Nissan: China Is A Major Concern Despite UAW Tailwinds

Introduction

The Company

Automakers have fallen out of investor favor in recent years, with the sector linked to very poor returns. In particular, many investors seeking high-quality companies with a moat tend to skip over the car manufacturing industry because of fierce competition, high capex, R&D spending, and low returns on capital employed.

Looking at Nissan, we have to know that Renault and Nissan recently announced that they have now entered into definitive agreements that will shape the new Renault-Nissan-Mitsubishi Alliance. The core of this new step is to rebalance Renault Group-Nissan cross-shareholdings. Nissan will become a strategic investor in Ampere, Renault Group's EV entity. The investment will be up to €600 million. At the same time:

Renault Group and Nissan will retain cross-shareholdings of 15% with lock-up and standstill obligations. Renault will transfer 28.4% of its Nissan shares into a French trust, where the entrusted shares will be voted neutrally, subject to limited exceptions. Renault Group would continue to fully benefit from the economic rights (dividends and proceeds of share sales) from the entrusted shares until such shares are sold. The transfer to the trust would trigger no impairment in Renault Group financial statements.

As a result of the transfer of the 28.4% of Nissan shares to the trust, Nissan would be able to exercise its voting rights attached to its shareholding in Renault Group. The voting rights of Renault Group and Nissan would be capped at 15% of the exercisable voting rights, with both companies able to freely exercise their voting rights within such limit.

The trustee will be able to sell the entrusted Nissan shares only if it will be advantageous for Renault Group, without a real obligation to sell them within a certain period of time.

As a result of this new step, Nissan is targeting to accelerate its EV ambitions by 2030, aiming at selling only electric vehicles in Europe.

Recent Results

Nissan reported at the end of July its Q1 financial results. Nissan reported outstanding results, with a YoY net revenue increase of 37%, an operating profit up 98%, and net income up 124%.

At the same time, retail sales were down 3.7%, especially because of its JV in China. Here, as reported during the last earnings call, "Nissan's unit sales dropped significantly in the first quarter. One of the reasons is the emergence of rapidly growing new energy vehicles offered by the local brands." Excluding China, sales would have been up 20.4%.

Overall, we see a company whose quarterly revenues still need to close the gap with the highs reached in the early 2010s. At the same time, the company shows to have a rather stable operating margin at 4%.

The last quarter was finally able to push the operating margin above 4%, coming in at 4.4% (¥2.917,7 billion over ¥128.6 billion; currently $1=¥150). For sure, we're nowhere close to a double-digit margin as we have seen in some competitors, such as Stellantis.

Nissan also disclosed its new FY outlook, both in terms of volumes and in terms of financial results. As we can see, new the outlook revises downward total retail sales due to challenges in China. North America, Japan, and Europe are seen slightly above previous forecasts. Overall, the new outlook still sees Nissan growing YoY. Yet, with China down 30% compared to the previous outlook, the company is taking a serious hit.

Nissan believes it needs to reach an OP margin of 4.4%, keeping its recent quarterly result as the benchmark for the whole fiscal year. For sure, China is not the highest-margin market and reduced China sales could actually favor higher-margin markets and make them weigh more on the overall results. Yet, we should not be deceived. An OP margin such as this is incredibly low for an industry that came out quite strong from the pandemic. European automakers, Stellantis above all, have all either achieved a double-digit margin or have come close to it.

China is a pain for Nissan. In fact, during the earnings call, the company had to admit it's using its plants at a low rate, with current sales falling well below total production capacity. To solve this issue, Nissan will explore the possibility to use its Chinese plants to produce vehicles that will be exported to other regions where production constraints are taking place. This can be a partial solution, but it will force production costs to increase as a consequence of export costs. With a 4.4% margin, Nissan doesn't have the profitability to sustain over the long run a decision such as this, as we can see if we compare it to the Big Three and VW.

The UAW Strike

Many analysts are forecasting a boost for Japanese automakers as a consequence of the UAW strike.

The union is seeking a 40% pay increase over four years and other demands include a four-day working week, pay increases linked to inflation, stricter limits on temporary staffing, and more holiday days.

Some analysts estimate a cost of $1 billion for every 10 days of strike by all 140,000 workers, who would lose around $900 million in wages. The total hit to the economy could be around $5 billion, considering the Big Three account for about 40% of US car sales.

If the strike goes on for long, for sure there will be a demand shift, leading potential Big Three customers to look at other automakers for a vehicle. Japanese cars should benefit from this. But in order for this shift to take place, the strike needs to go on for several months in order to create enough unmet demand to be perceived in terms of market share changes.

So far, the strike has only started, and we don't yet know how long it will last. Nissan runs the assembly plant in Smyrna, Tenn., which is one of the largest in the U.S., with a production capacity of 640,000 cars. Surely, Nissan would be able to supply new cars with the speed in case many customers in need of a new vehicle won't be able to wait for GM, Ford, and Stellantis to solve their issues.

In addition, Nissan has much more debt than cash, unlike Stellantis. This means that, as I have explained in another article, Stellantis has a strong balance sheet which will be able to support higher production costs without impacting the company. Nissan, on the other hand, can't stretch its production too much because it already has a lot more debt than cash. In addition, its woes in China already give it a headache which will impact on the future balance sheet.

Valuation

Nissan is witnessing a three-year CAGR below 10%, whereas STLA is at 50.25%. Its margins are well below Stellantis', as we have seen. Yet, it trades at an fwd PE of 6.3, while Stellantis is below 3. Nissan's fwd EV/EBITDA ratio is at 9, while Stellantis has a 1. For a company whose growth is undermined by China, I don't see the UAW strike as a strong enough tailwind to offset the impact of a much more strategic region. This is why I think Nissan is overvalued, and I think it should trade around a 4 PE.

Conclusion

I suggest not to be fooled. The UAW strike can be a boost for Japanese stocks, but we're too early in the game to understand if this will be meaningful. In addition, Nissan is not a company whose financials are as strong as other automakers, Stellantis above all. Therefore, I believe the recent surge in price the stock has seen this year should be the right opportunity to cash in and move to more profitable stocks.

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