Thursday, 18 February 2010

Company Focus – PSA Group – Poor Hunting In the Lion's Den

PSA Group Stock Price (Paris @ 18.02.2010, 23.00 GMT)
Ordinary: Euro 20.41

PSA was formally created on the verge of 1974 by the sheltering of the then flailing Citroen brand under the Peugeot umbrella. A few years later, with sound finances and corporate optimism Chrysler Europe was integrated into the group, yet overburdened by complexities and cash drain the previous memory of essentially an independently run and successful Peugeot, the company was to see 5 years of blight between 1980-85.

This episode taught the Peugeot family much about the importance of independence, created by the ability to 'run lean', the core enabler to do so the philosophy of a 'pick & mix' technical and product strategy with external parties. That formula re-built the company through the 1990s, and by the late 90s was seen as the grandmaster of reduced level, high impact CapEx capability, common platform & components between Peugeot & Citroen enabling at the time impressive margins for such a marginal player.

Having expanded its sales of affordable, youthful cars to a plethora of new customers throughout the age range, broadened national markets (Germany & the UK being prime volume regions), and created joint ventures with Iran and China to enter new markets using amortised platforms (405 & ZX respectively) cracks started to appear in 2006. Folz's 11 year reign came to a close in 2007 when the ex-Airbus Streiff was appointed, but reportedly his style created personality clashes with the family and management led to his dismissal quickly after the loss-making FY08 results were announced.(To present a counterpoint, Streiff's unpopularity could have also been a case of 'hard truths' not wanting to be heard and intransigent management). Into the breach stepped ex-Corus man Varin, presumably the Peugeot family and others believing his more consensual style and deeper knowledge of the upstream value-chain given his steel industry acumen would be of more immediate and consequential assistance.

[NB investment-auto-motives believes that the Peugeot family's possible intent is to create a far greater inter-connected, conglomerate model Chinese PSA division. Able to drive down raw material costs through a PSA owned value chain and critically better orchestrate flexible transfer costs between sections of the vertical chain to suit the Chinese & regional economic cycle].

The recent report of perhaps PSA's worst ever financial year - after previous year on year losses – demonstrates the urgency of re-organising the company as a viable entity. In a recent Financial Times 'View From the Top' interview, Varin appeared 'upbeat' to the camera about the Euro3bn loan (at 6% interest) given by the French government (as with Renault) to effectively bail them out of the woes generated by the collapse of credit and consumer markets. Varin was keen to focus on the recent rise in capacity utilisation, something he knows is a key metric to financial analysts, stating that by H209 it was running at 92%, yet also oxymoronically stated that capacity will be cut by 25% between 2008-2012. This we suspect is simply the consequence of only slightly reduced production set against a modelled forecast of 2012 global TIV demand, thus the 25% figure appears somewhat concocted.

Given that to date the EU region is well over-capacity producing 14.5m units versus 12.5m sales, and that only one (Belgian GM) plant has been shuttered, surface impression is that the Euro3bn aid is indeed being used to maintain PSA status quo, presumably in the hope that when the economic uplift returns and so car-demand returns, PSA will be in a strong competitive position But future EU TIV looks 'flat' to 2020 and probably beyond; thus no case of 'a rising tide lifting all boats'. Until that slight uplift to the perpetual 'flat-line', as the EU's #2 largest auto-maker strengthened with state aid it will seemingly fight its way forward to that point – possibly via a price war. By similarly producing an almost a flat YoY volume of cars in the short-term will increase levels of product and plant amortisation, which in turn provides a per unit cost reduction, and so enable price reductions on the dealer floor. Thus a case of pricing-power to buy market-share also assisted via generous credit if feasible via PSA Banque and additional 'goodies' incentives. Thus PSA re-enacts its downturn play-book, as we saw with the extended run-out strategy of 206 to claw-in sales.

Given PSA's stature as now a pseudo-nationalised entity, Varin may well see this European market scenario as the only one available given the envelope of conflicting forces he must operate within -ie government paid job-creation vs structural cost cutting.

That is the present-day's pragmatic look behind the still well stocked dealer inventories and PSA's own 'shop window' consisting of an attention grabbing, almost intendly distracting, sizable concept car family stretching across is 2 core brands and newer DS sub-brand. The reality behind the glitz looks far less glamorous, and demonstrates that the company must continue to properly address its cost-structure, product direction, product mix /cadence and overall brand & product(s) appeal.

