Continental AG: Future Growth Combined With A Legacy Business

seekingalpha07-07

Continental AG shares present an attractive valuation, with Price to Earnings of 10x next year's earnings.The restructuring program is expected to generate €400 million in cost savings annually from ...

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GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4702782-continental-ag-future-growth-combined-with-legacy-business><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Continental AG shares present an attractive valuation, with Price to Earnings of 10x next year's earnings.The restructuring program is expected to generate €400 million in cost savings annually from ...</p>\n\n<a href=\"https://seekingalpha.com/article/4702782-continental-ag-future-growth-combined-with-legacy-business\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"SG9999014914.USD","symbol_name":"UNITED GLOBAL QUALITY GROWTH (USDHDG) 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INC"},"translate_title":"大陆集团：未来增长与传统业务相结合","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"ALV":1,"UBER":1,"SFFLY":1,"PLLIF":1,"PH":1,"MGDDF":1,"MBLY":1,"GTES":1,"GT":1,"CTTAF":1,"CARZ":1,"BRDCF":1,"AG":1,"AUR":1,"APTV":1},"content_text":"Continental AG shares present an attractive valuation, with Price to Earnings of 10x next year's earnings.The restructuring program is expected to generate €400 million in cost savings annually from 2025.7,150 layoffs create a leaner, more focused business with operations growing in autonomous technology and industry diversification.Sundry Photography/iStock Editorial via Getty Images Thesis Continental AG (OTCPK:CTTAF) share price has declined over 50% since 2019, and I believe the shares present an attractive valuation with a P/E of only ten times next year's earnings. The ongoing restructuring program is expected to generate €400 million annually in cost savings from 2025, in part due to 7,150 employees being laid off from their automotive division as the company shifted focus to electric vehicles and autonomous technologies to support business growth counteracting the slow growing legacy tires business. Introduction Continental AG is one of the largest automotive businesses with 200,000 employees distributed across 56 countries with annual sales in excess of €41 billion. The legacy tire business has performed admirably, ranking 4th amongst global competition, with growth expected in the Automotive and ContiTech sectors. The Automotive business contributed €4.8 billion sales in Q1 2024 from their safety, autonomous driving technology and in-vehicle user experience technology such as the infotainment screens and heads up displays that proliferate new vehicles. ContiTech provides a degree of diversification from the automotive sector through industrial solutions supplying the construction, engineering and agriculture industries. Management has stated their intention to increase exposure to these sectors, further diversifying revenues from the highly cyclical automotive business, a move that I believe will transition the company to become more comparable to an industrial conglomerate with a technology arm operating across a diverse set of industries. Group Structure (July 2024 Investor Presentation) Business Update Group revenues for 2023 of €41.4 billion displays the scale of the business, distributed across four business units comprising Automotive generating 49% of revenues followed by Tires with 34% of revenues, and ContiTech generates 17% of revenues and the Contract Manufacturing unit contributing 1% to revenues. Sales By Business Unit (Q1 2024 Results) As part of the restructuring and cost management programs, net debt has been reduced from €5.5 billion to €5.2 billion YoY, ensuring Continental AG can maintain its strong credit rating, which is currently safe with Moody's rating Baa2, Fitch BBB, and S&P BBB enabling access to favorable capital terms. Growth Prospects / Outlook Continental AG provided an updated investor presentation July 1st providing a business update and outlining the roadmap for the transition out of restructuring, as can be seen below the planned execution timeline is 2024. The restructuring costs impacted the Q1 2024 financials with a €20 million associated cost, indicating the end of the 'era of calibration' as management refer to it. This restructuring effort is a result of management's plans to implement €400 million in operational cost savings by 2025 through reduced organizational complexity and grouping of activities to create cost efficiencies. i.e., headcount reduction. Roadmap (July Investor Presentation) Looking ahead to the financial performance outlook, the group is forecasted to grow in the high single-digit percentages in the short to medium term on the back of the restructuring program, positioning the business to capture growth through initiatives such as the Software-Defined Vehicle. An area experiencing significant change is the Internet of Things automotive technology segment. The ContiTech business unit is targeting growth through industry diversification, capitalizing on its strong position as a leading OE supplier. Autonomous technology systems are of strategic importance to Continental AG; this vertical for future growth is being developed through their partnership with Aurora Innovation (AUR) which counts Uber (UBER) as a substantial investor. The system under development is designed to achieve level 4 autonomy in commercial trucks, with scaled production scheduled for 2027. The Autonomous Mobility business is focused on the key areas of growth: radars, cameras, control units and systems & software, competing with companies such as Mobileye (MBLY). Group Outlook (July Investor Presentation) Continental's legacy tire business remains a significant source of revenue for the group, at €14 billion in 2023. The tires segment is expected to grow 3-8% annually through 2028 across the US, Europe and Asia, as the brand's resilience and OE relationships continue to create positive returns. ContiTech is an interesting business unit operating across industry and automotive. Generating €6.8 billion of sales in 2023, the industry segment serves an array of products including conveying systems serving construction, mining and energy, while the automotive arm serves ICE, BEV and commercial vehicles. The current revenue split is 58% industry and 42% automotive, with a long-term target to increase the industry segment to 80% of revenues, diversifying from the automotive sector. So, would I buy at the current share price? I believe the restructuring plan will bring the expected €400 million in savings through synergies and cost management, which is forecast to be completed by 2025. These savings should translate to the bottom line of the balance sheet, creating upside potential with an already low forward PE of 10 times next year's earnings. Group revenue has begun the resurgence from the covid impacts, and relative to a market capitalization of €12.2 billion, the valuation seems reasonable at €41.4 billion of annual sales and earnings per share of €3.62 paying a dividend of €2.20 per share for a 61% payout ratio. Group Revenue (SA) Continental AG's share price underperformance becomes apparent when benchmarked to the relevant index, in this case the First Trust ETF (CARZ), has seen significant underperformance to the benchmark since 2011, leading me to believe the shares currently offer good value when considering the growth forecasts and attractive valuation of the business. Data by YCharts Dividend The dividend is a nice cash reward for shareholders while the restructuring program is underway. A 3.6% yield from the €2.20 per share dividend is based on a dividend policy of 20-40% of net income on 200 million outstanding shares, so fluctuating dividend payout amounts are to be expected. From my perspective, this is a positive for shareholders looking to receive a higher yield as the business improves its net income. Investors in German-listed equities should be aware of Germany's withholding tax of 26.375%. Dividend (Investor Presentation) Competitors Although the below list of competitors is not exhaustive, it is clear that competition is strong across the business units. Continental AG does maintain a market-leading position in many of their product categories, briefly outlined below: Tires:  Pirelli (OTCPK:PLLIF) Michelin (OTCPK:MGDDF) Goodyear (GT) Bridgestone (OTCPK:BRDCF)  Automotive:  Autoliv (ALV) Schaeffler (OTCPK:SFFLY) Aptiv (APTV)  ContiTech:  Gates Industrial Corporation (GTES) Parker Hannifin (PH)  Risks The restructuring program underway requires a reduction in headcount of 7,150 across the Automotive business unit as they pivot to focus on the industrial sectors. Large-scale layoffs in Germany typically involve heavy-handed government intervention, which can cause delays and potentially costly redundancy payments. Supply chain disruptions can cause havoc for a business such as Continental AG, raw materials such as rubber are 90% sourced from Southeast Asia, which brings its own set of risks before being shipped across the globe to their manufacturing facilities. As global tensions arise and shipping disruptions continue, the risk of disruption could materially impact the financials. However, keep in mind, Continental AG has navigated each global event and remained a market leader. I estimate the risk level for financial impact as a result of supply chain disruption directly impacting the business is low. Conclusion Continental AG has evolved significantly from its roots as a traditional tire manufacturer, to its current diversified business, producing an array of products and services across the automotive and industrial sectors. The automotive technology business transition is expected to improve operating margins, while the smaller business unit ContiTech evolves further into a diversified offering outside the automotive space. In recent trading, the share price has risen sharply following positive news from management regarding the automotive business unit, which is expected to post better results in August than previously anticipated, contributing to an estimated 26% increase in group adjusted earnings. This positive news has been long awaited as the restructuring and cost management programs have been implemented, and it appears these efforts are starting to produce positive results, which leads me to my Buy conclusion for Continental AG. I expect further EPS growth to increase the dividend and a retrace closer to the historical average PE of 15x.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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