This research report, giving a micro analysis of Nokian’s business with the focus on how their story evolves over time, is based on a full tyre stocks sector analysis with a macro overview.
For those who prefer watching, here is the video on Nokian, article continues below.
I have listened to all the presentations from Nokian’s 2018 Capital Market day and to their last conference call where, unfortunately, the story completely changed. For example, in October 2018, the management expected the Russian market to grow at 6%. Actual growth over 2019 was -2%. Given the subdued environment and low visibility, we have to establish a range for the value of the stock, expected returns, risk, margin of safety and then you can see how, and at what price level, this could fit your portfolio, or not.
Figure 1 Nokian Tyres stock price – how things change
quickly, from exuberance to gloom
Let’s see what is the real value. I will try to estimate
long-term earnings in line with the outlook for the environment and Nokian’s
They are pretty well established in Nordic countries and
Russia with set distribution networks and market leadership. For example, they
own most of their Vianor network in the Nordic countries. Their plan and hope
is to grow in the rest of Europe and the United States. They have built a new
factory in Dayton that will supply the North American market with a yearly
capacity of 4 million tyres and options to grow capacity to as much to 12
million tyres yearly by simply enlarging current construction. In 2020, the
Dayton factory is expected to produce 1 million tyres alongside a slow ramp-up.
Figure 3 Nokian’s production capacity is not fully utilized Source: Nokian
The situation is the following; we have 4 million production
potential in Finland that is going to be curtailed to probably 2 million due to
the current situation in the markets. Workers will have many days off over the
next year. The Russian facilities can produce 17 million and Dayton should be
able to produce 4 million. In short, they, as many other tyre producers have
capacity oversupply and therefore can flood the market easily. It is hard to
estimate when will the market situation return to the 2018 level as car sales
in Europe, Russia and North America have actually been declining.
They are not present in China
as there is no regulation for winter tyres, even the above 2% growth estimation
for Russia was too optimistic (their estimate was 6%) and Nordics have also
slowed down. Further, the North American market is also in a slowdown.
If I take a look at past
numbers, Nokian really enyojed a tailwind over the last 20 years as yearly global
car sales almost doubled from 1999. But, over the recent years, new car sales
peaked. Russia was the growth engine for Nokian, alongside Central Europe.
Figure 6 Global car sales per year Source: Statista
The number of cars on the road went from 670 million in 1996
to the current estimation of 1.3 billion. The number of cars is expected
to reach 2 billion in the future, but not in the markets Nokian is focusing on
as Asia will be the main driver of that growth.
Globally, car sales have seen their best days. The
consequences can be seen reflected in stock prices of most auto makers.
Figure 7 Global car sales per year Source: Bloomberg
The above boom in car sales pushed earnings for the whole
sector up, from new tyres to replacement ones. We now have to estimate what
will the market look like over the next 10 years, that is the only way we can
get a fair and a risk free value for Nokian (what is the value for you will
depend on the kind of investor you are).
It is likely that automotive sales will see limited growth
in Europe and North America in the future, perhaps even a decline given all the
new technologies announced like car sharing and autonomous driving.
Demographics certainly don’t help. EU automotive demand has boomed over the
last 5 years thanks to ‘free money’ and 0% car loans. Nokian is basing their
growth estimations on the premise that the party is going to continue, both in
Europe and in the US.
Figure 8 Past car sales trends in the EU by category from 1995 to 2018 Source: SIUlisse data
However, car sales have been subdued lately in Europe.
Secondly, something very important for Nokian is the Russian
currency, a weaker ruble is also not good given the high amount of sales there.
This has also been the reason why their revenue didn’t grow since 2013 as the
ruble lost 50% of its value against the euro.
Nokian’s growth ambitions have been pretty bold; 50% sales growth
in Central Europe, double growth in US and heavy tyres sales up 50% too.
Figure 10 Nokian’s positive growth ambitions were baked into
the 2018 stock price
On net sales of 1.6 billion with 12% of it in the US, 27% in
Europe and 12% of revenue from heavy tyres, a back of a napkin growth calculation
would say that we have to add 200 million in revenue from the US, another 200
million from Europe and another 100 million from Russia and heavy tyres. Thus,
Nokian’s estimations for growth are to add 500 million in sales over the next 5
years or to grow at 5% per year. Given the current market decline, lower sales,
it is unlikely the company will grow as planned because to grow, the only
option is to gain market share from others, which is a costly option. (note:
Russia has been the key market for Nokian over the past decade and more.
However, the replacement tyre market there grew from 25 million in 2004 to the
current 40 million per year).
