Good & Lucky

They say is better to be lucky than good, but if you can pull off a bit of both, you can come out in much better shape than expected.  More on this in a minute. Back when McLaren reported its Q 1 results, I wrote:

On paper, McLaren had a very solid 2019 with good growth across a number of key P&L metrics.  Q1 2020 was exactly the opposite Coming out of 2019, McLaren’s financials looked quite respectable.  It had a growing business, the ten-year-old supercar business made money, and as a privately held company, has been able to attract outside investment whenever necessary.  On the surface, it was the F1 team that presented the biggest financial challenge and the supercar business looked solid.  Then Q1 2020 happened and McLaren’s results imploded.  The F1 team is certainly no longer McLaren’s biggest issue. McLaren sold fewer cars and lost more money in Q 1 than Aston Martin.  Some of this was by design and some of it not.  What caused this, well the “hamster” died in late 2019.  The “hamster” in this case, which had spun the wheel that powered the McLaren financial model since 2015, was the Ultimate Series and LT series cars.  The model simplistically was that the high profitability from the limited-edition cars would help fund incentives when needed to keep the regular production supercars moving out of dealer’s showrooms.  What killed the “hamster”, overwork and exhaustion.  Instead of keeping the Ultimate Series cars as a once in every 5+ year’s event, McLaren had started churning them out on an almost annual basis as McLaren had become reliant on the profits.  In addition, the last LT car produced, the 600LT was no longer a capped production run and McLaren flooded the market with them.  What happened in 2nd half of 2019 broke the model.  The last Ultimate Series car launched, the Elva didn’t sell out and McLaren was forced to cut the planned production run from 399 units to 249.  The writing was on the wall for the Elva by the way the secondary market was allowed to develop for the Senna.  With no restrictions on how long you needed to hold the car for, a significant number of Senna owners flipped the cars shortly after taking delivery.  This gut of Sennas on the market depressed values and for the 1st time in memory, a limited edition hypercar was available on the secondary market at or below list.  While I do believe the way Ford managed the application process for the GT was atrocious, the one thing they did do right was lock owners into holding their cars for at least two years.  At the same time this was happening, in order to move a glut of 600LTs out of showrooms, McLaren was having to provide incentives.  So instead of the 600LT being a high profit contributor, it became a drag on the P&L.

To McLaren’s credit, they did realize they had a major problem well prior to the Coronavirus taking its toll.  Planned production for 2020 was already reduced heading into this year and McLaren just announced a major restructuring.  In addition, capital spending and marketing costs have been cut substantially. The launch of the new Sport Series models has been pushed back to 2021 and the main focus for 2020 is delivering the “hamsters” dying gifts, the Ultimate Series Speedtail & Elva, along with highly profitable 765LTs.

Reducing volumes and drastic cost reduction is where McLaren was good.  McLaren had already planned to reduce volumes in the 1^st half to flush excess inventory out of the dealer network.  McLaren also moved quickly on a restructuring and got the cost base down and in line to where it would more likely need to be moving forward.  Budgets were cut across the board with variable spending reduced significantly.  Capex was down 25%.  Gulf Oil has been brought on-board as a major new sponsor for the F1 Team and as a key partner on the automotive side.  Between new sponsors and the sales of a few of the heritage race cars, the financial drag of the F1 Team on the group has been cut in half between 2019 & 2020.  The continued improved performance of F1 Team on track, along with Ferrari’s increasingly poor performances, is another potential upside for the year to go.  The short-term liquidity issue has been resolved and funding is now in place to carry McLaren into 2021.  If I had to guess, probably the best move McLaren has made recently is bringing Paul Walsh on board as Executive Chairman late last year.  Prior to joining McLaren, Paul was the Chief Executive of Diageo Plc for 13 years.  All the quick moves taken on cost reduction in a crisis are exactly what I would expect to see coming from a highly experienced executive with a background in global consumer products.

Working capital and product mix is where got lucky.  As a general business practice, when McLaren ships a car to a dealership, payment from the dealership to McLaren is due in 30 days.  However, in general it appears that McLaren has up to 90-day terms with its suppliers.  When dealerships reopened, most of the excess inventory had been worked down and McLaren was able to start building and shipping cars again.  These newly built cars were being constructed mostly out of parts McLaren had on hand.  Net net, McLaren was able to build cars out of parts that had already been paid for or would not need to be paid for until Q3 while collecting payment for these cars in Q2.  The net result is working capital in Q 2 was flat vs. the large outflow in Q1. 

McLaren has also gotten lucky in terms of the product mix especially for the year to go.  The irony here is the over reliance on the Ultimate & Limited Edition series cars that got them into long term trouble is what is saving the business in the year to go.  Call it the “hamsters” last dying gift.  In the 2^nd half of 2020, McLaren is planning on producing roughly 1000 cars.  Approximately 75% of these cars will be very high margin Speedtails, Elvas, and 765LTs.  This will have a hugely positive benefit to the P&L in the year to go.  My rough estimate is the combination of these three has the potential to deliver £360-400 million in sales in the 2^nd half. Total sales for automotive has the potential to land in the £600-650 million range which will put it at roughly a 50% decline vs. 2019 in terms of revenue but this revenue will be generated by just 1/3^rd the number of cars sold in 2020 vs. 2019.  If a few things go well in the second half, McLaren as a group has a chance of recovering to finish the year with EBITDA in the range of £0 to -25 million vs a loss of £115 million in the 1^sthalf.