Several Headwinds Hit Continental Q1 Results, Reduces 2022 Profit Guidance; EUR 143 FVE Unchanged

Business Strategy & Outlook

Considering industry trends in connectivity, electronics, and safety, the Continental’s revenue will grow at a faster rate than the estimated 1%-3% long-term average annual growth in global vehicle production. Above-industry-average research and development spending enables consistent product and process innovation, supporting Continental’s revenue growth, healthy return on invested capital, and a narrow economic moat rating.

After an acquisition binge that culminated in 2007 with the purchase of Siemens VDO, Continental has grown from being predominantly a European tiremaker to a global supplier of automotive components, systems, and modules. In 2008, Continental became an acquisition target as Schaeffler unsuccessfully bid for the company (Schaeffler still owns 46% of the voting interest).

Continental should benefit from automotive industry trends, including advanced driver-assist systems, autonomous driving features, V2X connectivity, and increased vehicular electronics. The company invests in and successfully cultivates innovative technologies. The Continental’s innovation combined with industry trends results in revenue growth and margins that are better than industry averages. Management’s long-term targets are to annually increase revenue in excess of 5% and generate adjusted EBIT margins in the 8% to 11% range. Management spun off its powertrain division in September 2021 into a new company called Vitesco that trades under the ticker VTSC. Since 2008, powertrain segment revenue has grown at an average annual rate of 6%. In 2019, pro forma Vitesco had EUR 9.1 billion in pre pandemic revenue and an adjusted EBITDA margin of 9.5%. However, in 2020, Vitesco pro forma revenue was EUR 8 billion with an adjusted EBITDA margin of 6% due to COVID-19-related industry factory closures. While Vitesco supplies components for internal combustion engine powertrains, the new company’s electrified vehicle powertrain product lines should support revenue growth in the mid-single-digit range.

Financial Strengths

Continental’s financial health appears to be in good shape. Management targets investment-grade credit ratings and a gearing ratio (net debt/equity) range of 40% to 60%. At the end of 2021, the company’s liquidity was EUR 7.3 billion, the gearing ratio was 30%, and total adjusted debt/EBITDAR, which treats operating leases as debt and rent expense as interest, was 2.7 times. Since 2011, Continental has averaged 1.8 times total adjusted debt/EBITDAR, while netting cash against debt results in about a 1.4 times ratio. The Continental’s cash generation and liquidity are more than sufficient to buffer a cyclical downturn in auto demand, including lingering effects of the pandemic and the microchip shortage.

By the end of 2006, Continental had reduced its debt to a more prudent level after its acquisitions made between 1998 and 2004. The capital structure became heavily debt-laden in 2007 when management made four acquisitions: Siemens VDO, Matador, Thermopol, and AP Italia. As a result, the company went through the financial crisis with a highly leveraged balance sheet, and debt levels remained elevated through 2013. Since 2011, the gearing ratio has averaged 47%. However, since 2014, Continental’s gearing ratio has averaged only 33%. The company has mostly used bank credit lines but also has outstanding bonds, securitization, factoring, asset-backed securities, commercial paper, and capital leases, all of which are on balance sheet. Maturities appear well laddered with the exception of roughly EUR 1.6 billion in short-term debt. The company has EUR 6.1 billion in open credit lines, of which, EUR 4.9 billion was available at year-end 2021. While Continental’s EUR 4.0 billion revolving bank line of credit due in 2025 had not been utilized, short-term debt includes EUR 1.2 billion outstanding on other lines of credit. The large short-term debt balance has typically been rolled to the next year.

Bulls Say

Continental is well positioned to capitalize on auto industry trends like safety, electronics, connectivity, and automated driving. As a result, the company’s revenue to average growth in excess of average annual growth in global vehicle production.

The ability to continuously innovate new process and product technologies should enable Continental to maintain a narrow economic moat.

A global manufacturing footprint enables participation in global vehicle platforms and provides penetration in developing markets.

Company Description

Continental is a global auto supplier and tiremaker. Operating segments include the autonomous mobility and safety segment and the vehicle networking and information segment in the automotive group, plus tires and ContiTech, which uses rubber in industrial and automotive components and systems, in the rubber group. Last year, pro forma for the spinoff of Vitesco, automotive group revenue was around 45% (AMS 22%, VNI 23%) of the total, rubber group revenue was 52% (tires 35%, CT 17%), and contract manufacturing for Vitesco was 3%. Top five customers include Mercedes-Benz, Ford, the Renault-Nissan-Mitsubishi alliance, Stellantis, and Volkswagen, representing about 33% of total revenue. Europe, at 48% of total revenue, is the company’s largest market, followed by North America at 26%.

(Source: Morningstar)
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