Global Automotive Stocks/EV Focus/Event Driven, SC Capital

SC Capital

SC Capital has over 20 years' experience covering the global automotive industry both on the Sell Side (UBS & Morgan Stanley) and Buy Side (Och-Ziff), along with a wealth of industry contacts. 

Current focus is on electric vehicle stocks & their supply chains. Aim is to identify the winners and losers from a long/short perspective. This includes close coverage of legacy automakers as well.  

From time to time. we cover opportunistic events with stocks in the manufacturing sector, food & beverage, healthcare and tech, where we also have coverage experience.

Global Automotive Stocks/EV Focus/Event Driven

Bridgestone's Q2 Results & FY17 Upward Revision Are Lackluster

Bridgestone Results Below Guidance; Higher RM Costs to Impact Bottomline in FY2018

Shift in US Auto Sales Mix and La Nina Effect Could Put Bridgestone in Troubled Waters

Bridgestone Visit: Price Hikes Passing Smoothly at Mid/High End Though Low End Is Competitive

Over 22 years covering Japanese equities on both the sell side and the buy side. 

Bottom-up Japan Equities Research

Equity Bottom-Up

FY18 Fundamentals are Weak, but Bridgestone's Buffers are Big: While Bridgestone's Q2 results announcement on August 9th could be in line with consensus estimates of Y106bn (which is 10% above the company's target of Y96bn), the quality of these numbers may disappoint. Tire demand conditions in Bridgestone's major markets are much weaker than expected, but the company's profit buffers are so big that it could undershoot its regional OP targets, yet still hit consensus estimates. The amount of "buffers" Bridgestone has if regional OP targets are missed amount to over 12% of its own total Q2 OP target.  The Weak Fundamentals: Volumes and pricing in the US tire market--nearly half of Bridgestone's global sales--are quite poor, while Japan and China are also weaker than expected. Much of this is due to last year's price hikes leading to lower-than-expected sales volumes. In the US, for example, Bridgestone said that Q1 local tire makers' sales were down -5% YoY while cheaper imports spiked by 14%. It appears like, while last year's price hikes may have "stuck", consumers are either buying less or looking for cheaper imported brands. The Huge Profit Buffers Bridgestone has for Q2: Bridgestone has a huge SG&amp;A spending budget for this year which amounts to 16% of 1H OP and 10% of 2H OP, versus the average four-year trend of only 3% of 1H OP and 2% of full-year OP. Management says they can trim this if needed, i.e. if regional tire sales are weaker than expected. Furthermore, Bridgestone is forecasting -Y3.5bn in segment OP eliminations and -Y16bn for the full year. This too is unusually high and Q1's eliminations were actually positive Y2.7bn, so if the Q2 elimination comes to just zero, there is a Y6.2bn buffer for Q2 OP target of Y96bn (or 6% upside to targets). Therefore, if Bridgestone misses its regional OP targets--which is a distinct possibility after seeing Michelin's 1H results--it has roughly a 12% OP buffer for the 1H and at least 10% for the full year. But the optics of this would be bad. The focus on Q2 results and FY18 guidance on August 9th should be on the company's regional OP trends, not the headline numbers.   Michelin's 1H Results Were Barely in Line: Michelin missed 1H consensus sales and OP estimates by only 2% and 1.7%, respectively due to (1) better than expected "price/mix" relative to raw material costs; (2) strong sales of highly profitable specialty tires for mining, agriculture, and earth-moving equipment; and what it said was higher market share in the 18"+ tire segment for the SUVs/light trucks. While Michelin maintained its guidance for "slightly higher" OP than last year on July 23rd (consensus sees +3% growth in FY18 OP), it did warn that higher raw material costs related to oil-related ingredients, could become a headwind in the 2H.  