Description

Summary:  Subaru has a great automobile lineup and is a great brand trading at a discounted valuation because of near term supply chain issues.  There are two catalysts that could make the stock more expensive again.  Subaru has less downside than any other car manufacturer (and less downside than most other companies, as well).  

Brand:

If you know any Subaru owners you know they tend to be kind of crazy about their cars.  

J.D. Powers reviewed automotive brands and Subaru was at the top (in 2019).  I would argue that not much has changed in the minds of consumers since then.

source: https://www.thetruthaboutcars.com/2019/07/j-d-power-releases-brand-loyalty-study-for-2019-subaru-takes-top-honors/

There are several reasons the brand is popular:

Their AWD (All Wheel Drive) system is well respected.  The WRX was popular with “tuners” as far back as the 90’s.  Their Ascent is popular with families (3rd row seating).  The Outback and Crosstrek are popular with “campers.”  My next-door neighbor typically buys cool, off-road cars like Land Rovers and Jeeps.  He bought a new Subaru Crosstrek and is very happy.  He still feels like he is driving something rough & rugged. 

Millennials like this brand, too, for ESG and philanthropy values.  https://www.torquenews.com/1084/why-millennials-are-flocking-new-crosstrek-and-impreza-models

Subaru has had many popular cars, going back decades.  Remember the Brat?

Source:  Bring-a-trailer auction (went for $20k!)

Valuation:

Subaru is in the doghouse because of the chip shortage.  I stopped by my local Subaru dealer and there were ZERO Crosstreks in inventory.  Customers are buying them sight unseen.  There is a waiting list.  It did appear that they had plenty of Outbacks.  

Sellside:  According to Bloomberg, there are 15 analysts covering Subaru (6 buys, 7 holds and 2 sells).  The lowest ranking analyst, from JP Morgan, says “sell” with a 1900 yen price target.  He says they need to control their quality costs and present a roadmap to improve profitability.  He is worried about competition from U.S. light truck market.  The 2 top ranked analysts have “buys” on Subaru with price targets between 2400 and 2900. 

Summary: Subaru is one of the best Japanese car brands and it is also on the cheap side.  

Catalyst 1 - Efficiency switch:

Demand for fuel efficient vehicles should increase as the price of gasoline increases.  There is empirical evidence that shows an uptick in the purchase of fuel-efficient vehicles starts two years after significant increases in gas price.

(source: https://www.alliedacademies.org/articles/the-impact-of-gas-price-trends-on-vehicle-type-choice.pdf)

All the pieces are in place for Subaru to benefit from this.

(a) Subaru has one of the more fuel efficient lineups:

source: https://nepis.epa.gov/Exe/ZyPDF.cgi?Dockey=P1010U68.pdf

(b)  Subaru is at the top of the list when it comes to improving efficiency.

Source: https://www.epa.gov/automotive-trends/highlights-automotive-trends-report#Highlight3

(c) As most of usl know, the price of gasoline made a significant move up in the last 6 months:

6 months ago gas averaged $2.20.  Now it is $3.10

It is fun to take things to the extreme.  At $300/barrel oil, a gallon of gas will still cost only $8.34 (Source:  https://econbrowser.com/archives/2014/06/gasoline-price-calculator).  If you are driving around a Jeep that gets 15 mpg and gasoline hits $8.34/gallon, the total cost of ownership (lease + fuel) for a shiny new Crosstrek will be lower than just the variable cost of driving your Jeep.  You can just park the Jeep (assume no salvage value) and lease a Subaru like my hipster neighbor.  If you actually drive off road and think that only a Jeep will do, worry not, the Subaru can handle it.

Comparison of Jeep Wrangler vs. Crosstrek:

https://www.youtube.com/watch?v=4PRQyNjLaXY

Summary of Catalyst #1:  Recent increases in fuel prices will lead to an uptick in the purchase of fuel efficient vehicles, of which Subaru is well positioned.

Catalyst # 2: Dividends.

Subaru cut their dividend distribution at a time of “peak covid” fear in March of 2020.   From Investor Relations: “The Company positions the return to shareholders as an important managerial issue and have adopted performance linked approach based on continuous and stable dividend payouts, taking into account the business performance, investment plans, and business environment for each fiscal period.  The global pandemic of COVID-19 and the worldwide semiconductor shortage continue to exert a significant impact on the Company's production, sales, and other business activities. As a result of considering, from a comprehensive perspective, this unpredictable business environment, future fund demands, and other factors, the company's common stock will be 28 yen per share as per the latest dividend forecast.”

Source: Subaru investor relations

They cut their dividend in response to pandemic and chip shortage (yet it is still yielding 2.5% after cut).  If the dividend is restored to prior levels, the equity would yield 6.4%.  Even after the dividend cut, the dividend has increased 8% per year since the beginning of the century.

Their cash is piling up. Cash per share is at an all time high.

When covid & chip shortage are behind us they will have no excuse not to restore their dividend.

Downside:

Most of the time I don’t know why car companies (or any other companies for that matter) trade at 2x ebitda or 20x ebitda.  When the market is feeling good, they trade one way.  When the market is feeling bad they trade another.  I can’t recognize bottoms.  I can’t recognize tops.  However, I know myself.  I’ve been through a few bear markets.  I have found that when the numerator causes TEV/EBITDA to hit 0 (and there are no bondholders to worry about) I usually am a pretty good buyer.  So please excuse my temporary digression into the investment climate we find ourselves.  I will tie it back to the value proposition for owning Subaru shares.

Equity inflows (whatever those are) are at a record high.  Where is this money coming from? What will happen when it stops?  Can it go on like this forever?

The Fed is quantifiably unhinged.  The Taylor Rule quantifies the Fed’s mandate (price stability and full employment).  The Fed Rate is lower than it should be by a wider margin than anytime in history:

For the first time in decades inflation is higher than the yield on the 10-year bond!

I don’t like it when people put scary macro data in a stock pitch but I needed it to set the stage for Subaru’s value proposition.  In a bear market a company’s share price can get cut in half for no reason.  In a bear market I can see 50% haircut happening to any number of debt-laden car companies but if Subaru’s share price gets cut in half you will be sitting on a business with a zero enterprise value (Free!).  If Ford’s market cap gets cut in half the enterprise value will still be higher than it was 3 years ago. Did they sell more cars this year than they did 3 years ago?  No, they sold less.  Toyota?  If their share price gets cut in half, the enterprise value will still be higher than it was last year!!!  There is solid ground down there with Subaru. You cannot say that for most stocks. The way Subaru is positioned verse other car makers is truly unique. Hopefully, we don’t touch zero ev.  If we do it will probably feel right to buy more.

Investment Risks:

Smallest car maker might be last in line to get the chips. 

Consumer tastes change?  Love turns to hate.  

Subaru’s plugin electric cars (based on Toyota’s tech) aren’t successful.   Note: Toyota owns 20% of Subaru.  Subaru’s Crosstrek uses Toyota’s plugin hybrid technology.  

Revenue was flat over 5 years prior to covid19.  

Catalyst

(1) Restorartion of pre-covid dividend

(2) Consumers shift to fuel efficient vehicles 2 years after significant increase in gasoline prices