UN­DER THE BONNET

The dust has set­tled fol­low­ing the car maker’s highly-an­tic­i­pated stock mar­ket flota­tion giv­ing in­vestors a chance to reap­praise its in­vest­ment cre­den­tials

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Should you buy As­ton Martin now its shares have fallen 26% since IPO?

The news is full of talk about the UK’s car man­u­fac­tur­ing in­dus­try as the Brexit dead­line looms ever larger, but there is only one car maker whose shares you can buy on the Lon­don stock mar­ket.

Bri­tish mar­que As­ton Martin

Lagonda (AML) was worth £4.3bn when its shares start­ing trad­ing at the start of Oc­to­ber at £19.00. That val­u­a­tion, to­wards the lower end of its ini­tial range, was still seen as toppy by many City an­a­lysts, but the shares have got a lot cheaper since, falling to £14.01. That’s a sig­nif­i­cantly greater de­cline than the FTSE 100 dur­ing its lat­est sell-off.

You might not be able to af­ford one of its pres­tige mo­tors (they cost about £150,000 on av­er­age) but is the in­vest­ment op­port­nity now at an ap­peal­ing price for for in­vestors?

SEC­OND CEN­TURY PLAN

To an­swer that ques­tion we must first un­der­stand As­ton Martin’s fu­ture plans and che­quered past (it has gone bust seven times in its 105 year his­tory). The com­pany’s Sec­ond

Cen­tury Plan con­cen­trates on bring­ing sta­bil­ity to the busi­ness, mak­ing it a more ro­bust model, and ex­pand­ing the prod­uct port­fo­lio.

Per­for­mance since 2013 shows de­cent suc­cess on the first mea­sure, and it is now fac­ing up to the sec­ond and third chal­lenges. Hav­ing de­liv­ered 5,098 new cars in 2017, get­ting more mod­els on the road is vi­tal. It wants to push pro­duc­tion to 14,000 by 2022 with a line of SUVs set to join its more tra­di­tional sports cars from next year.

It is even em­brac­ing the switch to elec­tric with the Valkyrie hy­brid model (al­beit it with a £2.4m price tag), part of its lim­ited line mak­ing a hand­ful of su­per­cars for the su­per-rich.

As­ton Martin’s big­gest mar­ket at the mo­ment is still the UK, ac­count­ing for a third of sales, fol­lowed by the rest of the EU (25%), Asia-Pa­cific (24%) and the US with 20%. Sur­pris­ingly only about 6% of sales go to China, an ob­vi­ous tar­get to im­prove given its pop­u­la­tion, emerg­ing high net worth mar­ket and eco­nomic growth.

As­ton Martin plans to open 10 new and re­fur­bished show­rooms out there in the months ahead.

WHAT IS PRICE-TO-EARN­INGS TELLING US?

As­ton Martin’s stock is trad­ing on a cur­rent year price-toearn­ings (PE) mul­ti­ple of 48.3, based on con­sen­sus fore­casts to 31 De­cem­ber 2018. That falls to 25-times in 2019, but rises again to 29.2-times in 2020 due to hefty in­vest­ment plans. These met­rics are based on av­er­age an­nual growth in rev­enue and op­er­at­ing profit of 25% and 36% re­spec­tively over the next two years.

By con­trast, Fer­rari, the New York-listed lux­ury sports cars maker (widely per­ceived as As­ton Martin’s clos­est peer) trades on a 2019 PE of

As­ton Martin has al­ways been quite ag­gres­sive in its poli­cies on cap­i­tal­is­ing R&D spend

27.8-times, based on its cur­rent $113.96 share price.

Some in­vestors may think these PEs im­ply As­ton Martin is de­cent value, oth­ers may think dif­fer­ently. We tend to be­lieve that the real val­u­a­tion story lies be­yond earn­ings largely be­cause of the big in­vest­ment re­quired to fuel its growth am­bi­tions. Let’s now take a look at cash flow.

IF CASH IS KING, IS AS­TON WEAR­ING NEW CLOTHES?

On the face of it, sales vol­umes, sell­ing prices and unit pro­duc­tion have all been im­prov­ing in re­cent years, a point re­flected in As­ton Martin’s gross mar­gin. It has gone from 32% in 2015 to 37% in 2016 and 43% last year. That’s helped As­ton Martin turn its first pre­tax profit in 2017 af­ter five years of red ink.

While net cash from op­er­a­tions has gone from £75.2m to £343.8m over the past three years, the com­pany has also had to plough enor­mous sums back into the busi­ness, al­most en­tirely wip­ing out free cash flow.

Mod­est £3.2m of free cash flow in­vites the ques­tion of how the com­pany could make a pre-tax profit last year. The an­swer comes down to how it treats re­search and devel­op­ment (R&D).

All car mak­ers need to in­vest in R&D to keep their ve­hi­cles up to date with rapid changes in tech­nol­ogy, but at the higher end – where As­ton Martin pitches its mo­tors – this is even more im­por­tant. And the com­pany has al­ways been quite ag­gres­sive in its poli­cies on cap­i­tal­is­ing R&D spend.

CON­TRO­VER­SIAL R&D TREAT­MENT

Cap­i­tal­is­ing ex­penses means in­vest­ment is recorded as a fu­ture as­set on the bal­ance sheet rather than a cost on the profit and loss state­ment. Com­pa­nies are al­lowed to do this when they can demon­strate a clear ben­e­fit down the line. That’s not al­ways pos­si­ble and there are rules around what can and can­not be ‘ex­pensed’.

As­ton Martin has al­ways been fairly ag­gres­sive in this re­gard although within the rules. Com­pany ac­counts show that be­tween 2015 and 2017 it spent £484.2m on R&D, cap­i­tal­is­ing £451.7m, or about 93%. First half re­sults for 2018 show the same ball­park (92%) fig­ure on £95.2m of R&D.

This is not un­usual for tech­nol­ogy-led com­pa­nies who are in­vest­ing to­day for in­come to­mor­row. When Ap­ple wants to de­sign the next iPhone, for ex­am­ple, some of that cost will be ex­pensed, but it will earn rev­enue on those new iPhones in the fu­ture.

With­out get­ting too bogged down in the ar­gu­ments for and against cap­i­tal­is­ing R&D, the rules al­low room to ma­noeu­vre. But many tra­di­tional and con­ser­va­tive in­vestors think this is sharp prac­tise be­cause it is not al­ways easy to work out what your in­vest­ment will earn you in fu­ture.

This puts As­ton Martin at the more ag­gres­sive end of the spec­trum com­pared to peers, ac­cord­ing to re­search by an­a­lysts at in­vest­ment bank Canac­cord, and far more so than Fer­rari.

The ef­fect on As­ton Martin’s profit is marked. Canac­cord’s an­a­lysts cal­cu­late the com­pany gen­er­ated ad­justed earn­ings be­fore in­ter­est, tax, de­pre­ci­a­tion and amor­ti­sa­tion (EBITDA) of £207m in 2017.

Fac­tor in the £213.2m of ex­pensed R&D and the com­pany’s op­er­at­ing profit is com­pletely wiped out, which tal­lies more closely with un­der­ly­ing free cash flow.

With sig­nif­i­cant in­vest­ment needed to meet its growth am­bi­tions (new model de­signs and ma­chin­ery up­grades across sev­eral pro­duc­tion sites), in­vestors might con­clude that ex­tra fund­ing will be needed. Miss­ing growth tar­gets would also be an ob­vi­ous blow.

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