Why Michelin's 1H Results Indicate a Tough 2H for Bridgestone: While Bridgestone and Michelin are the number one and two global tire giants, respectively, Michelin's earnings structure is different in two key areas. First, and foremost, the European tire market is firm, while conditions, as mentioned above, are weak in the US. Michelin has only 35% of its global sales linked to the North American market, whereas Bridgestone has 48% exposure, while Michelin has 39% of its sales derived from Europe, where Bridgestone only has 17% sales exposure. Michelin is at a clear advantage, as the US tire market is very weak (1H volumes at Michelin were only up +1%), while Europe's replacement market was up +6% YoY in the 1H. Despite its higher exposure to the weak US market and low presence in Europe, Bridgestone's 2H targets call for (1) "near 10% growth" in global tire volume sales; (2) +4.7% revenue growth; and (3) +23% YoY OP growth. Michelin doesn't disclose such targets, but consensus estimates sees only +2.7% revenue growth in the 2H and +11% YoY OP growth (see table-1 below).Bridgestone's Tire sales Mix Lagging Michelin's: While Bridgestone's operating margin has been higher than Michelin's for the past six years as the euro--Michelin's home currency--has gained +35% in value relative to the yen, this has changed in the past 12 months. Even if Bridgestone hits its 1H targets, its OP margin of 11.9% will be lower than Michelin's 12.5%, making it the second half-year in a row that Bridgestone under-performs Michelin in profitability, despite yen weakness and euro strength (see Chart-1).   Price/Mix Spreads versus Raw Material Costs Have Been Superior at Michelin over the Past 4 Years: Looking at both company's OP contribution from volume/pricing/mix minus raw material costs (tire spreads), Michelin has seen higher tire spreads than Bridgestone for 6 out of the 9 past half-year results (see Chart-2). This is despite Bridgestone having a currency advantage over Michelin (forex impact is not counted in the tire spread, but allows for better pricing power at Bridgestone). One of the key reasons behind this may be linked to the fact that Michelin's highly profitable specialty tires for mining/agricultural equipment (roughly 25% OP margins) make up 20% of its global sales, while at Bridgestone, large mining tire sales only comprise around 10% of sales.   China is Tougher than Expected at Bridgestone: Replacement tires make up most of the profits of a tire maker (original equipment, or OE tires, carry very low margins, but contribute to capacity utilization) and in most markets, Bridgestone's sales weighting of replacement to OE tires is 70%/30%. In China, however, it's a 50-50 split and competition is fierce, despite overall firm demand. Bridgestone's Q1 results in China were weak, with +1.3% YoY sales growth and an OP decline of -15% YoY because of weak replacement tire sales. Bridgestone says it can still make it's 1H OP target in the China segment due to easy hurdles and a recovery in high-margin truck tire sales. The situation appears fragile, nevertheless.  Bridgestone's Home Market of Japan Could Disappoint: The Japan Automobile Tyre Manufacturers Association (JATMA) revised its domestic demand outlook for replacement tires downward by -2% on July 23rd. Michelin also cited weakness in Japan and South Korea as the main factor behind falling Asian sales.  While Japan's tire market is not that large, Bridgestone's 40%+ market share in its home market does provide around 17% of OP, by our estimates, so it's not insignificant. Bridgestone is Boosting Tire Capex by 44% while Michelin Has Been Cutting Capex: Despite what seems like the peak of the cycle in the global tire market, Bridgestone is boosting tire capex by 44% to Y310bn ($2.8bn) in FY18, while Michelin's capex has been gradually shrinking to an estimated EUR1.75bn ($2bn, see Chart-3). Bridgestone says that much of this is to increase capacity in the EU, US and Canada via higher efficiencies, as well as growing its Indian presence. Spending for growth in Europe and India makes perfect sense, as those markets show stable growth and Bridgestone needs higher exposure there, but expanding capacity in North America--where excess industry capacity is the core problem to weak profitability--at the peak of the cycle is a bit of a concern.  Valuations &amp; Profitability: Bridgestone's FY18 PER (based on company targets) is 10x and its EV/EBITDA is at 4x. Both are lower than the 5-year averages of 11.4x for PER and 4.5x for EV/EBITDA, however it should be noted that EBITDA has grown by 143% from its trough in FY09 and is -6% below its FY15 peak. FY18 targets at Bridgestone call for 9% EBITDA growth FY18. Michelin trades at an FY18 PER of 10.7x consensus estimates and an EV/EBITDA of 4.9x. Michelin's valuation premium is most likely due to less downside to its guidance this year, higher profitability and a better geographical footprint. Given that the global tire market has grown immensely over the past 8 years, further upside appears limited and therefore current valuations at Bridgestone and Michelin do not appear attractive, in our view.

