Description

Summary

Iveco Group (IVG) is an Italian manufacturer of light, medium and heavy-duty trucks, commercial vehicles, buses, and specialty vehicles focused on firefighting, defense, and other uses. IVG spun out of CNH Industrial in January 2022 (see blee1020’s CNHI write-up for background). The spin-off resulted in technical selling, resulting in significant underperformance relative to industry peers. Current depressed valuations overemphasize near-term challenges. Intrinsic value is likely closer €9 per share and potentially significantly higher.

Investment Thesis

The investment thesis rests on the following:

1. Underperformance since listing – Recent geopolitical and cyclical concerns have weighed on the sector and market generally since IVG’s listing on 4th January 2022. Iveco shares have underperformed the market and sector significantly since listing despite better-than-expected Q1 2022 results. The shares have fallen over 40% versus -25% for Traton (German-listed), -19% for Volvo Trucks (Sweden-listed), and -5% for PACCAR. Other references points include -19% for the MSCI Europe Cap Goods Index, -12% for FTSE MIB Index ~9% for CNHI. 

2. Selling pressure exacerbated by technicals rather than fundamentals – Technical selling took place after the CNHI spin-off given lack of US-listing and the agriculture focused ownership of CNHI. The transaction did not include any lock-up arrangements. Over 70% of total shares outstanding traded by the end of February; the largest shareholder, Exor, owned 27% of IVG at the listing is unlikely to have sold significant stakes. The relatively large size of the parent relative to the SpinCo (Market caps ~€18.5bn for CNHI versus less than €2bn for Iveco) likely also caused larger holders to sell rather than attempt to build larger positions in Iveco; investors received 1 Iveco share for every 5 CNH Industrial (CNHI) shares held.

Index considerations also exacerbated selling pressure. Iveco’s relatively small size failed to satisfy the market cap requirement to remain in MSCI Europe / Stoxx Europe 600 index, which suggests ~18m of net share selling (~10% of IVG shares outstanding). The stocks deletion from MSCI Europe (17.3m shares to sell) and Stoxx Europe 600 (3.93m shares to sell) exacerbated pressure from passive flows. Active long-only managers tracking MSCI Europe or Stoxx Europe 600 are also more likely to unwind their positions regardless of underlying fundamentals. 

2. Selling pressure has caused the shares to trade at low absolute and relative valuations – The company is now trading below 1x P/B and less than ~1x EV/EBITDA, with one of the lowest EV/Sales (~0.1x) in the European multi-industry space. A reverse DCF indicates that markets are pricing negative perpetual growth assuming Iveco meets its FY26 margin guidance outlined during the spin-off. Similarly, Sum-of-the-parts valuation suggests similarly low valuations; a reverse SOTP using the current share price implies almost zero value for the Trucks segment despite the business being profitable assuming other divisions valuations are in-line with peers. Current valuations more than reflect the near-term difficulties Iveco will face during 1H22 from prolonged supply chain pressure and management’s more cautious near-term guidance. 

Pushback on valuation tends to be focused on reduced near-term cash flow generation and lack of dividend, particularly given investors’ recent renewed emphasis on cash flow metrics over top-line sales growth. Free cash flow was slightly negative for FY2021 and will be minimal in FY2022 (or slightly negative) before gradually ramping up to normalised figures. Depressed near-term FCF expectations are due to (1) increased working capital to deliver high orders, and (2) increased R&D (and investment capex) to meet €4.1bn of investments forecast between 2022 and 2026. ~€400mn average R&D per year for the foreseeable future, in addition to ~€400mn of physical/maintenance capex). IVG’s total capex (tangible and intangible) per year was €400mn in 2020, €492mn in 2019, and €437mn in 2018 (3.5%-4.0% of sales).  The proportion of R&D to capitalise is open to debate. However, the market is assigning near-zero value to R&D investments at this price per share, so any related positive asset value implies upside.

3. The depressed valuation ignores numerous positives – The business has a number of attractive traits including (1) low to mid-teens cash return on invested capital, (2) attractive growth prospects, (3) strong market position in certain European market segments (i.e. >20% market share in Buses), (5) strong 2021 order book which supports earnings growth visibility in 2022/23, and (4) technology for energy transition (LNG/CNG) and partnerships.  

4. Iveco could be seen as an M&A target – Iveco’s could be an attractive strategic acquisition target given its position as a medium-sized player with leading exposure in transition technologies such as LNG/CNG and innovative partnerships. Deals in the truck space have averaged ~14-15x EV/EBIT, implying €4.0-€4.5bn enterprise value on 2022 consensus analysts estimates for IVG (many of which have been recently reduced).

The Iveco segment was subject to takeover speculation in the past with CNHI open to offers. In 2020, the press reported that FAW (Chinese state-owned car maker) had made a preliminary offer in July 2020 to buy Iveco for ~€3bn/$3.5bn which CNH rebuffed as they considered this valuation low. In 2021, the press reported CNH ended potential deal talks that had been going on since 2020. 

