Michelin, a clever bet for the future

Did you say cyclical?

Historically speaking, so many negative macroeconomic elements have seldom been combined: recession in Europe is almost certain, banks are affected by the sovereign debt crisis, the US is trying to recover from one of the toughest crisis and even China is facing a slowdown in its economy.

In this situation, investors look for safe havens such as German Bunds that give a negative real return (since inflation is higher than the yield of these Bunds), while abandoning risky assets like equity.

In my opinion, this is when good fund managers can make a difference by acting against the general market psychology and by buying cyclical stocks. What? Cyclical stocks with so much uncertainty? “No way”, you may say. But not just any cyclical!

Cyclical stocks have been hammered, because of the uncertainty on global growth. However, among them, there are companies who have a clear strategy in terms of market diversification: They don’t rely on a particular region but on several ones, which makes them less vulnerable. Those are the ones to be watched.

Michelin is very good example of that type of cyclical stocks. Their revenue basis is well balanced and their strategy is pretty clear. Although European and North-American markets represent more than 60% of their sales, Michelin aims to make the most of the growth in emerging markets.

A strategy that consists in keeping a leading position in mature markets as well as in expanding in new ones is the right strategy. Even if it doesn’t pay right away because of the economic situation, it will pay in the long run.

A promising market

In 2009, 57 million cars were produced worldwide. In 2010, this figure went up to 70 million, emerging markets accounting for 30%. That is a fact: more and more cars are produced, hence more and more cars are in circulation. There are currently 1.2 billion car tires in the world. There will be 2 billion in 2020.

Tire manufacturers can benefit from this trend by equipping newly-produced vehicles as well as the ones already in circulation.

Michelin bets on emerging markets and technology

The first dimension of Michelin’s strategy is a focus on emerging markets. They are building 3 enormous factories (an investment of 1 billion euros each) in China, India and Brazil, and they will be adding a new factory every year.

The goal is to push Michelin’s revenues coming from emerging markets from 30% in 2011 to 40% in 2016 and 45% in 2020.

To do so, building production capacity is a good thing, but they should also be able to sell products that consumers are willing to buy. And that is where Michelin is very good. Indeed, they are in phase with demand. If consumers worldwide look for safety at a reasonable price, their needs may differ according to the region of the world:

–       In mature markets, consumers are very sensitive to the price of energy and welcome any product that can make them save on gas. They are also getting more and more receptive to sustainable development issues. Products like Michelin’s Energy Saver perfectly respond to those needs.

–       In emerging markets, price elasticity is much higher. Therefore, Michelin is selling cheaper tires under other brands (such as Warrior in China). Besides, their R&D enables them to manufacture products specially designed for emerging markets. For instance, they noticed that, due to road conditions, punctures happen on average every 80 000 km in Europe whereas every 6000 km in India or China. That is why Michelin is working on a tire that can regenerate itself after a little puncture!

Technology is definitely part of Michelin’s strategy.

One last thing I would like to emphasize on: management. Michelin has always been run like a family business and none of their investment decisions is made lightly.

For all those reasons, Michelin seems to be a clever bet for the future. They want to leverage the growth in emerging markets and put the means to it: their investments in both R&D and factories show Michelin’s will to keep a technological advantage in a market that is far less commoditized than it seems.

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