Investment thesis: Renault (OTCPK:RNLSY) seemed to have a well-adapted strategy for the EU and for the global car market just a few years ago. Low-cost cars, which it could produce profitably and sell to customers in Europe and in many other parts of the world, at a price that the surging global middle class could afford seemed like the winning strategy. The low-cost approach even seemed to work in Renault’s favor with respect to the emerging EV trend, where its affordable Renault Zoe dominated the top spot in terms of European EV sales for many years. Looking back about half a decade, all reasonable analysis would have suggested that Renault had a bright future ahead. A series of events, starting with the COVID outbreak, followed by last year’s commodities price surge which brought about an inflationary spike starting last year, which persists and even shows signs of getting out of control this year have severely diminished Renault’s recent results as well as its future prospects. Environmentalist pressures, the Ukraine war, and other factors are all working against it, creating a situation where European automakers, in particular, may see their global status diminished, with Renault being perhaps the first major EU car company set to fail in the face of a convergence of a number of negative trends.
Within the context of a tough start this decade for the global car industry, Renault stands out as a particularly badly affected car company
Starting with the COVID outbreak which sapped consumer confidence, causing car sales to plummet right at the beginning of the decade, then the chip shortages, and now seemingly, there is an impending global economic slowdown, due to the economic confrontation with Russia over its invasion of Ukraine, the global car industry has had a very rough start to this decade.
Renault’s fortunes in particular have declined severely in the post-COVID crisis world. As we can see, its sales in Europe have been cut in half, based on the sales figures we are seeing in the first two months of the year, compared with sales for the same months in the previous years. Renault’s own presentations suggest that its sales decline is a worldwide trend.
It should be noted that Renault’s recent decision to suspend its activities in Russia, and possibly pull out altogether will present a further hit to its sales. Russia is by far its most important market outside of the EU. The potential loss of sales, as well as the potential write-down of its assets, will make this year a very challenging one for Renault. It could potentially lose about 1/6 of total global sales just due to the Russian market issue.
Renault facing a challenging situation, ranging from an impending loss of the Russian market to production challenges stemming from a shortage of chips, but inflation that is killing demand from its core customers by income demographics is perhaps the most significant challenge
For the first quarter of this year, Renault’s sales compared with the first quarter of 2021 were down 17.1%. It sold 114,000 fewer cars for the period. The Russian market was responsible for 38,000 of that total decline. The Russian market loss is clearly a major hit and Renault is facing the potential evaporation of that market, meaning that Renault is facing further declines in unit sales in coming quarters. But clearly, this is not the only issue that Renault is facing, given that 2/3 of the decline in sales was due to its sales in the rest of the world.
Renault has been facing some of the same challenges that have been plaguing most of the global auto industry. In addition to that, the strategy that seemed like a perfect adaptation just a few years ago, namely producing affordable cars for the emerging global middle class, is now becoming a liability. The global middle class is not what we tend to think of as middle class. It is the middle class in emerging markets that makes up the bulk of the global middle class. Even the EU middle class is on average significantly less affluent than the US middle class, which is why the $8,000 Dacia sedans that Renault has been offering in past years have been so popular in the EU market. Now Renault is facing a dual problem in regards to continuing with its low-cost vehicles strategy.
First and foremost, those Europeans who would ordinarily constitute its customer demographics are seeing their livelihoods squeezed by soaring energy and food prices. Higher energy and food prices take up a higher percentage of household incomes in lower-income households. These households feel the inflation, driven by higher energy and food prices to a higher degree than higher-income households. The customers, who would ordinarily be Renault’s prime customer base are now unlikely to buy a car at all within the current economic environment. Renault can gain some interest from higher-income demographic segments as they too are feeling some inflationary pressures, which might make them consider a lower-priced car. It is evidently not nearly enough to make up for the loss of Renault’s main customer base.
The second factor that threatens Renault’s business model is the higher input costs that it is faced with, even as profit margins are paper-thin. Companies with products that enjoy higher profit margins can absorb the increased costs of production much easier. For instance, Ford’s F-150 is said to have a gross profit margin of over $10,000 per unit. That is more than some Renault cars sell for. Ford can therefore absorb an increase in input costs of as much as about 25% without having to raise the price of a Ford F-150 without losing money. An increase of less than 10% in input costs can leave Renault with no choice but to either accept losses or raise the sale price of their cars. Raising vehicle costs on customers who tend to be very price-sensitive is not easy to do, without suffering significant sales declines, which is in part what is happening with Renault sales.
