Porsche Stock: Reduced Share Price Provides A Buying Opportunity (OTCMKTS:DRPRF)

(Note: all amounts in the article are in EUR. At the current exchange rate 1 EUR is around 1.08 USD)

Investment Thesis

Dr. Ing. h.c. F. Porsche AG (Porsche AG) (OTCPK:DRPRY) (OTCPK:DRPRF) shares have seen a setback over the last months and are now below their 2022 IPO price of 82.5 euros.

There is one clear reason behind the share price development: a decline in sales in China in 2023 and a cautious outlook for the Chinese market in 2024.

I covered Porsche AG previously on Seeking Alpha in April last year. I gave a Buy recommendation after the company reported record deliveries for the first quarter of 2023. Deliveries were up 18% YoY not only globally, but also in China. This changed dramatically over the year and turned to a negative 15% in China for the whole year. Accordingly, the stock is down 30% in Euro (and -33% in US dollars) since my recommendation.

There are two ways to look at the disappointing share price development in 2023. Investors who bought shares at the IPO and have not taken profits afterward on the way up have lost a year. For them, this is a good time to reevaluate the investment thesis. For those who have missed the IPO and the following share price appreciation, the reduced share price provides a buying opportunity – if, and that is a key condition – they believe that the weakness in China is a temporary setback.

The stock has already bounced back from its low of around 75 euros and might continue to do so. But a lasting upward movement probably needs a clear improvement in at least one of the key parameters: sales growth or profit margins.

Porsche will update four of its six model series this year, with a strong drive towards electrification, which could provide a catalyst for an upward movement of the stock, and especially help sales in China. Reviews of the new electric Macan and the upgraded electric Taycan point in the right direction.

Also, in 2024, the price increases established in 2023 should have a further positive impact on margins.

The drive toward electrification has risks, but Porsche has a well-balanced geographical distribution of sales, with Europe, the US, and China being of around equal size. Growth in emerging markets is also strong, and as a consequence we could see four sales regions with equal size, ideally all of them growing. However, even if this happens, it will take several quarters to play out.

Record deliveries in 2023, but weakness in China

Porsche achieved global deliveries of 320,221 vehicles in 2023, a 3% YoY increase and a new record.

Sales in almost all regions grew 10% or more, but overall they were dragged down by declining sales in China. Europe emerged as the growth engine, with deliveries rising 11.3% YoY (including Germany). Overseas and emerging markets also contributed significantly, registering a 16% increase. North America grew by 9%, while China experienced a 15% decline. The decline in China even accelerated in Q4. For Q1-Q3 it had only been 12%. In the press release announcing the 2023 deliveries, the company said that it expects market conditions to remain challenging in China in 2024, due to weak economic conditions in the region.

It is notable that Porsche maintained a well-balanced geographical distribution, with North America, Europe, and China about the same size. Porsche has the unusual habit of reporting sales in Germany separate from Europe. If you put them together, Europe is the most important region, followed by North America, and China is now only in third place.

Overseas and Emerging Markets, which includes India and South Korea, shows the most growth in relative terms but have some way to go to catch up.

The same is true for its model portfolio. Porsche has six different models, which are highly customizable. All models showed growth in 2023 except the Cayenne, where the dip should be temporary as there was a model change in 2023. The balanced portfolio mitigated the impact of individual model fluctuations and ensured overall market stability and growth.

What was different in China?

The decline in deliveries in China stands out as in all other regions were increasing. Also, the domestic Chinese car market overall grew by 6% in 2023, while Porsche sales declined by 15%. So what happened here and what is next?

Porsche was open about the issue in an Investor workshop in November 2023 which was held in Shanghai.

It is important to point out that, while Porsche is most associated with its iconic sports cars like the 911 model, what has driven sales up over the last years was the foray into sports limousines and SUVs. Porsche’s stock symbol is P911, but the line 911 model line accounted for less than 16% of global sales in 2023, whereas the two SUV models Cayenne and Macan accounted for 54%. The sports limousine models Panamera and Taycan made up 23% of sales and the 911 and 718 sports car models together only 22%.

From 2001, the year before Porsche introduced its first SUV model, to 2023 Porsche deliveries to customers have grown over 500%, but the sports car model lines 911 and 718 only grew by around 30% over those more than 20 years. In 2004, just two years after its introduction, the Cayenne already outsold its sports car cousins.

