Has Volvo’s Strong Value Creation Been Overlooked by the Market?

Value play with strong dividend growth potential

The post was originally published here.

Highlights:

• Acquisition in China to ride demand wave
• Consistent value addition through strong profitability
• Leading role in EV and hydrogen to reclaim market share

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Price on the way to turn bullish, volume signal unclear

• In 2H21, the 50 DMA has mainly stayed below the 200 DMA
• However, most recently, the 50 DMA started to rise, and it seems like it can cross the 200DMA very soon
  • If the 50 DMA-line were to continue to rise, we would consider it a bullish signal
• The RSI-Volume recently converged to the 50%-line which, if continues, would also be a positive sign

Q1 2022 hedge fund letters, conferences and more

Volvo’s revenue breakdown 9M21

Acquisition in China to ride demand wave

• China is by far the strongest and fastest-growing market for heavy duty trucks in the world
  • It is the primary market for the company to realize future growth opportunities
• Instead of exporting to China, Volvo aims to ramp up sales by establishing a production site in the country

New production site adds 7% capacity

• Volvo confirmed its plan to acquire JMC Heavy Duty Vehicle which owns a manufacturing site in Taiyuan, China
  • The acquisition accumulates to SEK1.1bn
• With the acquisition, Volvo aims to ramp up its sales in China
  • It adds 15,000 trucks to Volvo’s capacity
  • As a comparison, in 2020, Volvo delivered 4,500 trucks to China

Consistent value addition through strong profitability

• Volvo’s impressive ROIC is attributable to its specialization in high-margin trucks and construction equipment
  • Volvo sold its passenger vehicles unit in 1999 as the synergies between commercial and passenger vehicles were low
  • Since 2021, Volvo Car is a separate listed entity under majority control of Geely

• Volvo’s biggest competitor Daimler followed a similar strategy by spinning-off its truck segment in January 2022

What happens to a company’s ROIC over time?

Leading role in EV and hydrogen to reclaim market share

• Over the past 5 years, Volvo has lost market share in its most important regions
• Still, its early shift toward pure EV vehicles could help to regain its market share over the long run
  • The company is also betting on hydrogen which could be more suitable for trucks due to its long-distance ability
  • Strategic partnerships with Daimler (largest truck manufacturer) could lead to a more concentrated industry

FVMR Scorecard – Volvo

• A stock’s attractiveness relative to stocks in that country or region
• Attractiveness is based on four elements
  • Fundamentals, Valuation, Momentum, and Risk (FVMR)
• Scale from 1 (Best) to 10 (Worst)

Consensus remains cautious but sees upside

• 17 analysts expect the company to outperform while 9 analysts still stay cautious
• Analysts expect strong revenue growth in the next two years, but might be too pessimistic in 23E
  • Given that the global truck segment is expected to grow by 7-8% until 25E, I believe that Volvo can maintain a growth rate above 5%

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Get financial statements and assumptions in the full report

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P&L – Volvo

• Net profit sees a strong rebound in 21E and could exceed its pre-pandemic level in 22E
  • The strong bottom-line is mainly driven by the margin expansion, but also strong growth prospects

Balance sheet – Volvo

• Net assets have fallen in 2020 after selling UD truck segment to Isuzu Motors
  • However, increased CAPEX for capacity expansion and battery development lead to increase in net fixed assets again
• The company is moderately leveraged
  • In 2020, its net-debt to equity ratio stood at 0.9x

Cash flow statement – Volvo

• Strong operating cash flow allows the company to resume its dividend payments in line with its pre-pandemic policy
  • I expect dividend yield over the near-term to range between 2.5-3.5%

Ratios – Volvo

• After the revenue rebound in 22E, we assume revenue growth to normalize
  • Beyond 2022, I see a healthy annual revenue growth potential around 5%
• EBIT margin expansion in 21E likely to stay
  • This helps Volvo to be among the most profitable trucks manufacturer

Long-term share price performance potential

Free cash flow – Volvo

• Strong cash flow generation is crucial for returning dividends to shareholders

Value estimate – Volvo

• I see a slightly higher revenue growth than consensus
  • Tapping further into the Chinese market could constitute a catalyst for the share price
  • Truck market has favorable growth prospects

World Class Benchmarking Scorecard – Volvo

• Identifies a company’s competitive position relative to global peers
• Combined, composite rank of profitability and growth, called “Profitable Growth”
• Scale from 1 (Best) to 10 (Worst)

Key risk is intensified competition in local markets

• Adverse regulatory environment in China could hamper business
• Underestimating smaller local competitors could make expansion difficult
• Failure to keep up with technological shift to long-distance EV vehicles

Conclusions

• Riding demand wave in China is biggest potential for growth
• Fast adaption to EV and hydrogen give it a timing advantage in the market
• Industry-leading ROIC, but still trading at a discount

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Article by Andrew Stotz, Become a Better Investor.