ALD SA (ISIN FR0013258662) – Cheap growth stock or potential Diesel road kill ?

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Background:

As mentioned a few days ago, ALD SA has been IPOed by parent SocGen on June 16th. SocGen sold ~23% of the stock and remains majority shareholder. The first question of course is: why did they do this ?

The official reason was the following:

The IPO confirms the strategic nature of ALD within Societe Generale group. It will allow ALD to accelerate its development and become a leader in a rapidly changing mobility space.

In my opinion, the real reason is that SocGen needs to shore up its CER1 ratio which at the end of Q1 was 11,6% and at the low end of systemically important banks. Selling a subsidiary at 2x book is clearly more attractive than to sell the parent’s stock at below  book.

SocGen IPOed at the lower end of the announced range (14,30 EUR vs. 14,20 -17,40). In the beginning the stock traded even further down to below 13,50 EUR. Clearly not a great achievement for an IPO by a parent which advises others on IPOs, but maybe they needed the capital boost for their Q2 numbers. If so, the IPO could present a chance for investors.

ALD SA & Auto leasing business

Auto leasing as such looks like attractive business. According to the IPO prospectus, ROE has been between 18%-21% in the last few years.

At first sight, the stock doesn’t look too expensive either:

Based 2016 earnings (net Income 512 mn EUR), ALD trades at a trailing P/E of 12,5. Not expensive if one considers that profit has grown by +22% p.a. since 2011. With around 3 bn EUR of Equity, the P/B multiple is 2,1, again not unreasonable for a 20% ROE financial business.

It looks like that leasing is much more attractive than the core banking and lending activities of SocGen which only produces ROEs in the single digits. Other than normal loan business, leasing allows more opportunities to create value both, for clients and shareholders. In ALD’s case fo instance they can achieve discounts as a bulk buyer which might not been achievable for their clients plus they can offer all kind of fleet management services. Another factor might be that salaries in the leasing sector are generally lower than in the fancy banking sector.

Things I don’t like

As always, whenever I start to like a stock, I look for stuff which is not so nice. An IPO prospectus like in ALD’s case is often a good source because it contains a very detailed risk section. And unfortunately, there were some things that I didn’t like:

  1. Funding mostly via SocGen

This is from the IPO prospectus:

As at 31 March 2017, 73% of the Group’s funding was provided by Société Générale on an arm’s length basis and 27% was raised from external sources. Société Générale
has committed to continue to provide the majority of the Group’s funding following the contemplated listing of the Company’s shares on Euronext Paris, as long as the Company requests it.
The Group intends to maintain its issuance program in the capital markets in the future. In the event of liquidity stress on the market, Société Générale has committed in the near term to provide the Group with liquidity support in order to enable the Group to pursue its operations.
.
If in the future the Group no longer benefits from debt funding provided by Société Générale on the same terms or costs as it has benefited historically or from
bank financing supported by guarantees or collateral provided by Société Générale, this could have a material adverse effect on the Group’s business

ALD currently only has a BBB Rating, which for a financial company is not that strong. It is hard to say from the outside how “arm’s length” the financing terms currently are. ALD has some outstanding bonds, for instance a 2022 Senor bond (ISIN XS1647404554) which trades at a Swap spread of 50 bps. But still it is a risk factor especially as SocGen seems to provide a backstop only “near term”, whatever that means.

2. Strangely low tax rate

For 2016, ALD showed only a tax rate of ~23%. ALD is active mostly in countries with higher tax rates (France, germany etc.) and the tax rate was 29% the year before. Honestly, I didn’t understand the reasons (annual report page 53), but I think in a normal year they should pay more taxes.

3. Diesel

I think I don’t need to explain a lot about the current “Diesel Crisis”. One of the effects at the moment is that prices of used Diesel cars are sinking, especially in German cities where there is a discussion about banning Diesel cars from the City centre. I think no one knows where this will end, but ALD clearly has exposure via the residual value of their car fleet. Reading the IPO prospectus I was surprised how high the percentage of Diesel cars is.

As of 31 December 2016, diesel engine vehicles constituted 80% of the Group’s fleet and 93% of the Group’s fleet in France.

It’s hard to predict what will happen. Clearly they will not go bankrupt because of this, but one could assume that at least the profits from the sale of returned cars might not increase that much in the future. ALD earned 200 mn in 2016 selling cars above the residual book value. (10% of sales value). In a worst case scenario we might see that a large part of the annual profit is wiped out with extra depreciation. So not a road kill, but clearly some risk.