I love the picture below. I think it captures the essence of the Porsche brand image and what makes Porsche consistently the most valuable luxury brand worldwide (according to Brand Finance).

Porsche has created and executed a successful playbook on how to move outside of the sports car niche and stimulate demand for a brand. (Note – Interestingly, even Ferrari (NYSE:RACE) seems to be doing the same now with the introduction of the Purosangue SUV.) As a result, Porsche’s sales growth is now driven by a different demographic than the sports car enthusiasts, especially in China where almost half of the customers are female and the average customer age is only 37 years.

To reposition itself for growth Porsche presented its own China strategy in autumn 2023 in Shanghai. Porsche says that it sees “China as a gym to get fit for the future”. As a reaction to the decline in sales, Production was reduced and the dealer network was no longer expanded for the time being in order not to jeopardize the brand’s premium positioning. At the same time, investments are being made in marketing, new models, a China-specific infotainment system (whereas the next-generation infotainment system which is used in the new Macan is based on Android Automotive OS), and a Porsche-branded charging network for electric cars.

Many parts of the China strategy are to be rolled out to other high-growth emerging markets. such as Saudi Arabia, South Korea, and India. Porsche would like to position itself there with its strong brand to benefit from the expected further economic upswing. Special requests for car customization from wealthy customers from these countries should also drive profit growth.

EV transition

Porsche continues to invest heavily in expanding its EV lineup, with plug-in hybrid and EV variants of the Panamera and Macan expected to drive electric uptake in the coming years.

Porsche set a goal for 50% of its sales to be electric in 2025. However, “electric” here includes both fully electric vehicles and hybrids, and there is no exact split between those categories: In 2030 80% of all sales should be fully electric, and PHEV vehicles will be phased out between 2025 and 2030:

While Porsche currently offers only one EV model, the Taycan which was first released in 2019, several new models are supposed to arrive between 2024 and 2025.

The first new model is the electric Macan SUV, which was just recently announced. The small electric SUV was originally supposed to enter the market in 2022, but the launch was held back by wider software problems in the Volkswagen Group (OTCPK:VWAPY), which also affected Audi and Porsche brands. Like the electric Audi A6, the Macan is based on the new PPE (Premium Platform Electric) architecture, which was co-developed with Audi. This illustrates how Porsche can benefit from its place in the larger Volkswagen automotive group, but how it can also work against the company when things go wrong on a group level.

The Macan has been Porsche’s best-selling vehicle over the last years, with more than 800,000 cars sold since the model was introduced in 2014 (as a 2015 model vehicle) There is some risk here therefore that customers will not go along. Still, Porsche is going full speed ahead with its transition to electric vehicles but hedging its bets and also offering PHEV variants. A new and significantly improved version of the Taycan will arrive in the spring of 2024. An electric 718 (Boxster/Cayman), a similar Cayenne, and a new luxury SUV are already in the works. While the iconic 911 will remain primarily an ICE vehicle, its powertrain options will expand with a hybrid alternative in 2025.

The transition to electric vehicles seems to have slowed down recently, for a variety of reasons. Electric vehicles are generally more expensive than cars with an internal combustion engine. Especially in North America, there seem to be anxieties about the charging infrastructure, and in Europe reduced government subsidies have a clear impact on sales.

In my view, those concerns do not apply significantly to Porsche. With an ASP above 100,000 euros, tax credits, and other subsidies are probably not the most relevant buying argument for a Porsche.

Financial results and valuation

Porsche AG has not announced the full results for FY 2023 yet. The scheduled date for the FY 2023 results is March 12. What we have are the Q1-Q3 financial results, but we can extrapolate form those as we know the 2023 delivery numbers.

In the first 9 months, revenue increased by 13% YoY to 30.1bn euros, outpacing the 10% growth in vehicle deliveries.

This means that the average sales price for a Porsche rose and averaged just under 125,000 euros, enabling a strong EBIT margin of 18.3%, well ahead of premium manufacturers such as the Mercedes-Benz Group Mercedes (OTCPK:MBGYY) with only 13.5%. However, the absolute luxury manufacturer Ferrari is still far away with an EBIT margin of 28% in the same period. However, with around 10,000 vehicles sold in the first nine months of 2023, Ferrari is also significantly smaller than Porsche and more comparable to the sister brand Lamborghini within the Volkswagen Group (which sold around 10,000 cars in 2023).