As regards its cost-structure, little looks achievable in Europe given the implicit promise to keep buoying French economy, only perhaps feasible in the CEE and in tandem with its Toyota JV on its A-segment cars (107/ C1 / Aygo). Indeed we suspect that PSA will be heavily reliant upon Toyota's present position and ability to re-negotiate broad parts cost savings given a combination of its woes due to its massive volume recalls, and the presumed intent to only slightly change the basic specification of the platform and variant cars. Better PSA cost-savings look probable elsewhere in the EM regions, as scale efficiencies are built-up and once again amortisation plays a critical role in BoM (Bill of Material) reduction.

Product Direction will be key as it tries to balance the continued phase-by-phase roll-out of aging product over various regions, against now very immediate, well gleaned consumer perceptions.

The Corporate Forward Plan as presented three months ago on 12.11.09, sets out the broad PSA strategy template, which derived from PESTEL trends highlights the need for:

1. Global Reach given growth & demographics in EM regions (esp Asia)
2. Urbanisation demanding cleaner vehicles
3. Convergent Worldwide CO2 Regulations
4. New Products & Services to cater for changed global demand.

Whilst PSA is undertaking typical CO2 reduction initiatives regards next generation vehicles (mass, aero, powertrain efficiency, etc) on ICE cars, it also states that it wants to attain 20% market-share for Hybrids and EVs by 2020, its effort promoted by demonstrators such as its diesel-hybrid and its rear axle e-motor as integrated into the front ICE engined 'PROLOGUE Hymotion4' SUV. It presents a catalogue of eco-solutions ranging from engine capacity downsizing (industry norm) to 'start-stop' to L-ion EVs. And like Daimler et al, divides car usage types into 3 categories: “Urban, Peri-Urban & Polyvalent”.

As part of what it lauds as an alternative approach - “new services for new customers” - it offers 2 types of EVs, one homegrown in the form of an electric CV per brand (Partner & Berlingo) and what is essentially a badge engineered Mitsubishi MiEV, (iOn & C-ZERO). History and circumstances indicate however that such efforts may well be more of a PR exercise to keep PSA in the competitive fray. Since PSA has offered electric CVs in the past, such projects being short-lived to the high-cost of such niche volume vehicles being largely restricted to temporarily cash-rich, pro-green municipality customers. And the Mitsubishi e-car offered in its 2 variant forms has had only moderate success in homeland Japan and is yet to undergo market-trials in Oregan, USA. Thus the 2 PSA cars will be in reality market-trial cars, and so any production forecasts presently given must be treated with caution - ie 100,000 units over next 5 years.

[NB that 20,000 pa figure represents only 0.61% of the 3,260,400 annual sales (2008 figure) and critically also includes the E-vavacity e-scooter, which investment-auto-motives' suspects makes up a large percentage of the 100,000 unit estimate. Thus the direct car contribution appears minimal].

Also of note is the exploration of creating an in-house (variable) vehicle rental-based business model, that follows in the footsteps of other French transport initiatives such as the bike-based 'Velo'. Under the name of 'Mu' it offers a Pay-Per-Use model via a pre-paid client card, and offers various 'fringe' vehicles relative to use; suggesting use of a 3008 for weekends, e-scooter for immediate use, (e)bike for half day ride and baby seats or a van for occasional need. This type of complimentary business model has been a constant byline in the industry, ranging from Ford's previous ownership of Hertz to its similar 'Indigo' exploration.

As a multi-vehicle manufacturer and with changing EU mobility habits, the management team has struck a chord with the modern green psyche. Its prime aim of course to generate up-front liquidity via the pre-paid cards. However, as a purely commercial enterprise it runs up against fairly entrenched competition, and would need to be willingly backed at scale and done so at a probably loss-making level for some years until it gained public recognition. Also the business fundamentals of appropriate cyber-physical retail channels, inventory logistics management etc are complex, with what may seem parallel case studies (such as Velo) generally simpler and critically typically commercially fudged given sunk-cost government funding for social good. Indeed such an initiative may well have been required for the French Euro3bn soft-loan. Hence the 2010 roll-out in Paris, Berlin and elsewhere (not yet announced) will be closely watched, and analyst/investor quizzing of the business's very basics should be justifiably expected.

Hence, whilst useful PSA 'feel-good' stories, the EV and Mu initiatives must be considered as icing on the cake. What matters is the business ingredients, mix and quality of the fundamental PSA cake across the primary Autos division and as an adjunct the health of its other smaller divisions: Faurecia, Gefco, Banque PSA Finance, Motorcycles, P-C Moteurs and Process Conception Ingenierie.

