UK investors will probably know Continental from its TV advertisements for tyres during the UEFA Champions League, which it used to sponsor, and the FA’s women’s football league cup.

However, the German firm isn’t just a dull but worthy tyre-maker, it happens to be one of the world leaders in automotive technology, in particular autonomous driving, vehicle software and safety systems.

It is also going through a period of restructuring which will leave it leaner, with a clear focus on just two high-growth business areas. We believe that, at the current price, the shares haven’t begun to discount this year’s recovery in margins or the long-term growth potential of its autonomous driving business.

SALES AND MARGIN RECOVERY

While 2020 was something of a disaster for car makers due to collapsing demand, the year finished better than many had expected with total motor vehicle production reaching almost 78 million units, a fall of around 15% on the previous year according to Statista.

China, Japan and Germany were the largest producers of passenger and light commercial vehicles, with China making more than 21 million vehicles or nearly a third of all cars, many in joint ventures with western firms such as General Motors and Volkswagen.

Given it supplies tyres and systems to most of the world’s volume manufacturers, Continental was hard-hit by the fall in production, with sales declining nearly 15% to €37.7 billion and adjusted operating profit more than halving to €1.3 billion from €3.2 billion the previous year.

At the start of this year, with car production expected to recover by 9% to 12%, the firm set out a target of generating between €40.5 billion and €42.5 billion in sales and an operating profit margin of between 5% and 6% compared with 3.5% last year.

STRONGER GROWTH

Fast-forward to the first quarter and despite a ‘persistently challenging market’, passenger and light commercial vehicle production increased by 14% on the previous year to over 20 million units.

Continental’s sales were up a better than expected 8.6% on an organic basis, while operating was up a staggering 92% meaning a margin of 8.1%. Moreover, orders for its high-performance engine computer systems soared.

The firm increased its margin target to between 6% and 7% and announced a major strategic shake-up. Once it has spun off the Vitesco powertrain business in September, from next January the company will be divided into two separate businesses, Autonomous Mobility and Safety.

This will allow it to implement its different strategies. ‘We are focusing systematically on growth and pioneering future technologies when it comes to assisted, automated and autonomous driving, and we are focusing on value when it comes to safety,’ says chief executive Nikolai Setzer.

WIN-WIN SCENARIO

The attraction of a tyre and component maker over a car manufacturer is that whoever wins in the race for market share in electric vehicles, new cars all need tyres and complicated electronic systems to work.

With so few volume producers of tyres, Continental and its rivals have good pricing power, so if raw material costs rise it can typically pass these on to its customers.

Meanwhile, if there is a global shortage of key items, as there is at present with computer chips, it has strong ties with German firms such as Infineon, one of the leading producers of semiconductors for automotive uses.

When questioned about the global squeeze in chip supplies, the chief executive was typically understated: ‘From an operational point of view, we have made a good start to the year.’ 

The Vitesco powertrain division had an excellent first quarter thanks to growth in electric vehicle component demand, growing sales by 12.8% on an organic basis and winning hundreds of millions of euros of new orders.

While spinning off Vitesco will mean a slowdown in sales growth at Continental in the short term, the disposal of the legacy combustion-engine assets and the simplification of the business will allow management to use the steady cash flows from the tyre division to fund higher-growth segments.

ATTRACTIVE VALUATION

Within the automotive and parts sector, Continental is one of the cheapest stocks in Europe in terms of enterprise value to sales.

Analysts at Swiss bank UBS believe consensus expectations for Continental could be upgraded significantly this year. The bank is forecasting earnings before interest and taxes, or EBIT, of €3.2 billion this year, which would equal 2019’s level and is around 20% above the current consensus.

Continental trades on the Frankfurt Stock Exchange and can be traded on most UK investment platforms although you should be aware buying overseas stocks can involve extra costs and charges. 

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