FY18 Fundamentals are Weak, but Bridgestone's Buffers are Big: While Bridgestone's Q2 results announcement on August 9th could be in line with consensus estimates of Y106bn (which is 10% above the company's target of Y96bn), the quality of these numbers may disappoint. Tire demand conditions in Bridgestone's major markets are much weaker than expected, but the company's profit buffers are so big that it could undershoot its regional OP targets, yet still hit consensus estimates. The amount of "buffers" Bridgestone has if regional OP targets are missed amount to over 12% of its own total Q2 OP target.  The Weak Fundamentals: Volumes and pricing in the US tire market--nearly half of Bridgestone's global sales--are quite poor, while Japan and China are also weaker than expected. Much of this is due to last year's price hikes leading to lower-than-expected sales volumes. In the US, for example, Bridgestone said that Q1 local tire makers' sales were down -5% YoY while cheaper imports spiked by 14%. It appears like, while last year's price hikes may have "stuck", consumers are either buying less or looking for cheaper imported brands. The Huge Profit Buffers Bridgestone has for Q2: Bridgestone has a huge SG&amp;A spending budget for this year which amounts to 16% of 1H OP and 10% of 2H OP, versus the average four-year trend of only 3% of 1H OP and 2% of full-year OP. Management says they can trim this if needed, i.e. if regional tire sales are weaker than expected. Furthermore, Bridgestone is forecasting -Y3.5bn in segment OP eliminations and -Y16bn for the full year. This too is unusually high and Q1's eliminations were actually positive Y2.7bn, so if the Q2 elimination comes to just zero, there is a Y6.2bn buffer for Q2 OP target of Y96bn (or 6% upside to targets). Therefore, if Bridgestone misses its regional OP targets--which is a distinct possibility after seeing Michelin's 1H results--it has roughly a 12% OP buffer for the 1H and at least 10% for the full year. But the optics of this would be bad. The focus on Q2 results and FY18 guidance on August 9th should be on the company's regional OP trends, not the headline numbers.   Michelin's 1H Results Were Barely in Line: Michelin missed 1H consensus sales and OP estimates by only 2% and 1.7%, respectively due to (1) better than expected "price/mix" relative to raw material costs; (2) strong sales of highly profitable specialty tires for mining, agriculture, and earth-moving equipment; and what it said was higher market share in the 18"+ tire segment for the SUVs/light trucks. While Michelin maintained its guidance for "slightly higher" OP than last year on July 23rd (consensus sees +3% growth in FY18 OP), it did warn that higher raw material costs related to oil-related ingredients, could become a headwind in the 2H.  Why Michelin's 1H Results Indicate a Tough 2H for Bridgestone: While Bridgestone and Michelin are the number one and two global tire giants, respectively, Michelin's earnings structure is different in two key areas. First, and foremost, the European tire market is firm, while conditions, as mentioned above, are weak in the US. Michelin has only 35% of its global sales linked to the North American market, whereas Bridgestone has 48% exposure, while Michelin has 39% of its sales derived from Europe, where Bridgestone only has 17% sales exposure. Michelin is at a clear advantage, as the US tire market is very weak (1H volumes at Michelin were only up +1%), while Europe's replacement market was up +6% YoY in the 1H. Despite its higher exposure to the weak US market and low presence in Europe, Bridgestone's 2H targets call for (1) "near 10% growth" in global tire volume sales; (2) +4.7% revenue growth; and (3) +23% YoY OP growth. Michelin doesn't disclose such targets, but consensus estimates sees only +2.7% revenue growth in the 2H and +11% YoY OP growth (see table-1 below).Bridgestone's Tire sales Mix Lagging Michelin's: While Bridgestone's operating margin has been higher than Michelin's for the past six years as the euro--Michelin's home currency--has gained +35% in value relative to the yen, this has changed in the past 12 months. Even if Bridgestone hits its 1H targets, its OP margin of 11.9% will be lower than Michelin's 12.5%, making it the second half-year in a row that Bridgestone under-performs Michelin in profitability, despite yen weakness and euro strength (see Chart-1).   