Porsche Automobil Holding SE Downgraded to Hold

Porsche Automobil Holding SE (ETR:PSHG_p), a major shareholder in Volkswagen (ETR:VOWG) and Porsche AG, has been downgraded to Hold from Buy by analysts at Stifel in a note dated Monday.

This change in outlook reflects shifts in Porsche Automobil’s investment case, driven primarily by reduced dividend inflows from Volkswagen and limited prospects for near-term deleveraging.

Stifel’s analysts cited growing concerns over Volkswagen’s financial outlook, governance issues at Porsche Automobil, and the ongoing complexity of its investment portfolio as key reasons for the downgrade.

Volkswagen Earnings Estimates Revised

Central to the downgrade of Porsche Automobil is a revision in their estimates for Volkswagen’s earnings per share (EPS) and dividend payout ratio. The new forecast suggests that Porsche Automobil’s dividend income from Volkswagen could be reduced by approximately EUR 500 million per year. This is largely due to the challenges facing Volkswagen, including pressures from unions, weak free cash flow (FCF) projections, and an uncertain economic environment.

Volkswagen’s decision to cut dividends seems increasingly likely as the company navigates the complexities of balancing shareholder returns with labor concerns, including possible factory closures and workforce reductions.

Volkswagen’s FCF forecast for 2024 has been reduced, from EUR 10.7 billion in 2023 to just EUR 2 billion, further complicating its financial position. As a result, Stifel expects Volkswagen’s dividend payments to fall by 30% in 2024 and 25% in 2025 compared to consensus forecasts.

This is less consequential for Volkswagen itself, but undermines Porsche Automobil’s financial health, which depends heavily on dividend inflows from Volkswagen to manage its debt load and fund operations.

Impact on Porsche Automobil’s Deleveraging Strategy

This reduction in dividend income is a key blow to Porsche Automobil’s deleveraging strategy. Stifel’s initial positive view on Porsche Automobil was based on the assumption that Volkswagen would generate strong cash flows, allowing Porsche Automobil to reduce its debt over time. With lower dividends expected, Porsche Automobil’s ability to deleverage now appears far more constrained, leaving fewer incentives for investors to prefer Porsche Automobil over direct investments in Volkswagen or Porsche AG. Stifel, therefore, adjusted its long-term holding discount for Porsche Automobil to 32%, lowering the target price from EUR 69 to EUR 45.

Governance Issues Compounding Financial Concerns

Adding to the financial concerns are longstanding governance issues within Porsche Automobil. The holding company’s supervisory board is dominated by family members of the Porsche and Piech families, raising questions about the independence and effectiveness of management oversight. Stifel flagged that seven out of the 10 supervisory board members are either family members or close advisors.

This intertwining of leadership roles across Volkswagen, Porsche AG, and Porsche Automobil, while offering deep industry knowledge, complicates independent governance. The fact that Wolfgang Porsche recently renewed his contract as a supervisory board member at Volkswagen, despite being well past the maximum age for board members, suggests little appetite for change within Porsche Automobil’s leadership structure.

Additionally, Hans Dieter Pötsch, as one of the longest-serving CEOs in the German automotive sector, presides over a company that has underperformed the broader auto index (SXAP) by 64 percentage points during his tenure, as per Stifel.

These governance concerns are compounded by Porsche Automobil’s historically weak share price performance and a lack of structural change, suggesting little immediate pressure to revamp the company’s management strategy.

Increasing Complexity of Investment Portfolio

Porsche Automobil’s investment portfolio has grown increasingly complex, adding to the challenges it faces. In addition to its core stakes in Volkswagen (31.9%) and Porsche AG (12.5%), Porsche Automobil has invested in approximately 20 smaller companies, including a recent stake in the German drone manufacturer Quantum (NASDAQ:QMCO) Systems. While diversification may provide long-term value potential, the market typically applies a discount to conglomerates with sprawling, multi-faceted portfolios, as investors tend to prefer clarity over complexity. Stifel argues that this growing portfolio complexity could increase the holding discount applied to Porsche Automobil, further limiting its upside potential.

With Lutz Meschke, Porsche Automobil’s board member responsible for investment management, recently extending his contract until 2030, it appears the company will continue its strategy of active portfolio management. This approach, while aligned with Porsche Automobil’s long-term vision, may not offer the simplicity or focus that investors are seeking in the near term.

Upside Risks Remain

Despite these challenges, there remains an upside risk to Porsche Automobil’s stock. Currently trading at about 2.5x estimated 2023 earnings, Porsche Automobil offers deep value if the Porsche/Piech family were ever to consider merging Porsche Automobil with Volkswagen. Such a move would eliminate the holding discount but would also reduce the family’s influence, making it an unlikely scenario in the near term. Wolfgang Porsche’s renewed contract as Volkswagen supervisory board member supports the view that no major structural changes are expected in the foreseeable future.