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Continental benefits from Auto Industry Trends in Connectivity, Electronics and Safety

Business Strategy and Outlook

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 (it still holds 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. 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 prepandemic revenue and an adjusted EBITDA margin of 9.5%.

Continental sees Q3 Chip Crunch Hit to Results, Maintains Adjusted Guidance; EUR 143 FVE Unchanged 

Narrow-moat-rated Continental reported third-quarter earnings per share from continuing operations of EUR 1.27, handily beating the EUR 0.81 FactSet consensus by EUR 0.46 and jumping EUR 4.54 from the EUR 3.26 loss reported in the COVID-19-affected year-ago period. Consolidated revenue missed consensus by nearly 1%, declining 7% to EUR 8.0 billion from EUR 8.7 billion last year. However, excluding currency effect, organic revenue declined 9%. Our EUR 143 Fair Value Estimate remains unchanged. 

Third-quarter adjusted EBIT was EUR 419 million for 5.2% margin, down from a EUR 727 million with an 8.4% margin last year as the chip crunch made customer production sporadic during the quarter. Consolidated revenue is expected to be in a range of EUR 32.5 billion-EUR 33.5 billion with adjusted EBIT margin forecast in a range of 5.2%-5.6% and free cash flow in the range of EUR 0.8 billion – EUR 1.2 billion. However, management lowered its tax rate assumption to 23% from 27% due to the lower profitability guidance, which had minimal effect on our fair value.   

Financial Strength 

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 2020, the company’s liquidity was EUR 10.8 billion, the gearing ratio was 44%, and total adjusted debt/EBITDAR, which treats operating leases as debt and rent expense as interest, was 2.6 times. Since 2010, Continental has averaged 1.8 times total adjusted debt/EBITDAR, while netting cash against debt results in about a 1.4 times ratio. 

Maturities appear well laddered with the exception of roughly EUR 2.2 billion in short-term debt. The company syndicated a new 365-day EUR 3.0 billion line of credit in 2020 due to the pandemic, which was unused at year-end. While Continental’s EUR 4.0 billion revolving bank line of credit due in 2025 had not been utilized, short-term debt includes EUR 1.5 billion outstanding on other lines of credit. The large short-term debt balance has typically been rolled to the next year.

Bulls Say’s 

  • Continental is well positioned to capitalize on auto industry trends like safety, electronics, fuel economy, and emissions reduction. As a result, we expect 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 Profile 

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 spin-off of the powertrain segment, automotive group revenue was around 50% of the total with AM&S and VN&I each accounting for about 25%. Rubber group revenue, also at around 50% of the total, includes tires at about 32% and CT at around 18%. The company’s top five customers are Daimler, Stellantis, Ford, the Renault-Nissan-Mitsubishi alliance, and Volkswagen, representing about 37% of total revenue (as reported, before the Vitesco spin-off).

(Source: Morningstar)

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