4. Margins

ALD shows “net interest income” of around 500 mn EUR, That’s a net margin of around 3,9% on an average fleet of 13 bn EUR. That sounds like a lot to me for a relatively low risk business. I am wondering that especially larger corporate clients are prepared to pay such high interest rates. However in 2015, the margin was 30 bps higher. So one needs to really understand if this is a trend. 2016, the fleet grew so much that they could set off the interest margin reduction but at some point in time this might not work any more.

5. No equity incentives for Management

It seems that especially the top management are technically employed by SocGen and only “seconded” to ALD. Therefore they only have SocGen share plans. In the variable component of the salary they have a net income per ALD share target but other than that, top management doesn’t have a big interest in ALD’s share performance. One could even argue that having a SocGen share plan puts their interest theoretically against minority share holders.

Good stuff

There is also a lot to like at ALD.

+ they seem to have a pretty diversified business
+ they are market leader in many markets and size is a plus in this business
+ the reporting is quite transparent. In the Sixt Leasing annual report fo instance it is much harder to see the underlying profit drivers
+ ALD has significant exposure to “Club Med” countries which could boost growth if they actually turn around

Nevertheless, I am not fully convinced that the stock is really cheap. The 12,5 earnings multiple looks cheaper than for instance Sixt leasing, but I am not sure if the 2016 level is sustainable. I think 15 times P/E would be “fair” for them, but that does not leave a lot of upside unless I would factor in some growth assumptions.

Compared to a true Spin-off or Carve out, ALD is still part of a (probably very) bureaucratic large organization. So the effect of being suddenly “free” which one could see in cases like Osram is less likely here and is also not incentivized.

Summary:

ALD looks like an interesting stock but there are also some issues (Diesel, taxes, funding). Without digging too deep into it, i think there might be some upside but maybe not enough to justify an investment at current prices.

Maybe if in the future, SocGen sells more shares, the stock is cheaper and management incentivized more towards ALD, it could be more interesting.

16 comments

  • Sixt Leasing (MarketCap 410 mio) mit netter Gewinnwarnung: “Für das Gesamtjahr erwartet der Vorstand nun ein EBT von rund 30 Mio. Euro (Vorjahr: 31,6 Mio. Euro). Zuvor war eine Steigerung des Ergebnisses vor Steuern im hohen (!!!) einstelligen Prozentbereich prognostiziert worden. Der Vorstand geht dabei unverändert von einer Steigerung des Vertragsbestands im Konzern sowie von einem leichten Wachstum des operativen Konzernumsatzes aus.Wesentliche Gründe für die Anpassung der Ergebnisprognose sind eine zusätzliche Risikovorsorge (!!!) für die Restwerte der Leasingfahrzeuge im Portfolio sowie verstärkte Wachstumsinvestitionen, insbesondere im IT-Bereich.”

  • “In the beginning the stock traded even further down to below 13,50 EUR.”

    Stock is back at 13,50€, are you interested now?

  • Small contribution. At least six analysts have delivered their initiation on ALD, very inline with your thoughts. Some brief extracts:

    RBC, Scale and diversity (but some residual risk) – Sector Perform (TP: 15.5€)
    Areas of concern: cyclical business, hence the outlook for global economic growth and the potential for a rise in interest rates need to be considered in relation to the potential for contract terminations, residual values and bad debts. The ongoing debate around diesel cars and potential legislation could also have a negative impact.

    ING: Accelerating ahead (Buy, TP: 18.0€)
    Funding risk, residual value management and default risk are the key risks faced by the leasing industry. On tax: In 2019 companies will be required to adopt a “right-of-use” approach in accounting for their leasing contracts. There are no changes proposed to the accounting applied by lessors, however lessees will be required to state their rights and obligations arising from leasing contracts on their balance sheets. This [..] may decrease the attractiveness to customers of its product portfolio relative to certain alternatives, such as the direct purchase of vehicles

    BAR: Released for growth (Equal weight, TP: 16.2€)
    Key risks: residual values, credit provisioning and funding. Other key risks include possible credit provision spikes, hits to finance margin and pricing pressure

    CS: Strong fleet growth potential but residual value risks reduce appeal. (Neutral, TP: 15.5€)
    Key risks: used car prices; changes to funding costs; adverse regulatory changes; rising competition; unexpected insurance losses and failure to integrate acquisitions

    HSBC: In pole position on a bumpy road (Buy, TP: 18.0€)
    Downside risks: car sales results, in particular, diesel cars’ residual values. Other risks: financial margin, ability to capture the growth from the private leasing segment in Europe, ability to maintain rating..

