It’s been off to the races for Italian initial public offerings this past year. The Borsa Italiana has seen some 30 IPOs, the highest since 2007, with the surge attributed to factors such as a law that nudges savers to invest in Italian companies, as well as the Milan exchange’s efforts to encourage new listings.
Not all of those newcomers look destined for the winner’s circle. Pirelli
—the tire manufacturer whose shares were relisted in October—has been drawing caution flags ever since.
A big challenge for the Milan-based tire maker, which supplies Formula 1 racing, is its already pricey valuation. The premium for Pirelli, which derives most of its revenue from higher-end tires, is justified, say Berenberg analysts in a recent note. But investors are unlikely to pay up even more, and its profit gains probably won’t outpace the sector’s overall growth, they note. The Berenberg team, led by Alexander Haissl, has a Hold rating on the stock and a price target of 6.20 euros ($7.35), implying a drop of about 13%.
irelli’s shares trade at 14 times estimated forward-year earnings, and another key metric—enterprise value to earnings before interest, taxes, depreciation, and amortization —comes in around 12. Those multiples stand above corresponding figures for Pirelli rivals: Compagnie Générale des Établissements Michelin
, and Goodyear Tire & Rubber
“Versus European peers like Michelin and Continental, Pirelli trades at a 20% premium,” fret Deutsche Bank analysts in a recent note, referring to both the price/earnings ratio and EV/Ebitda. And that’s with Pirelli carrying more debt and generating less free cash flow, says the bank’s Gaetan Toulemonde and his colleagues. They have a Hold rating and price target of €6.70 on the stock.
Another worry for Berenberg is that most of Pirelli’s move toward higher-end tires may already have taken place. Revenue from “high-value-add products” rose to 55% in 2016, up from 45% in 2014; the company’s goal is to hit 63% by 2020. Meanwhile, rivals are also eyeing the premium market. And don’t expect a big boost from lower rubber prices. Oversupply peaked several years ago and the market appears set for a period of more stable prices, Berenberg says.
What about Pirelli’s famous brand? “Unlike luxury goods, where brand power is the main recipe for market-share protection and price increases, in the tire sector the dynamics are governed by a slightly different set of rules,” Berenberg writes. Brand perception for tires is malleable, with younger car owners particularly showing a willingness to try lesser-known manufacturers that offer a good deal. The bank’s team adds that while supplying Formula 1 is “the ultimate branding exercise for a tire maker,” that exclusive supplier has changed over time, and Pirelli is locked in only through 2019. “We wouldn’t rule out the possibility of an emerging tire maker such as Hankook Tire
eventually entering the Formula 1 arena,” Haissl and his colleagues say.
To be sure, Pirelli often draws praise. Luxury-car sales are taking off in China, and consumers there won’t put cheap tires on expensive vehicles, said Adrian Croxson, head of European equities for Oz Management, during a presentation in London last month in which he called Pirelli his favorite stock for 2018. The company generates revenue from a mix of countries, with the U.S. providing 14% of sales, Brazil 11%, Germany 7%, and China and the U.K., 6% apiece, according to FactSet data.
Goldman Sachs analysts say Pirelli is in the pole position to capitalize on the growing enthusiasm for electric and self-driving cars, citing the company’s innovative products. Those include smart tires with sensors that communicate with a mobile app and “green” tires that deliver low-rolling resistance. “While autonomous driving and electrification can present a risk to automotive suppliers, we see megatrends as supportive for premium tire makers such as Pirelli,” says Goldman in a recent note.
Yet upbeat stories can end on a down note as valuation concerns emerge. Goldman says the stock is “already trading at a premium to close peers.” The bank has a Neutral rating on shares, along with a price target of €7.30, around where they’ve been trading lately.
Pirelli’s stock is up about 10% from its IPO at €6.50 per share in early October. The company returned to the public markets after ChemChina took it private in 2015, with the Chinese state-owned chemical giant retaining Pirelli’s industrial-tire business and focusing Pirelli on car tires.
But just because Pirelli is back on the public market doesn’t mean investors have to take it for a spin.