Some will push back on IVG’s M&A prospects given CNHI’s (and perhaps more importantly Exor’s) previous unsuccessful efforts to sell the company. However, I suspect the starting point for negotiations would have been at much higher valuations than those implied by the current IVG share price. Minority shareholders will undoubtedly be open to offers if valuations remain near current levels and conditions stabilise. 

The primary risks are prolonged supply chain bottlenecks (beyond H1 2022), cyclical exposure, regulatory pressure, and management failing to meet targets. 

Company overview

Company overview – Iveco Group is an Italian manufacturer of light, medium and heavy-duty trucks, commercial vehicles, buses, and specialty vehicles focused on firefighting, defense and other uses. The company employed 32,964 individuals as of 2020, with the major workforce concentrated in the European region.

In September 2019, CNH Industrial (CNHI) announced its intention to separate its 'On-Highway' (Commercial Vehicles + Powertrain) and 'Off-Highway' (Agriculture + Construction Equipment + Specialty Vehicles) businesses. The separation, which was initially planned to take place in 2021, eventually occurred on 3rd January 3, 2022. The 'On-Highway' part of the business was named Iveco Group. 

The CNH Industrial demerger divided the company into two parts. CNHI RemainCo is focused on Agriculture and Construction. The IVG spin-off is focused on Commercial & Specialty Vehicles (including Trucks) and Powertrain.

Iveco is among the top 15 global truck OEMs (>15tn) globally, mainly exposed to Europe (75% of revenues) and North America with ~80% unit exposure to the Heavy segment. The firm commands meaningful scale with ~7% market share in EU and LatAm. Iveco’s products, particularly, electric and hydrogen offerings, incorporate meaningful technological expertise.

Sector overview – Iveco faces substantial competition. Daimler, Traton, Volvo, PACCAR and Iveco group capture the majority of market share in North America with a combined market share of 96% followed by South America with 93% and Europe with 82%. The European market has a fragmented market share with Traton leading at 27%, followed by Volvo and Daimler. North America is dominated by Daimler and PACCAR with a market share of 33% and 32% respectively. Traton leads in the South American region with a market share of 41% followed by Daimler and Volvo with a market share of 21% and 19% respectively.

The order back logs of the trucking industry were strong into the beginning 2022 and the order book continues to sit at record level. However, widely reported semiconductor supply chain issue hitting the car and supplier industry are also impacting the truck market. Supply chain issues will likely weight on the production recovery in FY22. 

Company outlook – Management has promoting the new IVG as an efficient and nimble organization with a lean management structure and shareholder aligned incentives. Iveco is planning to continue spending on R&D, execute a heavy-duty truck turnaround in Europe and re-invent the medium duty truck segment with alternative propulsion. The company has relevant technology and knowledge producing electric vehicles as demonstrated by the LCV and electric bus applications launched in the market across regions. Iveco and Nikola, a US-based electric trucks manufacturer, have partnered for the development, production, and commercialization of new alternative propulsion vehicles.

The company faces the near-term supply chains headwinds alongside the sector. Supply chains were operating at roughly 75% of normalised capacity in Q1 2022. This is likely to have continued in Q2. IVG observed some decrease in market share for heavy duty trucks in Q1 driven by production constraints caused by supply chain disruptions. So far, IVG has managed to pass on price increases to customers; the company reported 7% increase in price across the vehicle range in 1Q 2022. 

Financial analysis

Liquidity & capital structure – IVG’s had €765mn net cash as of Q1 2022. Available liquidity was €3,390mn including undrawn committed RCFs. 

Recent earnings (Q1 2022) – IVG’s first set of results as an independent entity was solid with Q1 2022 revenues of €3.05bn and EBIT of €102mn. The Commercial & Specialty Vehicles division continued to perform well with +7.6% yoy revenue growth and improved EBIT margins. Powertrain revenues fell by 4.9% due to lower volumes from third parties. The company took an tax impairment charge of €51m in connection with Iveco’s operations in Russia and in Ukraine. European Truck book to bill ratio was roughly 1.2x. 

Earnings outlook – Management provided the following 2022 preliminary guidance during the Q1 results:

• Consolidated Adjusted EBIT between €350 million and €370 million 

• Net revenues of Industrial Activities flat to up 3% versus full year 2021

• SG&A costs of Industrial Activities lower than 6.5% of net revenues

• Net cash of Industrial Activities slightly up versus 31st December 2021

 The company is aiming to reach a revenue target of €15bn by 2024 and €17bn by 2026. Management is targeting adjusted EBIT margins of 5-6% (vs. 3.6% in 2019) by 2026. The group’s product strategy will expand their market share and help them realize higher sales and revenue.

