Tuesday, 16 February 2010

Company Focus – FIAT Group SpA – Cross-Breeding Pandas & Rams and Playing Desert Island Discs, All On Reduced Group Rations.

FIAT Group Stock Price (Milan @ 16.02.2010, 17.25 GMT)

Preferred – Euro 4.8075
Ordinary – Euro 7.8800

FIAT Auto is perhaps recognised as the most ambitious of present-day manufacturers. It's strategy to leverage its much improved health over the decade, maintain investor belief in the company and exploit the US governments restricted options to negotiate the operational integration of, and share-holding in, Chrysler LLC.

On paper, the synergies of the two entities look compelling from geographic & product portfolio fronts. FIAT gains a powerful 'piggy-backed' entry point into North America, and Chrysler gains relatively low-cost access to a suite of re-engineered, re-badged small & compact cars. Moreover FIAT is assisted with US government grants to ease the domestic's transition to a more eco-orientated company, and Chrysler new stake-holders are more closely aligned as the UAW recognises the part it must play in regenerating the company.

On the surface, this plan that substantially remodels the face of western industry, looks relatively simple, and during less harsh economic times it would indeed be. But there is a growing argument that the typically high cash-burn required to speedily merge operations, platforms etc will have to be tempered given re-emerging negative macro-economic concerns.

Having had the credit crisis followed by the banking crisis, EU and US economies are now hampered at fiscal supply and demand ends. The respective culprits being:

a) the possible EU contagion of sovereign debt default, one ramification of which is the tightening & costs of wholesale & corporate lending
b) the US' ongoing weak employment data, weak housing data and a strengthening US Dollar all of hamper the underlying fundamentals of the domestic economy and so consumption

[NB investment-auto-motives believes the German 'hard stewardship' stance towards Greece to be the correct for long-term EU stability. The converse, of Greece's self or otherwise expulsion from the bloc, would provide a medium-term opportunity of national currency devaluation and so economic 'pull-back', but as Merkel recognises an isolation of Greece, perhaps followed by Italy, Spain and Portugal creates the context for Sarkozy's ideology of an effectively French-led 'Mediterranean Club' economic bloc, which obviously undermines the EU rationale).

Relative to this last point, such a 'Club Med' entente cordiale would obviously boost Med-regional trade and economics, and add to the consumer-base of FIAT et al in time, but the structural consequences for the EU would mean a re-ratcheting of the EU cost-base (western & CEE) which would severely constrain passenger and commercial vehicle demand. This is the issue which the likes of a possibly 'Club-Med' pro FIAT, Renault & PSA would have to confront.

In regard to the FIAT story 'as is' thus far, having previously planned on an expected 2010 global economic rebound FIAT started the wheels of FIAT-Chrysler integration early in 2009, done so at apace given the US administration's expectations and injection of public finance.

[NB. In 2008 investment-auto-motives was far less optimistic having foreseen the 2010 picture)

In retrospect was it the right call and the right time?

Whilst 2007 was a good year per se, FIAT ended 2008 in a less than prolific position. Before its Chrysler tie-up FIAT had only $5bn in liquid cash at hand, down from $9.2bn a year earlier, and had just prior to the tie-up, $7.6bn in debt. The initial forecast that 2009 would bring $3.7bn in profit was later heavily discounted when reality hit to an expected “in excess” of $387m – thus a tenth of previous. Thus although with the assistance of US governmental financial aid and a pre-pack bankruptcy process (which largely - via disregarded creditor rights - cleansed the balance sheet) FIAT was perhaps in a less plausible position than appeared. By May 22nd 09 it had a FCF of approximatley Euro 1bn and reduced its debt-burden to under Euro 5bn.

However, given that the stars will never be perfectly aligned, especially so during such volatile times, FIAT 'walked up the plate' when few others dared.

Although perhaps overtly upbeat in public about FIAT's position and abilities given that at the time it was riding its product peak, presumably the 3 primary governing figures: Cordero di Montezemolo, Elkann & Marchionne have considered alternative fall back scenarios in case all did not go according to plan with a 2010 economic rebound. Fall back plans that presumably consist of more than appeals for individual EU nation-sate funds.

Given the poor national balance sheets of most except France & Germany, sovereign backed funding has become increasingly scarce. And moreover, it will be largely Germany & France that 'bails-out' at-risk neighbours, so diminishing cash availability for pan-EU conglomerates. Thus companies must look back to financial intermediaries & markets, but even this normal option still looks fragile given the muted demand for fixed-income and equities. At a time when new fears are emerging and gains are being 'locked-in' through sell-offs, the previous demand for corporate bonds has diminished at all but the highest credit rates, and stocks – looking overbought by many and still not aligned to fundamentals – are wavering and looking to trade 'sideways' as has been the historical norm after a post-crisis rally.

Thus Marchionne and the FIAT Group Board may have to consider alternative scenarios and measures to keep the FIAT-Chrylser integration rolling.. These in effect, to either:

1. maintain the present level of funding to merge FIAT-Chrysler – probably via asset divestment,
2. slow the merging process - which could compromise the promise of 'early' US generated income

Either way, as with GM, the ideal of any short-term IPO of the new FIAT Auto division presently seems premature given the now lost stability of 2009's macro and micro conditions. 2010 income reduction seems inevitable as geographically patchy and diluted secondary vehicle stimulus initiatives - as seen in the UK but not in Germany - consequentially subdue consumer sentiment .