While Ferrari was able to increase its EBIT margin in the current year, Porsche’s margin fell by 0.6 percentage points YoY from 18.9%. The poor performance in China is probably a major reason since particularly luxurious sports cars tend to be purchased here, and margins and profits are disproportionately affected by this decline.

Accordingly, operating profit was up only 9% YoY at 5.5bn euros. Given that deliveries increased by 9.6% in the first nine months, and only by 3% for the full year, I expect margins to decrease further to around 18% for the full year. This would be at the midpoint of the company guidance which is 17-19%, and unchanged from 2022. The company guidance is for sales to be between 40-42bn euros. The operating profit should therefore be around 74bn euros and EPS around 5.9 euros, a 10% YoY increase, resulting in a P/E ratio of around 14. For a luxury brand, this seems cheap to me. I think Porsche shares will eventually go back to the valuation they had at the time of the IPO, where the P/E ratio was above 20 – providing an upside of around 50%.

While I would argue that Porsche should be valued like Ferrari, the current difference does not seem right to me.

Per its dividend policy, Porsche AG intends to pay out approximately 50% of the group’s profit after tax. This should lead to a dividend yield of around 3.5 to 4% at the current share price, a nice add-on for income-oriented investors while they wait for the share price to appreciate. (Note – like it is common practice for German/European companies Porsche AG pays only one annual dividend.)

Risks to the investment thesis

Porsche has an aggressive transition roadmap towards electric vehicles. 2024 will be a pivotal year with several new EV models coming out. So far it looks like Porsche is executing well. After a not-so-good first half of 2023, sales of the Taycan have picked up and the new fully electric Macan is getting good reviews across the board.

But EV growth in general is coming down in 2024. In Germany, Porsche’s home country., the German Automobile Industry Association (Verband der Automobilindustrie, VDA) forecasts even a 14% decline in EV sales in 2024 as the German government abruptly ended all subsidies in November 2023. Porsche cars are too expensive to have benefitted from those subsidies in the past, at least directly. But still, even luxury and premium electric cars, need charging infrastructure, so setbacks in the transition to electric vehicles probably could have an impact on Porsche, too.

Political risks with China are also a potential concern. Unlike its parent company, Volkswagen Group, Porsche does not manufacture in China. All Porsche cars sold in China are imported. If the EU moves forward with restrictions on EV imports from China, and China retaliates, for example with increased tariffs, this will make Porsche cars more expensive.

There is an argument to be made that a situation cannot continue where China subsidizes exports of electric vehicles and EU countries subsidize purchases. It is hard to forecast how this will play out. The two EU countries with the most vested interest in automobile manufacturing, France and Germany, have moved in different directions. Germany has cut all subsidies for electric vehicles, although not because of imports from China (which are still small), but because of budgetary concerns. France started to restrict imports with similar regulations like the Inflation Reduction Act in the US.

Alternative ways to buy Porsche AG shares

Porsche AG is part of the Volkswagen Group and Volkswagen owns three-fourths of the company. Theoretically, this makes Volkswagen a good alternative to buying Porsche, but that has not been a good strategy in the past. The Volkswagen share price has not benefited from the Porsche IPO and the increase in market cap since the IPO. The 75% stake in Porsche is worth almost the same as the whole market cap of Volkswagen.

The same argument can be made regarding Porsche Automobil Holding SE (Porsche Holding) (OTCPK:POAHY) which owns 12.5% of Porsche AG. I have written about this in previous articles. But as one reader has observed in a comment: those are formal facts regarding net asset values, the market reality is currently different.

While Volkswagen and Porsche Holding shares are very much in sync, which you would expect as the purpose of Porsche Holding is to hold Volkswagen shares, neither of them has benefitted much from the Porsche IPO and the price increases for Porsche AG shares after the IPO. They have not been dragged down by the recent downward movement either.

Conclusion

Porsche AG shares are back to the IPO price in September 2022 and the current reduced share price provides a buying opportunity for investors with a long-term view. With a PE ratio of around 14 shares look cheap for a luxury brand that is growing sales and earnings by 10% annually.

Aggressive model refreshments and electrification over the next two years could provide the necessary catalyst for further sales growth, especially in China where sales declined last year

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.