Monday, 28 January 2008

Company Focus – FIAT Group – “Free at Last, We are [Debt] Free at Last!”

Sergio Marchionne is an inveterate imaginative, charming and hard-headed performer during financial reporting calls; and the timeliness of Martin Luther King Day allowed a topical reporting title. The respect from investment bank and equities houses’ analysts is clear given his ability see the very big picture that is FIAT Group aswell as specific divisional details…but then of course that’s his job as has been his tendency to beat earnings guidance. Equally that of analysts is to best deconstruct financial reporting to get to the nub of understanding the shape and future performance of FIAT, especially so given the company’s size and multiple divisions.

And of course the corporation is one to watch, many wondering whether Marchionne can maintain the growth patterns of recent years. From €-9.4bn debt to €400m cash surplus between FY04 and FY07, a massive €7.5bn attained from disposals, providing a 04-07 CAGR of 8.7%. This lightened group entity to maintain continued traction through 2008 and beyond; intended through:

1. Division operational improvement (NCH/Agriculture & Construction & FPT),
2. Product renewel (Mass & Luxury FIAT Auto) & Iveco Trucks
3. US geographical expansion (Alfa-Romeo & Iveco ‘piggy-backing’ NCH)
4. ‘On track’ performance from Components (FPT, Marelli, Teksid, Comau etc)

But what of those reported figures? Of course the spot-lighted issue was the de-shackling of debt and associated costs, but that wasn’t really the surprise given the revenue levels. Especially over 2007 and the big Q4 push across all sectors to get FY figures into impressive double-digit territory. The big question looking forward was just how much was going to be turned over to enriching CapEx spending vs cushioning Cash Reserves, given evident pressure in such competitive sectors, the need to ride the credit-crunch and the desire to regain that all important investment-grade status from the likes of Moodys, S&P etc. (A sore point with the CEO)

So at this time of corporate celebration, the stock-market fall-out over the last week has hit auto-stocks given the reliance on consumer credit and sentiment, but Marchionne firmly believes FIAT’s suffering was underserved. Given turnaround performance and spread of the Group’s business portfolio. We think that he has a major point, but as ever stock-market sentiment doesn’t immediately absorb critical data and rationalise corporate fundamentals, at times of concern it just systemically reacts. Fortunately the FIAT financials re-charged company stock, new confidence stemming from:

- Group revenues up 13% to €59bn (much thanks to Autos)
- Trading Profit up 66% to €3.2bn
- 5.5% FY07 Trading Margin vs 3.8% FY06
- achieved €300m cost-down target in spite of raw material cost increases
- nearly €7bn liquidity (€426m via 07 share buyback)
- a new high of 2.2m units for FIAT Auto (best since 2000 & Euro #5)
- a 33% jump in volumes at Iveco
- 20 new products at CNH Agriculture & Construction
- record volume at FPT with 3.1m engines & 2.2m transmissions.

Given the stresses and strains of the automotive sector these are credible performances, and the level of detail in the reporting presentation (with special focus on 3 year traction) was given to underline the good work achieved thus far. Marchionne knows that analyst and market sentiment has been severely dented by economic prospects and wanting to demonstrate FIAT’s divisional spread across many industrial sectors, not wholly reliant on one or two – unlike some counterparts.

It is evident that FIAT Auto has provided much of the Group impetus and lion’s share of contribution and so has attracted much of the attention. New vehicles (Grande Punto esp) winning European-wide acceptance as will new 500. But there is still heavy reliance on the Italian (60% sales) and Brazilian markets. Analysts are rightly concerned about the product cycle and mixes going forward, worried that FIAT may have peaked with Grande Punto & Bravo in terms of optimum margin-volume mix. New 500 will undoubtedly be a high volume seller (target of 190K units) the shared FIAT-Ford platform required to reduce both party’s CapEx in the project and maintain reasonable margins, but volume and options-pricing will be key for 500.

As for Brazil, optimism reigns with market leadership in cars and LCVs (at 26%) and buoyant local market demand (est 10% increase in 08) so the opportunity to ‘ride the wave’. But given so financiers want to see true value extraction from such bull markets. Adam Jonas at Morgan Stanley wanted to compare FIAT’s Brazilian unit margin to Ford’s at 15% (possibly centred on a re-vamped Ka). Comparison details weren’t forthcoming, we suspect because FIAT knows that Ford’s smaller vehicle portfolio is more ‘cost-containable’ with far less product variation, and on a competitive front appears more contemporary. (In Brazil FIAT looks for market coverage whilst Ford seeks a narrower, slightly more upscale focus). Hence Brazil is a battle-ground FIAT must focus on given Ford, Chevy, Renault, Honda, Toyota and of course VW. Although a heavyweight FIAT is we believed posed to lose ground to intense competition. One must ask exactly how much of the expanded +10% TIV will be secured amongst such credible peer products. FIAT must react quickly here to maintain FGA and the Group’s momentum. Older product and possible pricing incentives do not work in thriving economy with demanding consumers so rapid product replacement is highly desirable as we’ll see with Linea (in BRI regions).