Industrial margins are expected to expand c.350bps from 2021 to 5.3% in 2026E as management delivers on the profitability turnaround in Commercial and Specialty Vehicles. The segment has been loss making but should break even in 2023E and sustain profitability thereafter.

The powertrain division should accelerate earnings in 2023 after engine related contacts with Stellantis have been fully discontinued in 2022. Overall, group adjusted margins are expected to rise moderately and steadily to ~3% by 2023 (vs 2.4% in FY21, and vs peak truck maker margins of c.10%) when the semiconductor supply chain issues eventually normalize.

Normalized earnings / free cash flow – The industrial activities of Iveco are unlikely to generate meaningful FCF until FY2024, after which ~50% cash conversion would be in-line with historical results. The depressed near-term FCF expectations are a consequence of an increased working capital to deliver on high near-term orders and a progressive increase in R&D and capex investments to meet the EUR4.1bn of investments guided by the company between 2022-2026E. Rising capital expenditures it should be offset by volume recovery across regions.

Management targets €16.5bn to €17.5bn of revenues by 2026. Ongoing capex is expected at 5% of sales, €825mn to €875mn per year assuming management achieves their targets. Assuming EBITDA margins of ~10% would suggest ~€600mn ongoing free cash flow. 

If management were to fall short of their targets and normalized earnings were to stabilize at FY2021 levels then free cash flow could be closer to €400mn per annum (assuming capex equivalent to ~5% of sales).

Valuation

Market implied valuation – Current valuations imply substantial pessimism. Assuming all divisions, other than Trucks, are valued in line with peers, a reverse SOTP using the current share price implies near zero value for Trucks despite the business being profitable. This over-penalises the segment, given the large backlog and management’s self-improvement efforts.

Backing out market implied enterprise value from current price suggest minimal value to the core business. The strong net cash position and investments, alongside partial capitalization of trailing five-year R&D suggests puts a floor on valuations near current levels. Whilst the cash position is unlikely to distributed to shareholders, the revolving credit facilities suggest that the company has plenty of liquidity excluding current cash. 

Absolute valuation – IVG’s absolute valuation is compelling at ~1x EV/EBITDA and ~0.1 EV/Sales.

At the low end, normalized (through cycle) free cash could be ~€300mn per annum assuming sales and EBITDA normalized near 2021 levels, working capital issues stabilized and maintenance capex averaged ~5.5-6.0% of sales. 10% FCF/EV yield would suggest intrinsic value ~€12.5 per share. 15% FCF/EV yield would suggest intrinsic value ~€9.75 per share.

At the high end, management targets for 2026 would suggest ~€600mn normalized free cash flow. 10% FCF/EV yield would suggest intrinsic value ~€25-30 per share. 15% FCF/EV yield would suggest intrinsic value ~€15 per share.

Asset valuation suggests solid downside production. Reproduction cost using latest reported figures and excluding intangibles suggests equity value of ~€2bn.

Relative valuation – –Iveco’s valuation is typically compared with traditional truck OEMs such Volvo Trucks, Paccar, Traton and Hino. Volvo Trucks’s product portfolio over the past 10 years is likely most relevant given the a) size of the asset, b) geographical mix and, c) product mix. 

Looking at the multiples over the past 9 years, Volvo Trucks has traded on average EV/Sales multiples of ~0.7 EV/Sales, x12 EV/Ebit and x7 EV/EBITDA delivering industrial average margins of 7.5%. Sell side analysts often use EV/Sales multiples as the preferred metric due the volatility in truck volumes over the cycle and restructuring which can impact the underlying EBIT margins and multiples. Applying competitors’ current EV/sales multiples to IVG implies levels completely disconnected from the latter’s current share prices/ Applying 0.7x EV/Sales to IVG would imply intrinsic value per share of over €30 per share. Apply ~0.4x EV/sales (similar to Traton or Daimler Trucks) would imply over €20 per share. 

Risks

Cyclical risks – Truck demand is highly sensitive macroeconomic cycle. A recession coupled with extended lead times and record backlogs of truck OEMs, could drive slower growth in trucks post 2022 

Difficulties in executing on HDT turnaround plan and other cost-cutting initiatives – Fulfillment of Iveco's margin ambitions rely on cost-cutting to drive savings, particularly for the turnaround of the HDT operations in Europe. ~90% of the group's employees are protected by collective labour agreements which could make the cost cutting more challenging than management expects.

Supply chain bottleneck – Iveco relies on c.2k suppliers for raw materials, parts and components to manufacture their products. IVG and competitors were struggling to source required parts even prior to the war in Ukraine. 

Market share loss to new entrants – There are concerns about new entrant risks in passenger cars as new technologies like BEV and FCEV are likely to gain traction in coming years. Iveco's market shares should stay unchanged through the transition given their track record of innovation. However, sustained market share declines would challenge management’s outlook. 

Catalyst

Supply chain improvements, management's operational improvements, takeover interest