November is reporting season for most automotive company’s 3rd quarter results. Aston Martin and Ferrari reported their respective 3rd quarter 2020 results in early November and McLaren followed last Wednesday. Ferrari had another very solid quarter given the current circumstances (Ferrari’s Q3 Results). Aston Martin’s Q3 was better than Q2 but that’s still a long way from good (Aston Martin’s Q3 Results). Aston is still a train wreck but even if its present is pretty ugly, the future, at least for the next 5-7 years, looks secure due to the technology deal with Mercedes and the £1.3 billion debt and equity package (£125 million via new share placement, £840 of 1st lien notes and £260 million of 2nd lien notes) just raised. Aston Martin’s current sport & supercar line up needs badly to be revitalized and this is unlikely to happen for at least a year. While the DBX launch has been declared a great success by Aston, actual proof of this has been about as nebulous as evidence of voter fraud in a recent election in a certain large 244 year old democracy. McLaren in many ways is in exactly the opposite position. McLaren’s current and near-term future product line up is both highly competitive and the next generation hybrid model is ready to go to market. It’s the long term future funding of the business that needs to be addressed. Unlike both Aston and Ferrari, which as public companies host presentations and a Q&A session for analyst’s, McLaren, as a private company, simply posts a short overview presentation and a summary of the financial statements on its website (McLaren Investors Center). On the one hand, being private, this is probably more than McLaren is required to do but on the other hand, I do miss listening to what the management team say, and even more so, what they don’t. As I did with the Aston & Ferrari results, instead of just looking at the numbers, I thought it would be more interesting to try and pull apart the story behind the scene.
A Bit of Luck
While Covid-19 has been devastating overall to the business, it has provided the impetus and cover to make a number of changes to McLaren’s operating structure which will pay long term dividends. We will come back to this shortly. Back when McLaren reported its 1st half results, I wrote:
Right now, McLaren is doing a highly commendable job of navigating in a challenging environment through a combination of making the right (good) decisions and getting a bit lucky in terms of available portfolio. The odious mess of a hangover that underlines the business is all related to sins in the past that management is taking steps to address. The financial situation, while currently stable, remains precarious and the room for error in executing the current strategy is tiny. If the aspirin works McLaren can restore the brand’s reputation with a combination of reduced production numbers and great new models, while significantly reducing the dependency on dealer incentives to move cars off the showroom floor, McLaren should be in a much healthier position in a couple of years. The turnaround in the fortunes of the F1 Team could also not come at a better time. The F1 Team should be a net profit contributor to the group in 2021.
Reducing volumes and drastic cost reduction are areas McLaren has exceled at. For 2020, McLaren will have pulled £75 million out of overhead costs and the benefits of this will carry forward. Capex was also reduced 25% by £110 million. Going into 2020 McLaren had planned to reduce volumes in the 1st half to flush excess inventory out of the dealer network. So far dealer inventory has been cut by over 60% in 2020 and now stands at a much healthier 1000 units. Looking at 2021 estimated volumes, this represents about 3 ½ months stock, down from over 6 months coming out of 2019. For McLaren, the silver lining in the Covid-19 pandemic has been the ability to get the reduction in overhead costs and with the reduction in dealer inventory done quickly. In a normal year both would have taken considerably longer and been more difficult to execute. This McLaren up well for the launch of its new hybrid supercar, the Artura, in 2021.
The Formula 1 Team has continued its transformation from loss leader to eventual profit contributor. Looking at 2019 vs 2020 EBITDA, the F1 team has delivered a positive swing of £29 million. The McLaren F1 Team currently sits in 3rd place in the constructor’s championship which is a one place improvement over 2019. If McLaren can hold onto 3rd place for the last 3 races of the season, this will mark the 4th year in a row of improved results. 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 by over half between 2019 & 2020.
