Description

Note: This stock is listed in France and all amounts are in Euros, which are worth about $0.90.

Renault SA is the largest Western European manufacturer of cars and light passenger trucks in Western Europe, producing about 2.3m vehicles per year. Its market share is about 11%, compared to VW with just shy of 11%. The largest portion of its sales are in France, where it has a long and established brand. It does not have significant operations outside of Western Europe. Renault has taken a beating recently for two main reasons. First, this is a very cyclical business and as everyone knows, the global economy is not doing well. Second, Renault has a fairly old product line up (4.7 years) while some of its competitors, VW and Peugeot, have much fresher lineups. As a result, Renault is in the uncomfortable spot of losing market share and preparing to launch replacements for many of its most profitable models which are currently under competitive attack. Renault currently has a 3b cost cutting program underway to help maintain its margins during this difficult time. The investment thesis, however, depends only modestly on the core Renault business, as the core Renault business is currently valued at less than zero. Let me explain.

Renault purchased 36.8% of Nissan motors back in 1999, at yen 400 per share. It recently announced that it would exercise its 540m warrants to increase its stake to 44.4%, at a price of yen 400 per share. Nissan will also take a 15% stake in Renault at current market prices. The current market value of this 44.4% stake in Nissan, which sells for yen 615, is 11,516m euros, or 41 euros a share. This has been a good investment for Renault. Including a few other of Renaults publicly held investments (a 20% stake in Volvo, and a 23% stake in Nissan Diesel), the per share value of publicly listed investments is currently 47 euros per share, compared to Renaults stock price of 39 euros per share today.

Given that all the value is in Nissan, any reasonable investor should get comfortable that Nissan isn't a risky proposition and isn't overvalued. Here is a little background on Nissan. When Renault took its stake in Nissan, Nissan had about 2.3 trillion Yen of industrial debt (from here, all references to net debt exclude debt associated with the retail finance operations, which are offset by finance receivables: both nissan and renault's finance operations are profitable) and was generating an operating loss. Renault put a manager by the name of Carlos Ghosn, referred to in France as "Le cost cutter". Ghosn put in place a three year Nissan Revival Plan (NRP) with three parts: reach profitability by 2000; reach an ebit margin of 4.5% by 2002; and reduce net debt to less than 700b by 2002. If any of the three goals were not reach, the entire executive committee would resign. Last year, Nissan hit an ebit margin of 4.75%, pared net debt to 953m and generated a net profit. In the first half of this year, despite a very difficult operating environment, Nissan grew its ebit by 41% for a 6.3% margin, and reduced its net debt further to 799b. Ghosn has been shuttering factories, raising utilization, selling off excess assets, consolidating suppliers, and reducing the workforce. Nissan currently sells for about 7x management's published earnings estimate for the year ended March 2002. It should generate EBIT of 350m this year and end the year with about 750b of net debt. Nissan appears to me to be somewhere between undervalued and fairly valued.

What then is Renault worth? Renault has been a pretty well run company over the past several years. It was privatized in 1996 when it went public (the government still owns 44%) and embarked on a 3b cost cutting campaign. EBITA margins averaged about 5.5% from 1998 through 2000, earning 1,827m euros of EBITA in 2000 on the core automotive and financing businesses (the commercial vehicles business was included in 2000 results but won't recur because it was swapped for a 20% stake in Volvo). This year will be difficult for the reasons mentioned above. Analysts are expecting somewhere between 500-900m of EBITA this year. What I have done is take a range of EBITA outcomes (Low to High), subtracted out the interest and taxes and then applied a PE multiple to arrive at a per share value for the core Renault operations. Here is the detail

EBITA range of 750 to 1,750m euros (versus three year average of 1,853)
Interest expense of 5% on net debt of 4,856m (adjusted for sale of 15% to Nissan and exercise of warrants). fyi, this is much higher than analysts interest numbers due to very low interest debt.
Tax rate of 35%, again much higher than analyst tax rate estimates.
PE multiple of 8x
This yields a range of per share values of 9.4 to 27.9 euros per share. Adding in the 47 euros per share of Nissan and other associates, gets me a target price range of 56 to 75 euros per share compared to the current stock price of 39 euros. Because this is not a business that I'm fond of (cyclical, capital intensive), I take the bottom end of this range and settle on a sell price of 56 euros (+44%).

Catalyst

Earnings estimates have come way down for Renault due to the difficult environment and the product transition: they have been cut almost in half at the EBIT level. If the economy improves and the new products show some success,these estimates could be substantially revised upwards. The cost cutting program could also help support the earnings.