Global economic shifts, EU environmental policies and geopolitical events are catching Europe’s car industry in offside, with Renault being perhaps the first major EU carmaker potentially set to fail this decade
The current difficulties that Renault is facing may be considered to be one-off pressures that are likely to dissipate going forward. There are plenty of reasons to expect the difficulties to linger for many years to come. Long-term fundamental changes may be very damaging to Europe’s car industry, with the local market set to decline, while there are some serious doubts about its ability to defend its market share in parts of Asia, and perhaps even in Africa. Renault will continue to suffer to a far greater extent than its EU industry peers.
Europe’s economic outlook has greatly worsened since the beginning of this year, with the war in Ukraine being a major drag. The IMF is forecasting EU growth will be half the pace it was forecasting before the war in Ukraine started. As bad as that may seem, there is far worse, for far longer yet to come for the EU economy going forward. Russia’s refusal to continue accumulating euro and USD reserves, in response to the aggressive move to freeze Russia’s central bank assets will hit the euro currency’s viability prospects as a global reserve currency in the months and years to come. It is an issue I covered in greater detail in a recent article. In the past few months, much has been made of Russia’s dependence on commodities exports earnings that the EU continues to provide it with. There seems to be very little public recognition of the level of support that the euro project received through the fact that Russia has been recycling a significant portion of its net export surplus into euro-denominated FX reserves for much of this century.
It remains to be seen what impact the rupture between the EU and Russia will have on the EU economy going forward. In the short term, Russia is certainly the more affected party. But within the context of a fundamental global commodities boom, Russia will be the one that will find new customers for its goods, mostly raw materials or derivatives such as fertilizers and other petrochemicals, while the EU is set to lose the Russian market, with no clear replacement for it. It will also lose a major holder and user of the euro currency. As Russia will increasingly refuse to sell anything or pay for anything in euros, it will have a knock-on effect, where its major trading partners will no longer feel the need to hold as much of the euro currency in reserve, if certain exporters such as Russia will no longer accept it as a viable payment method.
A bleaker than expected outlook for the EU economy will hit car sales particularly hard on the old continent. On top of the bleak economic prospects, there is also the pressure to transform the industry into a pure EV producer by the end of the decade, with an uncertain outcome. What does seem like certainty is the fact that the re-tooling and other costs will add to the difficulties that the industry is already facing. This is Renault’s most important market by far.
The imminent and permanent loss of the Russian market, in the name of the current wave of Western corporate social activism, is also set to deliver a major blow to the entire EU car industry, with Renault being particularly strongly affected. Relations with China are also on a seemingly deteriorating path. If the EU car manufacturers will lose that market as well, it might lead to its demise by the end of the decade. The position of EU carmakers in the Central Asian market, as well as in parts of the African markets can be imperiled as certain nations around the world might be forced to choose between two emerging global economic blocks. One centered around the Western World, the other around China & Russia which will attract a number of other emerging economies around the world on its side, including some of the developing world heavyweights that make up the BRICS group. Renault’s hopes in China recently faded as well, with its gas-powered car production activities in that country having ceased recently.
While many of Renault’s EU industry peers are faced with many of these same problems, many of them have one major advantage, namely their robust presence in the North American market. EU car sales declined by over 20% in March compared with the same period last year, while in the US they declined by about 22% for the same period. On the surface, it may seem like North American prospects for the car industry are not much better, but I do believe that US demand will remain far more robust than it will in the EU, mostly because of the more pronounced impact that the Ukraine conflict is set to have on the EU economy this year, but also beyond. For this reason, many of Renault’s main European competitors such as Mercedes (OTCPK:DMLRY), BMW (OTCPK:BMWYY), and Volkswagen (OTCPK:VWAGY) do have a significant advantage, given that a significant part of their total global sales is in North America.