McLaren caught a bit of luck in terms of the current product mix for both especially the year to go and 1st half 2021. The irony here is the over reliance on the Ultimate & Limited Edition series cars that got them into long term trouble is what’s keeping the lights on for the next several quarters. Call it the “hamsters” last dying gift. (see: McLaren’s 1st Half 2020 Results, in summary 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 needed to keep the ever increasing number of regular production supercars moving out of dealer’s showrooms as McLaren ramped up production. 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. McLaren had become addicted to both the large deposits placed when a customer ordered the car and high profits generated by each unit. 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 the 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.) Through Q3 2020, McLaren has delivered 897 cars and is targeting around 1,700 for full year 2020. This will require a significant step up from 313 units in Q3 to 800 cars in Q4. While this is a massive step up on Q3 it is still only 60% of Q4 2019’s volume. Dealer sales are estimated at 2,700 units for the year. The difference being the reduction in dealer’s inventory. Over 60% of the cars in the year to go will be very high margin Speedtails, Elvas, and 765LTs pending parts availability. This will have a hugely positive benefit to the P&L in Q4 if McLaren can get them built and delivered. YTD, McLaren has delivered 52 Ultimate Series cars which means there are 203 chassis still to be built in Q4 2020 and 2021. If the high margin current product mix was the “hamsters” final gift, the unwind of the deposits in the Ultimate Series cars is the turd the hamster left behind. Working Capital, which was a surprise Q2 bright spot, turned ugly in Q3 and will remain that way in Q4. The driver is the unwind of the deposits placed on the Ultimate Series cars which are now being delivered. This amounted to -£64 million in Q3 and is estimated at a further -£90 million in Q4. This unwind will continue into 2021.
McLaren is now estimating that 2020 revenue will be in the range of £750-800 million, which is reliant on delivering a £400 million Q4. If McLaren delivers against the current full year 2020 estimates, it will represent a 46% decline on revenue against a 64% decline in car sales. Back at the end of the 1st half, I estimated total sales for automotive had the potential to land in the £600-650 million range which would put it at roughly a 50% decline vs. 2019 in terms of revenue but generated just 1/3rd the number of cars sold in 2020 vs. 2019. This now seems about right. I also had called for EBITDA in the range of £0 to -£25 million, recovering from a loss of £115 million in the 1st half. McLaren’s official EBITDA guidance is now -£30 to -£40 million for full year 2020.
While their short-term liquidity issue was resolved in Q2 and funding is in place to carry McLaren into 2021, refinancing McLaren’s £650 million of long-term debt and landing a further equity infusion are now job one for Paul Walsh and his finance team. While the majority of the debt, $250 million and £370 million of 5-yr Senior Secured Notes, doesn’t come due until July 2022, McLaren will need a further capital infusion to get it through 2021. On top of this there is the not so minor issue of £840 million in un-amortized new product development costs that will need to taken to the P&L at some point.
Despite doing a lot of things right and getting a bit lucky in terms of product mix, McLaren has a number of major underlining challenges. McLaren is still sitting on a massive pile of debt, a large amount of which was generated buying unhealthy growth via dealer incentives. The timing on the rapid ramp up of car production was tied closely to an increase in complaints on McLaren’s build quality and reliability. Its been a lose lose, as McLaren now has a work to do on rebuilding its reputation alongside a very difficult debt situation to manage. Once Elva & Speedtail production wraps up in 2021, the next Ultimate Series McLaren is not slated to appear until 2025. With roughly £840 million in un-amortized new product development costs and that rather large pile of debt that will need to be either paid down, McLaren is going to need to pull some new levers to fill the missing Ultimate Series revenue and profit gap.
With the new hybrid supercar, the Atrura, coming in early 2021, the base business should be secure. McLaren will also carry over orders 120-150 Ultimate Series cars into 2021 along with 400-450 765LT orders. Add in another 765 orders for the as yet unannounced, 765LT Spider, and you have over a 1/3 of your 2021 estimated 3,250-3,500 units and given the high-end mix, 50% of the revenue, already in hand.
Also, as we just saw with the 620R in 570/600 Sport Series, I don’t think the LT will be the final model in the 7XX series. I would not be surprised to see a 785 R announced in late 2021 or early 2022.
So far in 2020 McLaren has done a a highly commendable job of navigating in a challenging environment. They have made a ton of hard calls that have stemmed the bleeding and set the company up for a better future. The financial situation, while currently stable, remains precarious and is heavily dependent on the debt restructuring negotiations and a further equity infusion. The successful execution of the dealer inventory reduction has set the stage for a good start to 2021 and will hopefully end the past financially debilitating dependency on dealer incentives to move cars off the showroom floor. Next comes the work to restore the brand’s reputation with a combination of matching supply with demand for great new models. The continued improvement in the fortunes of the F1 Team could also not come at a better time. The F1 Team should be a net profit contributor to the group in 2021.
Thoughts and comments? Please see the comments section below.
The sign up for new blog email notifications is at the bottom of the page.