"The automotive sector's low quotes could present opportunities in the near future"

In the MAPFRE AM interview of the month, we spoke with manager Lucas Maruri, who reviewed the quote for several sectors so far in 2024. The automotive sector is a notable example, which is encountering an increasingly competitive landscape due to the rise of new players, disruptive technologies as well as rapidly evolving demand. "The sector is experiencing historically low valuations, which could lead to interesting opportunities in the near future," he remarked.

• How long have you worked at MAPFRE AM and what are your responsibilities?

Next February it will be two years since I started working at MAPFRE AM. I was part, along with María Torres, of the equity team in Discretionary Portfolio Management, led by Cristina Benito. The main goal of the Discretionary Portfolio Management division is to make investments that offset liabilities: in other words, that they generate enough returns to cover the group’s future obligations. That’s why more than 80% of financial investments are made in fixed income.

After achieving the first objective, the focus shifts to the second: to generate additional returns that help to cover operating costs of investment activities, that contribute a financial result to the group's income statement, and that at times strengthen the overview or provide extra profitability to shareholders. Finally, liquidity management is a key priority to address any short-term needs that may arise.

This is where the second objective, variable income, comes into play, and these are the priorities we take into account when designing the portfolio: our role is to generate additional financial result by investing in shares of publicly listed companies, either directly or through the MAPFRE range of funds. The investments managed by my team account for a small percentage (5.5%) of the insurance company's balance sheet assets. However, due to the higher-risk nature of equities, they have the potential to contribute significantly to financial profits.

• Considering your role in managing the insurer's balance sheet, what are the key priorities when selecting equity assets? What types of companies do you think MAPFRE finds the most valuable when it comes to investing?

In order to undertake our functions effectively, we need to narrow down the vast European stock market and choose stocks with solid long-term growth potential. We maintain ongoing communication and analytics with the companies we invest in as part of this task. This approach helps us to delve into the knowledge of the reality of companies as well as the opportunities and challenges they encounter, allowing us to adapt to shifting market conditions, anticipate potential negative trends, and to optimize the risk-return balance.

However, it will come as no surprise that the greatest value for MAPFRE is found in large cap companies, with established and proven business models that also show signs of strong future potential. Building trust is crucial for the management team, particularly regarding their decisions concerning capital allocation. On the other hand, we strongly favor companies that stand out when it comes to managing environmental risks, aligning their interests with diverse stakeholders as well as upholding high governance standards.

• Tensions in the Middle East are causing oil price volatility. What is the impact on oil companies' quotes? What has 2024 been like for this sector?

2024 has not been a good period for oil companies on the stock market so far. Following the extraordinary profits of 2022-2023, driven by the surge in energy prices due to the Russian invasion of Ukraine, 2024 brought the long-awaited normalization of crude oil and gas prices as well as refining margins. This involves a swift impact on cash flow generation for less efficient oil companies (those with a higher break-even per equivalent barrel) or those more exposed to raw materials fluctuations (especially those heavily involved in exploration and production). If this goes on in the long term, executives will be forced to either reduce stock buybacks, dividends payments or growth investments, or face an increase in debt for a period of time.

For the time being, the ongoing conflict in the Middle East has not made an impact on global crude oil or gas production or transportation levels. There is market concern however due to the risk of the conflict escalating and involving Iran, potentially disrupting transit through the Strait of Hormuz, a key maritime route through which a quarter of the world's oil and a third of its liquefied natural gas (LNG) goes through.

When it comes to investing in companies in this sector, MAPFRE AM meticulously assesses their medium- and long-term plans for reducing scope 1 and 2 greenhouse gas emissions, and periodically reviews whether they are making progress toward these goals.

• Electricity prices have stabilized in recent months, even reaching zero prices. How has it affected publicly traded electricity companies?

2024 is a year of moderate stock prices when we're talking about the electricity sector. However, there's a significant variation when taking the different business models within the sector into account.

We have companies that are exclusively dedicated to renewable energy generation on one hand. Due to low pool electricity prices, these "pure generators" are experiencing a sharp decline in their share prices. They are forced to sell electricity as it’s produced, which is when the electricity supply in the system is at its highest and which doesn’t always coincide with peak demand. A prime example of this is the output from photovoltaic panels during daylight hours in the summer months.

This type of investment should be avoided at all costs. Hence, when it comes to investing in generation, it’s better to focus on generators that either have their entire production sold at a fixed price, ensuring profitability (PPAs), or on flexible generators. The latter refers to generators that can choose when to produce energy, or that, if they're unable to do so, at the very least have energy storage systems (such as batteries or pumped water) that enable them to balance generation and release to the network at the most suitable times. We also encounter companies on the stock market that still have significant exposure to older, dirtier generation technologies like coal. These types of companies are viewed by us as medium- to long-term underperformers and we exclude them from our investment universe based on this criterion.