Unsurprisingly, the recent 10th February FY09 presentation was one of optimism, highlighting the ongoing turnaround in fortunes especially given the H2 sales lift. EU passenger car market-share was up by 14.3% in Q4, and 13.7% for full year, EU commercial vehicle sales was up to 22.2% market-share and global market-share was up to 5.1%. But in total, units sales were down 2.2% YoY to 3,188,000 (assembled & CKD) units. As a CO2 count, of these approximately 1m emitted 130g/km or less, and of those, 750,000 emitted 120g/km or less.

But importantly, over 2008/9, PSA's previously broadly considered unique sales proposition by the capital markets as a low CO2 car company stalled in comparison with fast-approaching competitors.
In short PSA due to whatever restrictions – technical, managerial etc - did not best utilise the previous lead it had, largely we suspect because of the necessary 'extended amortisation basis' the business presently runs upon (eg 206+).

[NB investment-auto-motives made note of this in 2008 and due to degraded PSA product appeal – ie 'guppy mouth' fronted and pick & mix styled Peugeots, style over substance Citroens and a cobbled DS proposition - did not share the general enthusiasm for the group's YoY prospects, and notes that in part new sales have been a result of poor quality vehicle returns, displeased lease-plan buyers tempted into new Citroen sales via price and credit incentives by dealers to 'shift metal' Thus, the seeds of PSA misfortune were being sewn in 2007].

However, as of today, all recognise the role that the Euro3bn soft-loan played, apportioned to reduce net debt from E2.9bn to E2bn, assist working capital and probably allow unhindered transfer of large stock inventory sales to be booked more or less directly into positive FCF (of E300m).

However, such financial engineering could not stem the major loss of E1.161bn.

In the face of such losses the age-old, auto-industry reaction to creeping value-destruction is typically the search for scale-efficiency. A route well understood and exploited by Renault given its decade-long relationship with Nissan. Understandably given its failed past attempts to build volume in this manner (ie 1977 with Chrysler Europe) PSA looks to build such scale and savings via technical alliances as it has generally successfully done (though less rewardingly in recent years) and we suspect the idea of building greater self-styled industrial verticality in EM regions to access both growing markets and so volume scale, and simultaneously self-direct the value chain.

This is a longer term ambition, and whilst being slowly built PSA should look to the probable advantages of creating yet further alliance relationships: with as present possibilities: BMW, Mitsubishi and Toyota.

The BMW idea, long mentioned on the grapevine, would theoretically provide BMW with cross the board savings on Mini and/or a tentative 0-series, something it would well appreciate, and provide via joint engineering PSA with improved product quality...possibly leading to improved in-house NPD acumen if it could adopt BMW's rigorous methodology. As Eurozone members there would be no fluctuating currency problem to better budget by, and such an alliance would politically assist the ideology of a united Europe, a hot topic at the moment. Indeed the venture could possibly enable low-cost EIB funding if it could be seen to have effect on the global stage.

A second option is to create a parallel model to Renault-Nissan, very probably with present ally Mitsubishi, given its small car capability (inc e-vehicles), the Japanese company's need for medium car leverage vs Japanese peers and its 4x4 competence (as seen with the 3008 project). Moreover such a R-N parallel (PSA-M) could indeed be cross-linked into Renault-Nissan on a project / regional basis, providing a bigger strategic possibility envelope for all companies involved with either direct lateral, indirect vertical or indirect diagonal strategy options. This would presumable also assist with all the individual party's needs to create a sustainable base to credibly compete in the upscale premium sector. (ie PSA to piggy-back Nissan's Infiniti).

As an alternative is the possibility to create a stronger alliance with Toyota, building upon the present A-segment JV, thus able to 'piggy back' Toyota's own massive cost-down achievements. Here PSA's Varin could feasibly lead steel procurement talks with global steel mills, and Toyota could lead component talks to achieve dual gains.

Varin's presentation highlights his desire to mimic the median financial achievements of the top-5 best performing industry players in hitting a 6% operating margin of E3.3bn on E50bn annual turnover, which when questioned by the FT was indicated as between 3-5 years.

Today, PSA sits in a somewhat precarious position running at 1% “recurring operating income” (E550m on E54.3bn turnover), so to fill that aforementioned profitability gap by 5% appears a huge task within 4 years. Of the E3.3bn required, he states 30% will come from Sales & Marketing (as we read typical incentives tied with vehicle replacement/upgrade offers), 15% from high growth markets (ie China, India, Brazil, Russia & RoW) and 55% from Production, Development and SG&A.

This latter section representing 55% suggests there is much fat-reduction to be had, and it is here that investors will want to see vital transparency. To achieve that level of uptick suggests that Mr Varin already has PSA's primary steel procurement contracts already signed and future technical alliance's secured, possibly with French political help, even if he is not letting on about any procurement coups today. This though is but inference, much more needs to be seen to give the capital markets true assurance.