Description

ALD Automotive is the largest independent lessor of cars in Europe after the recent acquisition of the Dutch LeasePlan. They promise shareholders a ~10% dividend yield at a 50% payout, together with 6% annual fleet growth. This hits my mental hurdle of 15% annual return and for that reason I believe it is a good place to park some cash in an environment in which many shares have run ahead of their still lingering fundamentals.

There are 2 catalysts. The 1^st is quite minor, but I believe that when ALD and LeasePlan first report as a combined entity on August 3^rd and set more detailed forward guidance, this creates more clarity around the undervaluation. The other catalyst is more significant but unfortunately is still 10 months out. At the time the acquisition closed, 53% shareholder SocGen committed to a 40 month lockup. LeasePlan shareholders who collectively own 30.75% committed to a 1 year lockup. While this provides an overhang, the limited 16% free float (~1.2b EUR) makes this too illiquid for institutional investors, who are the most likely buyers of boring European financials with a 10% dividend yield. When the lockup expires in May 2024, this will significantly improve the free float of ALD. As a consequence of the recent rights issue, the free float in # of shares already increased by 40%.

It’s not a sexy thesis, but I believe it will make a decent return even without assuming a rerating. Besides, what European financial nowadays earns an ROE in the high teens? That means there is at least some franchise value here. ALD was the #4 lessor in Europe while LeasePlan was the #5. Together they will own 3.3m vehicles vs Volkswagen at 10.6m, Toyota at 4.7m and Mobilize (Renault) at 4.0m. The merger doubled ALD’s size and many synergies are not surprisingly on the procurement side (cars and tires).

Other than the limited free float, the opportunity exists because car lessors are currently overearning due to historically strong residual values. Income from Used Car Sales has been elevated since 2021. To complicate things further, ALD changed their depreciation assumptions for their existing fleet from Q2 2022, because carrying values were already at or below fair value. This means that the excess earnings temporarily move from Used Car Sales to Leasing Contract Margin. Disclosure from ALD on this aspect is sufficient to calculate normalized earnings. Unfortunately the same cannot be said for Leaseplan, so my calculation of normalized earnings is embarrassingly inaccurate.

At closing, the CET1 ratio is expected to be 12% which warrants a rating upgrade from BBB to A- by Fitch and S&P. Funding is diverse and consists of Société Generale funding, deposits, bonds/loans and securitization. Liabilities roughly match the short duration of their lease book (average ~2 years). The rising interest rates have so far been more than offset by rising lease rates. The big question is whether this will change when residual values have normalized. If elevated RVs are the result of a supply / demand imbalance, we either need a supply catchup, which might take a few years given we still need to catch up on 2 years of undersupply. A demand slowdown is of course in the cards as demand correlates with European economic activity. European politicians have been working hard for the last 20 years to slow down their economy in every way imaginable.

ALD’s price graph is a bit misleading due to the recent 1.06 EUR dividend and the dilutive nature of a rights issue at 7.50 EUR (2 rights for each 5 shares owned).

Synergy targets have been increased to 440m EUR, up from 380m EUR at deal announcement. The expected C/I ratio has gone from 45% to 46-47% due to inflationary pressures.

So in short, EPS will normalize from the 2.75 EUR that ALD earned in 2022 as a stand-alone entity. This normalization will probably take 2-3 years to work out. In return we get a bunch of synergies coming in over the next 3 years. My inaccurate model tells me we end up at a ~5-6x P/E, with a high-teens ROE. That’s enough to afford a 10% dividend and 6% fleet growth and still leave some change to fund vanity projects or to deleverage. I believe the 10% dividend is sustainable and therefore provides some downside protection in case we all freak out like it's 2022 and stocks go down.

The main risk I see is that the inflationary environment makes the C/I ratio worse than targeted. This is probably the part of the math that I have the least confidence in. Residual values also need to be watched. Europe does not have an equivalent to the Manheim index, so this is a little harder to track, but for 2023 RVs continue to be strong.

Below is my model but I’ll caveat by saying that it’s a back-of-a-napkin calculation that got out of hand. It could prove to be embarrassingly imprecise. I also haven’t bothered to model the path of normalization, offset by the path of synergies minus integration expenses, nor any growth.

Catalyst

Reporting of combined financials on August 3^rd 2023 with operational updates and forward guidance.

Increase in float, partially as part of the December rights’ issue, with the large increase in May 2023 when the lockup of LeasePlan shareholders expires. This might act as an overhang until then.