuing to grow well while Buses and Construction slow, we could see benefits from a further change in product mix, also.
Balance sheet & Cash Flows
Volvo is conservatively financed, with a ND/EBITDA ratio of 1.9x, much of which is lease liabilities. This has allowed the business to generously allocate capital from its highly consistent FCFs, investing in growth and shareholder distributions.
Also previously mentioned, dividend growth has been strong, even while cash has accumulated by (arguably) too much.
Industry analysis
Presented above is a comparison of Volvo's growth and profitability to the average of its industry, as defined by Seeking Alpha (27 companies).
Volvo performs quite well in our view. The business has achieved comparable growth over a 5-year period, although slightly lags in a shorter period. The forward growth rate slightly trails but both results are extremely good.
Profitability is where the business really shines, however. It noticeably outperforms every key metric, even from an efficiency perspective. Given that these are mature industries, profitability will always be preferred to growth.
Valuation
Volvo is currently trading at 10x LTM EBITDA and 7x NTM EBITDA. This is a discount to its historical average.
A premium to its historical average is undeniably warranted in our view, as Volvo has achieved greater scale, margin improvement, and further product development.
Equally, we believe the business should be trading at a (smaller) premium to its peers, owing to its enhanced profitability but factoring in the comparable growth and the risks around maintaining margins (given this was boosted post-pandemic and it is not certain to survive a downturn).
Based on this, there is seemingly good upside based on Volvo's current share price. With a FCF-Y of 9% and a dividend yield of c.4%, the business looks a winner.
Key risks with our thesis
Although we have been very positive about the business, there are a few glaring risks, which is likely why the business is trading as it is.
The risks to our current thesis are:
- Chinese producers. The Chinese automotive businesses have really taken the EV game by the neck, dominating volume statistics and beginning a global expansion strategy. They are producing comparable, if not superior products, at a fraction of the cost. There is a big risk that Volvo loses the market share it has gained in the last decade as these businesses expand into its key geographies.
- Growth. It feels like we are at an inflection point. Quarterly growth could easily begin to decline or flatline at the current levels. Should a decline occur, we could see negative price action in the near term, rendering Volvo "dead money" until economic conditions improve.
- FX. As a global business reporting in SEK, the company faces the risk of currency depreciation.
Final thoughts
We very much like Volvo. The business has performed incredibly well, showing resilient growth and incremental margin improvement. It has a high-quality business model with good growth potential ahead through EVs and Autonomous vehicles. Its diversified revenue stream is showing its value currently, as demand uncertainty begins to flatline revenue.
The business is cheaper than its peers and historical average, despite the noticeable improvement. We rate the stock a buy.
For further details see:
Volvo: Driving Sustainable Innovation In The Transportation Industry