Price/Mix Spreads versus Raw Material Costs Have Been Superior at Michelin over the Past 4 Years: Looking at both company's OP contribution from volume/pricing/mix minus raw material costs (tire spreads), Michelin has seen higher tire spreads than Bridgestone for 6 out of the 9 past half-year results (see Chart-2). This is despite Bridgestone having a currency advantage over Michelin (forex impact is not counted in the tire spread, but allows for better pricing power at Bridgestone). One of the key reasons behind this may be linked to the fact that Michelin's highly profitable specialty tires for mining/agricultural equipment (roughly 25% OP margins) make up 20% of its global sales, while at Bridgestone, large mining tire sales only comprise around 10% of sales.   China is Tougher than Expected at Bridgestone: Replacement tires make up most of the profits of a tire maker (original equipment, or OE tires, carry very low margins, but contribute to capacity utilization) and in most markets, Bridgestone's sales weighting of replacement to OE tires is 70%/30%. In China, however, it's a 50-50 split and competition is fierce, despite overall firm demand. Bridgestone's Q1 results in China were weak, with +1.3% YoY sales growth and an OP decline of -15% YoY because of weak replacement tire sales. Bridgestone says it can still make it's 1H OP target in the China segment due to easy hurdles and a recovery in high-margin truck tire sales. The situation appears fragile, nevertheless.  Bridgestone's Home Market of Japan Could Disappoint: The Japan Automobile Tyre Manufacturers Association (JATMA) revised its domestic demand outlook for replacement tires downward by -2% on July 23rd. Michelin also cited weakness in Japan and South Korea as the main factor behind falling Asian sales.  While Japan's tire market is not that large, Bridgestone's 40%+ market share in its home market does provide around 17% of OP, by our estimates, so it's not insignificant. Bridgestone is Boosting Tire Capex by 44% while Michelin Has Been Cutting Capex: Despite what seems like the peak of the cycle in the global tire market, Bridgestone is boosting tire capex by 44% to Y310bn ($2.8bn) in FY18, while Michelin's capex has been gradually shrinking to an estimated EUR1.75bn ($2bn, see Chart-3). Bridgestone says that much of this is to increase capacity in the EU, US and Canada via higher efficiencies, as well as growing its Indian presence. Spending for growth in Europe and India makes perfect sense, as those markets show stable growth and Bridgestone needs higher exposure there, but expanding capacity in North America--where excess industry capacity is the core problem to weak profitability--at the peak of the cycle is a bit of a concern.  Valuations &amp; Profitability: Bridgestone's FY18 PER (based on company targets) is 10x and its EV/EBITDA is at 4x. Both are lower than the 5-year averages of 11.4x for PER and 4.5x for EV/EBITDA, however it should be noted that EBITDA has grown by 143% from its trough in FY09 and is -6% below its FY15 peak. FY18 targets at Bridgestone call for 9% EBITDA growth FY18. Michelin trades at an FY18 PER of 10.7x consensus estimates and an EV/EBITDA of 4.9x. Michelin's valuation premium is most likely due to less downside to its guidance this year, higher profitability and a better geographical footprint. Given that the global tire market has grown immensely over the past 8 years, further upside appears limited and therefore current valuations at Bridgestone and Michelin do not appear attractive, in our view. 

Bridgestone (5108) Q2 Preview--Don't Get Seduced by Its Chart or Michelin's 1H Results

Bridgestone Corp

Bridgestone (5108) Q2 Preview--Don't Get Seduced by Its Chart or Michelin's 1H Results