Renault shares suggest this is a value trap, but top fund managers disagree

This article first appeared in the Telegraph’s Quester section.

A useful rule of thumb for investors is to avoid companies with price-to-earnings multiples of less than 6 times. Usually these are value traps.

Therefore, the forward price/earnings ratio is less than 3, as is the case for the French automaker. renault (FR:RNO), which is usually a major red flag. But that didn’t deter the world’s biggest fund managers, who are passionate supporters of equities.

Thirteen of these investors, each in the top 3% of the 10,000 equity fund managers tracked by financial publisher Citywire, own Renault shares. As a result, the company received the highest AAA rating from Citywire Elite Companies, which rates companies based on support from top-performing fund managers.

Source: Citywire/Morningstar, latest holdings data.

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Let’s start with the bad news, which explains why the stock’s valuation is so low.

Europe’s internal combustion engine (ICE) car industry has long been plagued by overcapacity and poor profitability. The phasing out of petrol and diesel cars is now forcing automakers to rethink their expensive business. However, electric vehicles (EVs), which are expected to replace ICE vehicles, are being manufactured more cheaply in China by AAA-rated companies and others. BYD (Hong Kong:1211).

Adding to this worrying long-term trend is the short-term economic outlook for Europe, where Renault earns more than three-quarters of its sales, is at stake.

Renault’s ability to adapt is also constrained by politics. Specifically, the French state owns 15% of the company’s shares, and labor unions are heavily involved.

That’s not the only problem. The company was shaken by the sensational arrest and subsequent escape of former chief executive Carlos Ghosn in Japan five years ago. His resignation marks a deterioration in Nissan’s key partnership with Mitsubishi, even before the coronavirus disease (Covid-19) disrupted the auto industry.

But since mid-2020, Renault chief executive Luca de Meo has been working to get the company back on track. His efforts seem to have captured the imagination of top fund managers.

A major step forward last year was the realignment of the Nissan Alliance, which unlocked value and paved the way for us to regain our investment-grade credit rating. In order to balance the voting rights of both companies at 15%, Nissan’s 28% share out of Renault’s 43% shareholding was placed in trust. A 5% stake has already been sold, allowing Renault to free up cash, while the remaining 23% in trust is worth around 3.1 billion euros at Nissan’s current market value.

Meanwhile, Renault is already progressing through two phases of a three-phase plan to restart growth and profitability. Operating margins are expected to reach nearly 8% this year, compared to his 6.6% peak over the past decade.

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While some analysts think this is for the best, DeMeo believes there is something better to do as he looks to profit from changes in the industry.

Renault is often seen as a likely victim of structural change. However, De Meo believes that by creating a flexible organization with delegated decision-making, companies can take advantage of the rapidly developing opportunities in EVs, software and the circular economy.

A near-term opportunity to achieve this objective is Renault’s plan to spin out its EV and software division Ampere in the first half of 2024. The company is discussing a floatation value of 10 billion euros, compared to Renault’s market value of just 10.5 billion euros.

Cynics point out that making Ampere profitable will require significant cost cuts and increased production, with a valuation that could be in the billions of euros if the division can be floated. suggests that it is high.

Meanwhile, a new joint venture with Chinese automaker Geely could help extend Renault’s ICE business. The partnership, called Horse, focuses on the production of ICE and hybrid engines and names Saudi oil giant Aramco as a potential investor and developer of hydrogen technology. Ultimately, Hose aims to supply engines for ICE vehicles that have a lower carbon footprint than current EVs.

Next is Renault’s actual car. The company’s high-end Alpine performance car division aims to grow sales from less than 1 billion euros this year to more than 8 billion euros by 2030 with the launch of four new cars. Meanwhile, the company’s low-cost Dacia brand has been profitable by industry standards, and the profitability of Renault’s other car brands has also improved.

There is also steady income from Renault’s RCI bank, which finances the purchase and provides insurance. As of June 2023, this business accounted for €52 billion of Renault’s total debt of €65 billion, with net debt of €45 billion.

The extreme undervaluation of Renault shares reflects significant risk, but given the ongoing changes in the group and the potential for deals to unlock value, so many top investors are ignoring classic rules of thumb. It explains why you think it might be worth doing.

Source: FactSet. Forecasts based on the next 12 months.