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Morningstar | Peugeot's 1H Surprises on Opel Vauxhall Profit; Raising FVE to EUR 16

No-moat-rated Peugeot reported surprisingly strong first-half earnings per share of EUR 1.58, blowing away the consensus EPS of EUR 1.31 by EUR 0.27, and EUR 0.19 better than EPS of EUR 1.39 reported last year. Being a company domiciled in France, Peugeot reports only revenue in fiscal first and third quarters and full financial results for the fiscal first half and full year. Owing to the surprisingly strong results, we have raised our fair value estimate to EUR 16, up EUR 2.30 from our previous EUR 13.70. Unfortunately, we think the market has got ahead of itself, with shares trading at a 47% premium to our new fair value estimate. In our opinion, this 2-star-rated stock is overvalued relative to our expectations for profitability, cash flow, and returns on invested capital.

Consolidated first-half revenue increased by 40.1% to EUR 38.6 billion versus EUR 27.6 billion, as the acquisition of Opel Vauxhall, or OV, was not included in the prior year's results, but revenue was roughly in line with our expectations. Revenue from the Peugeot Citroen DS group was solid, jumping 11% to EUR 22.1 billion from EUR 19.9 billion, slightly better than we expected. Opel Vauxhall contributed EUR 9.9 billion, while Faurecia's contribution to Peugeot's revenue was EUR 9.0 billion.

However, we had expected OV to be much more earnings-dilutive, with recurring operating income (ROI is before special items) of slightly less than EUR 200 million and a margin just shy of 2%. Instead, the OV group posted an astounding EUR 502 million ROI for a margin of 5.0%. The Peugeot Citroen DS group ROI margin also saw healthy expansion, jumping 120 basis points to a very respectable 8.5%, from 7.3% in the first half of 2017. Faurecia contributed ROI of EUR 642 million, up 10% from EUR 583 million last year. Consequently, consolidated ROI skyrocketed 48% to EUR 3.0 billion versus EUR 2.0 billion reported in first-half 2017. Consolidated ROI margin expanded 40 basis points to 7.8%.

After acquiring OV last year, management had guided to OV ROI margins of 2.0% in 2020 and 6% by 2026. We thought we had been forecasting more optimistically, based on management's stellar performance turning around the troubled Peugeot Citroen DS operations, by forecasting margin just shy of 2% in 2018. The OV margin dilution in our estimate resulted in a 110-basis-point contraction in consolidated 2018 ROI margin to 5.3% from 6.4% reported in 2017. With first-half OV ROI performance at 5.0%, we have raised our full-year consolidated ROI margin assumption to 7.4%.

Based on General Motors’ information, on a U.S. GAAP basis, OV’s ROI margin from 2007 to 2015 averaged negative 6.8% with a high of negative 1.2% (2007), a low of negative 15.3% (2009), and a median of negative 7.1%. We used Peugeot management's figures to calculate OV 2016 ROI margin at negative 1.6%, but including adjustment for IFRS capitalization of R&D expense, the margin was positive 1.6%. OV margin while under Peugeot management from August 2017 to the end of the year was negative 2.6%. However, August and December holiday shutdowns tend to seasonally skew margins lower in the second half.

During the past 10 years, Peugeot's high, low, and median EBITDA margins are 11.0% (2015), 4.1% (2012), and 7.1%. The average EBITDA margin during our Stage I forecast is now 10.2%, up 140 basis points from the previous model's Stage I average of 8.8%. The average includes an 11.8% peak EBITDA margin in 2020 before contracting in years four and five to a normalized sustainable 7.0% midcycle EBITDA margin. Our new midcycle assumption reflects an 80-basis-point increase from our prior model's 6.2% midcycle assumption.

Because of the persistent losses experienced by OV under General Motors' ownership, partially offset by Peugeot management's demonstrated ability to turn around troubled operations, we had previously believed that OV would remain dilutive during our Stage I forecast. Our new midcycle assumption reflects our belief that OV ROI margins will be in the 7% range by 2020, versus management's 2020 2% target.