Continental AG: Split in response to apparent undervaluation (OTCMKTS:CTTAF)

Continental (OTCPK:CTTAF) (OTCPK:CTTAY) simply looks undervalued. They will shut down their automobile business. We don’t really have any details on how much debt will be offloaded to newCo or other important information to set targets for those entities, we recognize that Continental is undervalued using fairly simple peers, which is possible because Continental’s businesses are fairly representative of the overall industries it’s in, and a spin-off can actually work. The problem is that they are exposed to recessionary concentrations in the meantime, as the spin-off is expected to take place in 2025.

Earnings and brief-off

The spin-off was only recently announced. In a session, the key data you want to be able to pin down on individual pieces is the debt figure, as spin-offs should theoretically lead to the same combined EV and the day after the demerger as a comprehensive entity the day before and is a useful anchor to be able to make an assessment as to whether the shares of newCo or the residual company are more interesting.

That data has not yet been provided and will depend on the company’s overall review, but other important data, such as the parts of the businesses being spun off, are already detailed. In short, it is separating its automobile business from its tire business.

This makes immediate strategic sense only because the tire business has well-defined industry peers and valuation levels. Also, in terms of segment margins at run rates, Continental’s tire business appears to be running at similar margins to its industry peers, namely Bridgestone (OTCPK:BRDCY) and Michelin (OTCPK:MGDDF).

The ContiTech business will remain with the residual company. They manufacture various rubber and plastic products used in industrial applications. It’s not particularly profitable and it’s also undergoing strategic review, which again makes sense as it demystifies the image around the tire business, which is most easily compared and benchmarked to peers.

Automobiles is under a fixed cost-cutting program, which has allowed the segment’s profits to grow. Growth areas were architecture and networking, with solid performance in safety and motion products, as well as automotive mobility. These segments are involved in powertrain and chassis manufacturing as well as braking systems. Product mix effects in architecture and networks also helped boost profits. These products are care items designed to provide sensor data and connectivity.

As with Bridgestone, there have been some problems in the truck markets, but their lower exposure to the US, where Thai imports have done most of the damage, has helped them avoid more serious performance hits. There was pressure on prices as input costs also fell, but overall replacement demand was decent, which is a key benefit for the tire market. In the long run, if electric vehicles do come in, their greater weight will wear out tires faster. In general, the volume has increased. Bridgestone has been down lately.

Automotive OE and general industrial OE in Europe is generally hit, also impacting tires a bit, but impacting ContiTech even more. Automotive OE levels are generally more affected in Europe than in the US, but cheap imports have a bigger impact on the US and the brands there. Continental does better with more European attention.

Conclusion

Earnings are not that remarkable, apart from the fact that they are not worse than peers. What we want to point out is that forward PEs for Continental are something like 8.56x based on analyst estimates. Bridgestone, which has been a bit of a laggard in performance lately, is trading at a forward PE of 10.4x. The default rating for the non-tire business is extremely low for Continental, using Bridgestone as compensation. About 35% of revenue comes from the non-tire business, which has an implied valuation of about 5x forward PE, assuming ContiTech should trade at tire multiples (it’s pretty low anyway). Taking Aisin ( OTCPK:ASEKY ) into account, which does some of the same things that Continental does in the automotive business, they have a forward PE of about 8.89x and are a Japanese company that tends to be thin compared to international peers which are listed. on more efficient markets. There certainly seems to be a value case here, and the spin-off may address that discrepancy.

Given that the multiples are actually pretty low here in an absolute sense and we’re pretty comfortable with the tires having replacement demand, we actually like the Continental. It also fell to historically low levels. We think it’s a buy. As for which side we would pick after the spin-off, it’s too early to say obviously and it will depend on the investor’s behavior after the spin-off (it will probably dump newCo, which is common).

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