Brake Bonanza: Decelerating into Prosperity
Brake Bonanza: Decelerating into Prosperity
The straightaways are the boring bits between the corners
Last week, I shared with you how I fell victim to the European Vacation Mania. While it may seem like a terrible waste to some, visiting new places can have a profound impact on our creative thinking and problem-solving abilities. New environments expose us to sights, sounds, tastes, and experiences outside of our everyday life. This break from the usual can expand one's perspectives and lead to more creative thinking. Travel can also make us less judgmental and less set in our ways. Magically, these novel experiences lead to the formation of new neural pathways.
Something I try to do when I am traveling is to pay attention to the environment around me and draw some valuable observations. For example, what products and services are people using? Which are the ones they really enjoy? How often do they buy them? How much are they willing to pay? Which are the outstanding local businesses in the area?
One of my trips this year took me to Bergamo, a picturesque city in northern Italy near Milan. Actually, Bergamo is two cities in one — the ancient hilltop Città Alta (Upper Town) and the modern Città Bassa (Lower Town). Città Alta, encircled by 16th-century Venetian walls, is a medieval gem frozen in time — cobblestone streets, Renaissance architecture, and stunning piazzas. The Piazza Vecchia, often described as Italy's most beautiful square, is the heart of the Città Alta. The city's stunning architecture and fabulous cuisine make it an absolute gem. I would definitely recommend it.
Bergamo also happens to be located in the part of Italy, which is the center of the famous Italian auto manufacturing tradition. Here is a map of northern Italy, outlining the most important cities in the auto industry.
As you can see, it is concentrated in this small area, which measures 770 km around and can be covered in 8.5 hours by car. From west to east, we have:
Turin area — historically the heart of Italian automotive manufacturing; home of Fiat (now part of Stellantis); nicknamed the Detroit of Italy.
Milan area — some automotive industry presence, including the headquarters of Alfa Romeo
Bergamo and Brescia area — Bergamo is the HQ of Brembo, the leading manufacturer of high-performance braking systems; and Brescia makes Iveco trucks
Bologna-Modena area — known as Motor Valley; home to luxury sports car manufacturers Ferrari, Lamborghini, Maserati, and Pagani.
Brembo
The topic of this issue is Brembo, the Italian high-performance brake system manufacturer that is the brake of choice of 100% of the MotoGP riders. The competition is considered the pinnacle of motorcycle racing, featuring the most advanced prototype motorcycles and the world's top riders. Basically, MotoGP is the Formula 1 of motorbikes. Speaking of which, guess what brakes most Formula 1 teams use? That's right - Brembo.
The company offers brake discs, brake calipers, side-wheel modules, and braking systems.
The business can be split into five segments, which are consolidated into two for reporting purposes.
Discs – Systems – Motorbikes
Aftermarket – Performance Group
Key figures
€3.2B market cap; 11.9% CAGR between 2004-2023
€3.9B revenue (FY23); €2B in H1 FY24; 9.5% CAGR between 2004-2023
€305M net income (FY23); €156M in H1 FY24; 11.3% CAGR between 2004-2023
€200M average free cash flow in the past 3 years, consisting of €470 cash flow from operations and €270 capex
10.3 P/E based on annualized H1 results; averaged 15-16 in the past 20 years
Sales are quite diversified across geographies.
The company has 9 R&D centers on 3 continents. In a testament to its culture of innovation, Brembo has accumulated 3092 patents, utility models and designs over 400 patent families in the 60 years since its founding.
Brembo's Past and Present
Founded in 1961 in a small town near Bergamo, Italy, the company's entry into brake manufacturing was serendipitous. Its founders, the Bombassei brothers and Italo Breda, were tasked to repair damaged brake discs from a truck accident delivering parts to Alfa Romeo. This twist of fate set Brembo on a path to becoming a global leader in high-performance braking systems.
In 1964, a truck delivering brake discs from England to Alfa Romeo here in Italy had an accident. Alfa Romeo asked Brembo if they’d be able to rework these damaged brake discs. And that’s how Brembo started making brakes.
What sets Brembo apart is their relentless focus on innovation and quality. They've been pioneers in the industry, introducing groundbreaking technologies that have shaped modern braking systems. Brembo was the first to offer aluminum brake calipers in the 1980s, revolutionizing the industry with lighter, more efficient components. In the 2000s, Brembo did it once again, introducing carbon-ceramic brake discs, which offer superior performance, reduced weight, and better heat dissipation.
In 2014, it presented its brake-by-wire system, integrating electronic control with hydraulic braking, providing more precise braking and energy recovery. As usual, it was first used in Formula 1 and gradually found its way into the mass market. Today, it is playing a big part in regenerative braking, which is in every electric vehicle. The better ones, such as Polestar, use Brembo.
Brembo's vertical integration is reminiscent of other companies synonymous with high-quality, such as Apple and Rolex. They own their foundries (in Italy, the Czech Republic, Mexico, and China) and control the entire production process from raw materials to finished products. This gives them greater quality control and flexibility in meeting customer demands. Brembo is unique in that it produces almost all components in-house, including pads, discs, calipers, lines, fluids, and cylinders. The braking calipers are produced from a single block of aluminum - just like the Mac's unibody is - emphasizing both performance and aesthetics.
