Investing.com -- UBS analysts have reaffirmed their bullish stance on Continental (ETR:CONG) stock, emphasizing the potential for value creation as the German automotive supplier moves closer to its proposed spin-off of its Autos division.
"We are Buyers now as we believe the discount will close ahead of the listing of NewCo planned before YE," the analysts said.
Continental's RemainCo - which will focus primarily on its Tires and ContiTech businesses - is expected to command a valuation premium compared with its peers, particularly Michelin (EPA:MICP), as per UBS in a note dated Thursday.
Currently trading at a substantial discount of 10-45% to its tire-making competitors, Continental’s shares are seen as an attractive opportunity by UBS analysts.
They estimate that this discount will likely narrow as the market increasingly views Conti as a tire-focused company in the lead-up to the anticipated spin-off of the Autos unit, which is scheduled to be completed before the end of 2025.
UBS’s valuation model places Continental’s RemainCo at €70-€110 per share, much above the current market price.
The spin-off of the Autos division, tentatively valued at €15-€25 per share, is expected to unlock value for shareholders despite concerns related to potential financial provisions stemming from the BMW (ETR:BMWG) brake recall.
UBS’s base case assumes NewCo will start with a net cash position of approximately €1.5 billion.
While this would increase RemainCo’s net debt to €5 billion and leverage to 1.5x, the analysts believe this level of financial gearing remains manageable for a tire-focused company.
A key argument for the bullish view is that RemainCo is likely to become a compelling story for shareholder returns.
UBS projects that the company could return approximately €4.3 billion to shareholders between 2025 and 2027, split between dividends (€2.8 billion) and share buybacks (€1.5 billion).
This implies a dividend yield of over 6% and suggests that approximately 20% of Continental’s market capitalization could be repurchased during this period.
UBS flags that RemainCo will be unencumbered by restructuring costs, which currently weigh on Michelin, and expects a dividend payout ratio increase from 40% to 50%.
One of the pivotal factors underpinning this confidence is Continental’s ability to achieve strong margin expansion in its tire business.
UBS’s proprietary tire price tracker shows that the margin gap between Continental and Michelin has narrowed over the past decade.
They believe that RemainCo’s operating margins could exceed 14% in the coming years, up from an estimated 11% in 2024, supported by cost-efficiency measures and an optimized production footprint.
Several near-term catalysts are expected to bolster investor confidence in the spin-off and the broader valuation story.
These include Continental’s fiscal year 2024 results, due on March 4, which UBS suggests could reveal upside surprises in the Tires segment and free cash flow.
Additional clarity on the company’s strategic direction may emerge from its annual general meeting in late April, as well as from investor days planned for the summer, where management is expected to unveil new financial targets for both RemainCo and NewCo.
Furthermore, Continental’s decision to dispose of its ContiTech OE business — a low-margin unit generating €2 billion in annual sales — is another step toward enhancing RemainCo’s profitability profile.
While uncertainties remain regarding the spin-off’s execution and the financial implications of the BMW brake recall, UBS analysts argue that the downside risks are limited.
They cite the possibility of M&A activity for NewCo, supported by its anticipated net cash position, as a mitigating factor.