    JPM: Opportunities to benefit from shifts in vehicle ownership. (Overweight, TP: 17.7€)
    Risks: competitive market, future decline in the number of in the market, infrastructure required for new markets, expansion, low free float, impact on residual values if used cars market declines, cost of risk, digitization, new businesses, economic outlook

    Note: This is not a recommendation or advice, just my opinion.

  • Great article as ever. Agree with the thesis – a levered play on European tax legislation and residual fleet values is not for the faint hearted no matter what the entry price. I’ve looked at aircraft leasing in the past and my conclusion is that unless you can do the fleet valuation yourself, you can never really come to a good conclusion on whether this is a proper value investment or not.

    • Although I think that the economics of car leasing are better tha aircraft leasing. More diverse suppliers and more diverse clients. Aircraft leasing is a pretty “narrow” business.

  • I am not that worried about the low tax expsenses. They are transparent on contributions from lower tax countries, e.g. they generate almost 20% of gross operating income in the UK (20% tax rate). Funding is done in Luxembourg (20% tax rate). Their reinsurance operation sits in Ireland (12.5% taxes).
    Of course, you can argue the latter is “aggressive tax structuring”, but at least for now, it is standard practice.

    • hmm, well they should earn their service margins and financing margins in the country where they are active. And appart from UK, the tax is higher in any of them. There is a significant effort under way to push back on these kind of “tax structurings”. Maybe not an issue near term but long term I think one should calculate with a higher tax rate.

  • ALD has been receiving some 900m DKK in dividends from its Danish subsidiary in the last four years, but the Danish leasing market is deeply flawed (basically there is an opportunity for leasing companies to exchange extremely high taxes for profits). It means that leasing companies in Denmark has had a bonanza while the tax authorities have been shafted. But it seems like the politicians are waking up, so things might change. Though I didn’t know about ALD’s IPO before I came across your blog my initial thought is this might be more worthy of a short than a long if other countries are waking up (but I don’t short, so don’t take that as advice).

  • Hi,

    Belgians are currently heavily incentivized to choose an ALD leasing car (marginal tax ~30%) over extra salary (marginal tax 60%). This will change next year as the govt will allow Belgian employees to be taxed at the same rate for the extra salary worth the gross car value (the impetus to semi-abolish the free car / free petrol for all employees, reminiscent of Venezuela’s heavily subsized inefficient oil price, is ecological). This will lead to revenue headwinds in Belgium. Diesel and car ownership are other

    Also, I think this business is a textbook example of not having much societal value or value to its motivated (tax) buyers, in Belgium (no offense but should be taken into account in any investment). In that way, it is similar to Edenred, also optically “quality”. It’s product “ticket restaurant cheques” perpetuate a communist system in France and Belgium that allows employees to pay for food and drinks … and anything else… in supermarkets at lower tax rates thanks & taking 3-5% commission for that ‘privilege’ of using their communist money 🙂

    • Hey TC,
      I think you will be happy to hear that Italy implemented a law that allows to depreciate (for taxes) cars for 140% (no typo) of their value.
      You set incentives and people will behave accordingly…nothing new under the sun.

      • Good points. Germany also incentivices (leased) company cars from a taxation point of view. So the business model seems to rely a lot on tax incentives. And they pay little taxes themselves. Interesting.

  • Hey mmi,

    while we are at financials: I have just listened to Barry Reitholtz interview with Ed Hyman, Chairman of Evercore ISI and Vice Chairman of Evercore. More importantly he is head of Evercore ISI’s Economic Research Team and for the past 41 years has been ranked by the Institutional Investor poll of investors for Economics, as # 1 for 36 years.
    I liked him and he mentioned ISI, which he founded, sort of went public by being acquired by Evercore. These guys own a third of the company and sre thus better incentiviced than the ALD management. They deliver strong returns, buy back shares to compensate for options.
    You should take a look at them:
    http://phx.corporate-ir.net/phoenix.zhtml?c=66653&p=irol-investorkit

    I am long.

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