You never know what will
happen in the future, but when it comes to investing I always look for
situations that can’t get worse because then the only thing left is upside.
With Nokian, the situation is tricky. They had set their strategic plans during
exuberant times and high car sales of 2017 and 2018 that they announced during
the ill-timed October 2019 Capital market day, just when the decline in the
If there is no market growth
over the next few years, given that all producers have a lot of production
capaicity, the pricing pressure in Central Europe can continue and spread
around while the American experience might end up as a flop, or big delay, especially
if we have a stronger economic slowdown.
The good thing about Nokian is its low debt, actually
negative net debt, with very little long-term liabilities. This allows it to
weather storms and also to mitigate possible mistakes like the timing on the
Dayton facility might be (you can never foresee these things).
The combination of high capex requirements targeting growth
and a soft market could lead to a few years of negative cash flows. Given the
conservative nature of the management (low debt), it is possible that they will
cut their dividend. As a dividend cut is never ever priced in a stock price, if
that happens, the stock will fall a lot, especially as it is considered a safe
dividend stock in Finland, practically a blue-chip. The current 6% yield shows
the market is already expecting a future cut.
I hope Nokian manages to weather the coming storm, that they
hit their growth targets and that they can expand market share. However, for
me, the risk reward of this investment is not tempting at this level. The
average earnings per share over the last ten years have been of €1.94. I assume
the company will be able to deliver such earnings in the future and also grow
them by 25% over the next decade, alongside their revenue growth plans. Thus,
on earnings per share of €2.5 going forward, a good buying price if you wish
for a 10% return is €25. If you wish for a 15% return, your buying price should
be €16.6 (unlikely to reach that, but you never know the factor combinations
that might influence the stock price like a recession in Europe, a dividend cut
and delays at Dayton etc.).
I’ve read some analysts’ reports on Nokian and Nordea
(October 2019), for example, doesn’t see any structural changes that could dent
future underlying growth with a €36 price target. It is likely they are right
with their estimations, but I don’t fancy the risk of the negative outlook I
described above that includes a structural change where their markets don’t see
organic growth anymore. For investors that seek low risk, high reward
investments, Nokian’s stock price in the teens would justify another look. On
the other hand, investors that are holding large diversified portfolios, should
be happy holding Nokian given its low risk as a going concern and quality niche
position. It is unlikely that you will lose money long term with Nokian.
However, the upside is questionable at this point in time and not worth the
Now, unlike other analysts, I am not expecting Nokian to confirm growing sales in North America and Central Europe to jump into the stock. On the contrary, if they cut their dividend, see slow starting sales in Eruope and in the United States due to a weak market there, if the ruble loses a bit of its value, then this might really be in the teens when the worst will probably be over. Thus, at that point the stock might be at €16 offering 100% upside over the next 5 years, when the actual growth will probably happen as the cyclical markets improve.
There are a few investment lessons that we can learn from
Catching a falling knife
Many say you should never catch a falling knife. I find such
an investment approach fallible because you paint every situation with the same
brush. Nokian stock is a falling knife but at some point, it will be a buy.
What is the differentiating factor? Well, fundamentals.
Businesses, especially the automotive sector is cyclical,
and you have to approach investing there from that perspective. At some point
it will rebound as the cycle turns. You can never know that beforehand, but what
you can know is what is the book value of the business, what will the average
earnings and growth be across cycles, does the debt level allow the company to
weather any storm?
good of a business this is – long-term risk estimation
I don’t think people can lose much with this investment. It
is either going to be bought by somebody when it achieves enough scale or it is
going to continue to grow. It is going to be cyclical but that is the nature of
the business. So, the business isn’t that risky form a survival perspective,
but as we see above, the stock is risky from a volatility perspective. Don’t
worry, this is completely normal for a cyclical stock. By investing in
businesses that will hardly ever go bust, you eliminate a lot of pain from your
dividend cut is never priced in beforehand
Many see the 6% dividend as a margin of safety that gives
protection to the stock price. What often happens is that the dividend is cut
and then panic follows. So, never ever is a dividend cut priced into the stock
price. If Nokian is forced to cut its dividend, I suspect the stock will be in
growth, doesn’t mean future growth
When a company is a growth stock, like Nokian has been given
the 8% yearly growth rate.
The question is always whether the company can continue to
grow. Here no past numbers can give you an answer, only a common sense analysis
of the business model. Keep in mind you will never be right here, nobody, not
even Nokian knows about the future. So, the only thing you can do is to
estimate from a risk reward perspective. How much money you make if it happens
and what is the probability for it given the environment? And, how much money
you lose if growth doesn’t happen and what is the probability given the
environment? That is investing.
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