Looking slightly more closely at “2nd round” stimulus beneficiaries, although the UK has extended its scheme until March, FIAT looks not to be a prime beneficiary given its current aging and unrelated model mix compared to Ford, VW, Renault & even PSA.

In the UK The 500 model is typically an emotional purchase as opposed to rational purchase choice driving 'scrappage sales' and whilst it will undoubtedly be lifted, the degree of that lift is debatable. More concerning for FIAT is that Panda suffers against more accomplished rivals, and face-lifted Punto-Evo realistically offers little draw beyond possibly value-destructive finance deals and incentives given the cosmetic compromise necessary for US & RoW market entry ASAP (as probably a Dodge alongside Lancia originated Chrysler variants.

With lesser gains from the UK and given Germany's decision not to repeat its scrappage scheme, FIAT must now look to its Italian homeland as a prime supporter via “2nd round stimulus”, and hope that it can once again buoy domestic sales to maintain the 2009 average of 33%. The “1st round stimulus” enables Italian car market sales to stay flat from 2008 to 2009, with just under 50% of all sales (Italian TIV 2.16m units) driven by the scrappage scheme which offered E1,500 rebate on specific low CO2 new cars. Expectantly FIAT benefited massively, but the when the government cash was withdrawn by year end the effects were immediate. January new car sales plummeted dramatically by 30%.

To counteract, Claudio Scajola - the Italian Economic Development Minister – stated that the scheme is being revived from February onwards, but there remains an implicit expectation by the government that FIAT does not shutter the Termini Imeresi plant in Sicily. Indeed, a good measure of real politik has emerged, the government seemingly trying to play FIAT against the Italian public and also seemingly the EU commission as it tries to inextricably link assistance to jobs.

As reported, the Termini Imeresi plant has become a prime examplar of national industrial strategy and private commercial strategy creating inevitable friction. With EU and national funding available for eco-enterprises, the over-optimistic business plan 'cooing' of private equity firm Cimino & Associates that hails to be the saviour of Termini Imeresi, puts pressure on FIAT to take the electric vehicle initiative so as to maintain Sicillian production and so assist the local economy. But, as Marchionne well knows – but will have a hard time convincing Ministers – the core-pillars of the Cimini business plan are overtly optimistic and effectually unrealistic: especially regards production capacity (ie sales) and the number of jobs to be saved. Given the close-knitted business and political network of Italy, it would not be a surprise is the Cimini proposition was in actuality quickly compiled and publicly released simply to try and force Marchionne's hand.

On a more immediate and realistic investment note, Marchionne recently signed the FIAT – OAO Sollers Euro 2.4bn agreement to create an Italian-Russian JV for vehicle production in Naberezhnye Chelny, Tatarstan The 50:50 partnership will produce FIAT-Chrysler cars from 2016, 10% of which will be for export, and assists in FIAT's reach into other EM markets beyond Brazil.

However, in the meantime FIAT faces an immediate concern.

The emerging product gap that has been described would be of lesser consequence for the Group under normal cyclical operating conditions when the Group as an entity can ride specific sector downturns. But as stated we face very turbulent times.

Due to the previous demands of Gianni Agnelli and the Italian government – given FIAT's national impact - Fiat Group is set-up as a (theoretically) counter-cyclical conglomerate, its Commercial Vehicle division, its Supplier Parts section and 'Agri-Con' business typically offering well aligned off-set income streams relative to the broad market spread of Autos. But within today's highly irregular business environment the usual sector-cyclical growth pattern has faltered, thus the normal upturn in the economic cycle which fosters demand in the Agri-Con, Commercial Vehicle and Parts businesses – as would be expected - has not arrived. And worryingly the EU, a prime market for FIAT, still continues to stagger.

Thus both critical dimensions of the FIAT Group – the innate strength of Autos & the off-set effect of the Other divisions – seem respectively lacking in potency and 'out of kilter'. This is not an inconsequential issue, such headwinds indicate that a very concerning funding gap could feasibly appear.

As with other global companies, FIAT Group has had to rely upon the EM regions of Brazil and India to sustain earnings momentum through 2009, and looks to lean on these regions once more in Q1 & Q2 2010, especially if the 'promised' Italian assistance doesn't come forthwith. FIAT Auto reported a Q409 profit of Euro 470m ($665.4m), down from Euro 691m for Q408. But there was a
Q409 loss of Euro-281m (-397m) due to sharp decline in truck and equipment sales to agriculture and construction sectors.

With global car markets looking to largely shrink once again this year with the exception of China as 'flat' and continued growth in India, FIAT will need to leverage its TATA connections more than ever. It will need to maintain scaled-back production levels, probably necessarily 'incentivise' its way through to drive revenue, even at the cost of margin in most markets and critically be seen to decisively win the Termini Imeresi battle with government via a well executed case that highlights the Cimini Plan as unrealistic, and indeed very possibly value-destructive for the tax-payer.

Instead, Marchionne knows that such a necessary move puts the Termini Imeresi ball back into his court, which may not be a bad thing if FIAT can gain appropriated Italian and EU funds to build viable small ICE-based eco-cars – perhaps similar to Daimler's smart and the new peer crop – that can be package protected or retro-fitted with e-motors.

But for the moment even with FIAT's impressive capital investment efforts due to pay of in the long-term, that problematic product gap, the concerning divisional cyclical gap and what could be an emerging fiscal gap regards working capital (especially for Chrysler integration & the UST loan payments) remains the top priorities for cautionary investors of all ilks.