Furthermore, there are companies that operate transportation or distribution networks, a regulated activity, where profitability depends on both operational efficiency as well as the compensation set by the regulator in each case. There is an unprecedented need for investment in this area, due to greater decentralization of electricity generation, while also increasing electrification in demand (the need for charging points for a growing fleet of electric vehicles, for instance). Both factors will lead to substantial growth in the regulated assets base. Having said that, it's important to recognize that each country develops its own regulatory landscape, so an approach needs to be adjusted based on the specific exposure in each region.

Finally, there are integrated companies that span multiple segments of the value chain. They generally have a fairly diverse generation mix; they have distribution assets and a wide range of clients in marketing. We have a strong preference for these types of companies, as they tend to be the most flexible, they hold strong positions in their markets and they're usually well-managed. They consistently generate solid value through their commitment to shareholder returns and strategic capital allocation.

• Another sector you keep your eye on is the automotive one, now in sharp focus following the EU's announcement of tariffs on Chinese electric vehicles. How are European car manufacturers responding to this situation? How are the markets affected by this impact’s measure?

The automotive sector has experienced the weakest market performance so far this year. Large makes and traditional self-part manufacturers are up against an increasingly competitive outlook, with the emergence of new players, disruptive technologies and demand in rapid transformation. To add to that, higher interest rates are an extra challenge for a sector where sales are usually credit driven. This stage creates a high level of uncertainty, which has led us to avoid the sector for the time being.

With this highly changing environment large capital investments are required to remain competitive and improve efficiency, adding pressure to an already capital-intensive sector. European and American manufacturers must find ways to compete with the aggressive supply of electric vehicles from Chinese manufacturers, who have become highly competitive in pricing and have increased their services significantly in recent years. This has led to the dominant position of large makes being threatened, as these are less cost efficient. Investments are being heavily geared towards new platforms that support the renewal of vehicle catalogs and offer a range of technologies (MHEV, HEV, PHEV or 100% electric hybrids). New players such as Tesla and Rivian meanwhile have shown that the key market value driver lies in software, which is becoming the main differential element. This focus on software will soon enable fully autonomous driving and a seamlessly connected user experience.

It’ll be years before we find out who are the ultimate winners in this new competitive environment, which is currently exerting significant pressure on prices, profitability, and cash generation capacity for most companies. However, given that the market is well aware of these realities, the sector has reached a historic low point regarding valuation levels, which could pave the way for exciting opportunities in the near future.

• Finally, the September European PMIs marked the first contraction in seven months, primarily influenced by downturns in Germany and France. What can be expected from industrial and equipment companies in the next few months?

Cyclical sectors, including industrials and equipment, are having a strong year in the stock market. This should surprise us, because as you pointed out, economic growth in Europe remains stagnant, showing no signs of a strong expansion that would boost sales for companies which are heavily reliant on the economic cycle. Meanwhile, China continues to experience sluggish consumption data, and concerns about the health of its real estate sector go on.

It should be taken into account however that the good performance of the sector is explained by the evolution of certain winners who, despite an unfavorable general context, keep growing thanks to their good positioning in certain key trends. Electrification has been a growth area, driven by the rise of electric vehicles or the transition to cleaner energy sources, innovation in batteries and charging systems. Substantial advantages are being gained by well-positioned companies in these markets. Data center construction is another area, driven by the high demand for artificial intelligence and cloud storage, favoring companies that provide related infrastructure and services. Moreover, investments in strategic infrastructures and sustainable mobility, such as the development of efficient and sustainable transportation networks, are supported by fiscal stimulus programs in Europe as well as the United States. This type of investment not only encourages sustainable growth, but also presents long-term opportunities for the companies involved.

The outlook for the coming months is still uncertain. Interest rate cuts in the USA, Europe and China could stimulate demand maybe, and these sectors may benefit from an even better stock market performance thanks to that.

• Hobbies: Reading, chess, traveling. Sport all the way: soccer, climbing, swimming, running, snowboarding, paddle tennis and squash (always making the most of MAPFRE facilities with this last one).
• A favorite dish: Outside the Mediterranean diet, I'll take Nikkei cuisine, which is the fusion of probably two of the best cuisines in the world: Japanese and Peruvian.
• A city/country: Any place on the north coast of Spain, from Irún to O Muíño.
• Favorite musical group/singer: Only one? That’s impossible: Bill Withers, Marvin Gaye, Al Green, Aretha Franklin, Nina Simone, Stevie Wonder...