Supply Constraints And Slow EV Adoption Will Challenge Future Profitability

Key Takeaways

• Supply constraints and new VNL ramp-up are impacting Group Trucks' operating margins in North America, potentially affecting future earnings.
  
• Uncertain demand for electrification and geopolitical challenges in key markets could hinder future revenue growth and margin performance.
  
• AB Volvo's strengthened order intake, strong cash flow, North America growth strategy, market resilience, and R&D investments indicate solid potential for future revenue and earnings stability.

Catalysts

Manufactures and sells trucks, buses, construction equipment, and marine and industrial engines in Europe, the United States, Asia, Africa, and Oceania.

• There are significant concerns related to additional manufacturing costs for Group Trucks in North America due to supply constraints and the all-new VNL ramp-up. These costs are gradually fading but still impacting operating margins, potentially affecting future earnings.
  
• The market forecasts show a normalization trend in demand across Europe and North America, driven primarily by replacements. This could mean slower growth in new sales, affecting future revenue projections.
  
• Despite increased investment in R&D for new technology and digital services, these expenses could compress net margins if the expected returns on these innovations are delayed or not realized as planned.
  
• The uncertain demand for electrification could impact future growth. While there is a significant increase in orders for fully electric vehicles, the transition to zero-emission transport is slow and driven by early adopters, raising concerns about future revenue growth.
  
• The Group is facing challenges in several regional markets due to geopolitical factors and economic uncertainties, such as the reduced outlook for the Chinese market and the currency impacts in regions like Brazil, potentially affecting overall revenue and margins.

AB Volvo Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming AB Volvo's revenue will decrease by 0.6% annually over the next 3 years.
• Analysts are assuming AB Volvo's profit margins will remain the same at 9.6% over the next 3 years.
• Analysts expect earnings to reach SEK 52.5 billion (and earnings per share of SEK 24.87) by about January 2028, up from SEK 51.7 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as SEK58.7 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 15.2x on those 2028 earnings, up from 12.2x today. This future PE is lower than the current PE for the GB Machinery industry at 28.5x.
• Analysts expect the number of shares outstanding to grow by 1.23% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.3%, as per the Simply Wall St company report.

AB Volvo Future Earnings Per Share Growth

Risks

• AB Volvo experienced a turnaround in order intake, turning book-to-bill positive for Group Trucks, VCE, and Volvo Penta, which could indicate a strengthening demand going forward, positively impacting revenue.
  
• The company has a strong cash flow generation and financial position, with an operating cash flow of SEK 24.3 billion and a financial position at SEK 86 billion, providing a buffer and potential for continued earnings stability.
  
• The introduction of the all-new VNL in North America is expected to be a significant growth platform, having required substantial investments and indicating future revenue and market share growth opportunities.
  
• Despite a challenging market environment, AB Volvo maintained a solid performance across service sales, showing a flat year-over-year development and resilience in softer markets, which can lead to consistent margins and steady revenue flow.
  
• Strong market shares for electric vehicles and heavy-duty trucks in core regions, combined with continued investment in R&D and digitalization, position Volvo well for future growth opportunities in evolving markets, potentially leading to improved earnings.

Valuation

• The analysts have a consensus price target of SEK314.15 for AB Volvo based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of SEK352.0, and the most bearish reporting a price target of just SEK274.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be SEK546.3 billion, earnings will come to SEK52.5 billion, and it would be trading on a PE ratio of 15.2x, assuming you use a discount rate of 6.3%.
  
• Given the current share price of SEK309.8, the analyst's price target of SEK314.15 is 1.4% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.