Renault’s EV segment might be the only potential bright spot, but it remains a wildcard
Between high gasoline and diesel prices, EV incentives offered to prospective car buyers, as well as increasingly stringent restrictions on average fleet emissions levels, the EU EV car industry has been expanding at a robust pace, at the expense of ICE-powered cars.
Renault used to have the top-selling EV in Europe for a number of years, namely the Renault Zoe, but many competitors have caught up and surpassed Zoe sales with their own models. The Zoe still grabbed fourth place in the European EV sales rankings in February, with the Dacia Spring also in the top ten.
Renault does still maintain a robust EV presence in the rapidly expanding European market. This could be the springboard that will secure a future for Renault, at least in the EU market, if the EU goal of having only EVs sold on the market within about a decade or so will come to pass. If this is the future of Europe’s car industry, then all the failures of Renault’s conventional car lineup will not matter.
If the EV plans will largely fail, much of the EU car industry will be hurt in the process, given that most of them have already staked their entire future on this envisaged shift. Renault in particular is poorly positioned with its own EV lineup to deal with a potential failure of the plans to shift all EU car sales to EVs. Renault is currently focused on providing city EVs, with a low price tag and also very low practical utility for consumers. For instance, one would find it a real challenge to drive from Berlin to Milan for a family vacation in a Dacia Spring in wintertime, regardless of how many charging stations are available on the way. The short range of the car, with only 175 kilometers of average real-world range capacity, makes it an impossible task.
In a world where ICE-powered cars and EVs will continue to coexist, EVs will mostly capture the high-end of the market where Renault does not have much of a presence. For the low-end of the market, consumers will continue to be better served by conventional car technologies, given that EVs will always have a range disadvantage below a certain price threshold. In the absence of aggressive government policies such as a complete ban on ICE-powered car sales, or making petrol prices so prohibitively expensive that people will find it unaffordable to continue driving conventional cars, the market will confine cheaper EVs with a low range to a niche status within the market, where sales will be mostly driven by lower-income consumers who feel compelled to voluntarily give up on some product utility for the greater global good.
My personal view is that the EU will have a hard time coercing lower-income car buyers into buying EVs with a low range that is not overly practical as an all-use car option. It goes without saying that the overwhelming majority of EU consumers will not be able to purchase EVs with a minimum price tag in the 30,000 euro range or higher. The majority of EU car customers tend to purchase a new car significantly below that price range. The average car price in the EU is about 30,000 Euros, but the median price, for which I have not been able to get an accurate credible number, tends to be significantly lower than that. The majority of Western EU car buyers cannot afford to go that high, while in the East European nations, as well as in Greece, Portugal, Spain, and a few other countries in the West where incomes are significantly lower than in the wealthier countries, only a significant upper-middle-class minority can entertain the idea of buying cars in that price range.
The most likely short to the mid-term outcome for Renault is that it is increasingly out of step with the current ICE market realities. Failure will also be the most likely outcome for Renault’s EV strategy, given that it does not seem to fit with consumer demographic realities. I used to have a more positive outlook on Renault a few years back, based on the market realities that prevailed then, but at this point, I have to admit that I made the right decision not to act on those positive views then, because it would have been a rough ride, to say the least. Going forward, I see the rough ride continuing unfortunately. The decline in the stock price from highs of almost $25/share back in 2018, to the currently low stock price of about $4.5/share is arguably a reason to make a contrarian bet, with high potential rewards if the trade works out.
Recent financial results, as well as the most reasonable expectations for Renault’s future market outlook make for a tough sell on that contrarian argument at the moment. There would have to be some developments that will go in Renault’s favor this year in order to justify taking such a position. For FY 2021, it did register a net income of almost a billion euros, on revenues of 46.2 billion euros, after a loss of over 8 billion euros in 2020. It is hard to see how Renault can avoid announcing another major yearly loss this year, if and when it will write down its Russia assets and also given the loss of revenues once it does, this year and beyond. The low current stock price may make it seem enticing, but for now it still remains a sell in my view. Renault could easily become the first major EU carmaker to fall, which will serve its competitors well since it will probably be a wake-up to the harmful effects of the realities that have been imposed on the industry, through decades of flawed policies that directly or indirectly affected them. It will be too late for Renault and its investors however, if it will be the victim that will need to fail in order to help sound the alarm for the rest of the industry.
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