Brembo has a dedicated material science laboratory where they develop and test materials for various brake components. For example, there are over 500 individual materials that can be used to make a brake pad.
The company has extensive testing facilities, including dyno benches, climatic chambers, and vibration dynos to test components under various conditions. Brembo's braking systems undergo rigorous testing, including 350,000 man-hours of bench testing and 200,000 man-hours of road testing annually.
The company takes innovation seriously and has taken a data-driven approach to R&D, as seen in this quote from the FY23 annual report:
In 2023, the globalisation of innovation processes also began at Brembo Inspiration Lab, with the launch of the new ATC (Advanced Technology Center) in Silicon Valley: here, product innovation takes place in synergy with the integration of new methodologies and algorithms related to data science, making use of research centres, institutions and universities within the local innovation ecosystem.
At the same time, Brembo started the experimentation phase on the use of exoskeletons in the plant aimed at alleviating the musculoskeletal load on the operator where, due to product/process constraints, a different process optimisation is not possible.
A key strategic priority in 2023 was the development of solutions to meet the criteria for the now controversial Euro 7 standard, which has been delayed to 2027 for light vehicles. In urban environments, brake wear is a significant contributor to particulate matter, especially in areas with high traffic density and braking frequency. EVs don't address this issue. If anything, they make it worse as the average EV weighs 10-15% more than its ICE counterpart.
The problem with Euro 7 is that it would be so expensive to comply with that either cars will become unaffordable, or auto companies will go out of business. It is also quite possible the environmental benefits are quite limited compared to the costs involved. Moreover, it doesn't make any sense for the industry to comply with the tailpipe emissions part of the standard when the EU is planning to phase out sales of new ICE vehicles by 2035.
No matter what happens with Euro 7, braking emissions are an issue that is getting a lot of attention and Brembo has been working on solutions, involving innovative alloy and ceramic coating for discs and newly engineered brake pads, that reduce particulate emissions by 83% for PM10 and 80% for PM2.5.
Today, Brembo is a global company. It is present in 15 countries worldwide, with production facilities strategically located near major automakers. This global presence, combined with their reputation for quality, has made them a preferred supplier for high-performance and luxury car brands.
Earlier this year the company transferred its registered office to Amsterdam and became an N.V. (naamloze vennootschap) company. The relocation aims to provide Brembo with greater flexibility in pursuing growth opportunities through acquisitions. The listing will remain on the Milan stock exchange.
On 10 July, Brembo announced the acquisition of a stake in Spoke Safety, a U.S. startup specialising in the development of digital communication technologies between vehicles and the road ecosystem.
With this investment, Brembo continues to strengthen its expertise in software and cloud connectivity for the digital innovation of its solutions. The main goal is to facilitate the communication of braking systems with other connected elements in the surrounding environment.
Financials
Let's take a clear look at the numbers now.
The top line grew at 9.4% over the past 10 years, and the bottom line - at 13.1% (the CAGRs in the chart below are a bit off, because I have not drawn the lines quite precisely and the period is not exactly 10 years). Its market cap grew at a 9% rate over the same period. Generally, we expect the share price to grow in line with earnings per share. Taking the 20-year period 2004-2023 confirms this. EPS grew at a rate of 11.3%, while market cap - at 11.9%. Currently, market cap is lagging, indicating that the share price is below where it should be.
Of course, this is a good place to note that although Brembo is a fascinating business, it is also quite mature. As such, growth is expected to be in the mid-to-high single digits. Besides, the company is a supplier to the auto industry, which is notoriously cyclical, and we are still due for a recession — since 2009 if we don't count the COVID flash recession. So, that's a big red flag right there, facing all your investments at the moment.
Brembo's returns are more or less in line with what you would expect from a mature auto supplier. Excuse the funny chart. The vertical axis should be percentages and the ROIC value is 9.85%, not 985%.
The subdued return figures are partly due to the ongoing investment in new technologies, which require both cutting-edge hardware and software. Moreover, this was happening in an inflationary environment.
Net investments in 2023 hit €412M, up 46.1% from 2022, when 2022 itself was up 34%. Once the capex cycle peaks, shareholders should start seeing improved return numbers. This is the price Brembo has to pay for being a top provider of high-performance components, even in a field as deceivingly simple as brakes.
Valuation
As I already mentioned, Brembo looks undervalued based on its historical valuation multiple of around 15-16 times earnings and on the subdued earnings growth as well. As you can see on the chart below, Brembo's stock price has been dancing around the 15x P/E line, only occasionally touching the 20x or 10x lines. Right now, it is very close to the latter, which has been a buying opportunity historically, and is quite a cheap price to pay for a category leader.
Brembo is paying a dividend, yielding 3%. Also, management has been returning cash to shareholders occasionally in the form of buybacks. Total shares outstanding have declined by 7.4% since 2005. Overall, this adds up to quite a decent shareholder yield of 4.6%.
In short, Brembo is a global premium braking solutions manufacturer with a solid track record of innovation trading at a suppressed valuation. I like the proposition and I will be initiating a position.