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Renault – Are the shares still a buy?

06744 CC Trader Talk V2

Shares of Renault came under pressure last week after the arrest of Carlos Ghosn for serious misconduct including systematic understatement of his Nissan compensation and misuse of company assets.

Who is Carlos Ghosn?

Carlos Ghosn is the Nissan chairman as well as Renault CEO and chairman, Mitsubishi chairman, and RNM Alliance Chairman and CEO.

Will his removal as CEO of Renault impact the company’s operations?

We think there will be limited impact on the day-to-day operations of the company. More importantly, the benefits of the Renault-Nissan-Mitsubishi alliance should continue. The alliance focuses on cost sharing and a mutually beneficial platform. Such cooperation is ever more urgent as the industry gears up for the challenges and significant costs of electrification and autonomous driving.

What are investors worried about?

The market is worried about the strength of the alliance going forward now that the pioneer of the alliance will be out of the picture. We do not think this is the case and the alliance will continue business as usual.

What is expected to happened with the alliance?

With the removal of Ghosn as the chairman of the alliance, Nissan wants to increase its presence in the alliance and be on the same level with Renault. In my opinion for this to happen there are two scenarios to look at. Nissan either need to increase their shareholding in Renault or Renault reduce their holding in Nissan. (Nissan have 15% in Renault and Renault have 43% in Nissan).

Nissan buy more shares in Renault (option 1) – A raid on Renault would be more effective. If Nissan’s stake in the French group rises above 25 percent, Japanese cross-shareholding rules should kick in, and Renault’s Nissan shares would lose their voting power. That would cost 2.1 billion euros, assuming a 20 percent premium to the current Renault price, just one-quarter of the Japanese group’s cash pile. Renault could retaliate by trying to dilute Nissan, but the Japanese group has the firepower to keep buying.

Renault reduce their shareholding in Nissan (option 2) – Some analysts are urging Renault to sell down its stake in Nissan towards 25 percent and use the proceeds to buy back its own stock.

Both options are favourable for Renault shareholders.

Is Renault still a buy?

We maintain our BUY recommendation on the stock with a 12-month price target of €100. Analysts who are reducing the price target are not doing so because they are lowering the outlook of the company going forward. They are doing so by applying a much higher discount rate to cater for the risks on the alliance without Ghosn in the picture. We have seen discount rates as high as 30%, which in our opinion is excessive at this stage. We are applying a discount rate of 10% in our model.

Trading on a Price-to-earnings ratio of only 3.4x and an indicative gross yield of 6.01%, this stock is not one to go unnoticed. Buy on weakness.

Outlook

• Increase Group revenues (at constant exchange rates and perimeter

• Maintain Group operating margin above 6.0%

• Generate a positive Automotive operational free cash flow

Recommendation rationale

Despite the negative quarter, we maintain our price target on Renault at €100. Trading on a Price-to-earnings ratio of only 3.7x and an indicative gross yield of 5.5%, this stock is not one to go unnoticed.

We believe the sector as a whole is undervalued and Renault is one of the best positioned in the industry to continue to benefit from an improvements in global growth.

The market is punishing this sector for the CO2 emissions scandal, increased costs due to a shift out of gasoline engines and an increase in technology.

Having said this, Renault continues to report an improvement in sales and margins. Management launched a new strategic plan for 2017-2022 with an ambition to reach €70 billion (at constant exchange rates) in revenues and 7% operating margin at the end of the plan, while maintaining a positive operational automotive free cash flow every year.

Given the strong track record of management, we are of the view that Renault will continue to deliver strong results and we continue to rate this stock as an attractive buy.

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