Valeo or the narrow door between long-term industrial strategy and shareholder impatience

Your money or your life!

Last week's exercise by Jacques Aschenbroich, Valeo's CEO, was quite emblematic of the difficulty that top managers in the automotive industry will face in the coming months. With a stagnant market at best and strong regulatory pressures, financial results will almost inevitably fall short of the promises made in the major strategic plans that each had developed. Analysts and financial markets will not appreciate and will drive down share prices.
CEOs will then have to stand firm and defend their long-term strategies and the investments that embody them against strong shareholder pressure.
The Valeo case is exemplary in this respect. Indeed, the company's fundamentals are quite good in 2019. Geographically, the business portfolio is sufficiently diversified for exposure to the risk of a downturn in the Chinese (13% of first-half sales in 2018) and European markets (31% of first-half sales in 2018) to be offset limited by a strong presence in North America (10%), South America (2%), "Asia excluding China" (19%) and Eastern Europe and Africa (15%).
Similarly, in terms of OEM clients, Valeo achieves 13% of its sales with French carmakers, 29% with the Germans, 18% with the Americans, 34% with Asians and 6% with "others". In China, Valeo generates 32% of its sales from Chinese automakersand they would have placed orders that would increase this share to 44% (if we include orders placed at the "electrical" JV with Siemens).
In terms of specialities, the four business areas "comfort and driving assistance", propulsion, thermal equipment and "visibility" account for 19%, 26%, 26%, 26% and 29% respectively in the original equipment sector.
Three of them outperform the market since only the "visibility" division is slightly behind. In addition, there is the turnover of €2 billion from a restructured, dynamic aftermarket, which grew by 10% at constant exchange rates this year.
If this is the case, it is probably because, almost 10 years ago, Jacques Aschenboich considered that Valeo should stop being what Challenges' journalist A.-G. Verdevoye calls a "disparate conglomeratewith eleven branches and 135 divisions, which manufactured very traditional products (clutches, brakes, starter-alternators, radiators...)".
He then gave his group two strategic priorities: comfort and driving assistance, and the reduction of polluting emissions and greenhouse gases. Priority was then given to R&D and innovation on the one hand and to the search for synergies between specialities on the other. It is with this "integrated system" that the company makes innovation the driving force behind its turnover growth, which between 2013 and 2018 was 10% per year. It is with this recipe that the company is positioning itself as a key player in the two major technological changes underway, namely electrification of powertrains on the one hand and the development of autonomous vehicles on the other.
Thus, in a recent Standards and Poors research report that attempts to assess the positioning of 13 major global equipment manufacturers (1), Valeo stands out as the only equipment manufacturer to invest more than 10% of its sales in R&D in 2017, along with Continental. 
The report considers that in terms of "Powertrain Mix", Valeo should, in 2025, be the one with Schaeffler that will be least involved in thermal energy. However, the report does not rate Valeo as one amongst the bests (such as Bosch, BorgWarner, Denso, Faurecia, ZF, Delphi or Aptiv) - nor amongst the bad ones for that matter (such as Aisin Seiki, Continental or Shaeffler) but somewhere "in between", a ranking shared with Tenneco. The main justification for this poor ranking seems to be that his JV with Siemens is losing money and that there is a "catching up to do". Jacques Aschenbroich had indicated in July about the said JV: "In 2022 we should clear an operating margin that will be of the same order of magnitude for the JV as that of Valeo as a whole". However, he added, as if to apologize to impatient analysts, "if production increases very quickly we will be permanently forced to make investments".
We are here at the heart of the problem of Valeo and its CEO. What happened in 2018 and what is likely to happen again in 2019 is perfectly explained and justifiable both by the WLTP and the downturn in the Chinese market, which has heavily affected a number of Valeo's Chinese automakers' customers. This certainly had a strong impact in the fourth quarter, but it leaves the group with an operating margin that, although lower than in 2017 (7.8%), still reaches 6.3% of sales and could appear very satisfactory.
Nevertheless, net earnings are down sharply from €877 million to €546 million and, since the number of shares has not changed, net earnings per share (EPS) have fallen by the same amount from €4.33 to €2.52. Faced with this, to calm dissatisfied shareholders and analysts, the CEO of this company, 97.6% of whose capital is floating and which must face the American asset manager BlackRock (5.02% of the capital) or the Californian pension fund The Capital Group (4.71%), does not adjust the dividend but maintains it: the pay-out ratio rises from 34% to 54% ! Traditionally, it promises, in the same perspective, a "massive use of offshore development" in R&D and an "acceleration of the transfer to low-cost countries" as well as a "variabilisation of costs" in industrial matters.
In 2018, Valeo spent 324 million euros on dividends and 118 million on share buybacks: Valeo therefore gave its shareholders 442 million euros, twice the amount of losses of its JV with Siemens that it is accused of and 28% of the amount of "net R&D costs"!
There is no danger here, but very clearly there is a contradiction between the two requirements: the virtuous vigilance of the shareholders of the theory that explains that their requirements are there to force managers to be good can turn into a tyranny of short-term management that ignores the time needed to succeed in a long-term strategy.
(1) Aisin Seiki Co, Aptiv, BorgWarner, Bosch, Continental, Dana, Delphi Technologies, Denso Corp., Faurecia, Schaeffler, Tenneco, Valeo and ZF Friedrichshafen AG
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Translated with, corrections by Géry Deffontaines

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