Although not imminent, Alfa-Romeo’s US market re-entry will require perhaps greater detailed orchestration than previously planned. Introduced at what could be the trough of a US recession, consumers will consider new car purchases very carefully indeed, specifically servicing & resale value. So the excitement of new Alfa vs a traditional and prestige Euro provider (BMW 1 series, Audi A1) may be initially squashed by consumer reticence, higher Sales and Marketing overhead needed to achieve planned 1st year targets. FIAT obviously wishes to replicate Mini’s success in the US but the parental credibility of Fiat does not match BMW.

But to give credit where due, the distribution-network plans have been achieved 1 year ahead of schedule. 310 additionally signed up FIAT dealers in 07 (replacing 145 underperforming dealers) should provide ‘on the ground’ visibility and allow for a more meaningful potential consumer dialogue converted into new sales.

And the re-born Abarth name will undoubtedly add credibility to the FIAT brand, supporting a more sporting façade and with the ability to provide much improved margins on mainstream vehicle variants. As the link to Alfa-Romeo, we expect this initiative to pay dividends in a sector that in reality has lost, or diluted, the heritage rich European 1960s sporty marques such as Alpina or RS, modern-day Japanese competition and badges spiritual successors. We reserve judgement on the level of new sub-brand success, but the basic foundations are at least being built.

Ferrari’s performance of 45% improved trading profit drew questions given ‘only’ 11% volume rise and 15% revenue rise. Where exactly this additional income came from was unclear, speculation that Formula 1 TV rights contributed much. Maserati at long last broke into positive trading profit at €24m, the first time since 1993. Maserati has historically had massive upturns and downturns, but given the strength of the brand’s return it is in a good position for expansion, utilising both Alfa-Romeo and Ferrari technologies to gain economies and uniqueness in the luxury sector. (And apparently Ferrari-Maserati margins are fast approaching Porsche’s). Looking forward we would hope to see range extension plans for obviously a Cabrio, probably not so an SUV, and baby-Maser range of saloons and coupes in the same mould at lower price point, based on the A-R 169 platform, allowing Maserati and Alfa to squeeze the Germans from top and bottom

As for CNH (Case New Holland) it is undoubtedly benefiting from global agricultural investments and housing/commercial construction – the latter in most regions except the US. Marchionne recognises the future weakness of US construction so expect a mid-term focus on Agricultural efforts, especially as the question of expanded land use and scaling-up of farming continues driven by record grain prices for food stuffs and bio-fuel ambitions. The High powered large scale Combine Harvesters and Tractions well suited to the Big Farm trends we see in NA, China, Ex-Soviet states, Latin America, Eastern Asia and of course the expectancies of Africa. (Latin America +85% Combine Harvester sales) CNH giving a record dilutive EPS ever.

A similar success story for Iveco trucks, buoyant sectors (especially within Eastern Europe and Latin America) showing major strides in light and heavy trucks if not in medium. Margin targets were achieved at 7.3% within the broad 7.1-7.9% targets, even if at the lower end, so keeping to market expectancies. Trading profits (+50%) were derived from favourable markets and product quality/mix aswell as offering Green Euro-5 compliant engines 2 years ahead of requirement, assisting fleet operators to better stagger their own procurement needs and costs.

All of these contributing divisions and more, demonstrate that by keeping its broad Group portfolio of companies that FIAT has been in a prime position to benefit from global macro-economic and localised micro-market trends such as: the major push in global agricultural development, continued civil construction projects in EE, LA and Asia, Brazil’s economic wave (that is reported to keep going), this driving the demand for light and heavy commercial trucks, the switch by western car buyers to seek smaller, frugal, fashionable cars, the rise of Chinese & Indian automakers seeking expanded deals (as with Chery in PT/cars and TATA in the same).

Some might say the stars aligned for FIAT, other that Marchionne knows his game intimately and has pulled all the right levers to turn the corporation around. Comparitively FY08 sales are projected at about €60bn, which after a gain of 13% to €58.5 in FY07 doesn’t initially look overtly ambitious. However given the expected turbulence of western economies Marchionne’s target (given his track record) has attracted investor confidence as seen by the 8% stock jump soon after FIAT’s reporting. Although there are issues to be dealt with, perhaps more than ever auto-stock and bond investors see the broad, diversified yet synergistic, portfolio and specific regional and segment competitive advantages of FIAT as a safe harbour in very choppy waters.

This business ethos seems to have been forever the heart of the FIAT-Agnelli empire ideal....and for today and the medium term it is working admirably. "More of the same please" investors will undoubtedly be thinking.